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OfficeMax Incorporated (NYSE:OMX)

Q2 2012 Earnings Call

August 02, 2012 10:00 am ET

Executives

Michael Steele

Ravichandra K. Saligram - Chief Executive Officer, President and Director

Bruce H. Besanko - Chief Administrative Officer, Chief Financial Officer and Executive Vice President

John C. Kenning - Former Executive Vice President and President of Contract

Michael J. Lewis - Executive Vice President and President of Retail

Analysts

Oliver Wintermantel - ISI Group Inc., Research Division

Michael Lasser - UBS Investment Bank, Research Division

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

Christopher Horvers - JP Morgan Chase & Co, Research Division

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

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

R. Scott Tilghman - Caris & Company, Inc., Research Division

Operator

Good morning. My name is Alicia, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the OfficeMax Second Quarter 2012 Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce you to Mr. Mike Steele, Senior Director of Investor Relations of OfficeMax. Mr. Steele, you may begin your conference.

Michael Steele

Good morning. Thanks for joining us. Today's call will be archived in our website for 1 year and is available as both a webcast and a podcast. Certain statements made on this call and other written or oral statements made by or on behalf of the company constitute forward-looking statements within the meaning of the federal securities laws. Management believes that these forward-looking statements are reasonable. However, the company cannot guarantee that actual results will be consistent with the forward-looking statements, and you should not place undue reliance on them.

These statements are based on current expectations and speak only as of the date they are made. The company undertakes no obligation to publicly update or revise any forward-looking statement. Important factors which may cause results to differ from expectations are included in the company's annual report on Form 10-K and in the company's other filings with the SEC.

Now I'd like to turn the call over to our CEO, Ravi Saligram.

Ravichandra K. Saligram

Thanks, Mike. Good morning, everyone, and thank you for joining us. I'm very pleased to report that in the second quarter, we continued to make solid overall progress towards our long-term financial goals, realizing significant year-over-year improvement in operating income and earnings per share.

Given the continued softness in demand and the weak economic environment, we remain focused on the things that we can control, satisfying our customers through highly engaged associates, driving execution of our programs and stringently controlling costs. This focus is yielding results. Our contract business and digital initiatives are gaining momentum. We're making good progress with our growth adjacencies, and we're taking the right actions to address the challenges in retail.

We recognize that many investors believe that our stock is significantly undervalued and we agree. We believe a few factors affect investor perceptions: First, investors continue to be concerned about the prospect of this sector based on global economic headwinds and the secular declines of certain categories. Further, investors are concerned about retail saturation as well as channel shifts to online.

Second, investors and prospective investors in particular, find some aspects of our balance sheet difficult to understand. As an example, the Lehman Brothers and Wells Fargo timber notes, although nonrecourse to OfficeMax, create misperceptions of our debt levels.

Let me address each of these issues briefly. While our sector is admittedly a challenging one, we continue to be enthusiastic about its long-term prospects. Office products in the U.S. alone is well over $200 billion in size with many segments and channels. We do not want to confine our view of the opportunity as just the OSS channel. Instead, we're taking a broader view and aim to capitalize on the fragmentation that exists in the overall sector.

We also believe our increasing focus on services will help our top line while improving our margins in the long term. We're also proactively investing in building our digital infrastructure, with a particular focus on multichannel efforts.

Let me now turn to the balance sheet. Our board and management are conducting a comprehensive analysis of our capital structure overall and are vigorously evaluating capital allocation alternatives. We feel it is important to look at the balance sheet simplification and capital allocation holistically.

Specific to our balance sheet, we continue to explore solutions to address legacy issues and divest noncore assets such as Croxley in New Zealand with the highest sense of urgency. Decisions regarding these assets will help to inform a holistic plan for capital allocation that benefits OfficeMax and its shareholders long term. As a first step of evaluating capital allocation alternatives, we've decided to resume a quarterly dividend of $0.02 per share. The dividend decision reflects our confidence in the future of OfficeMax. Also, it does not preclude us from pursuing other alternatives for allocating capital.

Our board and I are committed to driving shareholder value. We will do this by improving our P&L performance as we've demonstrated in the last 3 quarters. Equally, we're committed to enhancing shareholder value by optimizing our balance sheet. We expect to continue to make meaningful progress throughout the remainder of the year.

So here's what we plan to cover on the call. First, I'll share the highlights from the second quarter and update you on some of our key initiatives. Then Bruce will walk through the financial details of the quarter and provide some additional color on our balance sheet. I'll make some concluding remarks and we'll move to Q&A.

Our team is executing well against our strategy, and I'm pleased with their performance in the second quarter, which builds on the success of a strong first quarter. Let me walk you through some highlights. We delivered adjusted operating income of $23 million, up $5 million on nearly 30% from the second quarter last year. This translates into earnings per share of $0.12, which is up $0.05 over the same quarter last year. This profitability improvement was primarily driven by reductions in SG&A, resulting from tight cost controls.

Our second quarter sales decline of 2.7% was in large part due to fewer stores opened this year and unfavorable currency translation. However, it is important to note that on a comparable basis, our second quarter sales actually grew a modest 30 basis points versus prior year. In fact, in the first half of 2012, we grew 20 basis points versus the first half of last year. Bruce will provide a more detailed explanation in a few minutes.

Let's turn to our Contract segment performance. We continued strong profitable growth in our U.S. Contract business. Sales grew 2.6% in the second quarter versus the prior year. We have a solid management team in place, and they're doing an effective job growing the core business and gaining traction on the higher-margin adjacencies.

Our net win to loss metric in absolute dollars was positive for the fifth quarter in a row, and we grow another record high quality retention of 93%. Further, we continued to see a slower rate of decline year-over-year in sales to existing customers. Key adjacencies, including facilities, products and services, print solutions and furniture and workplace showed good growth during the second quarter. In fact, in aggregate, all 3 combined grew double digits during the first half of the year.

We recently expanded our SMBs, small and medium business sales unit operations, to 4 additional markets. This follows the initial launch of 4 markets at the beginning of the year. I'd also like to congratulate our Contract team for receiving 3 awards this quarter related to providing outstanding value, services and cost savings by 3 of our largest customers: Corporate United, Novation and Premier. These awards are examples of why we've been setting record customer retention rates.

Turning to our international Contract business. Our rate of decline is stabilizing, with a 2% sales decrease in local currency versus the prior year and in line with the first quarter decline. We believe the international business is core to our growth strategy, and we are focused on steering the business back to top line growth.

Our recent initiatives to improve gross margin and streamline the cost structures in Canada, Australia and New Zealand have been driving significantly improved profitability. We now have a solid team in place in Australia and New Zealand that is driving an operational turnaround. Our Contract teams throughout the world are doing a better job with cross-country collaboration and sharing of best practices. Our Australia and New Zealand business, combined with our North American operations, and low-cost footprint in Europe and Asia, provide a powerful network through which we serve global customers.

As a point of reference this quarter, Australia and New Zealand combined, were the company's third largest business behind U.S. Retail and U.S. Contract in terms of both revenues and profits. We have the #2 market share in Australia in the Contract segments, and we have the #1 market share in New Zealand in the Contract segment and are now an authorized Apple reseller there.

Overall, I'm pleased with the progress we have made so far in the Contract business globally. Second quarter Contract segment income was nearly $26 million, an increase of $8 million or 48% versus the prior-year period. And segment income margin was 2.9% in the second quarter of 2012, a 90 basis point improvement from the second quarter of 2011.

Moving on to our Retail business. This team's seeing stabilization in our comps over the past few quarters, thanks to strong execution by our Retail team. Second quarter U.S. comp -- sales comps declined 1.3%, a sequential improvement to this year's preceding quarter. Transaction counts declined slightly, and average ticket was up slightly. Our furniture and supplies categories comped positive with gains in some writing instruments, copy paper and chairs. Weakness in the technology category drove the slightly negative overall comp.

We're feeling the impact of softness in customer demand in several technology categories such as software, printers and computer peripherals. However, PCs comped positive, driven principally by inventory clearance activities. Additionally, major vendors have reduced their promotional spending in the technology category, and this is having a negative impact on revenues and profits.

Delivering profitable sales volume in our stores has been a top priority. Therefore, we have been focused on strengthening our competitive position and price image through simplified selling messages and an increased emphasis on the value proposition to our customers; creating a selling and service environment through improved associate engagement, training and performance recognition; and expanding current service offerings while exploring new categories, which have strong appeal to small business customers.

While we recognize the technology sector is experiencing short-term softness, we remain committed to its strategic relevance. Our tech world initiative in 14 established pilot locations in San Francisco continues to meet our customer experience and financial goals. Now we're remodeling the technology section of an additional 12 stores in Michigan and Illinois for completion by next week. We expect to expand the pilot to an additional 39 stores by the holiday season.

Our in-store services were bright spots again in the second quarter. ImPress print and demand, Print & Document services comped positive, and we are pleased with the volume we are seeing at ctrlcenter, our in-store technology and computer support offering, which was fully rolled out to our U.S. retail stores at the start of the year. Our associates are doing a great job driving sales to these higher-margin services as we emphasize them in our stores.

We recently kicked off the important back-to-school season, where we are focused on offering value and great prices to moms who are the decision-makers for school supplies. We have a solid in-store campaign strategy, which will be supported by external marketing efforts in broadcast, print and social media.

We have launched partnership marketing programs with Payless ShoeSource and Old Navy, and we continue to support teachers nationwide through our teacher appreciation days and special savings programs, all building towards A Day Made Better initiative in October where we surprised 1,000 deserving teachers with supplies for the classroom.

Our new channel's growth adjacency continues to expand, currently more than 7,000 retail outlets for the upcoming back-to-school season. This growth adjacency expands our reach into other channels and retail outlets outside of our store base to capture incremental business from individual consumers of office products.

And finally, we opened 2 stores in Mexico, an important growth adjacency for us. In the second quarter, we continued to see positive sales comp growth on a local currency basis. Our retail team is focused on execution in a difficult environment. We continue to optimize our store network by selectively closing, downsizing and relocating stores in the U.S. I'm confident that our ongoing changes to our retail store network will improve both productivity and return on assets over time.

I'll conclude with an update on digital. The team has made strong progress on several fronts. Digital again delivered double-digit profitable growth in the second quarter on officemax.com, driven by solid increases in traffic and sales conversion rate. We continue to build out our digital team, to listen to our customers and to execute against the product roadmaps on each of our websites and in multichannel, improving our customer's experiences.

On officemax.com for example, we improved product detail pages, shopping cart and added the ability to buy from our online circular. We're also working to install a new search engine in the coming months. On our OfficeMax Solutions website, for example, we added capabilities to better showcase alternative product choices and accessories. We plan to add more features, new features and update the look and feel of the site later this year.

Recently, the digital team also worked closely with supply chain our merchants to implement the capability for users to view in-store availability, which is the first step towards a buy online, pickup in store multichannel offering, on track for implementation later this year. I'm also pleased with our operational capabilities. In fact, in May, officemax.com was ranked #1 in critical site performance on both Internet Explorer and Firefox by Compuware Gomez, a leading authority on website speed, performance and consistency monitoring.

In summary, we had another good quarter, and we are pleased with our overall progress in executing against our strategic plan. At this point, I'll turn it over to Bruce for the financial review and outlook.

Bruce H. Besanko

Thanks, Ravi, and good morning, everyone. Let's begin by walking through the income statement highlights. Consolidated net sales in the second quarter of 2012 decreased 2.7% to $1.6 billion compared to the prior-year period. On a local currency basis, net sales decreased 1.7%. Adjusted for currency translation, store closures and the shift in weeks for our U.S. businesses to the 53rd week in 2011, consolidated adjusted sales growth was 0.3% versus the prior-year quarter.

Second quarter Contract segment sales were $878.8 million, a decrease of 0.2% compared to the second quarter of 2011. On a local currency basis, Contract segment sales increased 1.0%. In our U.S. Contract business, which is approximately 2/3 of our Contract segment, sales increased 2.6% from the prior-year second quarter.

In the second quarter, continued strong net new sales, that is sales to new customers exceeding lost sales to former customers, more than offset a 2.5% decline in sales to existing customers, which was a sequential improvement in the rate of decline from Q1. As Ravi mentioned, net new sales were positive for the fifth consecutive quarter, and we achieved another record quarterly retention rate.

In Q2, sales in our international Contract business decreased 6.0% in U.S. dollars or a decrease of 2.3% on a local currency basis.

Second quarter Retail segment sales decreased 5.7% to $723.6 million compared to the second quarter of 2011, reflecting fewer stores and a 1.8% decrease in same-store sales, which was negatively impacted by 90 basis points from the currency translation of the peso.

U.S.-only retail same-store sales decreased 1.3%, with fewer transactions and a higher average ticket. Furniture, supplies and ImPress print and copy services all comped positive while the technology category, including ink and toner, comped lower.

Q2 Mexico same-store sales increased 3.5% on a local currency basis, a decline of 6.9% in U.S. dollars.

OfficeMax gross margin was 25.6% for the second quarter, a decrease of 20 basis points compared with the prior-year period. Contract segment gross margin was flat, primarily reflecting lower occupancy and delivery expenses, which were offset by slightly lower customer margins.

Retail segment gross margin decreased 40 basis points for the second quarter, primarily due to lower gross profit margins in Mexico and higher freight and delivery expense in the U.S. These factors were partially offset by increased customer margins in the U.S.

Adjusted total operating expense, which includes general and administrative expense, improved to 24.1% of sales in the second quarter of 2012 compared to 24.7% in the prior-year quarter. Contract segment operating, selling and G&A expense was 19.4% of sales for the quarter, down from 20.3% in the second quarter of 2011. The improvement was primarily due to lower payroll expense due to reorganizations and facility closures in 2011, which was partially offset by higher incentive compensation expense. And please remember that in 2011, we had minimal levels of incentive compensation expense.

Retail segment operating, selling and G&A expense was 29.1% of sales in Q2 2012 compared to 28.9% in the second quarter of 2011. The increase was due primarily to higher incentive compensation expense, primarily offset by lower credit card processing fees and lower advertising expense. Adjusted operating income margin in the second quarter of 2012 increased to 1.4% from 1.1% the prior-year period. The 90 basis point year-over-year improvement in the Contract segment was partially offset by a 60 basis point decrease in the Retail segment.

As we mentioned in this morning's press release, Corporate and Other segment operating expense was $5.5 million in the second quarter of 2012 compared to $7.5 million in the prior-year period. The decrease was primarily due to lower pension expense.

For the second quarter of 2012, we recorded adjusted net income of $10.7 million, or $0.12 per diluted share, compared to $6 million, or $0.07 in Q2 of last year. Please note that adjusted sales growth, adjusted operating income, adjusted net income and adjusted earnings per share are non-GAAP financial measures which we reconcile to GAAP financials in our press release.

Now let's turn to the balance sheet. At the end of the second quarter, we had cash and cash equivalents of $445 million, and total debt, excluding the nonrecourse timber securitization notes, of $237 million. In June, we paid a $35 million medium-term note at its scheduled maturity date. Please bear in mind that the total debt I mentioned excludes the $1.47 billion of nonrecourse debt shown on our GAAP balance sheet. As we said in the past, in order to reflect OfficeMax's obligations accurately, we as well as third parties such as the 2 major credit rating agencies, exclude the $1.47 billion of timber notes from the calculations of various financial metrics and ratios used to assess the valuation of the company because they're nonrecourse to OfficeMax. Please visit our Investor Relations website for answers to frequently asked questions regarding the nonrecourse timber notes securitization program and the impact on our financial statements.

As Ravi mentioned, we're in the midst of a comprehensive review of all aspects of our balance sheet. Our goal is to simplify and create greater clarity for investors. The issues are complex but the benefits of resolution are compelling.

Consider the Lehman portion of the timber notes. While we can't comment on the bankruptcy proceedings, we now believe this matter is likely to be resolved by year end, such that OfficeMax will no longer be required to record the nonrecourse debt liability on its balance sheet. At that time, OfficeMax would also expect to write off the remaining carrying value of the timber notes receivable asset. Once this is resolved, all the Lehman-related asset and liabilities will be taken off our balance sheet, resulting in a significant noncash gain and a write-up of book equity.

Supporting our optimism is the fact that an initial distribution from the Lehman estate of approximately $50 million was received in April. As of June 30, the distribution was classified as restricted cash, and the carrying value of the Lehman-guaranteed installment note, which is reflected as an asset on the balance sheet, was reduced by this amount. We expect the cash to be ultimately distributed to the noteholders, and we don't have the right to access the cash for any other purpose. Although much of the timing of these next events are outside of our control, we're working to influence events where we can.

Similar to the Lehman matter, we're evaluating certain other legacy and nonoperating assets and liabilities, including the Wachovia Wells Fargo backed half of the timber notes securitization program, our underfunded pension obligation and the investment in Boise. Again, we're using a holistic approach to evaluate opportunities to address the balance sheet so that we can fully address our capital allocation, including the cash balances.

Our evaluation is not limited to our noncore operating assets. To that end, we want to confirm efforts are underway to sell our Croxley business in New Zealand. This wholesale business with an outstanding -- which is an outstanding performer led by an excellent management team, does not align with our long-term strategic goals. Our goal is to find a buyer interested in investing and growing the business to its full potential.

In summary, in regards to simplifying our balance sheet, we continue to explore ways to enhance the capital structure.

Now turning to working capital. Inventory and accounts receivable as of the end of the second quarter were at comparable levels to Q2 of last year when adjusted for foreign currency rates. Accounts payable at the end of the second quarter were $42 million lower than the prior-year period, primarily reflecting the timing of certain purchases and foreign currency translation.

Looking at cash flow, we generated $82 million of cash from operations in the first 6 months of 2012 compared to $27 million in the prior-year period. The increase primarily reflects favorable working capital changes and higher earnings. Keep in mind that there was a minimal payout of incentive compensation expense in the first half of 2012 reflecting our 2011 performance.

Capital expenditures totaled $33 million for the second quarter of 2012, funded by cash from operations mostly for systems improvements related to our growth initiatives, software enhancements and infrastructure improvements and a couple of new stores in Mexico.

Now turning to outlook. For the third quarter, we anticipate that total company sales will be approximately flat to slightly higher than the third quarter of 2011 despite the anticipated negative impact of foreign currency translation and the fact that we had 32 fewer U.S. stores at the beginning of Q3 than at the same time a year ago. We also anticipate that for the third quarter of 2012, adjusted operating income margin will be approximately in line with the 2.3% for the prior-year period.

With respect to consolidated gross margin, we expect an approximately flat to slightly lower gross margin rate for the third quarter compared to Q3 2011. We expect SG&A expense dollars will be approximately flat as compared to Q3 of 2011 despite a minimal level of incentive compensation expense last year.

For the full year 2012, we anticipate that total company sales for the year will be approximately in line with the prior year, including the anticipated unfavorable impact of foreign currency translation and excluding the additional fiscal week in 2011, which generated $86 million of sales.

Please note that we now expect foreign currency translation to negatively impact our consolidated sales results for the year. As of the last time we had provided full year outlook in May, we had expected it to be a benefit. Also keep in mind that we've taken out a significant number of stores from our U.S. network, which hurts our overall reported sales growth rate.

Adjusted operating income margin for the full year 2012 is anticipated to be approximately in line with to slightly higher than the 1.7% for the prior year. With respect to consolidated gross margin, we expect an approximately flat to slightly higher rate for the full year as compared to 25.4% for 2011. We expect full year SG&A expense to be lower than last year. Keep in mind that we recorded minimal levels of incentive compensation expense in quarters 2 through 4 of 2011.

Our outlook also includes the following assumptions for the full year 2012: Capital expenditures of approximately $75 million to $85 million, primarily related to maintenance and investments in IT, e-commerce and infrastructure investments and upgrades; depreciation and amortization of approximately $75 million to $85 million; pension expense of approximately $3 million; and cash contributions to the frozen pension plans of approximately $21 million to $28 million. And please note that if as expected, we receive direction from the U.S. Treasury Department prior to our next regularly scheduled October payment regarding the interest rates to use in accordance with the recently passed pension funding stabilization legislation, then we anticipate that our minimum contribution would be at the low end of that range.

We expect interest expense of approximately $69 million to $72 million and interest income of approximately $42 million to $45 million, and adjusted effective tax rate approximately in line with the adjusted effective tax rate for the full year 2011; cash flow from operations exceeding capital expenditures, with working capital expected to be a seasonal use of cash for the remaining 6 months of 2012; a net reduction in retail store count for the year, with up to 35 store closures and 1 to 2 store openings in the U.S.; and in Mexico, we plan to open 8 to 10 stores and close 1 or 2 stores.

And with that, I'll turn the call back to Ravi.

Ravichandra K. Saligram

Thank you, Bruce. 2012 remains the year of building the foundation for sustainable profitable growth. In the first half of the year, in spite a weak demand and an overall uncertain macro environment, we remain focused on executing against our business plans and priorities. Specifically for the first half of 2012, like-for-like sales grew 0.2%, adjusted operating income of $66 million was up 42%, and adjusted earnings per share of $0.35 was up 75% versus the prior year. I'm encouraged by our team's strong progress and overall sense of urgency. Our performance clearly demonstrates that our turnaround is gaining traction and gives us the confidence to recommence our quarterly dividend.

And with that, let's take some questions. Bruce and I are joined by Michael Lewis, President of Retail; John Kenning, President of Contract; Jim Barr, Chief Digital Officer; and Ron Lalla, our newly joined Chief Merchandising Officer. Operator, please open the line.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Oliver Wintermantel of ISI.

Oliver Wintermantel - ISI Group Inc., Research Division

You mentioned that the spend of existing customers in B2B was down again this quarter even though it was better than the last few quarters. Can you just tell us what drove that negative trend and which categories, please?

Ravichandra K. Saligram

Let me turn that over to John. John, do you want to address that?

John C. Kenning

So when you look at the overall B2B spend in the, what I would say, macro environment, we believe it's been down by things, as we stated, such as unemployment, the rate within our organization. But if you look at our customer base, as we mentioned, we've increased our retention across-the-board. Our existing spend within our customers has actually come down over this period of time, and we continue to grow new business outside our customer base. So overall, if you look at the B2B marketplace, we believe in North America, we actually have taken share, and we believe we can continue to take share as we move forward.

Ravichandra K. Saligram

So, Oliver, let me just add to that. First, when you look at -- the encouraging trend we're seeing is that on-contract versus off-contract, off-contract is actually improving and getting higher. And when we look at it on a sequential basis so that's encouraging at least for us. Number two, the fact that the existing declines are reducing, I think, is a positive. One of the things that has affected us, as you know, was the fed business, and that affected the spend. But over time, as we are lapping fed, the decline in fed now is almost down to minimal amounts compared to the huge double-digit declines we had, had a year ago. So I think we look at all 3 levels, when we look at how are we doing on new business, how are we doing on retention and then now the existing business, I think, it's positive. And then as we sell more adjacencies to our existing customers, over time, we think that will pick up.

Oliver Wintermantel - ISI Group Inc., Research Division

Okay. And then for the question traffic versus tickets in retail, you said that traffic was negative and ASPs were up slightly even though your comp was down negative 1.8. So can you give us a little bit more details there? If it was traffic was down in 2% to 3% and ASPs up 1% to 2% if that's ballpark right, and then compare it to the previous few quarters.

Ravichandra K. Saligram

Michael, would you take that please?

Michael J. Lewis

Let me see if I could just answer that. It's Michael here. Listen, first of all, we're reasonably pleased with the Q2 results. April and May was a bit sluggish and then picked up in June, and again, I'm pleased with what the team is doing here. We're seeing importantly conversion rate improving through time. Traffic and tickets are being managed well, we're happy with that, and we're just watching traffic in terms of managing it through the course of our promotional efforts. Importantly, in terms of share and market for the quarter, we registered a slight erosion of 10 basis points, and that is good in the context of our footprint share decline, which has been the 50, 60 basis points area and if you take a look at unit share and not dollar share, we gained significantly in technology and in office supplies.

Operator

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

Michael Lasser - UBS Investment Bank, Research Division

Ravi, as part of your review of the balancing capital allocation, are you including a broader look at a range of strategic alternatives? And as part of the answer, can you update us on your thinking about the need for industry consolidation?

Ravichandra K. Saligram

Michael, we're talking about capital allocation alternatives. And in terms of -- we feel we're getting traction on our strategic plan. We're driving that forward and at this point, that's what we're laser focused on.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And on that answer, can you perhaps reconcile the greater optimism and the traction that you're experiencing with some of your strategic initiatives, with you tightening your range of fiscal guidance for sales for this year? So what got a little weaker?

Ravichandra K. Saligram

I think, on the sales side -- and I'll have Bruce also add to that. Look, on the sales side, essentially it's foreign currencies not giving us the favorable momentum that we thought it would have. But the key to look at is that for the first half, after 5 years of decline, we're actually comping, while it's very modest, the fact that it's up 0.2% versus prior year, on an organic basis. On a like-for-like, I think that's encouraging for us. And the gains we are making on digital, which is strong double digits and the gains we are making in Contract, I think, are positive. So clearly, these are all a result, especially in the very weak economic environment because of our initiatives and the execution of our teams. So we're not optimistic necessarily by the economic environment, but we are optimistic about our execution on what our teams are doing.

Michael Lasser - UBS Investment Bank, Research Division

My final question is, I guess, SG&A dollars year-over-year were down about $20 million. You mentioned some reductions in staff, and that $20 million reduction was in spite of incentive comp coming back. So can you expand on where the reductions have come and any potential implications from that down the road?

Ravichandra K. Saligram

Bruce?

Bruce H. Besanko

Sure. Hey, Mike, great question. So you hit it right. We've improved roughly 60 basis points in the second quarter on SG&A, which is about $20 million to $21 million in absolute terms, and so that was driven by some very tough decisions that we made. Through the course of last year, as you may recall, we had 3 CFC closures that were in the back half of last year. We had a number of restructurings in our Canadian business and our Australian and New Zealand businesses. And as a consequence, the benefits of those restructurings are now taking effect into this quarter and on SG&A. So we also closed a number of stores, underperforming stores, and so there's lower payroll from those store closures. And we're also getting a bit of a benefit because of the FX issue in our international businesses. As the dollar is strengthening, the SG&A that occurs in those international businesses actually has a slightly favorable effect. So all of those things, including these very difficult decisions we made last year, are now starting to show up in the P&L.

Michael Lasser - UBS Investment Bank, Research Division

If I can sneak one last one in. Can you give us the EBITDA associated with the New Zealand business that you put up on the block?

Bruce H. Besanko

Yes, we're not going to comment on the level of EBITDA, but what I would tell you about approximately is the process is beginning to unfold. It's 1 of 2 businesses that we own in New Zealand. This one's a wholesale office products business. It's well-respected in New Zealand and it's well-led. The book value for that business is about $45 million, making it a sizable business for us. The process is taking place, as I mentioned in my prepared remarks, we're in the process of drafting and offering memorandum as an example. We've hired a transaction partner. So that sale process will take place throughout the back half of the year.

Operator

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

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

Just wanted to ask a follow-up question on the capital structure. Just wondering if you all could provide a little bit more of your thinking behind putting a dividend into place rather than a buy back, obviously, a much greater commitment behind the dividend.

Ravichandra K. Saligram

So let me start on that, Brad. Look, it's not an either/or issue. And for us, through 2008 where we're giving a dividend and dividend was easy for us to put in place quickly, we wanted to demonstrate that we are listening to our shareholders. And we also felt confident about how our future cash flows and how the company's doing, and therefore we decided to reinstate the dividend. So that does not preclude other alternatives, including a share buyback, and that's all part of this overall comprehensive evaluation that we are doing.

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

Great. And then just stepping back here, Ravi. Last November, we talked about 2011 and '12 being years of strengthening the foundation and 2013 through '15 being years of gaining momentum and where the investments that you're making right now really can start to flow through to the bottom line. As you look at the business today, what are the areas that you're feeling more confident about? And how do you feel about that opportunity for 2013 to really see more traction?

Ravichandra K. Saligram

Brad, first of all, in terms of strengthening the foundation, frankly, I'm pleased that look, the first half that sales are up 0.2% on an organic basis versus prior year, that our operating income is up 42% and EPS is $0.35, up 75%. So if that's strengthening the foundation, I'll keep taking that and we'd like to keep working on that. So where I think I'm really pleased with the momentum is on our digital business. Jim and his team are doing a fabulous job. And then on our Contract business. I think Contract, we've worked at it over the last 18 months. Every quarter, we're making improvements, and John has been a great addition as a leader. And so I think those 2 businesses. And then there are adjacencies that support especially the Contract are getting good traction. I'm also pleased with what's happening in Australia. The team there is really -- last year was -- we got lot of blocking and tackling, took a lot of costs out, got the synergies between Australia and New Zealand. And now we've got a new leader who's getting the top line going. So when I look at those, I'm pleased with how we're coming through. Retail business, tougher. Michael's taking all the right disciplined steps, some structural issues, we're going to address them, we're continuing to work it. But overall, I'd say we're getting some of the levers going for us.

Operator

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

Christopher Horvers - JP Morgan Chase & Co, Research Division

Want to follow up on the buyback question. The adding back the dividend required board approval and so would adding a buyback. So clearly, the decision was made not to buy back shares, at least not yet. So perhaps you could talk about the rationale as to why do you need to have asset divestitures for the buyback to happen as you don't want to dip too far into cash given the environment? Or is there some other catalyst such as a real improvement in the macro side that you're waiting for to buy back the shares?

Ravichandra K. Saligram

Chris, thanks for the question. Look, I think first, obviously, the whole capital structure, our board is very much involved in it and very much involved in these decisions. They, like I, both of us are very committed to getting our shareholder value up. We understand the issues and some of the valuation concerns of our investors. So we felt the dividend decision was good immediate decision that we could take. It's an ongoing one, we want to reinstate it. It does not preclude, by any means, any other capital allocation alternatives. We just, as I think Bruce mentioned, there's lots of complexities on our balance sheet and we need to tackle them systematically and holistically. So we want -- we feel we'll make progress as we proceed through the year but that was basically it.

Bruce H. Besanko

Ravi, could I add just got a couple of other thoughts. One is that we feel it's absolutely critical to take a holistic comprehensive analytical approach to analyzing the capital structure, and that includes exploring ways to simplify the balance sheet at the same time that we evaluate these capital allocation decisions. So that's point one. Point two is in my prepared remarks, I made the comment that our evaluation on the balance sheet and the capital structures are not limited to our noncore nonoperating assets. What I meant to say was that, that evaluation is not limited to our nonoperating assets.

Ravichandra K. Saligram

So final thing, Chris, is, look, the dividend in our mind is a good thing as a first step. So let me repeat it, a first step in the journey of capital allocation.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So putting that all altogether from the investor perspective, it sounds like, look, we can sell this New Zealand business, we can get the Lehman clarification behind us, look into the Boise investment, we'll be in a better position to buy back the shares. Is that the way you're thinking about it?

Bruce H. Besanko

I think, the first half of that statement is absolutely correct. I think, we want to refrain from making any kind of suggestion as to what our capital allocation decisions may be in the future. We're comfortable with the dividend. That's what Ravi said, that's a very comfortable and tangible first step for us. And let us go through, given the complexities of the balance sheet that you point out, given those complexities, the analysis because it's going to take some time, but we expect to make some meaningful progress over the back half of the year.

Ravichandra K. Saligram

And your first part is right, Chris, it will allow us to better make capital allocation decisions.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Fair enough. And then just one quick one. The $175 million investment in Boise, is that actually something that you can sell to a third party? Or does that -- is that something that you would -- you have to sell to the controlling party? And presumably perhaps you could comment on what you think the fair market value of that is.

Bruce H. Besanko

First on the second part of the question, the fair value, we do, as required by our accounting rules, we do an impairment test annually on the book value of that asset, and at this point, feel that it's -- the book value is appropriate. In terms of the first part of the question, we have been, back in 2009, again in the early part of this year, we have looked at a number of ways to value some of these or to get additional value for these legacy assets. And so we have put on -- we have looked at various alternatives, and I don't want to comment on any particular one but know that we're looking at all the available options to us as it relates to these legacy assets and liabilities.

Operator

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

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

I also want to dig a little bit deeper into the capital allocation discussion. First, on 2 items that you cited, one was the pension piece and then the other was the Wells Wachovia piece of the notes. I guess, my real question is how would changes to the way those are structured today impact your financial flexibility if at all? That would be my first question.

Ravichandra K. Saligram

Bruce, you want to talk about the...

Bruce H. Besanko

Yes, so when we -- I mean, these things all -- as we look at our balance sheet and try to inform ourselves on capital allocation decisions, these things all require analysis and potential trade-offs. And so today, we have an underfunded pension obligation at the end of the year, it was about $330 million. It was the frozen pension plan but we feel like, over time, we would want to ensure that, that thing was fully funded. And so on the Wachovia note, the Wachovia Wells note, we continue to look at options for that thing to see if there's -- that can drive -- that would allow us to drive greater clarity on the balance sheet. So all of those things that we're looking at require, first of all, a lot of analysis and some time to do. And we want to be sure that as we look at those and we think about capital allocation, that we don't do them in an isolated fashion and that we do them in this comprehensive, holistic approach.

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

Bruce, as you think about the Wells Wachovia piece, would there be any change in the economics of that liability for you? Or is it more frankly about just perception and optics on the balance sheet in simplifying the look for investors?

Bruce H. Besanko

Well, the overall goal is to simplify the balance sheet so that prospective investors and frankly, our existing investors have greater clarity to the underlying assets and liabilities of the company. That thing is a nonrecourse liability. And that does, I think, in our view, create some confusion for prospective investors. And so our overarching goal here is to create greater clarity for investors. Might there be an economic impact from any decision on a Wachovia note, I think, it remains to be seen.

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

On the capital structure. Clearly, you are sitting on a lot of cash and you have a stock that's lower than it's been for most of your time as a public company. At the same time, the earnings base is somewhat depressed and the leased abilities are there. So how do you think about some of the traditional leverage metrics that the rating agencies will look at like fixed charge coverage and leverage? Are there triggers that for those metrics that would lead you to be more aggressive with capital structure? And are those considerations for you as you think about capital allocation?

Bruce H. Besanko

That's a good question, Matt. We are in -- we continue to have ratings by our -- by the 2 major credit rating agencies. We continue to have an active dialogue with them, and we certainly want to understand their perspective as it relates to our balance sheet and capital allocation. And so we'll consider their views as we look through what we may do in terms of this analysis.

Ravichandra K. Saligram

Ultimately, just to add, when we take all points of view into consideration, look, what we really -- the ultimate goal here is to drive shareholder value. So we've got to look at all of these and say, what are the tactics and actions that lead to shareholder value creation. And given that there's lot of complexities, that's why we want to look at this holistically.

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

And then just finally, just one piece of clarity on the revenue guidance. Your total company revenue is down approximately 2.7% in the second quarter. You guided to total revenue flat to up. Obviously, currency moves around, by our measure, it's probably, based on the spot rate, about a percentage point favorable in terms of its impact on sales versus where it was in Q2 so that should buy you a percentage point. But to expect you get to flat or better, are you looking for improvement in the underlying rate of growth or are there other dynamics like calendar, et cetera, that would be responsible for some of that growth rate?

Ravichandra K. Saligram

Let me kick it off and then I'll turn it over to Bruce, in that guidance of flat to better was for third quarter. And so essentially, we feel very good about the programs we have in place for our back-to-school season and Retail. And we're continuing to see good momentum on the digital business and the Contract business. But back-to-school, there were good program. Bruce, do you want to add anything to that?

Bruce H. Besanko

No, I think that's complete. I just wanted to make sure that you got it, Matt, that the flat to slightly higher was for the third quarter because in the full year, we're crawling approximately in line with.

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

So it sounds like you're actually expecting or seeing some underlying improvement in your trend in your core businesses.

Bruce H. Besanko

Well, that's clearly the case in U.S. contract, and I think we might have alluded to our back-to-school is a big season for us, holiday is a big season in retail and so we had -- we're cycling what we think to have been some issues on our back-to-school last year.

Operator

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

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

Related question on the guidance. So year-to-date, the adjusted operating margin's up 60 basis points. You're saying that for the Q3 expected to be flat. But for the full year, you're saying sort of flat to slightly up, which would seem to indicate that you're expecting operating margin deterioration in Q4. So I'm just trying to figure out if that's just being conservative and maybe I'm just reading too much into it or is there something fundamental that you think could change in Q4?

Ravichandra K. Saligram

Bruce?

Bruce H. Besanko

Well, I think what you're sensing is that we are -- we want to be cautious here. We have 2 big selling seasons coming up in the back half of the year. The first is our back-to-school selling season in retail, and the second is our holiday selling season. And as you've probably been reading and hearing about, the overall economy, that the economy's clearly not providing any tailwind. And so what I could tell you is that what we're going to focus on and whatever demand environment might occur, we're going to focus on what we've been doing, which is delivering on the growth adjacencies, delivering on the digital, continue to make good progress on U.S. Contract and continue with the retail strategies. And so when we look at the second half of the year, the guidance we provided, although uncertain in its nature, so it's what we think is going to happen.

Ravichandra K. Saligram

And there's a range that we've provided and recognize that in the second half again, we have to go over the intent of comp that we didn't have last year. So that's another thing to consider.

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

Okay, that's helpful color. And then just one follow-up. You mentioned SMB, you plan to roll that out to additional 4 markets. I was just wondering if you can give us any color on the early results from, I guess, the 4 markets you're in right now?

Ravichandra K. Saligram

John, do you want to comment on it?

John C. Kenning

So the 4 markets that we've entered into so far, we've had, what we would say, is good results. We're gaining customers in those markets. We're on target for our average order size. So at this point in time, we feel very comfortable with those markets. We've rolled out the next 4 markets at this point in time, and we're hitting those markets hard and we're gaining traction there also. And we continue not only in those markets but we continue to have good progress in our SMB space that we've been in for a long period of time across the rest of the marketplace. We've made, what I would say, a nice investment into these first 8 marketplaces, had some nice traction, nice growth and we feel comfortable to continue with that but we also focus on the SMB marketplace across all of North America and continue to see nice growth in our overall business across all our channels from the existing business standpoint.

Ravichandra K. Saligram

And, Anthony, one other thing to add is that, at least, what we view as a positive, one of the key reasons for doing SMB and putting the focus is that it's significantly higher margins than the large and enterprise. And so far, the teams have been bringing it in at the margins that we expected and which is important for us. And this is a standardized business, high-volume, it's a density local business where you build relationships. So what we did in the first 4 markets is what encouraged us to get to the next 4.

Operator

Your final question comes from the line of Scott Tilghman of Caris & Company.

R. Scott Tilghman - Caris & Company, Inc., Research Division

Wanted to touch on 3 things. I'll just outline them and then we can run through. First off, on the Lehman side, I was wondering if you had gotten any further distributions or noteholders had received any further distributions? And related to the potential closure there, if you expect that small cash tax that's due to be paid this year. Second, on CapEx, it looks like year-to-date, your trend is well below where you're guiding for the full year. So I'm wondering what drives the acceleration in the second half? And then third, I was just wondering if you could speak to the competitive environment you're seeing with back-to-school.

Bruce H. Besanko

Okay, great questions. Let me start with the first one, Scott. So on the distribution of Lehman, there's -- the distribution that we've referenced, the $50 million is the...

R. Scott Tilghman - Caris & Company, Inc., Research Division

That's April.

Bruce H. Besanko

Yes, that's the only one that we've received or know about. In terms of cash taxes, depending on the disposition of Lehman, if the thing is resolved by the end of the year, cash taxes could be paid out. Otherwise, it would be sometime in the following year. The second question was on CapEx trends. We did, as you know, we've -- I think, have $32 million, $33 million of CapEx expense through the first half of this year. We're guiding to $75 million to $85 million of CapEx for the full year. That is a reduction from what we've previously talked about. I think, we've previously talked about a range of $75 million to $100 million. So we are acknowledging that there's a little lighter pace in the first half of the year relative to CapEx versus what our expectations were. And then in regards to the competitive environment...

Ravichandra K. Saligram

Michael will handle that.

Michael J. Lewis

Thanks, Bruce. It's Michael here. As I mentioned before, our customers remain pretty price sensitive given the challenges of the economy, both on the customer lead [ph] side and on the whole consumer side. In Q1 and 2, we saw a normalized environment from a point of view of competitive activity. Likewise through as we see the early signs of back-to-school, it appears that it's normal as well. And so as Bruce has mentioned, we made adjustments to our plan this year based on last year's learnings. We're happy with that. It's still a bit early on back-to-school in terms of reading it right now. Given that many schools across the country have pushed back their start date, the shortening of the school year, [indiscernible] our programs going forward, much of [ph] activity is pretty normal.

Ravichandra K. Saligram

Thank you very much. I think that was the last question, Mike. So thank you very much for participating. Good day.

Operator

This concludes today's conference call. You may now disconnect.

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