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Staples (NASDAQ:SPLS)

Q2 2013 Earnings Call

August 21, 2013 8:00 am ET

Executives

Chris Powers

Ronald L. Sargent - Chairman, Chief Executive Officer and Chairman of Executive Committee

Christine T. Komola - Chief Financial Officer and Executive Vice President

Demos Parneros - President of North American Stores & Online

Joseph G. Doody - President of North American Commercial

John Wilson - President of Europe Operations

Analysts

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Daniel T. Binder - Jefferies LLC, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Michael Baker - Deutsche Bank AG, Research Division

Kate McShane - Citigroup Inc, Research Division

Gary Balter - Crédit Suisse AG, Research Division

David Gober - Morgan Stanley, Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Gregory S. Melich - ISI Group Inc., Research Division

Michael Lasser - UBS Investment Bank, Research Division

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2013 Staples, Inc. Earnings Conference Call. My name is Theresa, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Mr. Chris Powers, Director of Investor Relations. Please proceed.

Chris Powers

Thank you. Good morning, everyone, and thanks for joining us for our second quarter 2013 earnings announcement.

During today's call, we will discuss certain non-GAAP metrics to provide investors with useful information about our financial performance. Please see the Financial Measures and Other Data section of the Investor Information portion of www.staples.com for an explanation and reconciliation of non-GAAP measures and other calculations of financial measures that we use to analyze our business.

I'd also like to remind you that certain information discussed on this call constitutes forward-looking statements for the purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed or referenced under the heading Risk Factors and elsewhere in Staples' 10-Q filed this morning.

Here to discuss Staples' second quarter performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer; and Christine Komola, Chief Financial Officer. Also joining us are Demos Parneros, President of North American Stores & Online; Joe Doody, President of North American Commercial; and John Wilson, President of Europe. Ron?

Ronald L. Sargent

Thanks, Chris, and good morning, everybody. Thanks for joining us today.

This morning, we reported results for the second quarter of 2013. First, the headlines. Total company sales were $5.3 billion. That's a decrease of 2% versus Q2 of last year. And earnings per share from continuing operations came in at $0.16 per share. Excluding the negative impact of stores that we closed in the 12 months before Q2 of this year, total company sales were down about 1% year-over-year.

During Q2, we achieved top line growth in staples.com, quill.com and our North American contract business, and this was more than offset by difficult sales trends in our international businesses and weak same-store sales in North America as demand for core office supplies fell short of our expectations. Despite the challenging sales environment, we continue to aggressively manage expenses, and we're making good progress on our reinvention priorities.

And let me give you a brief update. First, our assortment expansion is right on track, and more customers are relying on Staples for categories beyond office supplies. During the second quarter, we added about 40,000 new products on staples.com. We expanded our assortment in categories like teaching and education, technology and furniture, and we now offer more than 20,000 retail store supplies. With 150,000 products on the site today, we remain on track to expand the assortment to more than 300,000 SKUs by year-end.

In terms of driving growth online, staples.com sales were up 3% in U.S. dollars and grew 4% in local currency compared to Q2 of last year. During the first half of 2013, our growth has been supported by our expanded assortment, and increased focus on customer acquisition and development. We're pleased with our ability to drive traffic but we still have a big opportunity to improve the customer experience on both our mobile and desktop sites. Our new e-commerce leadership team has built a plan for the back half of the year which reallocates resources toward improving site performance, converting customer traffic and creating a more personalized shopping experience. We plan to accelerate online sales growth throughout the second half of the year as we lay a foundation to build on our momentum beyond 2013.

Turning to our services business. Copy and print sales in North American Stores & Online were up in the mid-single digits during the second quarter. We're seeing solid demand both in-store and online for core categories like color printing and wide-format signs and banners. And our copy and print sales force continues to increase its productivity.

A few months ago, we reinvented Staples Rewards program and at the same time, relaunched our copy and print business discount program to a broader segment of small business customers. The new program offers improved benefits like priority service, custom pricing and free shipping on online orders. EasyTech sales grew in the double digits during the second quarter as we continue to evolve our offering. Our EasyTech results during Q2 were driven by an expanded assortment of cloud-based diagnostics and antivirus protection, which provide a great value to our customers.

We're also making progress integrating our retail and online businesses to allow customers to shop how and when they want. We have now opened 8 of our new 12,000 square-foot stores, and early customer feedback has been positive. The majority of these new stores are retaining more than 95% of their sales and some are at over 100% of previous sales volume. We've received high marks for improving organization and layout, and customer satisfaction with our more interactive copy and print, and EasyTech services has been strong.

Across the chain, our updated staples.com kiosks are supporting a more coordinated cross-channel offering, and we're building momentum with our endless aisle shopping experience. Today, our kiosks generate low percentage of retail sales, but the investments we've made in training our associates are paying off with double-digit growth here during the second quarter.

In terms of funding the future, during the second quarter, we completed our annual vendor negotiations, which came in right on target. We continue to reduce expenses by outsourcing low-complexity tasks in areas like data entry and reporting. And we're having good success reducing non-product-related costs across the company. We remain committed to driving $150 million in gross savings for the year, and given the weaker-than-expected sales trends, we're going to be more aggressive reducing expenses.

We're also focused on driving retail productivity and continue to rationalize our North American store network. During the second quarter, we had 9 net store closures, and we downsized and relocated 10 stores, with sales per square foot about flat year-over-year. For the full year, we remain on track to close 40 stores and downsize and relocate 45 stores.

In Europe, we continue to take cost out of the business by reducing headcount and streamlining our operations. We're also in the early innings of a cross-channel initiative to streamline our core profit assortment across Europe. This is a big opportunity for the European team to consolidate demand, drive better terms with vendors and increase the mix of Staples brand products as they work hard to improve profitability in Europe.

Now let's take a look briefly at our Q2 results for each of our business units. Starting with North American Stores & Online. Sales for the second quarter were $2.4 billion. That's down 2% compared to Q2 of last year. In the 12 months prior to Q2 of this year, we've closed 54 stores in North America, and this negatively impacted our Q2 sales growth by approximately 1%. Second quarter same-store sales, which excludes staples.com sales, declined 3%. Customer traffic declined 2%, and average order size declined 1% year-over-year. Staples.com sales grew 3%, as I mentioned earlier, versus the prior year.

During the second quarter, growth in tablets, facilities and breakroom supplies and copy and print services were more than offset by weakness in business machines and technology accessories, ink and toner and computers. North American Stores & Online operating margin decreased 118 basis points versus last year's second quarter to 4.1%. This was driven by lower product margins, costs related to our growth initiatives in staples.com and deleverage of fixed expenses, partially offset by reduced retail store labor expense.

Back-to-school season is underway. This is a competitive time of the year, and we're excited about our offering. We have great deals on a broad assortment of school supplies and the latest technology products. Staples brand products are a great way for customers to get quality products at lower prices, and this year, we're featuring an expanded assortment of fun and fashionable school supplies. We're also offering our popular back-to-school savings pass, which provides customers a 15% discount on supplies all season long. While we still have a few big weeks ahead of us, early results are about in line with our expectations.

Moving on to North American Commercial. Sales for the second quarter were $1.9 billion. That was an increase of 1% compared to last year. Sales remained steady during the second quarter, with a low-single-digit growth in both contract and quill.com. Top line growth remains strong in adjacent categories like facilities and breakroom supplies, which grew more than 20% during the second quarter. We also achieved solid growth in furniture and tablets. This momentum was partially offset by weakness in office supplies and print solutions. North American Commercial operating margin for Q2 decreased 85 basis points versus last year to 6.6%, and this reflects increased sales force and marketing cost to drive growth.

In international operations, sales for the second quarter were $946 million. That was a decline of 8% in both local currency and U.S. dollars versus Q2 of last year. The sales decline reflects broad-based weakness in Europe and Australia. In the 12 months before Q2 of this year, we closed 49 stores in Europe, and this negatively impacted Q2 sales growth for international operations by about 2%.

In Europe retail, same-store sales were down 6% during the second quarter, with sales per square foot up about 1%. Customer traffic decreased about 5%, and average order size was down about 1% year-over-year. Our European delivery businesses remained under pressure as the difficult macro trends in Europe, retender pressures from enterprise customers and weak demand for ink and toner, furniture and core office supplies weighed on their results.

During Q2, international operating margin decreased 60 basis points versus last year to a loss of 2.1% of sales. This was driven by deleverage of fixed expenses, lower product margins in the company's European delivery businesses and Australia, partially offset by reduced marketing expense and savings related to headcount reductions in Europe and Australia.

And with that, I'll turn it over to Christine Komola to review our financial results.

Christine T. Komola

Thanks, Ron. Good morning, everyone. During the second quarter, total company sales were $5.3 billion, a decrease of 2% versus the second quarter of last year. In the 12 months preceding Q2 of 2013, we closed 103 stores in North America and Europe, which negatively impacted total company sales growth for the second quarter by about 1%. Excluding these closures, total company sales were down about 1% during Q2.

Our second quarter earnings per share from continuing operations on a fully diluted basis decreased 16% to $0.16 versus the second quarter of 2012. Gross profit margin for the second quarter decreased 54 basis points to 25.6% of sales. This reflects lower product margins in each of our business units due to pressures in core categories like ink, toner and paper, as well as the strong top line growth we saw in lower-margin categories such as mobility and tablets. We also experienced deleverage of fixed expenses on lower sales.

During the second quarter, we continued to aggressively manage expenses and reduced total company SG&A by $19 million. This reflects savings related to headcount reductions across the businesses, lower stock-based compensation expense due to a change in the structure of management compensation, as well as reduced legal and marketing expense. Unfortunately, as a result of weak top line trends, SG&A rate increased 12 basis points versus last year's second quarter to 21.8%.

Total company operating margins decreased 65 basis points during the second quarter to 3.5%, and our effective tax rate for the quarter was 32.5%, which is unchanged versus Q2 of 2012. Year-to-date capital expenditures came in at $124 million, which is in line with the prior year. With operating cash flows of about $348 million, we generated cash flow of $224 million, and we do remain on track to generate more than $900 million in free cash flow for the year.

During the second quarter, we repurchased 6.4 million shares for $100 million, and our plan is to continue repurchasing common stock through open market purchases during 2013. At the end of Q2, Staples had approximately $2.3 billion in liquidity, including cash and cash equivalents of about $1.2 billion and available lines of credit of about $1.1 billion.

Turning to our outlook. Due to softer-than-expected results during the second quarter, we're taking a more conservative view of our sales and earnings expectation for 2013. We continue to make good progress on our reinvention priorities, and we're growing in categories beyond office supplies. However, weak trends in office supplies have more than offset our progress. We now expect full year 2013 sales to decrease in the low-single digits compared to 2012 sales on a 52-week basis of $23.9 billion, and we expect full year 2013 diluted earnings per share from continuing operations to be in the range of $1.21 to $1.25. Our free cash flow guidance of more than $900 million remains unchanged as working capital improvements will offset our lower net income for the year.

Thank you for your time this morning. I'll now turn it back over to Ron.

Ronald L. Sargent

Thanks, Christine. Clearly, we are not happy to be taking down guidance this morning. I believe we're making good progress on our strategic reinvention, but it hasn't been fast enough to offset the tough trends in some of our core categories. We remain committed to our growth priorities, and as I said earlier, we're going to be even more aggressive reducing costs going forward.

So I'll now turn it back over to our conference call moderator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brad Thomas from KeyBanc Capital Markets.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Wanted to first talk about the North America stores. Over the last year, the company has obviously closed about 54 stores, and it sounds like you're seeing very good results when you do a remodel or relocation, as you alluded to in your prepared remarks, Ron. Recognizing this is still a very profitable segment for you, overall, I was hoping you could just talk about how many stores may be candidates for closures and relocations and what kind of returns you see when you do those store actions.

Ronald L. Sargent

Sure. We spend a lot of time on that. I'll ask Demos to answer that one.

Demos Parneros

So first, on the closures. We try very hard to get the right closures. In some cases, there's no benefit to us when we close a store. And when we are able to reposition a portion of the network, we're able to see good sales and profit transferred to the rest of the network, therefore, giving us a good positive lift to the -- that specific market. So we'll continue to go down the path of making closure decisions upon lease end, and we have between 175 and 200 lease decisions over the next 3 years. With respect to the downsizings, we're seeing good success with downsizings. Our new store size is 12,000 square feet, and we're seeing roughly a 95% sales retention on that. A little bit early since we don't have a ton of stores done, but we're encouraged by the early results. Obviously, we need to continue to work on the mix inside the store and getting the precise assortment inside those stores. But the combination of less rent and the good omni-channel capability inside stores looks like a very positive combination for us

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

That's great. And if I can then, just add follow-up on a bright spot for the company, the facilities and breakroom category. Ron, it seems to me that, a few years ago, when you hosted an analyst day, it was categorized as a category with over 2 -- $20 billion in opportunity, and the share of Staples was low-single digits. Could you just give us an update maybe of what inning you are of growing share here and how high the attachment rate is? Because it does still remain a bright spot for the company.

Ronald L. Sargent

Yes, it does. And we've got several other categories that we're working on hard just like facilities and breakroom. But facilities and breakroom already is way over $1 billion in sales force, and the contract area, in particular, it's growing in the 20% range last quarter. So we think it's very early, probably in the first inning or maybe even the second inning of our plans for facilities and breakroom. Retail, we're a little bit further behind because we were slow to kind of break it out as a separate category. But we've continued to expand stores. Demos, we're up to now 5...

Demos Parneros

It's close to 500 stores with -- fully expanded. But I know we mentioned close to 20% in our commercial business. We're lagging a little bit, but it was a high mid-teens comp last quarter. So it's a good retail idea as well.

Ronald L. Sargent

It's really natural for a retail, small business manager who's in there buying office supplies and ink to pick up breakroom supplies and cleaning supplies as well. So it's early days. It's a big category, and it's growing nicely. And I wish it were growing a little faster because I think some of the core office supplies are shrinking a little faster than we thought they would.

Operator

Your next question comes from the line of Dan Binder from Jefferies.

Daniel T. Binder - Jefferies LLC, Research Division

I have a couple of questions. First, just given your last statement, which is that maybe core office is shrinking faster than you thought, I'm just curious what your thoughts are, plans are for accelerating some of the change and particularly, how you react on a cost-cutting basis to prevent too much hemorrhaging on the bottom line.

Ronald L. Sargent

Yes. I think the core supplies weakness has been more of a retail phenomenon, although it certainly affects our contract and delivery business as well. Not only does it affect our top line, but also the mix. When you're evolving your mix from paper-based products to more technology-based products, the margins aren't nearly as good. At the same time, I think given that, that is probably a reality, that the core office supplies are going to continue to shrink, we do have to be more aggressive in cost takeout. And whether that's looking more carefully at the stores that are about to be renewed, whether that's being more aggressive on SG&A, I think we've done a nice job controlling cost. But obviously, our job is to improve earnings per share, and we'll continue to take cost out going forward. There's a lot of great new stuff that's coming. And I don't know, Demos, you've got a whole lot of exciting things that are coming to replace core office supplies, and many of the categories that we've recently launched are doing quite well. So Demos?

Demos Parneros

Yes, if I could just add. I mean, you said it. The game is how quickly can we reduce space in our stores in these unproductive categories. We're doing that through the overall store reductions. And in addition to that, we're reflowing stores to eliminate or reduce space in these sort of, let's call them, dying categories or weak categories and then replacing that with things like mobile phones, where we're going to 1,000 stores. Talked about facilities and breakroom, which is catching fire in retail stores, and that's soon to be in over 1,000 stores. We have a lot of test categories that are in place today, including safety, early education, office gifting, et cetera, and those are continuing to grow as well. So we're very active in freshening up the stores, and we're seeing that in the productivity on a per-foot basis in the stores that we've touched.

Daniel T. Binder - Jefferies LLC, Research Division

And that leads me to the second part of my question, which is on those categories that you're adding, you focus on mobile and technology products. You've got -- you had Best Buy report yesterday nice share gains in mobile and notebooks. It's been a little bit tougher for you guys. I'm just curious, do you think that you need to accelerate price investment as well, so to just take the haircut now, get it over with and try and stabilize the comps.

Ronald L. Sargent

We've been taking price investments over the last year. I think we're going to continue to take intelligent price investments. We think the direction we're on ought to be able to allow us to stabilize comps. We expect the comps to stabilize, certainly, the remainder of the year. But yes, I agree. I think there are some categories where -- particularly when you're comparing online competitors, where we're too high, and we're continuing to take those prices down.

Operator

The next question comes from the line of Brian Nagel from Oppenheimer.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

It's Brian Nagel from Oppenheimer. Maybe a couple of bigger questions on sales. So if I look back in the first quarter results, Ron, I think the real theme that came out of the call there was stabilization. And then we look at results today and they notched -- the trends notched lower again. So I guess the first question, you commented on back-to-school. And the comment you made was it was basically in line with your plan. But as we look into Q2 and maybe the deceleration from Q1 to Q2, is that more a function of maybe a weaker start to back-to-school? Or is it more of a function of kind of a weaker trend in the core business category?

Ronald L. Sargent

Yes. I don't think it's a weaker start. I think it's a little slower start. It seems like, the last 3 years, we've seen back-to-school start later and later and later in the season. And I think in a few years, July is not going to really be much of a month for back-to-school. I think it's kind of pushing closer to school. We had planned for that, and we're seeing that. And our back-to-school savings pass should guarantee some much better back-to-school volumes in August and September. And our back-to-school really goes through the end of September.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Got it. And then another question on sales, and maybe just to follow up a little bit on what Dan was asking. But -- and I guess it's easier to frame this in terms of contract, where you have maybe a closer relationship with some of your consumers. But as we look back through the economic downturn, and shortly after the economic downturn, even as employment was picking up. And one of the things we kept on hearing is that a lot of your customers had, sort of say, stocks of office supplies they were kind of burning through in their offices. Well now, we're at least a few years past the depths of recession, I would assume those stocks are probably now blown through. When you talk to your customers, and this is a simple question, okay? Why -- if employment is picking up, why aren't you buying as much office supplies? What are they saying?

Ronald L. Sargent

Joe?

Joseph G. Doody

I think, it's mainly, Brian, there's a technology impact there. Clearly, it's affecting not only small businesses but large businesses as well. So they're better controlling their spend than they ever have and also the mix of what you're selling them. So everything from Board of Directors' presentations that used to be sent out in hard copy in binders are now being done digitally on tablets. So it's a change in technology. It's impacting our core business. That's why when we look at NAC in this quarter, the headwinds that we had to fight were negative office supplies, ink, toner and paper, all slightly negative, in spite of what I would argue as slight market share gains.

Operator

The next question comes from the line of Mike Baker from Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

So I just wanted to ask about the delivery business and what are you seeing -- or the commercial business, I should say. What are you seeing at some of your customers as it relates to the Office Depot, OfficeMax merger? One of your competitors said that some of their customers have been a little hesitant to -- or some of their prospects, I should say, have been hesitant towards Office Depot and OfficeMax because of uncertainty around the merger. I think some people figured that would be a share opportunity for you guys, or do you feel like you're capitalizing on that? Without that, would your delivery business have decelerated more than it did? If you could comment on what you're seeing there.

Ronald L. Sargent

Yes. Joe?

Joseph G. Doody

Mike, I think it's very true that a prospect would have a hard time going to one of our 2 major competitors. They're not the only competitors out there but obviously the 2 major competitors, because there is going to be change depending upon which one you go with. You don't know what platform is going to be the long-term platform, and you're going to have to go through another change. So that's entirely true. But it doesn't mean that if you're a customer of 1 of those 2 major companies, that you're going to automatically leave because of the fear of integration. You've not seen any impact yet, and you might not even know that much about it. We, obviously, tell these users of our competitors about it. But they're not going to change just based on fear. It's a major decision to be made, and fear alone will not make the change. So when there is disruption, that's when there will be action. And there has not been disruption yet.

Michael Baker - Deutsche Bank AG, Research Division

Okay, fair enough. But to follow up on that then. With some of those prospects that might be reluctant to -- do you guys feel like you're picking up any more of that? So I don't know if you guys talk about win ratios and new customer sign-ups or anything along those lines. Has that seen a benefit from those prospects?

Joseph G. Doody

Yes. If you look at our contract business in this last quarter, our sales to existing customers were down slightly, but they were more than offset by a good customer acquisition and modestly higher retention rates. So we're happy with our retention rates of our existing customers. We're happy with our new acquisition, but we are fighting the down sales of existing customers.

Michael Baker - Deutsche Bank AG, Research Division

Sure. And so were those acquisitions any better than they have been in previous quarters?

Joseph G. Doody

Say that again, Michael. I'm sorry.

Michael Baker - Deutsche Bank AG, Research Division

Was -- the growth in acquisition of new customers, was that any better than it had been in the previous quarters?

Joseph G. Doody

Yes, it is. It is up especially in dollars of customers. You can measure acquisition in terms of number of customers you acquire, as well as the dollars of sales you acquire, and it's up in both of those metrics. And if you were to look at a comparative analysis between ourselves and our 2 major competitors, you'd see that our differential in sales is actually widening.

Operator

The next question comes from the line of Kate McShane from Citi.

Kate McShane - Citigroup Inc, Research Division

Just back to your comments, Christine, about the $150 million in cost savings. And I think, Ron, too, you said that you were going to try and get more aggressive with the cost savings because of the reduction in the sales expectation. Could we see more than $150 million this year? Or is this over the next couple of years?

Christine T. Komola

Well, we've got -- our goal is $250 million over the next couple of years, and we're very confident in the $150 million. But clearly, based on these results, we absolutely are going to get more aggressive in the cost takeout. So I think we'll -- we've got several things in motion on more accelerated -- looking at ITO, BPO things. How much actually comes to fruition this year is still to be determined, but we are going to get more aggressive on it.

Kate McShane - Citigroup Inc, Research Division

If we look at how... .

Ronald L. Sargent

Based on overall..

Kate McShane - Citigroup Inc, Research Division

I'm sorry. Also, you've mentioned streamlining the core assortment across Europe. I wondered what inning -- are we in the very beginning innings of that? And how much in savings and margin improvement will come from the initiative?

Christine T. Komola

John?

John Wilson

Sure. Thanks, Kate, for the question. We are looking at that in several ways. We have completed the very first wave, which we think is probably 75% to 80% of that. And you will see the new assortment, the new more common assortment, in Europe in our fall catalogs as early as next month, in September. We're also looking at subsequent waves. We've made great progress, and we're very pleased with the results, getting both a better assortment for our customers, as well as better terms and costs from our vendors. And we do anticipate, in this first wave, benefits on a run-rate basis in excess of 100 basis points.

Christine T. Komola

And Kate...

John Wilson

And that will be as we go through our income statement and the inventory changes and so forth, so that is very back-end loaded this year.

Christine T. Komola

Kate, I will give John some credit. So I'm pleased to say, actually, Europe has made nice progress on the operating improvement this quarter. So our deleverage in international is -- and the increased deleverage, has really been driven more by Australia. John and his team has done a nice job of realizing and accelerating some of the benefits that he's put in place last year as part of curiosity. So hopefully, we'll be more aggressive in that area as well going forward.

Operator

The next question comes from the line of Gary Balter from Crédit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

A few questions. When you look at your numbers, you're -- starting with retail. If you look at your numbers in retail versus your 2 public competitors, Office Depot and OfficeMax, your numbers were weaker on a directional basis than their numbers, maybe because they had an easier start. Was July -- your quarter ends differently. Was July the weakest of your 3 months for the quarter? Does that help explain some of the issue?

Ronald L. Sargent

Yes, it was. I mean, I think, again, back-to-school continues to be pushed out of it. And July, of the 3 -- it was relatively consistent, but certainly, July was the weakest of the 3 months of the quarter.

Gary Balter - Crédit Suisse AG, Research Division

How else then, from that side, would you explain why there was a deterioration versus the 2 other players?

Ronald L. Sargent

Yes. It's hard for me to know kind of what the other 2 players were doing. Probably, the biggest one that I'd point at is a very significant promotion we had on ink last year in the second quarter that, because of the economics, decided not to repeat this quarter. But it's hard for me to say kind of how did our marketing spend compare to theirs and all the rest, but...

Gary Balter - Crédit Suisse AG, Research Division

Okay. Second question is you commented in the North American Commercial and the margin decline, about the increased sales force. Could you talk about what -- the change there? And is that an anticipation of opportunities from the merger?

Ronald L. Sargent

Sure it is, yes. I mean, we are adding salespeople because we think the opportunity is going to be better and better as time go on. And Joe?

Joseph G. Doody

Yes, Gary. If you look at our operating margin, we said we deleveraged, as you know, by about 85-ish or so basis points. About 3/4 of that was sales force and marketing. As we indicated, the marketing was heavily on the Quill side to drive growth, the sales force investments, clearly, on the contract side. And it's primarily an investment in specialists, specialists in facilities, specialists in print, promotional products, technology and furniture, to really drive those boss [ph] categories in alignment with our OP reps that are out there, that are the strategic leaders within those accounts. So it's really penetrating our existing customers, as well as new customers in beyond office supply categories, as well as our core.

Gary Balter - Crédit Suisse AG, Research Division

So when we're thinking about, like, the investment that you make in hiring, when do you start to see the beneficial results of those hires? Is that a 6-month to 1-year process?

Joseph G. Doody

It's more in the 1-year to 18-month time period, Gary.

Gary Balter - Crédit Suisse AG, Research Division

Okay. And then just the last question is you've commented that the online was up, but it was up only 3%, which was actually -- it looked like it was a deceleration from previous quarters. Can you talk about what's going on with online?

Ronald L. Sargent

I think staples.com was up 3% just like it was in the first quarter. In fact, local currency, it was up 4%. But again, it really reflected, I think, our decision to turn down the dial on customer acquisition so that we can really focus on getting the website competitive with the best of the online players out there. And I think we've talked about kind of hiring a new team in the staples.com world. And I think there were so many things that we didn't know we didn't know. And I think we're learning a lot, and I think we're positioning ourselves for a very strong second half in the staples.com world.

Operator

Next question comes from the line of David Gober from Morgan Stanley.

David Gober - Morgan Stanley, Research Division

Obviously, the international trends remain challenging, and it seems like you take a little bit of a step back there in 2Q after seeing some stabilization, I guess, particularly on the retail comps in 1Q. I was just wondering if maybe John could touch a little bit on the progress in Europe. And maybe more broadly, kind of what you saw, was it market, was it an erosion in the underlying market, which, I mean Europe seems to be stabilizing a bit. And maybe Ron, if you could touch on Jay's progress in Australia and what you're seeing there.

Ronald L. Sargent

John?

John Wilson

Sure. Thanks, David. Just to be clear, to reiterate what Christine said earlier, for Europe only, the operating loss rate for Q2 was actually flat over last year, around 1% loss each quarter, Q2-to-Q2. That actually represents sequential improvement over Q1 versus the prior year. It's also, I think, important to note that this actually includes onetime costs for the restructurings that are still going on in Europe. We haven't broken those out. So we've just closed 2 facilities, for example, in the second quarter, Tongeren distribution center in Belgium, as well as an Eupen call center. So we are actually flat in Europe in total, despite incurring some onetime costs for some of those major consolidations we've been talking about. So from an overall result, we're actually on track. From a sales point of view, we are seeing some softness. We don't believe we're losing a material market share in any one of our businesses. I would say that the one business I am surprised at some of the developments has probably been in our Advantage business, our contract business. And there what we've seen is -- the only thing I can say is probably pricing beyond my expectations in some of these large contracts. Some of those contracts are being priced now by one of our competitors, in particular, below our variable costs. And so that is probably the only significant surprise I've seen in the marketplace. In terms of developments going forward, I'm pretty pleased with our focus on back-to-school and our retail environments. And I'm encouraged by the early results that we're seeing in our back-to-school, which is really just coming out this month for Europe in a material way.

Ronald L. Sargent

And I'll ask Joe to talk about Australia since Jay Mutschler reports to Joe Doody.

Joseph G. Doody

Yes. In Australia, I think the -- I classify it as stabilizing the business, really reducing the -- almost eliminating the losses of business customers that we had over the past 1, 1.5 years. Our comp number has gone down. First quarter, it was in the -- we were down negative mid-teens; second quarter, down negative high-single digits. Second half of the year, we expect that to be, both on top line and bottom line, contributing positively, which has not been the case in the first half of the year. So the trend of the business is good. We are fighting a little bit worse local economic situation there than a year ago. But in spite of that, we would expect, and do expect, it to move positively both in terms of its contribution on the top and bottom line in the second half of this year.

Ronald L. Sargent

And finally, our team in China has been working really hard and making some great progress, and they had a pretty solid quarter during Q2. That's the third piece.

David Gober - Morgan Stanley, Research Division

Got you. That's helpful. And just a quick follow-up for Christine, if I could. Looking at the free cash flow guidance, still above $900 million. Obviously, the operating profit numbers sound like they'll be a bit lower. What's the offset there? Is it lower CapEx, maybe more of a benefit from working capital? What's the offset to the operating numbers there?

Christine T. Komola

Yes. it's basically, as you said, working capital continues to be a pretty good managed part of our plan, as well as we'll manage our capital spend accordingly. So that's why those 2 levers are what we're planning to offset any sort of earnings loss.

Operator

The next question comes from the line of Matt Fassler from Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Two questions, the first relates to retail. To the extent that you can discern it and with your back-to-school comments, you might have sort of intimated, is the weakness in the retail channel more a function of the traditional consumer business or of the small business customer in that channel?

Ronald L. Sargent

Demos?

Demos Parneros

It's a combination. Small business traffic is slightly down, consumer traffic is better, but neither is great. In terms of the categories, it's a combination of PCs, because of its size, and then the related businesses, computer peripherals, software, things like that, that are just -- they have no chance to grow, they're just deteriorating fast. In the traditional supplies, some of those areas were down, not severely, but they have an impact on mix. So that's kind of the quick story on it.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And if you look at the new categories you brought in, whether they be technology, like mobile, or stuff like breakroom, are those new businesses drawing, if it's possible to generalize, from the consumer population or from the small business customer base?

Demos Parneros

On the retail level, it's a little tough to say, although it can be specific with a few. On the mobile phone side, I would say, it's primarily consumer. The issue there is that we don't have enough scale. So at 500 stores, we're unable to market the way we want to so we're expanding that in a very efficient and cost-effective way to 1,000 stores by year-end. That will give us more scale and ability to drive that business quicker. On the facilities and breakroom, I would say it's some small business, so we're encouraged by that. And we're also encouraged by the traffic that -- the repeat traffic that, that's generating. So I'm not going to -- again, it takes longer to reset stores, obviously, so we're moving along as fast as we can to get that into more stores.

Ronald L. Sargent

Matt, when you look at total comps, I mean, consumables for North American retail were down 1.6%, and non-consumables were down 5%, really driven by PCs. Just to add a little more color [ph].

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Understood. And then my second question briefly relates to the prospective Office Depot, OfficeMax dynamic. Can you talk about your contingency planning for change in sort of the retail footprint in the event that they need to divest stores as part of their deal and/or ultimately choose to close a bunch of stores? Certainly, there's going to be some real estate floating around. As you think about the balance sheet and you think about other things that you might do strategically in front of that, can you talk about how your -- what your thought process looks like?

Ronald L. Sargent

Well, I think, we've tried to plan for every possibility. One possibility would be a lot of stores available, and the other extreme would be no stores available. I'm not sure that, given our direction is 12,000 square-foot stores going forward, that we're that interested in a lot of 20,000 or 25,000 square-foot stores. I was recently in St. Louis, and the market seemed vastly overstored and the sizes of the stores seemed very, very large. So we're planning whatever comes our way. But frankly, our strategic direction is really focused on the reinvention plan. And kind of assuming nothing happens, and then if something does fall in our lap, we'll consider it at that time. But we're really not spending a lot of time trying to sort out what may or may not happen.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. So it sounds like you would probably rather see some of that capacity disappear than take it over yourself even if the lease terms are favorable, just given format changes?

Ronald L. Sargent

We'll figure it out, what's best for Staples at that time.

Operator

The next question comes from the line of Greg Melich from ISI Group.

Gregory S. Melich - ISI Group Inc., Research Division

I had 2 questions. One, Demos, given the success of the 12,000 square-foot stores, what do you think is the next stage with that? Is it a chance to do more relos in that format? And ultimately, how many locations do you think that box size could work?

Demos Parneros

It's a combination of closures where it makes sense, so we get some square footage reduction and some sales transfer that way; and of course, downsizing. And as you know, downsizing costs more money. It's a little bit more painful to do, but we're encouraged. It's early. Of this new format, we've got, as of today, just about 10 or 11 stores done, with another 30 or 40 in the pipeline. So I think, for our team, it's a matter of really refining what we see the sales retention looks to be the most promising at the moment. Margin mix, we're still working on. But no question that we'll move faster as we see better results. In the meantime, we're working on it, refining it and moving as fast as we can.

Gregory S. Melich - ISI Group Inc., Research Division

And Ron, I think you mentioned, last year, some promotions that may have influenced sales trends and ticket and things like that. As you cycle that, I guess if you were to break down the comp or top line into what was -- you did give traffic, and ticket which is helpful. But in that ticket, was -- what does inflation or price look like versus items?

Ronald L. Sargent

I'm not sure I can parse it that carefully. Demos?

Demos Parneros

I'm -- but I shouldn't guess. That kind of impact I -- I don't -- obviously, there has been a disappointment throughout a lot of categories. That one hurt worse on the incline which had been trending a lot better. I don't have a precise number at the tip of my tongue, sorry.

Gregory S. Melich - ISI Group Inc., Research Division

Maybe more broadly, how would you describe the competitive environment? I know, last year, there were some paper price increases that sort of went through and then they didn't. Right now, how would you sort of overall describe that?

Demos Parneros

Well, right now, we're in the throes -- on the retail side, we're in the throes of back-to-school. We're in the heat of it in the Southern markets and are, as mentioned before, encouraged by very good traffic, great response to our assortment. Our teams are ready. We're in stock for the whole season. So we're in good shape on back-to-school. We're looking to see that through. We sold a lot of back-to-school passes, which we had a huge success with last year. And we know that, that has multiple trips connected to it so we expect to see that throughout the season.

Gregory S. Melich - ISI Group Inc., Research Division

Great. And then finally, I can't remember who mentioned it, but there was restructuring costs that were -- you guys are just expensing as it goes on. Christine, could you help us understand and put that in some context as to maybe how much of the deleverage that would have been or when the peak corridor of those sort of costs you'd expect?

Christine T. Komola

Sure. That was from John Wilson, and that's where we are closing fulfillment centers in Europe. It's not kind of material to the overall business, definitely not material to Staples, Inc. overall. But it did have impact, but it was planned. And it's on strategy and within our numbers in our guidance. For the most part, going forward, kind of big charges this year in our guidance is not incrementally different, so we're covered.

Operator

The next question comes from the line of Michael Lasser from UBS.

Michael Lasser - UBS Investment Bank, Research Division

I'm focusing on kind of a timing issue. And when you can expect to see some inflection point for which your -- the categories that are growing, especially in the retail side, facilities and breakroom, the tech services, et cetera, when do those reach a critical mass, which they can begin to offset the categories that are in structural decline? Because if we look at the retail business, it really seems to be kind of decaying at an accelerating rate despite you picking up some momentum in the categories you're growing?

Ronald L. Sargent

Demos?

Demos Parneros

Sure. So that's a question that we wrestle with every single day. Obviously, these are good categories for us. Facilities and breakroom, it's not as large as in the commercial side, but growing rapidly, and we're looking to accelerate that. On the mobile phone side, again, as we scale, we'll go faster. It's not one-for-one, obviously, otherwise, we'd have better results here. So we're moving fast. I don't have a precise date. But I actually think that with some of the categories that are going away, some boxed software is actually shifting, as well as going away, peripherals are reducing, and moving to our online business, a lot of this is going to continue to shrink, and we'll continue to reposition the stores and have more productive stores. So there'll be a lot of shifting over the next several quarters still.

Michael Lasser - UBS Investment Bank, Research Division

So just to try and pin you down a little bit, Demos, is it quarters or is it more like years when -- before you'll see some inflection with the growth from those categories?

Demos Parneros

Yes. I mean as an example, our tablet business has been very, very strong. Our EasyTech business has grown strong double digits. Our copy and print business is growing very well. When you focus on facilities and breakroom, its ratio -- we just can't move as quickly in retail stores as we can online. Because of the difficulty of resetting stores and the cost that comes with that, so we're moving fast but it's hard to sort of catch up exactly step by step. So I wish I had a more precise answer, but obviously, our goal is soon as possible, fast.

Ronald L. Sargent

Just one added point there. You just look at computers being replaced by mobile devices, whether it's phones or tablets, and it used to be computers were 95% and tablets were 5%. Now it's about -- it looks like about 60% computers and about 40% tablets. So that kind of gives you a sense for where that market is moving, and tablets are going to be, not replacing, but certainly bigger than computers very soon.

Demos Parneros

From a unit movement standpoint, that's happened already. The dollars obviously lag because of the ticket size.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And Ron, a follow-up question. The business has kind of stagnated for the last couple of quarters. Is there a point at which -- and I've asked this in the past, but is there a point at which you need to take some deeper actions, kind of sound the alarms to be a little more aggressive to reposition across all segments?

Ronald L. Sargent

Well, I'm not sure what you're suggesting. But I think the alarm has been sounded in terms of I'm not at all happy with taking down our guidance this morning and I'm very frustrated that we're not seeing the kind of the sales grow as quickly as we'd like. But I think, we're not -- there's a lot of examples where this kind of reinvention seems to be working fairly well. I think there's a lot of proof points, whether it's the online sales continue to grow, and we expect that to accelerate in the second half. Our contract business continues to grow, and we're investing heavily in that. The SKU assortment, we've added 120,000 SKUs in the last 18 months. Marketplace, which is part of our business that didn't exist a year ago, is approaching $2 million per week in volume. In-store kiosk sales, they're growing double digits. Services are growing nicely. We've certainly invested in lowering our pricing to be more competitive in the new world. And we've got a new store prototype that we feel pretty good about. So I agree with you that we have to do more faster, and I agree that we've got to aggressively take cost out. And whether that's relooking at the million-square-foot reduction in retail in last year and the million-square-foot reduction that we're taking this year, but SG&A is down $65 million year-to-date due to headcount and cost reduction efforts. And I think, again, we're going to get more aggressive because I'm not at all happy about our performance in the second quarter. I think the problem is it's just not working fast enough. Retail sales are too soft, given -- driven by the supplies erosion. The mix is a little more unfavorable as core supplies decline. And Europe and Australia, although they're starting to stabilize on the bottom line, they're still struggling as well. So do I really -- do we have work to do? Yes. But I also agree with you that we should stay the course because there's a lot of indication that the strategy seems to be working.

Operator

The next question comes from the line of Anthony Chukumba from BB&T Capital Markets.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

So I had 2 questions. One kind of touches on the things that have been talked about before. In terms of this deceleration or deterioration in core office supplies. I mean, I know for sort of years and years, you talked about it was kind of like a slow bleed, kind of a low-single-digit percentage bleed. I mean, has that accelerated? I mean, is it now declining at a faster rate than that?

Ronald L. Sargent

It's hard to know based on the 90-day window. But it's been declining kind of 1% to 2%, and that's where it declined in the first quarter and in the second quarter. And again, it could be kind of the promotion we didn't cycle this year. It could be a little slower start to back-to-school. But office supplies, kind of core office supplies, were down 3.5% to 4% in the first quarter on the retail side of the business. So one quarter doesn't make a trend, as much as sometimes we think it does. I'll let you know at the end of the year, but I think it's probably in that minus 1% to minus 2%, which we've been planning for all along.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Got it. Okay, that's helpful. And then sort of a related question, maybe I'm playing a little bit devil's advocate here. But -- so Q2, historically, from a seasonality perspective, it's your smallest quarter of the year. In addition to that, you talked about the fact that back-to-school is starting later and later. So that probably impacted your July sales, so that will probably move into Q3. I'm just almost wondering -- you missed numbers by a couple of pennies. So I'm almost wondering, are you maybe being too conservative in terms of the guidance reduction?

Ronald L. Sargent

Well, we spend a lot of time debating that internally. And I do think there are some future upsides associated with our business. I mean, I think you've got a little more aggressive cost takeout that we're working hard on. We're cycling some of the investments that we've made over the last year. Looking forward a couple of quarters, you're going to have much lower interest expense as we pay off the last of the Corporate Express debt. Even Hurricane Sandy, which really affected our results last year and the last week of the third quarter and the first couple of weeks of the fourth quarter, we're hoping and assuming that's not going to repeat itself. And again, I think everything we're doing is kind of, the plan's getting some more traction. Having said all that -- and Christine is smiling at me. Having said all that, I think we don't like missing our numbers, and we don't plan on missing our numbers going forward. And we're going to work to not only meet these numbers but see if we can beat them in the second half.

Operator

The last question comes from Joe Feldman from Telsey Advisory Group.

Joseph I. Feldman - Telsey Advisory Group LLC

I think we kind of touched on a lot of what I might sort of ask about. But I guess one question I had was, I know we're talking about the delivery business earlier, the commercial business now, existing customers spending a little bit less or somewhat less. I guess I'm wondering why that is. Like, I know you're retaining those customers as customers, but are they spending elsewhere for some of this product and they're now spending in 2 places? Or are we losing share in that regard? Or is it just they're literally just not spending as much because how long can they continue to de-stock, I guess?

Joseph G. Doody

Yes. I think, Joe -- it's Joe Doody. It's not just a de-stock issue. I think, again, I think that what they're using, they're using less core office supplies today than they were previously. The example I used is things being sent like Board of Directors' packages being sent electronically today that were always sent in hard copy in binders previously. So that volume goes away entirely. So it is a change in their usage, not just a stocking situation within their companies. Plus, I think there is less leakage out there. I think companies are doing a much better job today of controlling their spend to make sure it doesn't go home with the workers, not just being used in the office by their workers.

Joseph I. Feldman - Telsey Advisory Group LLC

Got you, okay. So it's not that you think they're spending a portion of that somewhere else, okay. And then the other question I have was, again, maybe for you, Joe. I know -- I think you had said that furniture sales were actually pretty decent in the delivery side of the business. And I guess I was interested as to what do you think is driving that. Is it that you're seeing more hiring? Is it more small business that you're starting to see inklings of? I guess I'm trying to read a silver lining in that comment.

Joseph G. Doody

I think what it is more than anything, Joe, it's more of a focus. It's a focus on one of these boss [ph] categories that we've got to drive growth in. Now we have a very small market share. We're talking to these customers. We've gotta be talking to them not just about office supplies, but about furniture and others as well. I will say that I was very satisfied with our furniture business in the U.S. in the quarter. Not happy with our furniture business in Canada. That was down double digits. Some of that is just timing of spend that was -- we would expect to be spent in the second half of this year by some of our customers up there than in the first half of this year. So even in spite of that disappointment in Canada furniture, we had an overall good quarter in furniture and an even better one in the U.S.

Operator

We have no further questions. And I would now like to turn the call over to Mr. Ron Sargent for closing remarks.

Ronald L. Sargent

Thanks, everybody, for joining us on the call this morning. We look forward to speaking with all of you again very soon.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a good day.

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