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Staples Inc. (NASDAQ:SPLS)

Q2 2010 Earnings Call

August 19, 2010 8:00 am ET

Executives

Laurel Lefebvre - VP of IR

Ron Sargent - Chairman and CEO

Mike Miles - President and COO

John Mahoney - Vice Chairman and CFO

Demos Parneros - President of U.S. Retail

Joe Doody - President of North American Delivery

Analysts

Chris Horvers - JPMorgan

Gary Balter - Credit Suisse

Oliver Wintermantel - ISI

Brad Thomas - KeyBanc Capital Markets

Kate McShane - Citi Investment Research

Will Truelove - UBS

Michael Lasser - Barclays Capital

Michael Baker - Deutsche Bank

Jack Murphy - William Blair

Daniel Binder - Jefferies

Colin McGranahan - Bernstein

Alan Rifkin - Bank of America

David Strasser - Janney Montgomery

Stephen Chick - FBR

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Staples Inc. earnings conference call. (Operator Instructions) I'd now like to turn the presentation over to our host for today's call, the Vice President of Investor Relations, Laurel Lefebvre.

Laurel Lefebvre

Good morning and thanks for joining us for our second quarter 2010 earnings announcement. During today's call, we'll discuss some 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 staples.com for an explanation and reconciliation of such 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 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' latest 10-Q filed today.

Here to discuss Staples Q2 performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer; Mike Miles, President and Chief Operating Officer; and John Mahoney, Vice Chairman and Chief Financial Officer. Also with us are Demos Parneros, President of U.S. Stores; and Joe Doody, President of North American Delivery.

Ron?

Ron Sargent

Thanks, Laurel, and good morning, everybody. Thanks for joining us today. I'm pleased to report strong earnings growth for the second quarter. Our operations are solid. Our growth initiatives are gaining traction, and we are delivering good earnings performance despite soft topline trends. Compared to last year, total company sales were flat at $5.5 billion, and adjusted earnings per share increased 25% to $0.20.

North American Delivery grew topline by 2%. North American Retail also grew sales by 2% and had flat same-store sales, which was a 200 basis point improvement in our three-year comp trend. And our international business declined 6% in U.S. dollars, but only 2% in local currency. On the bottomline, we expanded operating margin in all three of our businesses for the second consecutive quarter.

Our view of the business for the back-half of 2010 remains unchanged. We expect to see a modest recovery in the economy and unemployment to remain high. We'll continue to drive the topline by investing in key growth initiatives, areas like facilities and breakroom supplies, business technology and copy and print where we're already seeing positive signs. And we'll accomplish important milestones on the Corporate Express integration, particularly in the areas of supply chain and systems.

Turning to our business units, starting with North American Delivery, sales for the second quarter were $2.4 billion and increased up 2% in U.S. dollars or 1% in local currency compared to Q2 of 2009. In Staples Business Delivery, we grew the topline in the mid-single digits. In Contract, sales grew in the low-single digits. And Quill's topline improved versus last quarter, with declines in the low-single digits.

Core office supplies and business technology were stronger in the second quarter, while durables like business machines and furniture remained weaker than the house.

The pricing environment contract remains rational. And during the second quarter, customer acquisition and retention in our contract business was strong. Sales from new customers drove topline improvement in the high-single digits. This was offset by lower spend from existing customers.

We're seeing good trends in the facilities and breakroom category. A growing percentage of customers have started to think of Staples for more than just office supply, particularly in contract where we've had some recent wins with larger customers who previously came to us for only their core supplies.

Our expanded assortment, better training for our sales associates, sharper pricing and increased marketing efforts drove topline growth in this category during the second quarter despite difficult comparisons from sales of H1N1 related products last year.

NAD operating margin increased 79 basis points to 8.7% compared to the same period last year. Our better buying and more favorable mix of discretionary products and lower amortization expense, all contributed to this improvement.

We continue to increase our average order size. For Q2, average order in contract was just under $206, which was an increase of almost $8 compared to Q2 of 2009. We also reduced the percentage of small orders, under $50, by a couple of hundred basis points compared to last year.

The integration of our supply chain is a multi-year project and includes development of common back-end systems as well as physical integration of our networks. Systems work is complete, and we're now making great progress with integrating the physical network.

During the second quarter, we closed two fulfillment centers. We upgraded 10 facilities with the capability to serve both Staples and legacy Corporate Express customers. The scope of our integration also includes our last-mile delivery homes, and we consolidated over 30 of these locations during the first half of 2010 and approximately 35 more are in the works.

This year, we've taken on more infrastructure projects than in any other time in Staples' history. Despite the additional complexity and resources required, the team has done an excellent job executing these projects while maintaining great customer service.

Moving on to North American Retail, sales for the second quarter were $2.0 billion, an increase of 2% in U.S. dollars or flat in local currency compared to Q2 of 2009. Second quarter same-store sales were flat with strengthened software, copy and print, tech services, offset by weakness in big ticket items like business machines and furniture. Consumable categories like ink and paper comped in line with the house during the second quarter. And our efforts to drive core office supplies were successful with positive comps in the low-single digits.

Traffic in the North American stores was positive for the fourth straight quarter, up about 1% versus Q2 of last year. Average order size remained negative, and that was down about 1%.

North American Retail operating margin increased 5 basis points to 5.3% for the quarter. We improved product margins and saw a benefit from reduced depreciation, distribution and marketing expense. These improvements were offset somewhat by investments we're making in our growth initiatives.

On the technology side, we continue to see strong double-digit growth in our EasyTech and good progress with attachment selling. Computers comped in line with the house during the second quarter as we carefully managed the profitability of this category, while lapping mid single-digit comps for computers during Q2 of last year.

Our copy and print initiative was growing nicely as well. We've increased associate training, expanded our offering, improved our quality and put a sales force in place to drive copy and print business to our stores. All of these efforts helped to driving high single-digit copy and print comps during the second quarter.

We kicked our back-to-school in early July and we expect this year to be promotional just like every other year. To drive strong store traffic, we're offering our weekly circular coupons, more promotional deals as well as laptop and software bundles that help customers save on technology. We're working to increase awareness of technology products and services by offering $50 in rewards for trading an old computer for a new one, as well as free PC tune-ups. While several big back-to-school weeks are still ahead of us, we're pleased with our results and our in-store execution so far.

Customer service scores remain at all-time highs, as we benefit from our quality programs and copy and print and EasyTech, as well as the positive impact from our associate training programs.

During the second quarter, we opened two stores and closed two stores, ending Q2 with 1,888 stores in North America. We remain on track to open about 40 new stores in North America for the full year.

And with that, I'll turn it over to Mike to talk about our international business.

Mike Miles

Thanks, Ron. Good morning, everybody. Sales for the second quarter in international were $1.2 billion, a decrease of about 6% in U.S. dollars and a decrease of about 2% in local currency compared to the same period last year. Operating margin for the international business was 1.2%, an increase of 86 basis points from the same period in 2009. Supply chain improvements, lower amortization expense, better results in China, and lower marketing expense all helped the bottomline.

Our delivery business in Europe continues to rebound from the depths of the recession. We have positive year-over-year sales in local currency during the second quarter, despite a very soft May, when the European sovereign debt concerns were most pronounced. We saw growth in both June and July and look forward to a better second half. And operating margins improved by over 300 basis points, driven by improvements in logistics as well as reduced amortization and G&A expense.

We continue to make good progress on integrating our systems and back office functions. During the second quarter, SAP went live in our Irish business. And we're rolling out common applications for warehouse management and replenishment. We're achieving the synergies we expected in supply chain and indirect purchasing. We're also leveraging our global e-commerce and marketing expertise with a consistent staples.com look and feel across all of our major websites in Europe.

Our European delivery businesses are on a good trend, European retail has been a different story; with same store sales down 9% and weakness across all countries. This performance represents a 700 basis point improvement over Q1 in the two year trend, but we clearly need to make some changes in our marketing and merchandising tactics. To that end, we've initiated a complete review of our plans for the second half with the goal of getting comps turned around.

We have some excellent long term growth opportunities in European retail, copy center, text services, our customer loyalty program, and new store growth to name a few. But we're refocused on 2010 and putting new store openings until we see some improvement in our topline.

The Australian business had a flattish quarter, with growth in office products undercut by softness in promotional products and technology services. Operating income de-leveraged slightly on expenses associated with the SAP roll-out in New Zealand and other initiatives. We picked up several big contract wins in the quarter, including government business with New Zealand and the state of South Australia.

In China, our back-to-basics approach is beginning to bear fruit. We saw topline sales growth in seven quarter, this growth was powered by the Chinese economy and achieved in spite of our exit from unprofitable business. We're also making progress in improving our gross margins with the consolidation of our Chinese buy-in from four regions to one central function that our pricing discipline and eliminations of unprofitable SKUs.

South America continues to post strong growth and improved operating margins. The printing systems division achieved flattish sales growth with strong sequential improvement in topline. The market remains tough for new printing, but our order intake continues to improve. Operating margins were better by about 100 basis points. And we remain confident and we'll breakeven during the back half of the year, providing a decent upside as we (flap) our restructuring efforts from 2009.

Also during the second quarter, we made further progress on our overall priorities for Staples International; people, portfolio and profitability. We recently added two strong players to our China team, Anders Kristiansen an industry veteran who most recently ran Lyreco's Asia-Pacific business will join us as president of Staples China next month. We also hired Noah Herschman who brings 20 years of merchandising experience, including time with Amazon in the U.S. and China as our chief merchant in Shanghai.

During Q2, we made two key acquisitions that build on our portfolio. We acquired Corporate Express, the deal included a 59% stake in Corporate Express Australia. During the second quarter, we increased our interest in the business to more that 98% and we expect to acquire the remaining shares that we don't currently own over the coming weeks. Having a 100% ownership of this business will allow us to address the Australian market more effectively especially with respect to the Staples brand.

We're also building scale in our profitable Nordics region. A few weeks ago we announced the acquisition of Lindell the leading Finnish office supply company. Prior to the acquisition, we had an alliance with them to serve our global contract customer in Finland. With this acquisition, we're not only expanding in an important market in our European portfolio, we're also adding a strong leader in Bo Nyman, CEO of Lindell and we look forward to accelerating the growth of this business.

Now I'd like to turn it over to John to review our financials.

John Mahoney

Thanks, Mike, good morning, everybody. The second quarter total sales were flat versus last year at $5.5 billion. The foreign exchange impact was neutral during the quarter as weakness in the euro and pound were offset by strength in the Canadian dollar and Australian dollar. Our second quarter GAAP earnings per share on a fully diluted basis increased 38% to $0.18 versus the second quarter of 2009.

During Q2, the company recorded pretax integration and restructuring expense of $22 million or $0.02 per diluted share, excluding these costs as well as the $30 million of pretax integration and restructuring expense that we incurred in the second quarter of 2009, adjusted earnings per share increased 25% to $0.20 versus $0.16 during Q2 of last year.

Our effective tax rate for the second quarter was 37.5% compared to 34.5% last year. This change relates to the expiration in this year of provisions in the IRS tax code, regulating the way we report international income on our U.S. tax returns, which we discussed during our Q1 earnings call. As a result of our tax expense for the second quarter, it was about $6 million higher than it would have been for the 34.5% tax rate.

Gross profit margin improved by 69 basis points to 26.4% during Q2. This reflects stronger product margins driven by increased vendor support as well as efficiencies in delivery and distribution expense. SG&A leveraged 7 basis points versus last year's second quarter to 20.9% of sales. This was driven by a reduction in depreciation expense as a result of lower capital expenditures last year.

Earlier this year, we made changes to our equity compensation plan and removed and accelerated adjusting benefit for associates under the age of 65. This change is one of the benefits from the previously announced $5 billion stock option derivative litigation settlement throughout the majority of the $19 million year-over-year improvement in equity compensation expense. We expect equity compensation expense for the back half of 2010 to be in line with the back half of 2009.

Adjusted operating margin, excluding integration and restructuring expense, increased 97 basis points during the second quarter to 5.2% compared with Q2 2009. Year-to-date capital expenditures came in at $151 million compared to $130 million that we spent on capital during the same period last year. With year-to-date operating cash flow of $245 million, we've generated $95 million in free cash flow during the first half of the year.

We remain on track to spend about $450 million on capital expenditures this year, as we invest in growth initiatives, new stores, remodeled systems and the integration of our distribution networks in North America and Europe. And we'll generate more than $1 billion of free cash flow for the full year.

During the second quarter, we spent about $400 million on the purchase of additional shares of Corporate Express Australia, as well as our acquisition of Lindell in Finland. We also ramped up our inventory for back-to-school and resumed our share repurchase program under which we bought back 5.1 million shares for $102 million.

With $872 million of cash and cash equivalents on our balance sheet and available lines of credit of more than $1.3 billion, our liquidity position remains very strong. At the end of Q2, we had 731 million shares outstanding. This reflects about 1 million share increase compared to the 730 million shares outstanding at the end of Q1, as our repurchase activity somewhat offset our annual restricted stock grant to associates which took place in early July.

Turning to guidance for the current quarter and the full year, we expect total company sales to increase in the low-single digits versus 2009, as year-over-year comparisons get tougher throughout the back half of 2010. During the third quarter, we'll anniversary a 500 basis point improvement in the sequential comp trend from Q2 to Q3 of last year in North American Retail and a 200 basis point improvement in the sequential topline trend of the North American Delivery.

During last quarter's call, we provided full year earnings guidance based on the expectation that Congress would extend certain expired provisions in the IRS tax code and that our full year tax rate would return to 34.5%. However, the extenders still haven't passed. And while there's still a chance that they may pass during the back half of the year, we're now planning for our tax rate to be 37.5% for 2010.

Without trying to explain all the complexities of our international tax structure, I thought it'd be helpful to give a little more detail on our tax planning. For the purchase of Corporate Express in 2008, we added a substantial number of foreign entities to our structure. Both companies rely on the so called check-the-box provision for the law to allow cash to flow freely among all wholly-owned entities.

We were not able to rely on this rule without impacting our efforts to buy the remaining shares of Corporate Express, governed by the Dutch legal system. We relied instead on a temporary provision of tax law that was expected to be extended by Congress, but to date has not been. As a result, we've now adopted a structure that we expect to allow us to return to a 34.5% tax rate in 2011, assuming no other changes in the tax laws.

The increase in the tax rate equates to about $0.06 earnings per diluted share for the full year. We also anticipate a combined benefit of about $0.02 of earnings per diluted share from our increased ownership in Corporate Express Australia and our share repurchase program. As a result, we now expect our adjusted diluted earnings per share, excluding integration and restructuring expense, to be in the range of $1.25 to $1.29 for the full year and in the range of $0.39 to $0.41 for the third quarter.

We expect depreciation expense to be $120 million to $130 million in the third quarter and $480 million to $490 million for the full year, amortization expense to be about $15 million to $20 million in the third quarter and $65 million to $70 million for the full year, integration and restructuring expense to be approximately $10 million in the third quarter and $55 million to $60 million for the full year, and net interest expense to be $50 million to $55 million in the third quarter and $215 million to $220 million for the full year.

Thanks for your time this morning. And now, I'll turn it back over to Josh for Q&A…

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Chris Horvers, JPMorgan.

Chris Horvers - JPMorgan

Few questions, first one on the PC business. We're hearing a lot of noise about weakness in that business in recent months, and our tech guys are talking about some back up in the supply chain in Asia. So can you talk about trends in that business and how you think how it looks to lap the Windows 7.0 release in late October?

Ron Sargent

Let me ask Demos Parneros to address that. He's a guy that's probably spending most of his time with technology with the expansion of our tech in Asia.

Demos Parneros

A few things to consider on this one; first, we continue to see prices come down. So then our tech machines continue to be a little bit less expensive this year, so a little pressure there. I'm pleased with our focus on selling the entire basket so that this will be more of a profitable one for us as we approach it from a more holistic standpoint and really get the customers what they need.

In terms of supply, we are in good shape. We're pleased with where we stand today. So we don't know about the next few months as far as that is concerned.

So I think it's one that we manage very, very carefully going forward, and have been over the past year or so. It's a little hard, Chris for us to kind of investing in the technology category, so we're growing it as we're expanding it.

But I have also heard the same issue that maybe tech trends are a little softer, particularly in light of the introduction of the Apple iPad.

Chris Horvers - JPMorgan

So you mean that there is weakness because you're growing the business; you could still see some comp contribution from PCs?

Demos Parneros

Absolutely.

Chris Horvers - JPMorgan

Okay. On the back-to-school side, you hear a lot of noise out there about how promotional it is. You say that's promotional as it always is. Can you delve into that a little bit? Is it just people just raising up advertising, really not invested in price or how is this season progressing?

Ron Sargent

It is as promotional as it's been, and as we've seen in prior years with back-to-school, a lot of different players become back-to-school players. So we are seeing a lot of different promotions out there from the traditional players like the OSS players as well as the mass and drug and supermarket stores.

But in terms of pricing, it's always been a very promotional few weeks. At any given week, there might be somebody running a special price on a particular item. I think for us, we feel really good about our preparation for back-to-school. We've got a wonderful assortment, I'd say even better than last year. We're in stock; we're ready for the whole season.

Our prices I think are sharper than anyone else's out there. We've got not only great prices but special deals. Every single week there's something new; different promotions. So we really don't see it as very different from prior years. It's just going to be a long, competitive season.

Chris Horvers - JPMorgan

And how do you think it's progressing so far?

Ron Sargent

Well, we're not getting into the details of the actual sales. And we're right in the heart of back-to-school right now. As we mentioned, it started in the early to middle of July, with some of the southern markets going back to school. But really the majority of the country goes back to school over the next two or three weeks, so we'll know a lot more then.

Operator

And our next question comes from the line of Gary Balter of Credit Suisse.

Gary Balter - Credit Suisse

First, Ron, I have to congratulate you on the Reds being three games ahead despite being swept by St. Louis.

Ron Sargent

Well, thank you Gary, and you and I have always thought that Dusty Baker was an excellent manager.

Gary Balter - Credit Suisse

Could you talk about Europe and the plans to improve that? Obviously the 9% comp isn't what you're looking for. Could you go into a bit more detail about what the plan is going forward?

Ron Sargent

Sure. Mike?

Mike Miles

Yes, Gary to your point, the European retail business is really on a different trend from the rest of our business in Europe. And I think that suggests at least to me that it's as much related to what we're doing or not doing as it is to the European economy. Frankly, our trends in the stronger markets in Europe, like Germany, are not any better than our trends in the most challenged markets like Portugal.

So again, suggests that we can look to ourselves for improvement. The weakest part of our business is in the technology space there. So of that is the result of our conscious decision to deemphasize price item technology offers that were driving a little bit of sales, but not much profitability.

We're trying to refocus our traffic driving efforts in the supplies area. In the U.S. we've used case paper very successfully to drive a business customer into our stores. And we think we've got the same opportunity in Europe.

In general, what we're doing in the second half of the year is looking to change our tactics around promotion and pricing, probably invest a little bit more in some of tried and true tactics from the past. And then in the long term, I think our expectation is that we'll be able to drive some of the same businesses that have helped make the North American business so successful, namely the copy center business, tech Services business, use of loyalty program more effectively than we have there so far.

And ultimately, get after new store growth there. We've had good improvement over the last several years in our operating margins in Europe. So that the stores there with decent sales are profitable, but obviously with a negative 9% comp, that goes right up the window.

So our focus is on getting that business back to positive comps from the second half of the year.

Gary Balter - Credit Suisse

Ron, could you talk about your outlook right now, like we're hearing all this stuff about? Obviously, consumer spending is weak. As you said, back-to-school, it sounds like it's getting off pretty well for you guys. But on the corporate side, is there a worry that there'll be maybe not a double dip, but just some type of retraction where business gets hurt at the (NYSE:SD) division, or are you seeing trends that maybe a bit more positive than that?

Ron Sargent

Garry, we're not seeing anything that would indicate a double dip and you'd really see that on the delivery side of the business. Let me start by saying, you guys know probably about as much about the economy as I do. But what we are seeing is just a kind of slow, steady improvement in our business. And I think the whole economy hinges on getting people back to wok over time.

You look at our contract business, it's slightly better than last quarter. You look at our catalogue business, it is slightly better than it was in last quarter. And I think all those things would indicate it's just going to be a slow, steady slog from here on out. And all we can do is focus on the things that we can control. And that's spending time and energy and money on growth initiatives. I think we tried to run a tight ship during this recession, and most important of all taking care of customers.

Operator

And our next question comes form the line of Oliver Wintermantel of ISI.

Oliver Wintermantel - ISI

Obviously we're on a period on uncertainty, but at the same time you net debt to EBITDA ratio is close to what it was, a bit forward in Corporate Express acquisition. And so how are you thinking about the right amount of leverage in the business, and what could that mean to share buybacks in the second half in 2011?

John Mahoney

We're very pleased with our ability to get our balance sheet back in the shape that it was before the deal, over a fairly quick period. As you know, we have debt repayments over the next several years, $500 million next year, and then $325 million in 2012 plus the $1.5 billion that's due in '14.

So I think we have to be aware of meeting those capital needs as we think about things like share buybacks, although, we felt very comfortable making the acquisitions of the remaining interest in Australia, and making the deal in Finland. So our priorities remain intact.

Our first priority is to invest in the business. We want to make sure that we maintain great flexibility to be able to do the kinds of things that we've been able to do. We also want to make sure that any excess cash that we have we are able to return both in the form of dividends and in share buybacks.

You heard that we bought about five million shares back this quarter. I think that reflects that the process that we have which is to buyback regularly in the market. By a little bit more when the stock is lower. Unfortunately, that's been the case recently. So I would expect to see similar trends as we move through the rest of the year.

Oliver Wintermantel - ISI

John, traffic was up 3% in the first quarter, and you said that traffic was up again in the second quarter. Could you give the exact split between thick in the traffics in the second quarter?

John Mahoney

Traffic was up roughly 1%, and average order size roughly down 1%.

Oliver Wintermantel - ISI

And what was the driver of the traffic in the second quarter? Was it in the consumer or business or small, medium size businesses?

John Mahoney

Unfortunately, a little bit more consumer than we would have liked, and a little bit less of the business traffic. So we'll take the positive, but driven more by consumer at this point. And a lot of the promotions that we've been running.

Operator

And our next question comes from the line of Brad Thomas of KeyBanc Capital Markets.

Brad Thomas - KeyBanc Capital Markets

Just want to follow up a little more about Europe and the comp trends there, could you share just a little bit more color about how much you think that in the macro backdrop versus just opportunities for you to improve your execution?

Mike Miles

Brad, I would love to blame it on the economy there, but as I said, it's a little bit hard to do when our delivery business is improving very steadily across Europe. And we see the same thing in a completely different sector with the printing services division. So it strikes me that most of the issue is the result of either our programs or what we were doing a year ago.

As I said, we're 700 basis points better in the second quarter on a two year basis than we were in Q1, but with a negative nine top, you're certainly not going to get very excited about that. So I think we're very focused on addressing the issues. They are a little different country by country. But particularly in the U.K. and Germany, which are two biggest retail markets over there, in terms of the number of stores, we've got businesses that seem to respond in much the same way that our U.S. and Canadian businesses respond. That gives me some confidence that the tactics that have worked to help us gain share here, we'll be successful over there and as you can imagine we're moving with as much speed as possible to get those implemented in the second half.

Brad Thomas - KeyBanc Capital Markets

And just to follow up on that, Mike, it was about a year under your belt now really focusing on the international segment. Can you just give us a sense of how you're feeling about the leadership positions over there and how many more changes or appointments we may look for on that horizon?

Mike Miles

I think we're in pretty good shape in Europe in terms of our leadership structure and the people we've got in the place, and the roles that are filled. There are always changes that occur over the course of time as people get promoted and people retire. In terms of the organization structure that we've got over there, we're generally pretty comfortable with it. We're going to have to continue to refine that in order to drive improvements in G&A. I think that's one area of our cost structure that we're still not satisfied with from a long term stand point.

But with respect to the leadership of the business, I think we've got the right people in place. And now with kind of a more permanent situation in China, I think he's done a great job over there on a temporary basis getting things turned around. And Anders Kristiansen will be able to take us on to the next plateau. I think around the world we've got a pretty good management team in place.

Brad Thomas - KeyBanc Capital Markets

Thanks, Mike, and then just lastly, Ron, I wanted to follow up on a couple of your comments on the contract side. The pricings been rational, seems like you guys are still having some nice success with acquisition of new accounts. Could you just talk a little bit more about the competitive landscape and your ability to add new accounts? Any changes that you are seeing or future opportunities that may come up with the U.S. communities contract for example?

Ron Sargent

Let me Joe Doody to comment on those questions.

Joe Doody

As we said it's continuously rational, you always find the instance where you have a question on a particular contract. One of our competitors gets extremely aggressively. But overall it's a rational market. We continue to be very satisfied with our customer acquisition activities. As we said, that's leading to growth in the high-single digits, more than offsetting our loss in business. We continue to get hurt with sales from existing accounts, but that negative has been improved slightly sequentially here in this quarter. So it's getting better.

As far as opportunities, we continue to drive for market share growth. We clearly believe we have a great lowest-cost delivery model in place that continues to drive market share gains, both in the mid-market as well as in the large account sector.

And as far as U.S. community is concerned, we're going to go aggressively after that business. As you probably know, we felt that the U.S. community agreement was in direct conflict with some existing agreements that we have that are out there today, generating close to $200 million of business for us in that space. So we were not going to go towards that contract, but we will go aggressively after that business in the marketplace with a very aggressive offering. And I think we will find some success there over time.

Mike Miles

And Brad, I don't know if you've heard, but the U.S. community's contract was awarded to a group of independence yesterday.

Brad Thomas - KeyBanc Capital Markets

That's helpful, thanks. I had not seen that.

Ron Sargent

Their intent at this point to award a development still has to go through some approvals. But that being said, we're going to continue to aggressively compete for that business. And the only other thing I guess I'd add as well is recent awarding in the state of Florida where we now have been awarded as one of the three winners in that state to go after that business, which is a $30 million to $40 million total opportunity that was the exclusive of one of our competitors prior to this.

Operator

And our next question comes from the line of Kate McShane of Citi Investment Research.

Kate McShane - Citi Investment Research

Just following up on that last question, I think there's also a contract up in Texas currently. Do you have any comment on who may or who may be leading in out there right now?

Ron Sargent

That was awarded in the last several days. OfficeMax as well as six independent contract stationers in Texas were awarded the Texas contract.

Kate McShane - Citi Investment Research

And what margin rate are we talking about with some of these contracts.

Ron Sargent

Not so good, but, Joe, what kind of margin rate are we looking at for some of these contracts?

Joe Doody

I think it's fair to say one has to be aggressive to get this business. That being said, a lot of times, the business directly with the state in terms of them buying directly off the contract is very aggressive. But there are municipalities that buy off and tend to have a little different mix of products that will give you a better margin performance. So a lot depends on how you're able to really leverage that state contract throughout all the buying agencies that can buy off of it. The broader that you do, the better your margin rate will be.

Kate McShane - Citi Investment Research

And are there any other state contracts that are coming up that are on your radar screen?

Joe Doody

Sure. California would be the other major one. But clearly it is the Florida, Texas and California have been the biggest that have been outstanding here recently.

Kate McShane - Citi Investment Research

And then my last question on the consistency of traffic at retail during the quarter. I think last quarter you highlighted that it was kind of choppy and volatile. Did you see the same pattern during Q2?

Demos Parneros

Yes, basically good weeks, bad weeks. It's a little choppy. Traffic obviously is doing better now that we're in the back-to-school time of the year. But certainly throughout the quarter, it was choppy.

Operator

And our next question comes from the line of Will Truelove of UBS.

Will Truelove - UBS

Now that you're going to basically stop the international expansion, do you have an updated kind of CapEx budget for this year?

Mike Miles

I don't want to overdramatize the fact that we're putting a few new store openings in Europe on hold, stopping the European expansion. I think we're only talking about five or six stores. So it's probably not from a context of $450 million of capital budget really going to make a major change. Obviously, we won't spend that capital, but I don't think that changes our capital outlook as a corporation significantly for the year. Our international growth plans generally are on track, and we continue to believe that's a good growth platform for us.

Will Truelove - UBS

So you're still looking to spend roughly $400 million this year in CapEx?

Mike Miles

$450 million.

Will Truelove - UBS

And then the second question I had was again about the contracts. You said pricing remains rational. But have you seen a shift in the margin expectations as it relates to if you can compare and contrast the government that contracts relative to, say, corporate contracts? Are government contracts getting probably where the margins are probably compressing faster than perhaps margin expectations on the corporate side?

Joe Doody

I would not say that's true. I think there is pressure there across the board. The largest companies out there are expecting to get the best prices and leverage that. And so the pressures exist. It's something that we deal with on an ongoing basis. And quite honestly, our team, especially on the enterprise side dealing with those large corporate customers as well as our state and government business, has done a great job of ensuring that we bring those customers on at acceptable margin rates. So we then continue to work to improve over time.

Operator

And our next question comes from the line of Michael Lasser of Barclays Capital.

Michael Lasser - Barclays Capital

On the European printing systems business, I think in the year, you expected to breakeven, and now it sounds like you're expecting to breakeven in the second half. So is that proceeding at a slower pace than you previously anticipated and perhaps why?

Ron Sargent

I think we were close to breaking even in the second quarter, just like we had expected to. Mike, do you want to address that?

Mike Miles

Yes, that's right. I think what I said at the end of the first quarter was that I expected to breakeven over the remainder of the year, and that's still my expectation. We've got a pretty good visibility in that business to our order book, and it's progressing as we expected. The cost reductions that we implemented last year have taken hold. So I don't think there is any significant change in our outlook for that business since the end of the last quarter.

Michael Lasser - Barclays Capital

And then similarly on China, it seems like sales trends there are maybe a little bit better than you anticipated. So does that suggest you might be able to improve the profitability of that business faster than expected?

Mike Miles

Somewhat. Most of the profit improvement that we're going to see in China in 2010 is improvement over kind of one-time expenses and special hits that we took in 2009. We lost nearly $50 million in Asia in 2009. Most of that's not day-to-day trading results of the business. So as the sales look a little better, we'll be a little bit better, but the big change that you're seeing there is kind of one-time stop.

Overtime, obviously the way we want to make money in China is by growing the business and improving margins, and we're pretty well on track with the plans that we've had throughout the year to do that.

Michael Lasser - Barclays Capital

Last question for John. What's the share count that's assumed in the guidance for the third quarter and in the full year?

John Mahoney

We're expecting about the same numbers here. So we had this about $730 million.

Michael Lasser - Barclays Capital

For both?

John Mahoney

Yes.

Operator

And our next question comes from the line of Michael Baker of Deutsche Bank.

Michael Baker - Deutsche Bank

I just wanted to focus on the full year guidance. So two questions regarding that. I think you said low-single digit sales growth for the year, but you're flat this quarter. So seems like that things have to get a little bit better in the back half from where they were in the second quarter, but you don't expect that recovery. So if you can help us flush out what's contemplated in that, particularly as comparisons get harder.

And then just numerically, on the full year guidance, I think if you adjusted the tax rate, you raised your guidance by $0.04. You said $0.02 from lower share count and Corporate Express Australia. So where is the other $0.02 coming from? Is that from better margins?

John Mahoney

Starting off with the sales guidance, I think we've been expecting relatively steady improvement. What we're saying is that we're not seeing any huge change in the tone of the business, but the steady improvements we're seeing, that is something we expect for the rest of the year.

With respect of the earnings per share, the tax hit is worth about $0.06. We had about $0.02 of benefit from the combination of the share buyback program and the additional earnings that we get from acquiring the remaining piece of Australia. So that's the reason that the range that we had before comes down by $0.04.

Michael Baker - Deutsche Bank

So just to follow up, the second quarter, is it fair to say that the sales were below your expectations? I mean you're not changing your expectations for the back half or maybe in the second quarter you expected flat?

John Mahoney

No, I think we'd said pretty much low-single digits for the year. And I think we continue to feel that. We of course were a little disappointed in the sales results for the second quarter. We think we missed some opportunities and believe that we won't in the second half of the year.

Operator

And our next question comes from the line of Jack Murphy of William Blair.

Jack Murphy - William Blair

Can you just a little bit about what you're seeing in off-contract purchasing? Is there anything encouraging to report there and what it might say about recovery in delivery business?

Mike Miles

I think we're getting a little better each quarter. I mean if you look at the trends over the last four, five quarters, the impact on our margin went from negative maybe three, four, five quarters ago. It's been positive in the last couple of quarters, and it's getting a little more positive this quarter. So I think again that would indicate maybe a slow, steady improving environment for our contract customers.

Ron Sargent

I can add, Jack, it's still below where we were a year ago. And we are making and steady progress and did benefit our margin in the quarter by about 15 basis points.

Jack Murphy - William Blair

When you look at the retail business and the volatility you're seeing around traffic there and compare that to some of the underlying metrics that you're seeing in the delivery business, is the small business customer and the more contract business customer coming back a bit more steadily and the retail customer lagging or is there anything to kind of draw to that?

Mike Miles

I'm not sure there is, because I think the biggest reason our traffic is notching around is the comparisons get tougher throughout the year. If you remember, in 2009, the business got better throughout. And as we get to the second quarter, we had harder comparison than the first quarter. And then that comes also to bear in Q3 and Q4.

I think in real time, it's a little hard for us to kind of gage is there something going on with business or consumer versus the larger business. But to me, I think consumers are feeling the same sort of pain that businesses are in terms of job growth or expectations about having their current job. And I think that creates a lot of uncertainty.

Operator

And our next question comes from the line of Daniel Binder of Jefferies.

Daniel Binder - Jefferies

I had a question on gross margin opportunity. The industry continued to show upside in gross margin this quarter, and I'm just kind of curious as you look across your businesses, what the opportunity looks like going forward? It's just a little bit more of a high-level question.

And then I have a question that is related to U.S. communities. You said earlier that you had a conflict originally with going after that business. Yet, it sounds like you're still going to pursue it maybe on a more individual account basis. I'm just curious what the change is there.

And then finally, on the share count, John, is the share count that you provided just a function of buyback activity offsetting option activity?

John Mahoney

I guess I'll start with the easy one on the share count. We do issue our equity in July. And so the biggest component affecting our share count is the restricted stock that gets issued that goes into the account. And that we believe will be offset the share buybacks that we've done. The remaining part, as you know, is the impact of using the treasury stocks on option price. And obviously, we can sense somewhat on what the share price does, but making reasonable assumptions about the share price, we will be about neutral.

As far as gross margin is concerned, it gets harder these days to talk about gross margin with all the moving parts because you have everything that's going on internationally combined with the integration impact of Corporate Express and NAD along with changes in mix that are coming in our U.S retail business. So without going on and on forever, we look really hard at each one of those businesses for ways to improve it.

We see improvements in supply chain across the board that have helped improve gross margins, that we've seen continued improvement in buying, somewhat as a result of Corporate Express, but also as a result of the investments the vendors have made in driving sales through Staples where they've had better success than maybe some other places.

And then in the internationally business, you got the combined effect of some of the buying benefits; they're kicking in more in Europe this year, as with farther down the road in integration. As well as some good disciplines that are taking place in the contract business in Europe that'll allow us to improve margins. So for us, we believe that our internal operations and focus on execution is really what's driving our gross margin improvement, and I think I can speak for the rest of the industry.

Dan, on U.S. communities; first, we've got two relationships out there today. One that JPA, which is a Staples relationships and wanted IPA which is former CE relationship and those two generate for us, I'd say close to $200 million business. The U.S. community's agreement, as one of our competitors I think said onerous, would've required us to be exclusive with them for one to participate in that. We decided not to do that. However, those customers that are out there today under U.S. communities contract are we feel fair game to after their business. And we are going to aggressively go after their business utilizing our other agreements.

So, that's what I meant by still going after of the U.S. communities business, it's their customers that we're going after.

Demos Parneros

Community, at least should explain to be sure what these contracts represent. These are buying organizations that offer the opportunity to buy under that contract to the various participants, municipalities and others. The municipalities and others can choose to buy under that contract or they can buy independently. So when Joe talks about going after that business, you don't have to have U.S. communities contract in order to be able to do business with the municipalities. For example, in Los Angeles, we today do about half of the office supplies business even though we don't own that contract, that they are buying cooperative contracts.

Operator

And our next question is from the line of Colin McGranahan of Bernstein. Colin, you may proceed.

Colin McGranahan - Bernstein

Just a couple of quick follow ups on the guidance here. John, was I correct in understanding that the new tax structure is independent of any changes to the Congressional laws around what you had before. So this is a completely new tax structure, you go back to 34.5% regardless of whether Congress gets off the ball or not.

Demos Parneros

That is it correct.

Colin McGranahan - Bernstein

And that won't happen till next year, just because of you have do it at a fiscal year break.

Demos Parneros

That's correct.

Colin McGranahan - Bernstein

Okay. And then secondly, on unallocated equity compensation, it looks like you ran about $35 million a quarter for the first half of the year. What the rational behind that stepping up to $42 million, which was the run rate in the back of the last year?

Demos Parneros

Well we do our awards in July, so the awards get recorded at the prices at that particular time in an ad, amortization of that expense over the investing period.

Colin McGranahan - Bernstein

Then finally on the guidance, just following up on the Michael's question, if the prior guidance was 125 to 133 and the tax impact was $0.06, the new guidance is 125 to 129. So if adjust the new guidance to be comparable to the old guidance, I get 131 to 135. So the mid point went up from 129 to 133 or a $0.04 increases in the mid point. I think that was Michael's question. That's my question as well, which is, and if I add two cents to that, are you raising the midpoint of the guidance by $0.04?

Demos Parneros

I think what we're trying to comment on is just the discrete changes that we talked. The operating results portion stands on its own, and I think is based on the results we've had for the first half of the year.

Colin McGranahan - Bernstein

And then final question, just on gross margin, the 69 basic points was better than certainly I had expected, especially given an increasing in tech and the mix, pretty solid showing. Can you break down in the aggregate, kind of at the consolidated level? I know you mentioned product margins and better vendors, how much was that worth and supply change and the persistence of those drivers going forward?

Demos Parneros

I think I would just say that, I mentioned how many moving parts there are, I mentioned some of the key drivers. And we do expect that those are the things that we can expect to see to continue. As you know we've tried, with the complexity we have now, we've tried to avoid giving line by line guidance.

So that fits what we're saying that the trends that we're seeing in executing our operations, we expect will continue. And it will be mix effects. It will be challenges associated with currency and a variety of other matters that truly don't make it very easy to get very precise on what we can expect for the back half of the year.

Colin McGranahan - Bernstein

As well try once more. Was supply chain more than a half of the 6 to 9 basis points or less than half?

John Mahoney

As I said, we're trying to avoid getting to within basis points of the details.

Operator

And our next question comes from the line of Alan Rifkin of Bank of America.

Alan Rifkin - Bank of America

First question with respect to the delivery portion of the business. For the third quarter in a row despite modest increases in sales you've been able to increase your operating margins pretty significantly. Can you maybe just provide a little bit more color on the sustainability of those improvements, or should we expect that that should start to moderate once you anniversary some of the things that you've done on that side of the business?

John Mahoney

I think Alan our goal is clearly over the next several years to get back to the profitability level of our business, pre-acquisitions. So we and the team are committed to that in terms of getting back to something that's 11 plus, and I think you'll see that you'll see a continuous path in that direction. So as we get continued benefits from our network integration, that will be a contributor. We continuously drive improvements in terms of the margin rate on the former CE accounts and drive average order size, small orders etcetera.

It's all those factors that we see as being a part of our continuous improvement to drive to get to that 11% plus over time.

Alan Rifkin - Bank of America

And then maybe a question for Ron. Ron, it's now been two solid years since the acquisition of Corporate Express. Putting the ill effects of the environment aside, relative to your expectations which you originally articulated would be about $300 million in synergies, can you maybe just provide an update on where you are in achieving those synergies? And can we expect that there will be further integration charges in 2011?

Ron Sargent

Yes. Let me just give you kind of the headline; the headline is, the Corporate Express acquisition has been a home run for the company. Whether it's people, whether it's margin improvement, whether it's scale, whether it's the ability to run our distribution network better, whether it's customer service capabilities, I mean it's really been a great acquisition that has been integrated very smoothly.

I think it's safe to say that in North America, we're probably 80% of the way there in terms of synergy captures. But for the next several years we've got some work to do in terms of integrating and rationalizing the backend distribution and the supply chain. And that's going to provide more upside.

I don't want to be too specific, as we are not even tracking synergies that way anymore. But I would say, we are far along in North America. And then in Europe, I think we are probably maybe a third of the way there in terms of where we are ultimately going to be. And I think you will see European profitability improve throughout the year and throughout next year.

So obviously the big one was in North America; that's where the most of the synergies were, because that's where we had the overlap in the contract business. In Europe we've got a contract business on top of a retail and a catalogue business; so probably not nearly as much synergy there. But in general, we'll capture every bit of those synergies that we talked about during the acquisition and more.

Operator

And our next question comes from the line of David Strasser of Janney Montgomery.

David Strasser - Janney Montgomery

Just a little bit bigger picture question too as we get towards the end of the call. Thinking about the international business and growth over a longer period of time, five years, seven years, your choice, it seems that right now you guys have made pretty big beds around most of the, sort of the mature economies and stuff, China being the exception. And you seemed to have figured that out, maybe going in the right direction there.

How should we be thinking about growth in bricks and other emerging markets going forward?

Mike Miles

David, I think in the next three to five years we see a lot of the growth in international coming from both sales growth and profit improvement in those material markets that you've referenced. I mean, we've just got so much scale there and so much opportunity there that it would be, I think a mistake in my mind to rely too much on some of those bricks economies.

That said, I think we are very excited about China and Brazil. Australia in many ways benefits from the growth in Asia, and so that's been the rationale behind our four investments down there.

And ultimately, I think India could be a good market for us as well. We don't talk about it much, but we've had good growth in both the delivery and retail businesses in India this year and they are progressing nicely on their profit plan to a point that we'd be very happy with that business as well.

We've not got a significant presence in Russia at this stage. There is a lot on our plates right now, but it's obviously a market that we're keeping an eye on. In general, I think those economies will be obviously the highest percentage growth parts of our portfolio. And then probably in the second half of this decade, we'll be providing meaningful dollar growth on the bottom line for Staples.

Operator

And our next question comes from the line of Stephen Chick of FBR.

Stephen Chick - FBR

I have a question on North American retail. The store growth in the quarter, it looks like maybe there was a shift because you had 20 open last quarter and two this quarter. And I don't know if that's kind of a shift in the timing of openings, but within that, the local currency retail growth for sales was flattish, one-tenth of a percent, and it looks like new store count or store count is up year-over-year.

So I was wondering maybe if Demos could speak to how the new store, the productivity is with new openings, and kind of how you feel about that. And how we should kind of think about the new store growth for the year of 40, how that should lay out for the second half?

Demos Parneros

The new store productivity is in line with our expectations. Obviously, the business has been bumpy as these new stores have come out of the gate reasonably well. We've opened in a number of different markets throughout the year. Probably a little bit of a timing issue. I don't have the specifics in front of me.

Mike Miles

I do have the specifics. It looks like we try to front-load as much as we can. And net opening was like 18 in the first quarter, and one or two here in the second quarter. So we're kind of halfway there. And the other one is, we got Canadian openings as well, and there we were plus two in the first quarter and plus one in the second.

Stephen Chick - FBR

So I guess the productivity as you put this in this quarter, it looks like might be just timing and math?

Mike Miles

That's really a function of kind of availability of real estate. And a lot of projects have been slowed and put on hold in this kind of economy.

John Mahoney

And I guess your question is sort of a math one in terms like season, and the impact of 20 stores on 1800 on a percentage base in terms of growth is pretty de minimis. So I wouldn't read anything into that. Our new store productivity is performing well.

Stephen Chick - FBR

And then second, kind of related to North American retail and kind of in the context of your topline guidance, the low single digit guidance for the second half and for the year. You had a pretty good, or as I recall a positive back-to-school season in terms of comp store sales a year ago, and I think even Windows 7.0 towards the end of the quarter contributed last year this time.

So within the context of your total company sales guidance, maybe Demos, are you guys budgeting for comps to actually be positive in the retail business for the third quarter?

Demos Parneros

I think what we said is that total sales would be up in the low single digits, and we're not getting any guidance about comp trends for the remainder of the year.

Stephen Chick - FBR

I am just trying to make sure we have the expectation right, because a positive comp would be a very big acceleration in both two year and three year type of stat trends. So it'll be an impressive performance, and it sounds like you think the back-to-school season started off pretty good here. So just want to make sure our expectations get aligned correctly.

Demos Parneros

I think the expectations is, third quarter, low single digit growth for the company.

Operator

At this time, we are showing no further questions available. The CEO, Ron Sargent, you may proceed.

Ron Sargent

Thanks, everybody, for joining us on the call this morning. We look forward to seeing many of you on our analyst day in October when we plan to get into a lot more detail about our growth initiatives as well as our long term financial outlook and expectations. So thanks again for your time.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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