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Staples (NASDAQ:SPLS)

Q2 2012 Earnings Call

August 15, 2012 8:00 am ET

Executives

Chris Powers

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

Michael A. Miles - President, Chief Operating Officer and President of Staples International

Christine T. Komola - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Demos Parneros - President of US Retail Stores

Joseph G. Doody - President of North American Delivery

Analysts

Gary Balter - Crédit Suisse AG, Research Division

Daniel T. Binder - Jefferies & Company, Inc., Research Division

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

Michael Lasser - UBS Investment Bank, Research Division

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

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

Kate McShane - Citigroup Inc, Research Division

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Alan M. Rifkin - Barclays Capital, Research Division

David Gober - Morgan Stanley, Research Division

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Joscelyn MacKay - Morningstar Inc., Research Division

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

Michael Baker - Deutsche Bank AG, Research Division

Denise Chai - BofA Merrill Lynch, Research Division

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

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Staples Earnings Conference Call. My name is Chanel, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Chris Powers, Director of Investor Relations.

Chris Powers

Thanks, Chanel. Good morning, everyone, and thanks for joining us for our second quarter 2012 earnings announcement.

During today's call, we will discuss certain non-GAAP metrics to provide investors with useful information about our financial performance. Please see the Financial Measures and Other Data section of the Investor Information portion of www.staples.com for an explanation and reconciliation of 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 Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed or referenced under the heading Risk Factors and elsewhere in Staples' 10-Q filed this morning.

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

Ronald L. Sargent

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

I'll start with the facts. Total company sales for the second quarter were $5.5 billion. That's down 6% versus Q2 of last year. If you exclude the impact of the stronger U.S. dollar during the quarter, total company sales declined 3% versus the prior year in local currency. We achieved earnings per share of $0.18, and top and bottom line trends declined across each of our business units. While we didn't provide financial guidance for the second quarter, these results fell short of our internal expectations.

One of our top priorities this year has been to accelerate growth beyond core office supplies, areas like facilities and breakroom supplies and copy and print. And during the second quarter, we continued to build momentum in these categories. Unfortunately, other areas of the business took a step back during Q2. A steep decline in computer sales, soft trends in core categories and ongoing weakness in the European economy more than offset our progress.

We're not satisfied with our performance. We've made progress growing adjacent categories over the past few years, but we haven't driven sustainable top line growth. Our retail store productivity has declined, and our performance in international remains particularly disappointing.

Improving these businesses is a top priority, and we have to do better. We're taking a hard look at each of our businesses, and we plan to make significant changes to improve results. We're also building a plan to reallocate resources, to take advantage of our best growth opportunities and to drive increased cost savings. We're in the early innings of this process, and as we solidify our plans in the coming months, we'll provide you with a lot more details in an update.

As a result of the weaker-than-expected trends during Q2, we're taking a more cautious view on our outlook for the remainder of the year. We now expect 2012 full year sales growth to be flat and earnings per share to grow in the low-single digits.

So that's the headlines, and now let me take a look at the Q2 results for each of our 3 business units. I'm going to start with North American Delivery.

Sales for the second quarter were $2.4 billion and that's down 1% in U.S. dollars and it was flat in local currency. We continue to drive top line growth in Staples.com with sales up in the low-single digits. This improvement was more than offset by a deceleration in our contract business, which was down about 2% during the second quarter. As you recall during Q3 of last year, we did not renew 2 large contract customers that didn't deliver adequate returns and this negatively impacted the total sales trend in North American Delivery by about 70 basis points during the second quarter.

We continue to drive growth in adjacent categories like facilities and breakroom supplies and promotional products. This improvement was not enough to offset declines in the core during the second quarter. Sales of core office supplies came in short of our expectations as existing customers continued to reduce their spends.

Taking a closer look at the facilities and breakroom. Sales grew 20% in Q2, and we're once again ahead of our plan. Coming into 2012, we plan to grow this business by about $100 million this year. We're quickly approaching that target and now expect full year sales to grow by about $150 million. This puts us on track to reach nearly $1 billion of facilities and breakroom sales in North American Delivery during 2012.

We're also expanding our assortment into new product categories. Over the past few months, we've added thousands of SKUs to our public website in categories like safety and education, technology and industrial supplies. We're in the early stages of this initiative and it will take some time to become a meaningful driver of our results.

Turning to profitability. North American Delivery operating margin for Q2 decreased 72 basis points versus last year to 7.7% operating profit. This decline was driven by lower product margins in core categories as well as ongoing investments that we're making in Staples.com.

In contract, we saw a modest decline in operating margin during Q2. We're doing a good job retaining customers, but it's coming at an increased expense. We've also taken cost increases in categories like paper, which take longer to pass along to our largest customers, but the real margin pressure during Q2 was in Staples.com where we continue to introduce new ideas to drive growth.

During the second quarter, we rolled out instant discounting to our best customers and reduced our threshold for free delivery. We also used more aggressive pricing in key categories to drive customer acquisition and grow share of wallet. These margin headwinds were offset by reduced marketing expense as we continue to shift away from higher-cost traditional marketing vehicles.

Moving on to North American Retail. Sales in Retail for the second quarter were $2.0 billion, and that's down 3% in U.S. dollars and 2% in local currency compared to Q2 of last year. Second quarter same-store sales declined 2% and came in below our plan. Customer traffic was down 2% compared to last year, and average order size was flat.

Strength in copy and print, mobile phones and accessories and facilities and breakroom was more than offset by double-digit declines in computers and software.

We're working hard to improve the productivity of our real estate portfolio. Year-to-date, we've relocated 12 stores to smaller formats and downsized 4 stores in North America with an average square footage reduction of about 35%. We expect to reallocate and relocate and downsize an additional 16 stores during the back half of this year. We now expect total store count in North America to be down slightly in 2012, and we're on track to reduce overall square footage by about 600,000 square feet this year.

During Q2, we opened 6 stores, we closed 5 stores, and we ended the quarter with 1,915 stores in North America of which 1,579 were in the United States and 336 were in Canada.

Demand for computers was particularly weak during Q2 and drove about 1/2 of the overall comp decline in North American Retail. We continue to have success selling Apple products in Canada, but industry data shows that the PC market declined double digits during the second quarter. We faced similar headwinds in PCs across our business, and we anticipate that overall computer trends are going to remain weak ahead of the Windows 8 launch in late October.

We continue to drive top line growth in several adjacent categories. Sales of copy and print grew in the mid-single digits, and customer traffic in our copy centers was up during the second quarter. This improvement was driven by our copy and print sales force as well as our expanded offering of instant products like wide-format signs, banners and business cards.

Another adjacent business that we're building at Retail is facilities and breakroom. Over the past year, we've expanded our offering, we've reduced our pricing and increased our assortment of national brands. Customers have responded well, and we drove double-digit growth again in facilities and breakroom during the second quarter.

During Q2, North American Retail operating margin decreased 59 basis points versus last year to 4.4%. This decline was driven primarily by deleverage of fixed expenses on lower sales as well as increased labor costs in Canada and investments in labor to support our mobile phone initiative. These headwinds were offset by improved product margins, which were helped by a lower mix of technology sales during the second quarter. We also had a favorable impact from a year-over-year decrease in marketing expense.

We kicked off the back-to-school season a few weeks ago with a strong assortment of core supplies and technology products. This year, our plan is focused on helping customers save money. Customers can save 15% on core supplies throughout the season with our back-to-school savings pass. We've rolled out things like a new binder recycling program, and we're offering our traditional hot buys in a weekly circular. We've also launched nationwide TV campaigns in the United States and Canada to help drive awareness during this important time of the year.

We also have a solid pipeline of new technology products and services. A few weeks ago, we added the Google Nexus tablet to our assortment, and customer demand has been very strong. We continue to drive double-digit growth in mobile phones and accessories are off a relatively small base. And over the coming weeks, we plan to reflow the technology planogram in about 1,200 of our stores as we prepare for the launch of Windows 8. We're shrinking the floor space that is dedicated to declining categories like boxed software and digital cameras and reallocating this space to expand our assortment of new devices and accessories.

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

Michael A. Miles

Thanks, Ron. Good morning. Taking a look at the second quarter headlines. Staples International reported sales of $1.1 billion, a decline of 10% in local currency and 18% in U.S. dollars versus Q2 of last year. Sales environment remains extremely difficult. Sales for the European office products business were down about 7% in local currency during Q2 with sales declines across all channels.

In Europe retail, same-store sales were down 9% during the second quarter. Customer traffic decreased about 5% compared to Q2 of last year, and average order size was down 3% year-over-year.

In our European delivery business, we saw a deceleration in the top line. Sales were particularly weak in Southern Europe where ongoing economic headwinds remain especially challenging, and the market has become increasingly competitive. These headwinds were somewhat offset by stable trends in the Nordics.

In Australia, local currency sales were down in the double digits versus Q2 of last year. As you know, we've made leadership changes, reorganized and reenergized our sales force and fixed our customer service issues. We further reduced headcount during the second quarter, which is now down nearly 15% over the past year. We're on the right track and expect to see sequential improvement in Australia throughout the back half of this year.

We continue to take costs out of the business, but we haven't been able to overcome the rapid decline in sales.

International operating margin for the second quarter declined 325 basis points to a loss of 2.0% of sales. As Ron said earlier, improving the performance of International is a top priority, and we have to do better. There's lots of work to do and some tough decisions to make. Everything is on the table. We're not in business-as-usual mode. And again, once we solidify these plans, we'll provide a detailed update.

With that, I'll turn it over to Christine to review our financials.

Christine T. Komola

Thanks, Mike. Good morning, everyone. During the second quarter, total company sales of $5.5 billion were down 3% in local currency and down 6% in U.S. dollars versus the second quarter of last year as the stronger U.S. dollar negatively impacted top line growth by about 250 basis points.

Our second quarter earnings per share on a fully diluted basis decreased 28% to $0.18 versus the second quarter of 2011. Excluding the $21 million cash tax refund during last year's second quarter, earnings per share on a fully diluted basis declined 18%.

Gross profit margin for the second quarter decreased 51 basis points to 26% compared to the prior year. This reflects lower product margins in North America Delivery and International as well as deleverage of fixed costs in North America Retail and International. This was partially offset by a favorable shift in sales mix and improvement in promotional activities in North America Retail.

SG&A increased 28 basis points versus last year's second quarter to 21.7%. While we do continue to reduce expenses, sales declined at a faster rate, resulting in modest deleverage during the second quarter. This is primarily due to deleverage of labor expense as well as increased costs associated with legal settlement. This is partially offset by a reduction in marketing expense, reduced headcount and a decrease in stock-based compensation expense due to a change in the structure of our management compensation.

Total company operating margin declined 78 basis points during the second quarter to 4%.

Our effective tax rate for the quarter was 32.5%, a 680-basis point increase compared to our tax rate of 25.7% during Q2 of last year. This increase was primarily driven by the favorable impact of the $21 million cash tax refund that we received in Q2 2011.

Year-to-date, we've spent $126 million on capital expenditures compared to the $164 million that we spent on capital during the same period last year.

With year-to-date operating cash flow of about $257 million, we've generated free cash flow of $131 million through Q2, and we remain on track to generate more than $1 billion in free cash flow for the year.

During the second quarter, we've repurchased 12.1 million shares for $159 million, and our plan is to continue using excess cash to buy back stock throughout the back half of 2012. Please keep in mind that we do plan to repay with cash our $325 million note, which matures in October of this year.

At the end of Q2, Staples has approximately $2.1 billion in liquidity. It includes cash and cash equivalents of about $1 billion and available lines of credit of about $1.1 billion.

As Ron mentioned at the beginning of the call, we are taking a more cautious view on our outlook as the result of softer sales in our -- in the trends of our business and the economy is slowing. And now, we expect total company sales to be flat for the full year versus 2011 including the impact of the 53rd week this year as well as the unfavorable impact of foreign currency exchange rate. We expect earnings per share to grow in the low-single digits compared to adjusted diluted earnings per share of $1.37 in 2011. If sales trends show a meaningful improvement during the back half of the year, we expect that earnings per share would come in above this range.

Thank you for your time this morning, and now I'll turn it back over to our conference call moderator, Chanel, for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Gary Balter of Crédit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

I'm just trying to -- looking at the results, there seems like there was a step-down in margins. Put aside the sales, which were not that bad, what happens -- especially in the contract business and to some degree in the Retail business, like International has been a challenge, what changed within those businesses that all of a sudden saw such a big decline in operating margins and how are you dealing with that?

Ronald L. Sargent

Yes, let me ask Christine to respond to it and then if Joe and Mike and Demos have some additional thoughts, we can add that.

Christine T. Komola

Sure. So, Gary, yes, the margins did go down. If you think about the businesses, North America Delivery, the challenge there was really gross margin and it was primarily actually in the Staples.com business as we invested in some ways to drive traffic into the website and that included things like free delivery, testing more with our best customers. The other thing that was a challenge was we did get paper cost increases that, for the larger customers, were hard to pass on and even on the website it was -- competitive marketing makes that harder to do. So that was the biggest challenge in the NAD business. In Retail, we actually did a good job because the product margin was basically flat. They were able to balance the pricing pressure that they got on things like paper with the mix of computers being down that helped it. Where they did invest was -- that you anniversary Q2 in things like labor, mobile and in the mobile department. So those would be examples in the Retail business. And to your point, International has been a challenge. It's been difficult to take the costs out as asset sales have dropped.

Gary Balter - Crédit Suisse AG, Research Division

And just following up on that because your reporting period's different than your 2 competitors, but one in particular showed very stable margins. Was July significantly worse than June and May?

Ronald L. Sargent

In terms of sales or margins?

Gary Balter - Crédit Suisse AG, Research Division

In terms of margins or sales and the implication for margins because your results are not consistent with at least Max's results on a margin basis.

Ronald L. Sargent

Yes, we saw a different trend in July than we saw in May and June, certainly, in terms of the top line. Softer in July to be more specific.

Gary Balter - Crédit Suisse AG, Research Division

And just as my follow-up, just switching to International. Obviously, there are some things going on and you talked about Australia with management changes, et cetera. But in a way, it's a touch disturbing to hear that we're exploring ways to change that given that International's been on the decline now for a while, you would -- we would expect that we'd be seeing these changes happening now and we actually heard more about changes that were happening 6 months ago. So could you, Mike, kind of expand on your commentary about what you're thinking about?

Michael A. Miles

Yes, Gary. I think, as Ron said, we'll announce what we've got when we've got our plans solidified. But I think, as you think about the International business, there's -- the bad news from a macro standpoint has probably continued to get even worse. We can't do much about that. There are some things that we can do about in terms of our structurally high G&A and businesses that are losing money. And frankly, our patience with those and our ability to cover for them is kind of reaching its limit. And I think our willingness to take a little more risk and more short-term pain to fix them is higher than it's been and I think those are the kinds of things that we'll be looking at as part of the plan. That's only part of the plan that we're putting together, but I think it's an important part.

Ronald L. Sargent

I think it's safe to say is we felt like there was a significant step-down in our International business second half of last year and we haven't been waiting. I mean, we've been making changes throughout that period of time. And now I think it's the point where we've just got to make a decision, is the macro environment in Europe going to get better anytime soon or not? And if not, we need to make some changes, more changes I guess.

Operator

Our next question comes from the line of Dan Binder, Jefferies.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

So kind of a little bit of follow-on to Gary's question, but maybe broader. And I realize you're in the early innings here, but Ron, when you think about sort of the bigger changes that you need to make here, it seems like it maybe needs to be a little bit more radical. I'm curious as -- are you thinking for the, particularly the North American business, do you need to go down a path of more aggressive store closures or store shrinking? Do you need to add very different products, maybe a build-out of services more rapidly? I mean, is there anything at a very high level that you can discuss with us today including cost-cutting?

Ronald L. Sargent

Yes, let me start with the fact that we're very unhappy with our Q2 performance, but I'm confident in the team and the strengths that the Staples brings to the party. But I also acknowledge that we need to make some changes to improve our results. We are still very early in the process. I think the major focus areas are going to be International. I think square footage reduction on the Retail side in North America, I think -- we believe that there's an opportunity there. We are going to be taking some costs to fund some things that we have got in the works to get our top line growing again. So we're trying to be responsive to our recent performance. We're also trying to be responsive to the difficult macro environment that, to me, seems to have taken a bit of a step-down in the second quarter versus the first. And even more importantly, we've got to be responsive to our customers and our shareholders and the marketplace. And obviously, we want to position ourselves better for the future and we'll be sure to plan a chance to kind of update you once we have a lot more to share in terms of specifics.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

And then as a follow-up, anything on the early back-to-school season thus far?

Ronald L. Sargent

Yes, let me ask Demos to respond to that one.

Demos Parneros

Yes, sure. Early on, the majority of our stores are really late market. I'd say that so far, so good. We've got a very strong back-to-school plan, really focused around saving customers money and a lot of the effort in marketing is around deals and special pricing and traffic-driving offers to get customers into the store. We featured and pushed our 15% savings pass, which has been well received by customers. And recently, about a week -- a little bit more than a week, we kicked off TV strongly. So I think we're in good shape to be in stock for the whole season and so far, so good in terms of our expectations for back-to-school.

Operator

Our next question comes from Brian Nagel, Oppenheimer.

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

So I guess I want to follow on, on the prior 2 questions as well, but it really focused on sales. So Ron, you mentioned just a second ago that you thought the macro environment got more challenging. But as we look at the sales slowdown really across your enterprise and particularly in the overseas but here in the United States as well, I mean, with Retail and contract, et cetera, is it as simple as, okay, the macro environment got more challenging so then your customers became more constrained in their spending and then you had the extra kicker of maybe people waiting for the Windows 8 launch, or is there something else there? I mean, is there something changing on the competitive environment or is something else that could explain what we've seen as far as the sales slowdown lately?

Ronald L. Sargent

I mean, you look at the biggest driver of our performance in Q2, it was soft sales in all business units and it's hard to know if in real time that's macro or something else. We haven't seen any significant kind of competitive shift that's affected our business at all. And again, you don't necessarily see that on a day-to-day basis, but I think our international performance in Europe and Australia was very difficult and that certainly affected our results a bit. If you look at sales, I think the biggest impact on our bottom line is when you've got 3% less sales than you had a year ago. That results in big deleverage on the expense base. I think -- and the biggest driver of that was PC sales. Part of that was investments that we're making to lower pricing, particularly in our dot-com business as we become more aggressive there. And obviously, part of it was execution. We should have done things differently and better so that we didn't have a minus 3% sales decline. So I mean at this point, it's time to take more significant action to drive the top line, improve our results and that's going to require some changes in the way we do business.

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

Just digging a little further with that. As we look at what other retailers have said lately, there were some signals of a slowdown, but listening to some companies report yesterday, sales have actually picked up again in July. It seems like you guys have had kind of a reverse trend. Are you able to look at the profile of your customers and say those with greater European exposure represent an outsized proportion of the sales weakness here in Q2 as opposed to those international...

Ronald L. Sargent

Sure. I mean, when you look at our European results, I think we're down 10% in the top line, which certainly had a big impact on the total top line being down 3%. When you look at our Delivery business, contract was softer than our dot-com business and Retail was a little bit of a traffic issue in Q2.

Christine T. Komola

And also, just to add to that a little bit. In terms of our sales, kind of the core products was down. But I mean it was significant in our computer business and that was across all of our channels. It was also kind of some unusual kind of things from -- such as furniture was down for NAD. So it really was we had a falloff in some of the unusual bigger large ticket categories and that's where we started to see the trend slow down in the back half of the quarter.

Operator

Our next question comes from Michael Lasser, UBS.

Michael Lasser - UBS Investment Bank, Research Division

Ron, as you take a hard look at your businesses, what's the priority? Is it to maintain the margin of the business, is it to maintain the sales level, the gross profit dollars of the business. How are you thinking about prioritizing all those financial metrics?

Ronald L. Sargent

Well, I mean, the hard part of the job that we all have in business is to try to do all those things simultaneously. I think, obviously, growing the top line is the most important line on the P&L because with sales, everything good comes. When you look at our fixed expense base, that drives everything else including most of your expense categories in the bottom line. So, to me, I think the 2 most important areas is growing the top line in our North American business and I think that's probably also true in our International business, although I think in our International business it's probably going to require some more work than just driving the top line.

Michael Lasser - UBS Investment Bank, Research Division

So would you be willing to sacrifice some gross margin in order to drive the sales?

Ronald L. Sargent

Yes, and I think we are. We certainly did this quarter and I think we continue to do that. But the guidance that we've announced this morning reflects what we think -- even making those investments in pricing, which we are making. We still think that EPS is going to be improving this year in the low-single digit range, so yes.

Michael Lasser - UBS Investment Bank, Research Division

And then as a follow-up on the capital allocation side and allocating resources, do you think there would be a big capital investment needed that could draw away from distribution to shareholders?

Ronald L. Sargent

No, I don't think so, but Christine?

Christine T. Komola

No, as we think about our capital allocation, particularly for this year, we don't see any major changes. So our capital strategy to invest in the business is the same investment that we expect to do. And our plan going forward fits within the context of the guidance. We plan to continue our buyback program and we plan to continue our dividends program. So no significant changes at this point.

Ronald L. Sargent

I think the opportunity is to redeploy some of the capital that we currently have planned.

Christine T. Komola

Right.

Operator

Our next question comes from Matt Fassler, Goldman Sachs.

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

I'd like to follow up on 2 points that you made today, sounds like there's some changes to the margin worth discussing. First of all, you spoke about dot-com investments in your introductory comments. And I think in the course of this Q&A so far, you've spoken a bit about price investment. So if you could give us a bit of a sense as to the kind of changes you're making and the kind of payout you anticipate for dot-com and presumably for price image across the business?

Ronald L. Sargent

Yes, I'll ask Joe to respond, but I'll tell you that our dot-com business, I think, is a very strong business that we think is probably the part of our business that's most likely to grow fastest. So let me turn it over to Joe.

Joseph G. Doody

Matt, I think, as you know, it's a competitive world out there and I think we needed to continue to look at our pricing especially in key areas. So we have looked at making some investments in the areas of ink and toner, as well as paper and facilities and breakroom. Those have been the ones where we've looked at making some adjustments to be even more competitive and really drive greater volume long term and won't happen overnight. The other thing we've done is, selectively, we've reduced free delivery on like all ink orders regardless of size. We've also altered our best customers to go from rewards to instant discounting, so they see that price reduction upfront and I think, as a result, have a much greater awareness from a price standpoint of where we stand. So those are the major things that I'd point to, Matt, and I think we're still early in the game and results will come certainly over time.

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

Got it. And then, Joe, just my follow-up question relates to the contract business. If you could give us a sense as to the rate of growth for existing contract customers and how that rate progressed from Q1 into Q2, please?

Joseph G. Doody

Yes. Well, we did decelerate, as you know, in Q1 to Q2 in contract. It was really, one, I'd point to the fact that we were comping over a strong Q2 of last year in contract. In fact, last year's contract growth was about 4% in Q2. So we're comping over that. We did have a strong quarter a year ago in project furniture in contract, which drove some of that growth that we're again comping over. And as Christine noted, we had a little bit of a drop this year in furniture, which impacted it. But if you look at the key metrics there, Matt, we're stable with retention and acquisition. Our deleverage really or deceleration really came from sales to existing customers did slow. And if I were to point to one area particularly, it was probably as much state and local government played a role in that. We went from positive comping in state and local government in Q1 to negative mid-single digits in Q2, so that had an impact. They really did pull back here in the lightest quarter. So that's at a high level, that's sort of what drove the deceleration in contract in Q2.

Operator

Our next question comes from Greg Melich of ISI Group.

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

Two questions. First, can you just be a little more specific on North American Delivery? Was the decline there with existing customers spending less or could you give the number there versus customer accounts? And then I had a follow-up.

Joseph G. Doody

Yes, Greg, it was all sales from existing customers. Our -- as I said, our retention remains stable, our acquisition as well remains stable and the decline was all due to less sales from existing customers. Certainly, saw it in, especially in dot-com and Quill where we saw lower average order sizes. So our frequency was actually up slightly, but the size of orders was down and that was just cautiousness on the part of our customers buying only what they needed when they needed it.

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

And you mentioned paper price increases not getting passed through. Is that a -- you think that's a structural thing or you think it's a timing thing from where you see it?

Joseph G. Doody

Well, it just takes longer, especially among our enterprise customers, to pass that cost increase on, Greg. So we're working on it everyday and everyday it will get better, but it won't get better overnight. So we take on the cost and try to drive it through pricing with our customers. We have -- we passed it on quite quickly within our mid-market customer. So it's really among enterprise and large health care customers, it's our biggest challenge.

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

Got it. And Ron, maybe bigger picture. As you think about rethinking the business and the assets and getting to where you want to be, could you help us on the timing of when we should expect to hear more from you guys on that? Is that something that gets done this year or is it really early next year we can expect to hear more?

Ronald L. Sargent

Well, obviously, we've been working on this for a while and we feel very confident that we'll be able to talk about this during the third quarter.

Operator

Our next question comes from Kate McShane, Citi Research.

Kate McShane - Citigroup Inc, Research Division

My question has to do with some of the announcements your competitors have made over the last quarter with getting a little bit more aggressive with store closures, and I wondered how you were thinking about this in the context of some of the changes you're making at the company and what you expect for that to mean longer term.

Ronald L. Sargent

Sure. I mean, I think there's a feeling there are probably too many office superstores in North American today. And I guess the challenge you have is what stores should close. For us, I mean, the key is store productivity and you can measure that in a lot of different ways. I tend to look at it as sales per store, but we also look at things like profitability and RONA. And when you look at the vast majority of our stores, they're high RONA, higher than the company average. They're very profitable. And I think, given the fixed cost nature of our Retail business, it'd be great if we could drive more sales through existing space or reduce the space. And I think the opportunity for us is more kind of downsizing the size of our store than it is some kind of a mass store closure because that would harm profitability, not help profitability.

Kate McShane - Citigroup Inc, Research Division

Okay, great. And then my second unrelated question is again with regards to North American Retail. You talked about possible changes on the square footage side, but what about the technology effort? How does that look going forward? And do you have any further comment about your mobile phone rollout?

Ronald L. Sargent

Sure, yes. Demos has been working hard on that one, yes. Demos?

Demos Parneros

Yes, definitely. There's -- it's an interesting time in the sort of the tech pipeline at the moment. On the positive side, I'd say that we've continued to show good growth and ramp in our 500 mobile phone stores. So mentioned positive sales growth and accessory sales there and that's ramping nicely. On the negative side, we talked about the huge impact of computers on the comp. That really drove a lot of the margin hit for us in the second quarter. The good news is that the pipeline is pretty robust going forward. We talk about Windows 8. Unfortunately, that's coming a little bit later, end of October, probably the last week of October. But we've had, I'd say, very good success with one product introduction that we've recently had, the Google Nexus tablet, which has been very well received, very well priced, very well received by customers. Good news is that there's more in the pipeline from other vendors as they latch on to the Windows platform and as new product hits between now and probably October-November time frame. So to get ready for that, we are getting our teams ready to hit stores with additional training. We are reflowing aggressively, 1,200 of our top stores, our 1,200 best stores, and expect to have good growth in some of the newer categories and newer products rather that are coming through.

Kate McShane - Citigroup Inc, Research Division

Okay, but you're not making any kind of change in mix to the existing technology that you have now, any kind of reduction in PC or laptop exposure or anything like that at least in the next few quarters?

Demos Parneros

Well, there's been a shift, obviously, with PC sales being down and a shift towards tablet. So I'd say that is a fundamental shift that's happening. Mobile also participates in that as the convergence of mobile phones, smaller tablets -- handheld product together taking share from PC. So that is the shift right there. The e-reader business has also been very strong for us. So I would say those are the driving forces. As far as some of the traditional tech categories, they're essentially flat to down as we look at traditional business machine, software and things like that.

Operator

Our next question comes from the line of Colin McGranahan, Bernstein.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

The first question back on NAD. You said the drag from the large contracts you lost in the third quarter last year was 70 basis points this quarter. What was it in the first quarter?

Joseph G. Doody

I think it's pretty much the same, Colin. No real change in that.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. So then just thinking about the combination of the top line and margins, the NAD business had been running kind of 1.5% to 2% growth. In local currency, it went to flat. But margins deteriorated dramatically relative to where they were. So understanding existing customers are down, but if that drag wasn't any bigger, I'm just trying to get my hands around the fact that you had a deterioration in both the margin profile, significant one, and a deceleration in the growth rate fairly significantly quarter-to-quarter.

Joseph G. Doody

Yes, I think, we -- as we said, we made investments in pricing as well as other actions, site development activities within our dot-com business. So we're clearly looking to invest there and are for the future for future growth. And on the contract side, we did have a slight margin decline and what really drove that was the failure to pass on all of the cost increases in pricing as well as just the more competitive nature in the marketplace to continue to renew existing customers, especially larger enterprise customers.

Ronald L. Sargent

But the vast majority of the margin impact was really Staples.com, not Quill.

Joseph G. Doody

Dot-com's contract.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Right. Okay, I understand that. So then going forward, clearly, you'll start to anniversary those contract losses in the third quarter. But it sounds like what you're doing in Staples.com, that's strategic, that's important, that's getting the right positioning. So should we expect any real change other than the anniversary of that 70-basis point drag? And based on that, it looks like the guidance for the year does imply some improvement and where would that be coming from?

Joseph G. Doody

Well, I think from an NAD standpoint, we're looking at going after -- well, one, a lot depends on sales to existing customers and will we continue to see some of that weakness and I know that state and local government and others that are pulling back. But we're also going after continued growth in the beyond office supplies areas, not just facilities and breakroom, which we're extremely happy with but also furniture, copy, print and promotional products to drive greater growth there. And then finally, I'd say we've got still great opportunities for growth of core categories within existing customers who are nonbuyers or low buyers. And we're going aggressively after that. That's -- that we view as incremental margin dollars, both top line and bottom line margin dollars.

Christine T. Komola

And Colin, just can I add to that. I think, we don't actually give business unit breakout, as you know. So if you think about our EPS guidance that we gave and we do expect improvement both in EPS and sales kind of on a trends basis, but it's primarily driven from all business units. It also includes -- we have a 53rd week to remind you about. We've got the share repurchase results, which have been accelerated based on our stock price this first half of the year, improved tax rate and we do have lower stock compensation out there. So in general kind of in the aggregate, we do see a better second half. And quite frankly, we are cautious on the sales results. So if sales do improve, that will drop to the bottom line. So I'm optimistic if that doesn't improve, we'll be able to return that based on the fixed base that we've got.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then, Ron, I understand that the plan isn't really fully ready for unveiling yet, but it sounds like from a cost reduction perspective, more of the focus would be on Europe. How are you thinking about cost reductions in North America at this point?

Ronald L. Sargent

I think we'll see cost reductions throughout the company, including North America.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay, and then final question then I'll let it go. Just given the stock performance and the fundamental performance, can you comment on turnover of the business and your ability to retain your employees? I know you lost -- for instance, Jay Baitler recently left the company.

Ronald L. Sargent

Jay Baitler's still here and he is retiring in October to spend time with his grandkids. So I wouldn't call him turnover. I'd call him retirement and we've got a great backup in Neil Ringel that Jay's been nurturing for the last 10 years. So -- but in terms of turnover of key staff, I don't know that it's any different today than it was a year ago or the year before really.

Operator

Our next question comes from the line of Chris Horvers, JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understanding you may not have exact numbers now, but in a best case scenario, at what pace could you and how many stores a year could you downsize in the U.S. and can you talk about the barriers to moving fast?

Ronald L. Sargent

Well, I mean, I think we've talked in the past, we've probably got 500 stores coming up for renewal over the next 3 years, so -- and somewhere I have that exact number, but I think it's more in -- here, I've got the exact number. In '12, you had 186; '13, you have close to 200; '14 you have close to 200. So that's kind of just the lease renewal. You can certainly do other things instead of waiting for the lease renewal in terms of downsizing or remodeling. So I don't know that -- I guess I don't understand the question well enough other than that's what we've told you in the past.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Well, I guess what I'm just trying to understand is that down -- how many stores could you potentially actually relocate or downsize per year versus perhaps going back to a -- a closure versus going back to the landlord and saying, hey, you know what, we need a 10%, 20% discount in rent if you want us to stay in this location.

Ronald L. Sargent

Let me ask Demos to respond to that.

Demos Parneros

Yes, I think the -- let's see if I can just get a crack at your first part of your question as well, the -- how many can you downsize. Not 100% because structurally we just physically cannot do that. Some landlords, they don't want to do that. And B, in some cases, we don't want to downsize. We may just want to leave. In some cases, the store might be super profitable and it doesn't make sense to downsize. In terms of how much capacity, we can do as many -- I mean, we've done a bunch this year and we've got more in the pipeline. Our priority is to reduce square footage, increase store productivity. That's game one -- priority one for us. And so the best of all worlds is to downsize the square footage and also attain a rent reduction and then move on, increase our productivity, do all the other things that we're doing such as planogram reallocation of space, et cetera, bring in new good product. If we can't achieve a downsize, we'd look for a closure and we've done more closures this year. If it makes sense to the network and to the profitability of that store and that network, that market we'll do the closure. And at dead minimum, we want a rent reduction under any circumstances. So that's kind of the way that we're attacking it. We've been very busy with this. As Ron mentioned, the number's a little over 500. So the team's busy working this and looking at all options. Obviously, good leverage for us given the amount of stores we have up for renewal.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And so remind us of what -- how those buckets are in 2012 downsize, closure/and relocate versus the total up for renewal?

Demos Parneros

So 100% of relocations are also relocations to a smaller size, and on average it's about 35-plus percent smaller. So we've done 4 so far. There are another 16 in the pipeline this year. So roughly 20 there. There have been a few closures. So all in, it's about 30 for the year.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Okay, understood.

Demos Parneros

That number could change a little bit. If we have a great opportunity, we'll go ahead and pull the trigger on that, so it could be plus/minus 1 or 2.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Right. So it's like it's probably about 20% of the renewals this year?

Demos Parneros

That's a good way to look at it, yes.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Okay, and then as you think about the metrics on the U.S. store base like a RONA, obviously that you have some of your older stores are probably pretty depreciated from an asset base. Looking forward, how do you incorporate NPV and in the need to really invest in the store base to drive that productivity and how that might affect future returns?

Demos Parneros

We take it into account. We've been very careful with how to spend capital dollars on an older base of stores. We know from our experience that remodeling full stores that we feel may be too big is not a good investment. So therefore, we are doing things like what we mentioned earlier, which is essentially a tech reflow to get us in a better position to take advantage of the good pipeline of product coming the second half of the year. So we've had good success in doing spot-targeted remodel by copy and print and the one that we're about to undertake over the next 3 months. So I'd say that we've been very careful and that's kind of the approach, and it's worked well.

Ronald L. Sargent

But any good retailer has a kind of a remodel program where they work through their entire chain every 3 years, 5 years, whatever.

Demos Parneros

Yes, no question. I mean, I think, if you look at -- if you just look at the store base, it's a fairly fresh store base. I think the focus has just been on rightsizing what's inside the store from the standpoint of the amount of space dedicated to tech, to services, supplies and furniture. We've been actively reallocating space for the last number of years.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then just one quick follow-up relative to International. I mean, it sounds like maybe International, your view on the stores is different from the U.S. and maybe take some pain and close some stores over there, is that right? And I guess why is International different from the U.S.?

Michael A. Miles

I think there are a couple of things going on there, Chris. One is the fact that the leases are expiring at a much different rate. So our ability to affect a significant amount of the store base quickly is lower. Demos told you roughly 40% of our U.S. stores come up over the next 3 years. That's only 10% of our store base, for instance, in the U.K. The other thing is the business case for a relocation investment is not as good because our stores internationally aren't as profitable. So as those leases come due, it's probably a stronger case for closure than for the kind of downsizing that we would do in the U.S. just because we don't have the same kind of profit performance for the international stores. But it's a challenging thing to deal with as through lease renewal just because of the longer lease lives that we have overseas.

Operator

Our next question comes from Alan Rifkin, Barclays.

Alan M. Rifkin - Barclays Capital, Research Division

A question on inventory. With business slowing in July versus the prior 2 months combined with inventory down only 2% versus revenue decline of 5.5%, did you have more conservative outlook for the back half of the year including back-to-school? Did that come after most of the ordering for back-to-school has been done? I guess what I'm trying to find out, do you believe that you are heavy in inventory for the back-to-school period? And what does that portend for gross margins going forward?

Christine T. Komola

Alan, it's Christine. And actually, we feel really good about the inventory. We've worked really closely with merchants to really make sure what we plan is what we sell, and we've had a good success rate so far. The inventory increase that is slight is really on things -- new kind of incremental inventory like the mobile phones and things like that. So we feel really good about the productivity of the inventory and definitely don't expect there to be margin-related issues around that.

Alan M. Rifkin - Barclays Capital, Research Division

Okay, and just a follow-up there. I mean, specific to PCs, I mean, how are your inventory levels and is there any risk of possibly even obsolescence in that category with your inventory?

Christine T. Komola

No, actually we've been selling through them pretty effectively. We have been very closely aligned with the merchants in terms of what they buy and what they sell, so -- and actually some products, we're probably out a little bit sooner than perhaps merchants would like in that category. But no, we don't expect at this point any obsolescence or significant write-down issues at this juncture.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. And I have one more follow-up, if I may. On the Retail side of the business, you said part of the reason for your deleverage in operating margins was continued investment in labor, particularly as it relates to the mobile phones. When do you believe that investment in labor will anniversary itself or when will we see less deleverage?

Demos Parneros

If I could take that. So mobile's been ramping nicely. We did make a change in changing our labor profile within mobile because we felt like it would be more effective taking it in-house and doing it ourselves, so that we've been in a little bit of a ramp-up and set-up mode for that and I think that cost us a little bit. Good news is that in the regions that we've converted, we're seeing good response and uptick in sales. So I would say rolling over the next 6 months, we should be in great shape with leveraging that expense and the inventory will not be a concern either for mobile.

Operator

Our next question comes from David Gober, Morgan Stanley.

David Gober - Morgan Stanley, Research Division

I'm just wondering if we could follow up on the monthly commentary earlier on the call. Just wondering if you could help us to size the magnitude of the drop in July. Were trends running similar to 1Q through June and was that also across-the-board, or is there a specific segment or specific product category that saw the significant drop?

Ronald L. Sargent

Yes, when you look at -- and I don't want to get into what sales were last week. But if you look at total company sales, they were pretty flat across the quarter. In fact, period 5 was a little better, but period 6 and period 4 looked pretty good. When you look at comps in our Retail business, that's where we saw period 6 being a little lower than period 4 and period 5. But it wasn't kind of fall-off-the-table kind of performance in our Retail business in period 6.

David Gober - Morgan Stanley, Research Division

Okay. And I guess just digging into -- I know you guys mentioned that the core sales were weak in the quarter, but could you just touch on paper and ink specifically? I know you've given some stats in terms of growth or declines in the past. What was the rate of likely declines in the quarter? And are you seeing increasing evidence that, that decline is accelerating?

Ronald L. Sargent

Let me try that one. During Q2, ink was minus 2 and paper was minus 6 for the total company. And you compare that to Q1, ink was also minus 2 and paper was minus 3 for the total company. So ink trends are pretty flat versus Q1, paper worse than Q1. And if you exclude the impact of a weaker foreign currency and look at the numbers in Q2, ink was minus 1 and paper was minus 5. So over the long term, market data would suggest that we continue to see declines in ink and paper in the 1% to 2% per year range and that's obviously why we're investing to build critical mass in adjacent categories like -- in adjacent categories and copy and print. You look at vendors and Domtar, their paper shipments were down 9% year-over-year and 6% sequentially. IP shipments were down 3% year-over-year and 7% sequentially. So I think there has been a slowdown in paper, certainly into Q2 versus Q1.

Operator

Our next question comes from Aram Rubinson from Nomura.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

By our math, retail product margins you run are around 40%, maybe better, after backing out rent and distribution and some other costs. I'm not sure, first of all, if that sounds fair. And then I just wanted to follow up on that.

Ronald L. Sargent

So what was your question, Aram?

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Well, so I guess if retail product margins are kind of 40% or better, I'm just wondering how Staples.com product margins look against the retail margins, both on a kind of a like-for-like product basis and also mix adjusted. Just trying to figure out where retail gross margins may need to go to be competitive in what's an increasingly electronic world.

Ronald L. Sargent

Yes. Well, I don't want to get into specific lines in our P&L. The dot-com business is a more profitable business because the mix is better and you have less technology. Our pricing is -- has historically been fairly close. So I think probably the mix or the office supplies, like-to-like, would be relatively similar. Having said that, I guess the question is in terms of competitiveness, will competitors be able to continue to break even or lose money or will competitor prices have to kind of respond to return on assets sort of calculation at some point in the future. But I think in our dot-com business, we feel like there is some channel shift going on in the office products business and we need to be very aggressive on pricing in order to play. And at some point, there'll be certain items that will decouple pricing from our Retail business in order to play. That doesn't mean you're going to reduce prices across-the-board, but that means you're going to understand your customer and be selective about what really drives the top line.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And also would you give us a sense in terms of the Staples.com revenue performance in Q2 as you saw it year-over-year and how that was against Q1's year-over-year to get a sense as to, let's say, the added price investment and what kind of either volume in units or in value it drove by being more priced, or if that was just enough to kind of hold serve?

Ronald L. Sargent

Well, I'll ask Joe, but I think we said that the dot-com is up kind of low-single digits during the quarter and I think that's probably...

Joseph G. Doody

It's a little bit of deceleration from Q1 when it was up mid-single digits. But again, the actions that we're taking are early stages here. So I don't think you can really judge the results of any changes on the early results so far. So we're seeing frequency up, Aram. We're seeing average order size down and again that's cautiousness on the part of our customers as we see it, just buying what they need when they need it. And to date, it hasn't resulted in the growth that we expect but it certainly is something we have clear plans for.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And you're still not seeing much elasticity at Retail when you test pricing there either, right, is that fair to say? And then I'll hang up.

Ronald L. Sargent

Sorry, what was that question, Aram?

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

I know in the past, you've tested pricing to drop -- to kind of lower them and see what kind of elasticity you get in your retail stores. Are you still continuing to do that? We're not seeing a lot of elasticity in the dot-com business, just kind of trends decelerate in Q2 from Q1 with even more price investment. So just wondering if that's still the case at retail as well.

Ronald L. Sargent

Yes, we're certainly continuing to test elasticity of pricing at retail and in dot-com.

Christine T. Komola

Just to clarify. I think, as you look at the trends that have decelerated in the dot-com business, the testing that we've done is truly different types of testing and some of the programs have worked and some of them haven't. So I'd say that, for example, the ink program has worked. But that's not a broad-based program that we've rolled out to all of our customers day 1. So I think it's a lot of testing and learning and that's what we're trying to figure out, and then whatever works we jump on it quickly.

Operator

Our next question comes from Joscelyn MacKay, Morningstar.

Joscelyn MacKay - Morningstar Inc., Research Division

A lot of my questions on the business side have been answered, but I just wanted to touch on your debt maturity that comes up in a little over a year. Thanks for answering my question on the October debt maturity, but I was wondering is there any early discussions I guess, Christine, in refinancing?

Christine T. Komola

We are talking about it. We've talked to banks and obviously the markets are very good these days. So no firm plans right now, but it is something that we're thinking about as we go forward with our strategy on our capital structure.

Joscelyn MacKay - Morningstar Inc., Research Division

And do you anticipate that will come within this year or...

Christine T. Komola

We haven't firmed up any plans either way. As we do, we'll definitely let you know.

Operator

Our next question comes from Anthony Chukumba, BB&T Capital Markets.

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

Yes, most of my questions have been asked -- sorry, had been answered as well. I did have a question, just kind of a clarification question. I was looking through my notes, you mentioned that you haven't seen any significant competitive shifts that would explain the slowdown that we saw in terms of sales. But on the other hand, you're also saying that in Staples.com, you're investing in ways to drive traffic. You mentioned free delivery, maybe getting a little bit more aggressive on pricing. So I'm just kind of trying to reconcile the 2 because it kind of sounds like maybe there is a bit of a competitive shift there and you're responding to that?

Ronald L. Sargent

I mean, we're certainly not responding to kind of any short-term changes on competitive tactics. I think what we're trying to do is saying for the last 3 years, we've been trying to grow the top line a lot faster than we've actually grown the top line. And are there macro issues that we should be dealing with more aggressively? The answer is yes and whether that's the economy, whether it's customers trading down to value, whether it's the shift to online, whether it's the shift to digitization, so I think we're trying to respond to the world we operate in, but we haven't seen any changes in competitors. In fact, some of our online competitors have -- the price gap that maybe we saw, like, a year or 2 ago has kind of narrowed over time as our online competitors have said at some point, we've got to make money.

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

Got it, that's helpful. And then one other thing that you mentioned and this is -- and we're going back probably a good 45 minutes of the call, but potentially taking some risk -- some level of risk and some level of short-term pain in Europe just to get more aggressive there given the disappointing results, I mean, could that be as -- could that encompass as much as getting out of Europe, selling Europe or maybe selling some portion of Europe? I mean, how aggressive are we willing to get here? I mean, it just seems like your North American business, I mean, even with the slowdown is fine and very profitable and Europe just continues to really drag down the overall results.

Ronald L. Sargent

Yes, I just think it's premature to kind of talk about what the plan is in Europe because we're just working on it. But as Mike said, I mean, we're frustrated with our performance and we're going to be making some changes. And as to what those changes are, I just think it's a little early to know.

Operator

Our next question comes from Michael Baker, Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

In the International business. So first, you didn't really address some of the countries that you've talked about in the past or areas, South America, China, even the printing press business in Europe. Can you describe what's going on there and are those more or less likely candidates for change? And I guess following up with that, within Europe in particular, are there specific countries where it looks like not only are things bad because of the economy, but there might be some structural reasons why they're not going to work out longer term? Just trying to understand where those changes might come. Is it going to be within Europe, is it going to be outside of Europe, et cetera?

Ronald L. Sargent

Well, Michael, as I said, everything's on the table. So we're looking at all of our businesses. To kind of step through your question, printing systems had a terrible quarter as you can imagine. It's a tough business right now, both from a product standpoint and a geography standpoint. The high-growth markets, China, South America continue to actually make solid progress on their way toward break-even and they improved nicely year-over-year from a profitability standpoint. They're way too small to make a difference in the total scheme of things, but they are more or less on track with our plans. I think as we look at Europe, I talked about some of the issues that we've got and as we look at business units that are subscale and don't have really any prospects of making it to be a #1 or #2 in their market and we reflect on the continued difficult economy there, we'll be even more aggressive and we've already shown that we're willing to get out of countries and business units where we don't think we can make profits over the long term. So that's certainly a piece of the plan that we're working on.

Michael Baker - Deutsche Bank AG, Research Division

So to follow up on that, 2 follow-ups. One, can you remind us where the areas are that you think you're subscale in terms of size. And then also remind me what -- in the past, what areas have you been aggressive getting out of businesses?

Michael A. Miles

Yes, well, we're in 16 different countries and multiple different business units in Europe and I don't really think this morning is the time to kind to walk through all of those. But we've exited the Czech Republic and Hungary and our business in retail Office Centre Germany over the past 3 years. And those are the kinds of situations where we've got low scale, the markets don't have tremendous amounts of potential and they're kind of bleeding us. And we've got several more of those given the situation in Europe today.

Operator

Our next question comes from Denise Chai, Bank of America Merrill Lynch.

Denise Chai - BofA Merrill Lynch, Research Division

Just could you talk a little bit about the traffic decline in North American Retail? I think it was kind of the largest in a while. What was driving this? Do you think it was really a shift to dot-com? And would you say it was more attributable to the retail or the small business customer?

Ronald L. Sargent

Demos? Down 2%?

Demos Parneros

Yes, it's been, I think, close to the trend. It's slightly lower than the recent trend. Honestly, it's product-related. I mean, we've mentioned before, not to hit on one area, but the demand for tech at the moment in the summer while people are waiting for new product introductions would be, I think, the principal reason for it. Too early for back-to-school at that time. That's pretty much what we've been able to isolate as the key reason. Everything else seemed actually, in most cases in reasonably good shape, but that was a fairly good hit to the quarter and it really hurt throughout the quarter, not just that 1 month.

Denise Chai - BofA Merrill Lynch, Research Division

Right, got it. Okay. And just my second question is regarding your square footage reduction plans. When you talk about smaller format stores, are you still looking at 15,000 square feet as being pretty optimal so that this is what you're trying to downsize to or open in terms of new stores?

Demos Parneros

Well, there's very little new store activity. But if there is new store activity, we have several formats that we deploy. I would say the 12,000 to 15,000-square foot range is where we are. There's no one set format. In some cases, we build well under 10,000 square feet. But I'd say in that 10,000 to 12,000 square feet is where we're moving to and 15,000 would be fine. We don't need a major downsize from that.

Denise Chai - BofA Merrill Lynch, Research Division

Okay, and just to follow on that. Could you please provide a little bit more color on your success in obtaining rental reductions?

Demos Parneros

We've got good success in obtaining rental reductions, particularly when we look at options for future rent. I'd say close to 90% of the time, we're able to achieve some kind of rent reduction, obviously a little bit lower to the current rent. But landlords have been willing to work with us very nicely on that.

Operator

Our final question comes from Scott Tilghman, Caris & Company.

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

Just wanted to touch on a couple of things that I don't think have been addressed. Joe mentioned a little bit about the state and local governments, so I was wondering if you could comment on some of the trends at the other verticals.

Ronald L. Sargent

Joe?

Joseph G. Doody

Well, I think I mentioned the state and local. Federal has been down and continues to be down in Q2. So it didn't really -- it deteriorated a little bit but not to the degree that the state and local did, which went from positive to negative. If you look at others, I'd say our mid-market initiative, overall, we're very happy with our enterprise business. I wouldn't break that out into anything other than the financial markets, which I'd say are the weakest of all the verticals among our enterprise customers. We've just seen big reductions there, probably all -- most all headcount-related. So it's those heavy, intensive white-collar places that have held or lowered headcount that has had the biggest impact on us.

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

Second, I wanted to touch on the currency issue for a minute. We've talked a lot about the impact on the top line. I was wondering if you could give a little color just given some of the cross-border transactions, what it looked like on the margin side.

Christine T. Komola

Canada's, obviously, our biggest area where there's currency fluctuation because -- on the bottom line because, obviously, Europe doesn't make a lot of money on the bottom line. So that -- but it's not significant in terms of the bottom line impact. It's mostly a sales-driven issue.

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

Okay, and then last. Mike, we've talked a little bit about the scale issue with some of the international markets. Are there some where there's an opportunity to improve that scale? It sounds like most of your discussion before was really exiting markets where the scale just wasn't there.

Michael A. Miles

Sure. I think as we think about sort of the contract business and the success we're having with the mid-market effort in Europe and we're just launching that in Australia, there's an opportunity to build on the scale and business units where we've already got a good delivery infrastructure. And that's something we'll look at down the road someday. If we get this thing properly turned around, there are always tuck-in acquisitions that you could make to build scale. But I think in the short term, we're more focused on improving our situation by subtracting than addition at the moment.

Operator

That concludes the Q&A session. I'd now like to turn the call over to Mr. Ron Sargent.

Ronald L. Sargent

Thanks, everybody, for joining us this morning. We appreciate your time and realize we went over our hour, but we look forward to speaking with all of you again very soon. Thanks.

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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