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Executives

Laurel Lefebvre - IR

Demos Parneros - President of US Stores

John Mahoney - Vice-Chairman and Chief Financial Officer

Mike Miles - President, Chief Operating Officer and President of Staples International

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

Joseph Doody - President of North American Delivery

Analysts

Alan Rifkin

Oliver Wintermantel - ISI Group Inc.

Daniel Binder - Jefferies & Company, Inc.

Kate McShane - Citigroup Inc

Michael Lasser - UBS Investment Bank

Gary Balter - Crédit Suisse AG

Bradley Thomas - KeyBanc Capital Markets Inc.

Matthew Fassler - Goldman Sachs Group Inc.

Christopher Horvers - JP Morgan Chase & Co

Brian Nagel - Oppenheimer & Co. Inc.

Michael Baker - Deutsche Bank AG

Staples (SPLS) Q2 2011 Earnings Call August 17, 2011 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Staples, Inc. Earnings Conference Call. My name is Chanel, and I'll be your operator for today. [Operator Instruction] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Laurel Lefebvre. Please proceed.

Laurel Lefebvre

Good morning, everyone. Thanks for joining us for our second quarter 2011 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 & 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 this morning.

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 joining us are Demos Parneros, President of U.S. Stores; and Joe Doody, President of North American Delivery. Ron?

Ronald Sargent

Thanks, Laurel, and good morning, everybody. Thanks for joining us today. Our second quarter results show that our team's hard work continues to pay off. Our core business is solid, our growth initiatives are building momentum and we delivered better-than-expected earnings and cash flows.

Total company sales were up 5% to $5.8 billion and adjusted earnings per share increased 10% or $0.22. On a GAAP basis, earnings per share were $0.25 including a $0.03 benefit due to a cash tax refund in our International business during the quarter.

North American Delivery grew the top line 3% with growth in all 3 channels and North American Retail grew the top line about 2%, with positive comps in the United States. In International, the top line was up 15% in U.S. dollars or flat in local currency.

All 3 growth initiatives delivered a strong performance during the quarter. The facilities and breakroom business continue to gain momentum, it was up 13% in the second quarter in North American Delivery. In North American Retail, Copy & Print sales were up 4% and we made good progress in our Technology business, with mid single-digit growth in computers and double-digit growth in EasyTech services.

While our growth initiatives are gaining traction, we're also seeing growth in core office supplies. With positive trends in the key back-to-school season, we're planning to deliver solid earnings growth in the second half.

Now let's talk about each of our business units in more detail, and I'm going to start with North American Delivery. Sales for the second quarter were $2.4 billion, up 3%. All 3 delivery businesses grew the top line, with contract growing faster than the house.

Core office supplies were positive during the second quarter and paper and ink were flat. Our facilities and breakroom category continued to grow at a double-digit rate during Q2 with sales momentum in all channels. Quill and Staples.com were up double digits, while the Contract business accelerated to 9% growth.

Investments we've made in sales people, training and pricing continue to drive the top line in this high-margin category. We also achieved nice growth in other adjacent categories. Promotional products increased double digits, Print Solutions grew high-single digits even before the benefit of the PRINTSouth acquisition.

In Contract, strong customer acquisition and retention continue to drive the top line, while sales to existing accounts remained soft. Trends in the federal and state government business are still weak and are not likely to improve significantly anytime soon.

Turning to profitability. NAD operating margin declined 33 basis points to 8.4%. Gross profit margin rate was about flat year-over-year. The operating margin deleverage is primarily due to investments in our sales force to support growth initiatives, higher fuel expense, investments in the Staples.com and Staples Advantage websites and cost to roll out our new common ordering platform.

The industry remains as competitive as always, but we've been able to maintain discipline in our contract pricing and we have successfully passed through most cost increases that we were slow to implement in the first quarter.

I should also note that the Staples.com achieved strong operating margin expansion in the second quarter due to fewer promotions compared to last year. With easier comparisons in the second half, we plan to leverage NAD operating profit in the third and fourth quarters.

Moving on to North American Retail. Sales for North American Retail for the second quarter were $2 billion. That was an increase of 1.7% and about flat in local currency compared to Q2 of 2010. Second quarter same-store sales were flat, with the U.S. comping better than Canada. Strength in Copy & Print, Technology Services, consumer electronics like tablets and e-readers and paper was offset by weakness in printers and computer media. Computers, however, comped positively with weakness early in the quarter and strong sales late in the quarter as the new product cycle launched.

Customer account comps decreased 1% compared to Q2 of last year and average order size was up about 1%. We continue to strengthen our position in core office supplies. Ink and toner was slightly positive and cut sheet copy paper comped up 3% during the second quarter. Our assortment, prices and loyalty programs continue to make us a destination for these 2 categories.

Our Copy & Print initiative continues to benefit from improvements in sales force productivity. We've recently enhanced our print offering with a new website, featuring an expanded range of products and services. EasyTech growth accelerated in the second quarter. We're seeing good traction with our Peace of Mind promotion, which offers unlimited PC support for a year.

We now offer 8 tablets in the assortment. As the technology improves, prices start to come down and customers become more educated on what tablets can do for them. We expect sales to continue to ramp throughout the year.

Attachment rate for accessories are very good. Kindle and Nook electronic readers also continue their strong performance during the quarter.

We're in the process of rolling out our mobile initiative to 500 stores this year, focusing on the small business customer. We're offering a 3-carrier model including Verizon, AT&T and T-Mobile and a great assortment of hardware and accessories.

We rolled out an expanded assortment of facilities and breakroom products in 400 stores in the quarter, and we're seeing double digit comps in the category chain-wide.

In early July, we kicked off back-to-school in the southeast markets and the season is off to a good start. We launched a new TV campaign and we've added a new focus on college students, featuring dorm room essentials including furniture, appliances and organizational items. We're also working to increase awareness of technology products and services by offering special promotions on laptops and tech accessories.

North American Retail operating margin was 5% for the quarter. That's down 23 basis points year-over-year. This reflects strong gross margin management during our seasonally lowest volume quarter of the year, as we carefully balance our mix of technology and services and drive better attachment rates, and that's offset by increased marketing and investments in our growth initiatives.

During the second quarter, we opened 8 stores and we closed 2 stores ending Q2 with 1,907 stores in North America, that's 1,576 in the United States and 331 in Canada. We remain on track for a net addition of 20 stores in North America for the full year.

Our focus continues to be on driving store productivity higher. And to that end, we've reduced the size of our Dover store prototype to 15,000 square feet, which is down from 18,000 square feet previously. We also continue to make good progress renegotiating the 150 leases that are up for renewal this year, and we leveraged rent expense again in the second quarter.

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

Mike Miles

Thanks, Ron. Good morning, everyone. Sales for the second quarter in International were $1.3 billion, an increase of 15% in U.S. dollars and flat in local currency compared to Q2 last year. We saw a top line growth in office products this quarter, although weakness in the Printing Systems division offset those results.

The top line in our European Delivery businesses and in high-growth markets maintained solid growth trends. And European retail sales improved sequentially in a still challenging sales environment.

Operating margin for the International business was 1.2%, an increase of 7 basis points from the same period in 2010. After a tough start to the year, we're seeing more impact from our profit improvement plan and have pulled back on some of our growth investments. This emphasis on bottom line results helped to reverse the margin compression we experienced in Q1.

Let me give you some examples of our profit improvement measures. We slowed our investment in new sales force in Europe and marketing for the dot-com launch in Australia. Our vendor negotiations in Australia, replicating the success we had in North America and Europe yielded significant improvements to our cost of goods. During the quarter, we completed the consolidation of our Belgian and Dutch operations of the Printing Systems division. And we improved gross margins in Europe retail through better pricing and a 200 basis point increase in Staples brand products.

We do continue to face fixed cost leverage in the European retail and PSD businesses and the cost of investments in new systems, which limited the overall improvement in profitability.

Europe office product sales growth was driven by strong performance in our Delivery business, offset by continued weakness in retail. Overall, Europe Delivery grew sales 6% in local currency in the second quarter, with contract up high-single digits and the direct business up low-single digits. Product cost inflation has put pressure on our contract margins, as we are challenged to pass on price increases in the current economic environment.

Our Contract mid-market effort in Europe continues to show promise, ramping nicely in the U.K. and off to a strong start in Germany. We're also very pleased with the first full year performance of Finland, which became part of Staples in July 2010.

In Europe Retail, comps declined 5%. While the macroeconomic environment continues to be very weak, we've made changes to our marketing and merchandising programs that have positioned the business for better results. You've seen good results from the implementation of attachment selling initiatives based on our success in North America. Remodels of stores in the U.K. have shown positive results. We've relaunched the copy center business in about half our stores in the Netherlands, encouraging early returns. And our German Retail business continues to improve from the repositioning strategy we implemented last year and posted positive comps in Q2.

China, India and South America all grew the top line. Printing Systems division continues to face very soft demand for new machines, although operating results in PSD are expected to improve this year due to cost reduction measures implemented over the last 2 years.

In Australia, the top line decreased low-single digits in local currency. Gross margin improved in rate and dollars, but operating margin declined as a result of supply chain and systems investments.

Looking to the back half of the year, we remain committed to increasing the profitability of the International business. Turning around the European Retail business, improving our contract margins and reducing G&A costs are top priorities over the next couple of quarters. We also continue with the progress we're making in buying and own brand penetration, consolidating supply chain and improving the profitability of our high-growth markets and PSD.

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

John Mahoney

Thanks, Mike. The second quarter total company sales increased 5.2% versus last year to $5.8 billion. Foreign exchange impact from stronger foreign currencies helped the top line by about 400 basis points, with about half of this benefit coming from strength in European currencies. Local currency organic growth was up 50 basis points for the quarter.

Our second quarter GAAP earnings per share on a fully diluted basis increased 39% to $0.25 versus the second quarter of 2010. Favorable foreign exchange rates benefited diluted EPS by about $0.01.

During Q2, the company received a cash tax refund for the collection of a tax receivable in Europe that was previously deemed uncollectible. As a result, our effective tax rate to the second quarter was 25.7% compared to the 35 -- 34.5% rate that we had planned. This reduced our tax expense by approximately $21 million or about $0.03 of earnings per diluted share in the second quarter.

Excluding the impact of this tax refund, as well as the $22 million of pretax integration and restructuring expense during the second quarter of last year, earnings per diluted share grew 10% year-over-year.

Gross profit margin increased by 4 basis points to 26.5% during the second quarter. This reflects improved product margins and rent and occupancy leverage in North America, offset by investments in the supply chain.

On an adjusted basis, SG&A deleveraged 49 basis points versus last year's second quarter, primarily due to investments in labor and marketing to support growth initiatives. Adjusted operating margin decreased 46 basis points during the second quarter to 4.8%. Year-to-date, capital expenditures came in at $164 million compared to the $151 million that we spent on capital during the same period last year. With year-to-date operating cash flow of $302 million, we've generated $138 million of free cash flow during the first half of the year. We remain on track to spend about $400 million on capital expenditures and generate more than $1 billion of free cash flow this year.

During the second quarter, we repurchased 12 million shares for $199 million. At the end of Q2, we had 711 million shares outstanding. The weighted average shares outstanding for the quarter used to calculate diluted earnings per share was 709 million.

We also tapped into commercial paper to support our seasonal cash requirements and stock buyback programs at attractive short-term interest rates. We ended the second quarter with about $255 million of commercial paper outstanding.

At the end of Q2, Staples had approximately $1.8 billion in liquidity, including cash, cash equivalents of about $823 million, available lines of credit of about $978 million.

As we look ahead to the third quarter and the rest of the year, we expect total company sales to increase in the low-single digits in Q3 and for the full year compared to 2010. We expect to achieve diluted earnings per share in the range of $0.46 to $0.48 for the third quarter and adjusted diluted earnings per share of $1.39 to $1.45 for the year. Our full year earnings guidance excludes the tax refund benefit in the second quarter of approximately $0.03 per share. We now anticipate a 34% effective tax rate for the year, excluding the second quarter tax refund.

Thanks for your time this morning. And now I'll turn it back over to our conference call moderator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Gary Balter of Credit Suisse.

Gary Balter - Crédit Suisse AG

Ron and John and Mike, could you address -- one of the questions that I think is concerning to people is you had a nice quarter this quarter, but it followed a very challenging Q4 and a very challenging Q1. And while stronger than the other 2 players, it seems like we're seeing similar inconsistent trends. How should we think about the consistency? Because you laid out a pretty solid second-half story, but what's impacting that consistency and what factors should we be thinking about as we look out and model?

Ronald Sargent

John?

John Mahoney

Well, I think Gary, when we, last fall talked about what we expected for 2011, we were a little bit more optimistic. And the fourth quarter was a tough quarter as you recall, largely because of weather. And as we came out of the fourth quarter, we still anticipated some strengthening. As we get into the first quarter, we didn't see that. And as a result, changed our view of the rest of the year and our view hasn't changed. Our view is that we're not expecting a substantial change in the trends we've seen in the first half of the year. And we've taken actions to make sure that we can deliver good profitability and still try and make investments for the long term. I think that's the balance we try and strike. And I guess what you have to consider is our ability to be able to make that, those changes on the fly, to be able to manage expenses within the quarter, as we see trends develop. And be able to particularly keep the momentum going on some of the growth initiatives, which we think are very good ways to drive our growth longer term, as some of the concerns that people have had about sequential declines in office supplies, which we think is a long-term concern. But as you saw from our results this quarter, aren't creating lots of pressure in the near term on sales. We mentioned we saw growth in paper, ink was positive. And we're filling in nicely with the categories like tablets, like mobile connectivity and the book readers. So I think the team has done a good job of trying to balance moving to the future and at the same time, controlling expenses against the, our core that's growing a little bit slower than it used to grow, but still growing.

Ronald Sargent

Gary, I'll just add to that. I think it's a little hard to talk about consistency based on the last 3 quarters. But I think our track record has been that we're pretty good at kind of executing the business, and we feel pretty good about the plans that we have in place for the second half. So it's hard to say that we're always going to be consistent for the next 10 years, but I do think we've got our arms around the business and are executing it pretty well in a pretty tough environment.

Gary Balter - Crédit Suisse AG

I appreciate that. Just clarifying that, because first quarter, there was this feeling that maybe expenses got a little bit out of control and you didn't pull back quickly enough. So have you changed any internal mechanisms to be more conscious of that going forward in case sales slowed down again?

John Mahoney

Yes, let me -- I think, as we made no secret of the fact that some of the more remote markets like Australia challenged us last year, and Mike has certainly taken strong action this quarter to make sure that, not only the culture in the places like Australia where we just acquired them in the middle of last year, as well as the information that flows from all of the markets into his office are -- he gets more visibility to that. And I think it's really part of the progression of getting all the corporate express operations integrated. And so I think we certainly have made internal changes and it's really largely been in the International businesses.

Gary Balter - Crédit Suisse AG

Okay. And then just one follow-up and I'll get off. There's a comment and I'm not sure I caught all of it. But you mentioned that North American Delivery, you expect margin leverage in the second half of the year and fewer promotional activity. What's happening from the promotional side or the aggressive pricing side of that, is it stabilizing? It seems like the other 2 players also showed better margins.

Ronald Sargent

I'll ask Joe to respond to that.

Joseph Doody

Well, first, we specifically stated that we were a little less promotional in Staples.com, which did help drive some nice margin improvement within that business. But overall from a competitive standpoint, it continues to remain very competitive. We continue to take share and I think we've shown that, with now 6 quarters of positive growth. Q2 versus Q1 sequentially, we had a 200 basis points improvement in our 2-year growth rate. Our team continues to remain disciplined about profitability and we continue to have significant advantage with our cost structure to be more profitable at the same price points as our competitors. So we're not going to chase unprofitable business in spite of the fact that our competitors sometimes will. So it's competitive out there, but we're well disciplined and I think we showed that during this quarter.

Operator

Your next question comes from the line of Oliver Wintermantel of ISI Group.

Oliver Wintermantel - ISI Group Inc.

Could you give us some more details on what drove the increase in the stock-based compensation and how should we think about that in the second half?

Ronald Sargent

Sure, John. John can answer that one.

John Mahoney

Yes, it's a little detailed and it's a lot of small pieces. It starts with, we changed the practice we had regarding the Rule of 65. So earlier we saw heavy accruals at the beginning, now it's spread out more, so we saw some of the benefit of that last year. We also had the receipt of proceeds from the backdating losses that was in last year. And then other smaller things like, we expanded our employee stock purchase plan throughout a lot of the CE organization in, particularly in Australia and New Zealand. And that resulted in a small piece of it. So all of those pieces added together increased stock comp by about $10 million.

Oliver Wintermantel - ISI Group Inc.

And how should we think about that in the second half?

John Mahoney

I think we should be thinking that the run rate that we're seeing now is what you can expect going forward.

Oliver Wintermantel - ISI Group Inc.

Okay. And I just have one follow-up for Mike. Mike, do you still expect the operating margins in International to be up year-over-year for the full year? And what gives you the confidence now that we see that European economies are struggling? And, yes, that's it.

Mike Miles

Well, it's certainly our objective to continue to improve the profitability in the International business. And we will certainly post leverage in Q3 and Q4 and my objective is to have that result in full year improvement year-over-year. It will be a close call one way or the other. It's not going to be huge if it's positive and it won't be significant if it's negative, either. It will be pretty close based on what we can see today. I don't think that -- although the European economy is apparently softening up, that we're seeing that significantly in our numbers at the moment. Our Q2 results in Europe actually improved relative to Q1. We were about 300 basis points of growth better in the second quarter, so certainly the European economy hasn't been helping us this year. And I saw the German GDP numbers yesterday, as I'm sure everybody did. But we were able to overcome that in the second quarter at least. And I think our expectations for the full year are -- incorporate a pretty soft economy in Europe. And as John said, a relatively slow economic recovery around the world.

Operator

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

Brian Nagel - Oppenheimer & Co. Inc.

I wanted -- look at your SG&A growth. So the -- you talked a lot about in the prepared comments, as well in the press release about the investments you're making and consistent with what you've talked about in the last couple of quarters. But if you look at the SG&A growth, it did tick up higher here in Q2. It went up about 7.6%, higher than it was in Q1. So I guess the question I have is, there's probably some moving parts, maybe some FX effect and then your stock-based estimate -- stock-based compensation might be affecting that. But is there also an underlying further acceleration on some of the investments you're making that's driving that SG&A spend here higher?

Ronald Sargent

Well, I think we're certainly investing in growth initiatives as we've been doing for the last 18 months. But at Staples, you really have to kind of earn your right to grow. And to the extent that we don't see the returns associated with those investments, we're going to stop doing them. So I don't think this is a, from my perspective, a permanent uptick in our SG&A. In fact, I think once you get to the second half, which are much bigger quarters, you should see some significant improvement in the SG&A rate. John?

John Mahoney

Yes. I'd just add to that we're only spending what we think we can afford. Obviously, this quarter with -- where expectations were and what our plans were, we were able to continue some of the investments and particularly in the North American Retail and the North American Delivery businesses, where we've seen good results with the facilities and breakroom and NAD and the rollout of tech initiatives, a lot of training regarding sales of tech. All of the things that we've done, largely with labor and to some degree marketing, which on an incremental basis are getting good sales results, were things we could afford to do this quarter and so I think, are keeping closely in touch with it and we'll only do what we can afford to do as Ron said.

Brian Nagel - Oppenheimer & Co. Inc.

Okay, got it. A follow-up for Ron. Ron, over the years through this economic recovery. I think you've made some really interesting comments about your views on the overall demand environment and overall economic activity. A lot of concerns out there right now among investors with respect to are we heading to another recession, is consumer spending slowing. From your perspective, how do you view overall economic activity at this point?

Ronald Sargent

Well, last quarter I said that the economy was stuck in neutral and nobody liked it. But I'm really not sure that anything has changed since then. I don't think things are any better. On the other hand, I don't think things are any worse. I think the good news is that Staples is performing pretty well in this environment. I mean, we're executing well. We're taking great care of customer. We're starting to see some traction with the growth initiatives. And I think we're probably well positioned to perform pretty well for the remainder of 2011 despite the economy. I'm not an economist at all, but from what I see, we have no chance at another recession. I think we're probably more likely to stay in economic purgatory for a while longer. But I don't have any worries about a double-dip at this point.

Operator

And the next question comes from the line of Matthew Fassler from Goldman Sachs.

Matthew Fassler - Goldman Sachs Group Inc.

I'd like to start by asking about the investments and you discussed them explicitly in the North American businesses in particular. Is there a way to quantify perhaps the discretionary investments that you're making in the business, and talk about the direction of those dollars will move as we go through the year?

Ronald Sargent

John?

John Mahoney

Yes, I mean, I'd say we don't quantify them. The business units have a lot of autonomy to spend the way they want to and they make a lot of trade-offs. So Demos or Joe may want to comment, but when we talk about operating results with Demos, we know the way he trades off labor in the core in order to be able to fund investments in some of the growth areas, and Joe would do the same thing with respect to sales force and other things. Any comment, Demos or John?

Demos Parneros

Sure. I think you will still see us [ph] moving capital around as an example, and the way that we think about remodels. We talked a little bit about mobile initiative. That's one that we're rolling out throughout the country. 100-plus stores at a time. We're currently on our path to get to 500 stores. We liked the results of that so we sort of move that along. We didn't like others, so we slowed those down. We mentioned facilities and breakroom for both business earlier. In the Retail business, we did a good amount of testing and liked the results. So we accelerated that plan to 400 stores and the team is putting plans together to do another set of stores, around the same number. So we try to stay flexible and responsible at the same time, to move where we need to and I think that's a couple of examples.

Joseph Doody

Yes and I'll just comment on, Matt, this is Joe Doody. Two areas for us, mid-market, new customer acquisition. We're extremely pleased with our team's performance there and we're making sure that we're fully -- have full headcount in that area. In the short term, we could generate the short-term earnings if we went under at headcount because of the returns there. But we want that headcount to be full, so that we continue to drive the customer acquisition, new customer acquisition that we have so far this year. The second area is facilities and breakroom, we're extremely pleased with the continuing growing strength of that. Quill and Staples.com have both come out of the blocks very good. Our Contract business moved up nicely from Q1 4% growth to Q2 9% growth. And that means that we're looking at making some additional investments in that business to even drive the growth higher, in terms of additional sales specialists in that area. So it's a pay-as-you-go. And as we see the performance, we will move resources in that direction and take away from others and those are 2 examples of how we do it.

Matthew Fassler - Goldman Sachs Group Inc.

That's great and that's helpful. By way of follow-up. I guess for Joe, you commented or Ron made a comment on the fact that you're taking market share in NAD. And if you could just give a little more color on that, in terms of which businesses are really gaining new customers?

Joseph Doody

Yes, it's heavily in our contract space. I mean, we are very pleased with our new customer acquisition in the mid-market. And so our new business is up and sequentially, it was a greater part of our growth in Q2 than it was in Q1. Our lost business has stayed pretty flat Q1 to Q2, and our sales to existing customers has stayed sort of flat at the same level as it was in Q2, both down. And that's the area of concern, but the growth vehicle has been a great mid-market model, this team is executing extremely well. And then selectively gaining new business in our enterprise business, but that's one that's a little bit more competitive and one that we use more discipline in.

Operator

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

Bradley Thomas - KeyBanc Capital Markets Inc.

I wanted to talk about the Retail segment. Obviously, it's a difficult environment out there and everyone in the segment is having a difficult time driving comp growth. I was hoping that you could just talk a little bit more about some of the traction you're getting from efforts to drive comp growth, and what you're seeing in terms of different product categories and from some of the different types of customers that you serve. We know that you're making investments in technology and phones and Copy & Print, but how are things holding up, when you look at a market share basis, especially versus some of the Internet competitors like an Amazon?

Ronald Sargent

Demos?

Demos Parneros

Sure. Well, we talked a little bit about some of the categories, where we're gaining traction and we're building nicely. A few of the examples are, the computer business has been strong for us. The tablet business, it's been a nice add-on as we see customers using this product as an add-on item as opposed to replacement add-on. And the good news there is that we've seen little cannibalization in that business. Copy & Print have been a continuing strong area for us and we've maintained our plans to put our outside sales force in place and have grown that, so we're seeing good traction there. We talked about our enhanced website in that business, so that's been a good steady performer for us. The business that's not a fast grower industry-wide. Our Tech Services business has been a good balance to the tech hardware growth that we've seen. So I think overall, we're just taking a good balanced approach, we talked a little bit about facilities at retail, so there's really no one big category that's the driver. There are always categories that are in decline and there are always categories that are in the growth trajectory, and our job is to find ways to do that. We've protected the core nicely as shown in the examples earlier with the ink and paper business. And so that's been sort of the plan. In terms of customers, we'd love to see a little bit stronger business traffic in our stores than consumer traffic. That being said, we will do the best we can with the traffic that's there and traffic has been pretty consistent over the last few quarters. And we're seeing good results in how we're taking care of those customers with our record customer satisfaction results that we've seen consistently throughout the last year or so. That touches a few of the key categories.

Ronald Sargent

And the only thing that I would add, we've done a lot of work on looking at online competitors and we're certainly one of those online competitors. But when you look at kind of share of market, I think online competitors have done best in areas like consumer electronics and business machines, and they have not done nearly as well in kind of the 8,000 to 10,000 to 30,000 SKUs of office supplies, which are fairly low turn and are probably not being focused on as much.

Demos Parneros

Just the other point I'd add is, Ron, that I think, when we think about competitors and they come in all different size and shapes, I think the thing that's exciting for us is to be able to offer both and we know that a lot of our customers, that they're buying tech. They definitely start online and either wind up online or in the store and really looking to continue to work closely across the 2 channels here to just take advantage of what we have. We have the incredible delivery capability that customers like. Offer things like pick up in stores. It's really about the way the customer wants to shop more than anything else.

Bradley Thomas - KeyBanc Capital Markets Inc.

If I can just follow up quickly on the tablet category. It seems like the results out of the non-Apple tablets have been disappointing. What level of risk do you have when someone like an HP comes out and lowers price shortly after they launch a product? How do you balance that markdown risk with the vendors as you get into periods like holiday, where these tablets may have more markdown risk?

Demos Parneros

So we're excited about the tablet business, first of all. It's a new business for us. But before it's a complementary business. We really feel like customers are becoming 3-device users with a laptop, a mobile phone and of course, the tablet and they use it differently. So in terms of the launch, we can't control whose manufacturing the product. Obviously, we have an excellent selection in our stores. We've got about 8 tablets in the assortment at the moment. Some are stronger than others. Clearly, there are winners and losers there. I think the pricing is going to find its way. I mean, it really depends on how they're moving the product, the customers are critical here because they have products to compare this to. There's a lot written about this product. We expect to just -- it's getting better. And I think by holiday, it will be pretty heated up.

Ronald Sargent

And typically with the vendors, we're price protected and in many cases inventory protected. So there's really no risk to us. We manage our inventory pretty well and work with the vendors to -- if they're going to lower the price, they're going to protect our inventory as well.

Mike Miles

We've given a lot of feedback to our vendors and if you look at the vendors that we've chosen to partner with, I mean, there's a big players that we have good track record and good relationships with such as HP and Dell, among others. And the nice thing about the rollout of this product, as it's happened is that we've got a lot of history now of building and we're able to make smart decisions about inventory and assortments.

Operator

Your next question comes from the line of Chris Horvers of JPMorgan.

Christopher Horvers - JP Morgan Chase & Co

As you think about the low single-digit sales guidance in the back half of the year, can you talk about what the embedded local currency growth rates you're thinking about in each of the divisions? I understand you don't project FX, but you'll continue to receive some benefits just assuming that it sits right here?

John Mahoney

Yes, we tend to look at forward rates on currency and expect that the current trends in currency will stay the same. Obviously, currency has been more volatile but we expect some benefit in the back half of the year.

Christopher Horvers - JP Morgan Chase & Co

So, I guess -- I mean, is there a way -- in that low-single digits, is that -- I mean, you saw 400 basis points this quarter roughly. I mean, that was above what we thought. I mean, does that moderate or -- in the back half based on how you think about rates?

John Mahoney

Yes, it does. I mean, we're expecting rates to stay in the range where they are now, and I think that compares to last year's rates that were only slightly lower than where they are now.

Christopher Horvers - JP Morgan Chase & Co

Okay, fair enough. And then on the retail side of the business, just curious if you could just rehash the commentary of around the PC business, do the comps that you talked about include tablets or exclude tablets? And then as you wrap that all together, you're in the heart of back-to-school, it sounds like these parts of your business, the tech plus the wireless are going to shift in the mix. Would that simple math suggest that you should see incremental traction in same-store sales as you head into 3Q?

Ronald Sargent

Demos, you want to talk to that?

Demos Parneros

Yes. Just to clean up the first item, that was the PC number that we shared with you. So tablets are above and beyond that. But the overall, I mean, just to comment on PCs in general as it relates to back-to-school, I mean, we've got a fantastic set of offers for back-to-school. We talked earlier about the college student as a part of business that we're focusing more on this year versus last year. In fact, we've got a great promotion that no one else has out there, where college students show us their college ID and you get an extra $100 off on products that we expect early in the season more college students and that's been successful for us. So we've got a good solid plan, excellent assortment, good inventory plan, PC should continue as the quarter unfolds and back-to-school unfolds. We talked a little bit earlier about the transition, oftentimes there's just not product available as new product is introduced that spike sales. So that's an explanation for the mid-quarter sales trend. So what else was in your question, sorry?

Christopher Horvers - JP Morgan Chase & Co

And then in the wireless business, how many stores is that in now? And if you put that wireless in the stores that wasn't there before, plus with this mix shift toward a better performing tech. Do you think that you could get to like a one sort of comp in here in the third quarter?

Demos Parneros

So our plan is to continue forward with the wireless initiative. Obviously, we're pleased with the results of the test that we did last year and the first several hundred stores that we've rolled out so far. So the challenge for us is now to continue to build awareness that we're in this business. We feel very good about the partnership that we have out there and the execution that our team has shown. So our plan is to continue to go forward, to get to the 500 stores, it certainly adds traffic to the store, brings in more customers who may not have been shopping us before. And that's part of our Q3 sales plan overall.

Christopher Horvers - JP Morgan Chase & Co

Okay. And the tough question for Ron and John, is there a way to think about, you -- embedded into your guidance is some acceleration in EBIT and net income growth into the back half of this year. Is there a way for us to think about how much of that has to do with maybe easy compares, better leverage in larger quarters and specific cost opportunities versus, with the accelerated benefits from customer acquisition or growth in gen center [ph] or those growth initiatives?

Ronald Sargent

I would just say it's all in there. In terms of parsing it out by what's an easier compare in Q4 because of the weather and what our acquisition rate is going to be and what our comp rate is going to be, it's just -- it's a little hard for us to share that for a lot of reasons.

Operator

Your next question comes from the line of Michael Lasser with UBS.

Michael Lasser - UBS Investment Bank

On the Retail side, how did the technology category performed in the locations that have the new planogram that's focused on this category and was there a halo benefit to the rest of the store?

Ronald Sargent

Demos?

Demos Parneros

Not sure specifically what -- which part of technology you're referring to?

Laurel Lefebvre

[indiscernible]

Demos Parneros

Okay. So clearly when we've made those decisions, we're getting a list that's significantly higher than the house. We have an enhanced assortment there. In addition to the assortment, there's a different look and feel in the stores, a little bit more of an authority look and feel and certainly a different operating model with a little bit more labor pointed towards those categories. So as we've indicated before, we continue to invest where things are working. If they're not working, we slow down and sort of readjust, but definitely seeing good results in the handful of stores that have.

Michael Lasser - UBS Investment Bank

Is the economic model of that model scalable enough such that you could roll it out more broadly?

Demos Parneros

Yes. We continue to refine the model. The difficult thing for us is to choose the privatization frankly. And in the case of the mobile phone business, we selected that as the #1 priority at the moment because it's new customers, it's plus business that we didn't have last year. The other initiatives are also in play and are rolling throughout parts of the country as we see fit and as we can handle and do well in each of the next couple of quarters.

Michael Lasser - UBS Investment Bank

Okay. And then a quick follow-up for John. You've nearly exhausted the amount of share repurchases that you indicated that you were going to do this year. How should we think about the back half, especially with the stock trading at the valuation that it is right now?

John Mahoney

I think as we said last quarter that we're going to be -- we're going to be aggressive when the stock price is low and I think we did that last quarter. Clearly, we had said $300 million to $500 million of share buyback for the year. We'll clearly be at the top end of that. So I think our plans are to continue to buy back shares and we'll do it in keeping with our overall capital plan.

Michael Lasser - UBS Investment Bank

Okay. And then the last one for Ron. Do you think that there's a need for any larger scale acquisition that would move the direction of the business kind of over the longer term, either in a more adjacent category or add a new complementary capability?

Ronald Sargent

Well, do I think there's a need? No. I mean, I think we're performing pretty well and I think as the economy improves, we're going to perform even better. We're certainly -- seem to be doing very well in our industry. We've got a lot of growth initiatives that I think we can fund and run internally. Having said that, if there was a great opportunity that we saw to improve our business and deliver shareholder value, we'd certainly take a look at it. But do we need to? No. I don't think we do.

Michael Lasser - UBS Investment Bank

Okay. Are those opportunities coming up do you think or are crossing your desk?

Ronald Sargent

We get opportunities all the time. Some are very good, some are very bad. And we always kind of put it through the filter of what's the right thing for Staples' shareholders.

Operator

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

Kate McShane - Citigroup Inc

With the sequential improvement in retail comps in Europe, even though they were still down, was there a particular region or country that saw the biggest improvement?

Mike Miles

Kate, it's Mike Miles. The U.K., Germany and the Netherlands, which are our 3 biggest retail markets, were all up quarter-over-quarter pretty significantly and about the same amount. So it was kind of across the board that we got better, obviously, negative 5 is still significantly down. And I think the good news is that it was generally in response to some of the efforts that we've been making. As we talked, we're trying to refocus those businesses a little bit more on the business customer and on office supplies and away from technology and kind of price item promotion. And in the U.K., we saw a nice growth compared to the first quarter in paper and office supplies. In Germany, it was in printers and paper and office supplies. Those categories improving significantly versus the first quarter. And then in the Netherlands, our copy center business moved up significantly, albeit off a small base but reflecting the relaunch that we did in about half the chain. So I think that while minus 5 comp is certainly -- leaves us with a lot of work to do, it reflect progress along the lines that we've been working.

Kate McShane - Citigroup Inc

Okay, great. And, Mike, if I could just follow up in light of some of the commentary that was made today about NAD and the ability to leverage expenses, with all the different expense controls, has there been a goal for when you'll be able to leverage and what is the timing for when you're going to bring private label internationally?

Mike Miles

Yes. I think the international team is working pretty hard to get private label into the business and we're seeing a very nice improvement particularly in Europe, where we're seeing a couple of hundred basis points of improvement. That's true in Australia and to a lesser extent in high-growth markets, where sort of quantities are still a bit of a challenge for us. With respect to leveraging, we're still working against the profit improvement plan that we described last year to get to 7.5% operating margins. And although the first quarter was clearly a disappointment, we were able to squeeze out a little bit of leverage in Q2 and expect to improve upon that in Q3 and Q4 and certainly 2012 and 2013.

Operator

Your next question comes from the line of Alan Rifkin of Barclays.

Alan Rifkin

Just a follow-up for Mike. Given your earlier commentary and with the growing concerns in Europe, would you be able to shed just a little bit more color on what you're seeing with respect to core demand on both retail and delivery in countries where the European crisis seems to be escalating as opposed to areas where it is not?

Mike Miles

Yes, as I said, there's -- certainly the European economy has not been any picnic for us, but Q2 wasn't significantly worse. There's a lot of concern about cutbacks in government spending, but that is not as much of an impact for us on our Contract business because to the extent we have a significant government exposure, it tends to be more in the Nordics region, where that hasn't been as much of an issue, say, compared to the U.K. where it's a significant issue. Germany, although it decelerated last quarter from a macro standpoint, as I mentioned we saw improvement in our Retail business and actually posted positive retail comps in Germany. So and -- Italy, which has been one of the toughest economies among the places we operate in Europe is one where we've actually seen nice sales growth this year. So we're able to see generally pretty good results in the Delivery business, in spite of the soft economy and I think our retail issues are relatively long-standing in Europe and we're continuing to work against those.

Alan Rifkin

Okay. And one follow-up if I may. Ron, you said that during the quarter, you successfully were able to renegotiate about 150 leases. I was wondering if you can maybe provide a little bit more color on your efforts going forward to possibly become even more aggressive in this regard and look at leases that aren't maybe even necessarily coming to their expiration?

Ronald Sargent

The 150 leases are the ones that are coming up for expiration this year. So that's about a typical number, 150 a year. And every time that a lease comes up or is about to come up, we obviously have those negotiations and discussions. The good news is given the availability of real estate out there, we've been able to be very successful and I think Demos' team has done a nice job in getting our rent expense leveraging again instead of deleveraging. In terms of going forward, I mean, we're working not just 150, but we're working the whole portfolio to see if there's opportunities that we could make hay a little quicker. Demos, I don't -- if you want to add anything to that?

Demos Parneros

Sure. I think the only thing I'd add is that it's roughly 500 stores that we have our eyes on right now. To your earlier question on, can we start the process earlier, the answer is yes and we have. The team's done a nice job at getting ahead of this to take advantage of some of the commercial real estate opportunities that are out there. I think the bigger issue for us is that we're able to reposition our entire retail portfolio, and if we take a store out of a market and let the other stores in the market do their job and grow, that's fine for us. We talked about the 15,000 square-foot store, which is our go-forward store. And in cases where we actually relocate stores or downsize, that's the store we go to. So it's really helping us in our continuing effort to shrink store size and get the right sized store for the right market as we have several different store sites to choose from.

Alan Rifkin

Okay. Any sort of quantification on just how much you've been able to save on an average lease that's been renegotiated, just so that we can hopefully apply that going forward? I mean, has the rent reduction been mid single digits? Has it been double digits?

Demos Parneros

I'd say there's a wide range, honestly. Some are in the double-digit range, some a little bit lower depending on the market and the situation. So it just really depends on where and when.

Ronald Sargent

Yes, and if you've got a great store and the landlord knows you have a great store, your rent might be going up at the end of the lease term as well.

Operator

Your next question comes from the line of Michael Baker, Deutsche Bank.

Michael Baker - Deutsche Bank AG

I wanted to focus on the SG&A and I certainly appreciate the need and desire to invest in the business. But I guess the question, the sales were better than they've been in a while this quarter. And yet you still deleveraged the SG&A and your operating margins were down. Is there a sales -- I guess, the question is this. Should we expect those investments to start to tail off a little bit? And I guess related to that, is there a sales level where we should expect the operating margins to once again expand?

John Mahoney

Well, I think we are, as we said in most of our business, expecting to see operating margin expand in the back half of the year. Certainly International and NAD will see that. North American Retail, we would hope to accomplish the same. So the bigger quarters where we have much more revenue give us a chance to leverage our fixed expenses better than the first 2 quarters, second quarter being our smallest. But as I said earlier, we try and take a look at what's working and what isn't working, what our profit targets are and do what we need to do to achieve our profit targets and try and invest as aggressively as we can in the things that are working, whether its mid-market in Europe or tech in North American Retail or the facilities and breakroom in NAD. We try and invest as aggressively as we can in order to sustain the kind of growth rates we're hoping to achieve long into the future. So we don't think of it as strictly a breakeven sales growth rate to leverage our operating margin rate, but more within the constraints of how the core is doing and how the growth initiatives are creating successful demand for investments, to try and balance that.

Michael Baker - Deutsche Bank AG

Okay. And then one other follow-up. There's something that you touched on, the online competition, but I want to ask this. So if one were to do just a simple price comparison on ink and toner between Staples.com and Amazon.com. There is a significant difference on like-for-like items, maybe in the 20% to 30% range. So I appreciate that you guys compete on service and the like, but is there any plans -- or how do you deal with that price gap? I mean, do you just try to maintain your premium and compete on service or do we think at some point that price gap needs to narrow?

Ronald Sargent

I think the gap is probably, first of all, a little narrower than people would think when you just do the SKU-to-SKU comparison. I mean, basically all of our ink is sold by customers who are utilizing the rewards program, so that knocks 10% off. We also have a recycling program, where we give $2 for every cartridge you come. Our pricing is not exactly the same in retail and delivery, so there's all kinds of differences. So I think you got to factor all that in to look at that. Having said that, we're growing our share in ink and toner. To the extent we weren't growing our share in ink and toner, we'd probably look at all the things we could do to be doing it differently. So I think it's a function of our business. It's an important business to us. And if it's not working, we make changes. If it works, we kind of use the program that we have in place. I don't know...

John Mahoney

And the only other thing I'd comment on, Ron, is as you get into the business customer, the experience with an Amazon ordering is going to be a little bit more difficult than how we can manage a small business customers demand. So I think it's -- we obviously gear our programs for the small business customer and the simplicity of being able to shop us across all the product categories is a benefit that many small business customers value.

Operator

And your final question comes from the line of Dan Binder of Jefferies.

Daniel Binder - Jefferies & Company, Inc.

Couple of questions for you. First on, a question really regarding delivery market share versus retail market share gains. You've done just a phenomenal job taking share in delivery and you can see that when we compare the numbers to your competitors. The retail share gains have been a little bit slower by comparison. I'm just curious, if there's anything you think you can do to accelerate that? It seems like in Delivery, it's a lower cost to serve. It's an ability -- it's buying power. Do you think you can make those same kind of investments in retail price to accelerate those share gains?

Ronald Sargent

You're saying if we would become more promotional, would our share go up? Is that...

Daniel Binder - Jefferies & Company, Inc.

No, not necessarily more promotional. But you're seeing more players talk about more disciplined EDLP and really striking a bigger price difference. And I'm just curious if there's an opportunity to -- while your competitors are struggling to be more aggressive there?

Ronald Sargent

Well, we've done a lot of testing, where we would go into a market and we would lower prices and we would tell the world that we're lowering prices, and we would determine whether that made a difference in our top line. And after an 18-month test in 2 different markets with 2 different competitive sets, you pick up a little sales. You wind up losing a lot on the margin side. In retail, it's all about convenience. And unless you want to put a store everywhere, I think you're not going to change the convenience factor in a lot of markets that we currently operate in. So I mean, we think it's -- I agree, it's slower, it's a slower grind. But having the right prices, right service, the right selection, the right people in your store, it's a little bit of a slow burn grind, but it's probably the right way to go about growing our market share. I don't think the big bang of we're going to lower our prices x% is going to result in prosperity going forward.

Daniel Binder - Jefferies & Company, Inc.

Okay. And you talked about operating margin improvement in the back half. Year-over-year, it sounds like for the, at least 2 of the 3 divisions, maybe retail as well. Just curious if you can give us a little sensitivity around what level of sales you need at a minimum to achieve that?

Ronald Sargent

I think when you look at our guidance, we're guiding to low single digits, growth in the top line and in terms of the bottom line, I think you'll see leverage in both Q3 and Q4 based on the guidance we gave this morning. Obviously, if sales are better, we could do better.

Daniel Binder - Jefferies & Company, Inc.

Okay. And then the final question is around this smaller dealer competition. Obviously, the wholesalers in this space have been enabling these dealers to do more and sell more to more folks. It doesn't seem to be getting in your way, but I'm just curious what you're seeing in terms of their progress, if you're starting to run into them more often and sort of midsized bidding RFPs.

Ronald Sargent

No, we're really not. I'll ask Joe to provide a little color commentary on why the wholesale numbers seemed to be a little better.

Joseph Doody

I think, Dan, a couple of comments. One is they are engaging with the dealers and that's the biggest part of their business. We're also a part of their business. Those are our friend and foe of ours and we clearly recognized that, as do they. I think you can see in some of the wholesaler numbers the fact that some dealers are continuing to go more and more stockless. They're also selling more and more categories and relying more and more on the wholesalers for that, so they're seeing some decent numbers from independents. But generally speaking, they're competitive out there, always have been. We compete well against them. Right now, our mid-market initiative in the U.S. is extremely successful [indiscernible] of acquisition and the growth in that business. So we're very happy where we're positioned against them right now in the marketplace.

Daniel Binder - Jefferies & Company, Inc.

And just one final housekeeping item. I apologize if you addressed this already. I got dropped from the call. But the -- in your press release you talked about NAD benefiting from some foreign currency change rates, what is the 3.1% growth look like in local?

Ronald Sargent

2.5%

Operator

And there are no further questions. I'd now like to turn the call over back over to management.

Ronald Sargent

Okay, great. Thanks everybody for joining us on the call this morning. We appreciate your interest and your time, and we look forward to speaking to all of you again very soon.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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