2nd UPDATE: Charge Swings Staples to Loss, Core Earnings Flat

--Impairment on Europe business pushes bottom line into red

--Core profit per share is flat, a penny better than expected

--Shares rise as company unexpectedly reaffirms full-year guidance

(Updates share movement in second paragraph; adds further details, comments from executives starting in the fifth paragraph)

 
   By Joan E. Solsman and Saabira Chaudhuri 
 

Staples Inc. (SPLS) swung to a fiscal third-quarter loss as it swallowed the falling value of its struggling European operations, but it managed to hold its core bottom line steady despite lower sales.

Shares were up 2.3% at $11.52 in recent trading, as the largest office-supply chain in the U.S., unlike rivals, showed improvement in same-store sales from the previous quarter and unexpectedly held its outlook steady.

However, also unlike rivals, it failed to flip the sales pressure into profit growth. Its smaller competitors, Office Depot Inc. (ODP) and OfficeMax Inc. (OMX), earlier this month reported unexpectedly strong third-quarter earnings growth as they benefit from progress in turnaround strategies, something Staples has only recently begun in earnest.

The sector has long faced a climate of increasing competition for weaker demand as governments contend with budget cuts and traditional items are replaced by electronics. Staples in September said it would need to intensify restructuring to cope, after an unexpected downturn in North American sales in the second quarter combined with continued sluggishness abroad.

Wednesday, the company said it expects to cut headcount again in Europe, the center of its international division's weak performance. On a conference call to discuss results, Chief Operating Officer Michael Miles said the process was in its early stages with progress expected to build over the coming year.

Staples now plans to close 46 underperforming stores, representing about 14% of its European retail network, with about half of them located in the U.K. It is exiting Belgium retail with six closures. It is also consolidating unprofitable delivery business units, serving Denmark with operations in Sweden, for example.

Previously, Staples eliminated about 300 positions in Europe and Australia in the first quarter and made further reductions in the second.

In the latest period, Staples same-store sales in North American retail fell 1%, an improvement from the second quarter's 2% decline. By comparison, Office Depot's held steady sequentially at a 4% decline and OfficeMax's deteriorated to a 2.1% drop.

Staples overall North American retail sales were flat as traffic declined but average order size increased. Sales in its North American delivery division rose 1%. The company suffered from the same weak technology sales in computers and software that others have, but it had a strong showing in core office supplies, copy and print services and facilities and breakroom items.

Chief Executive Ron Sargent said while the third quarter only had two days of sales linked to Microsoft Corp.'s (MSFT) Windows 8, "the early response from our customers has been positive."

"We look forward to continued momentum from Windows 8 throughout the holiday season," he said.

However, international revenue decreased 12%, or 8% on a local currency basis, because of continued weakness in Europe and Australia. Economic woes drove the declines in Europe, Staples said, including a 6% decline in the region's same-store sales.

Helping preserve the bottom line was retail operating margin in North America, which edged up to 10.8% from 10.7%. Staples improved efficiency and reduced distribution costs, though it also weakened the margin with promotions.

For the quarter ended Oct. 27, Staples posted a loss of $596.3 million, or 89 cents a share, versus a year-earlier profit of $326.4 million, or 47 cents a share. The latest quarter included an $811 million impairment charge linked to its European retail and catalog businesses, as well as lesser charges for restructuring and amortization. Stripping out one-time items, Staples's per-share profit was flat at 46 cents.

Sales slipped 2%--1.4% on a constant currency basis--to $6.35 billion.

Analysts polled by Thomson Reuters recently expected per-share earnings of 45 cents on revenue of $6.45 billion.

Gross margin narrowed to 27.6% from 28.1%.

Staples reaffirmed its view for the year, predicting sales would be flat with the prior year and per-share earnings would increase in the low single-digits. Analysts were expecting 1% declines in both.

Chief Financial Officer Christine Komola said disruptions from Hurricane Sandy would be a "modest headwind to the top and bottom line" in the fourth quarter, which was reflected in the guidance.

Write to Joan E. Solsman at [e-mail] and Saabira Chaudhuri at [e-mail]

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