ODP Corp (ODP) 2012 Q2 法說會逐字稿

Good morning, and welcome to the second-quarter 2012 earnings conference call. All lines will be on a listen-only mode for today's presentation, after which instructions will be given in order to ask a question. At the request of Office Depot, today's conference is being recorded.

I would like to introduce Mr. Brian Turcotte, Vice President of Investor Relations, who will make a few opening comments. Mr. Turcotte, you may now begin.

Thank you, Julie, and good morning. With me today are Neil Austrian, Chairman and Chief Executive Officer; Mike Newman, Chief Financial Officer; Kevin Peters, President of North America; and Steve Schmidt, President of International.

Before we begin, I would like to remind you that our discussion this morning includes forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the Company's current expectations concerning future events, and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

A detailed discussion of these factors and uncertainties are contained in the Company's filings with the SEC. In addition, during the conference call, we refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures, as well as our press release and accompanying webcast slides for today's call, are available on our website at www.officedepot.com. Click on Investor Relations under Company Information.

Neil will now summarize the Office Depot's second-quarter 2012 results. Neil?

Thank you, Brian, and good morning. Office Depot reported second-quarter 2012 sales of $2.5 billion, down 7% compared to the prior year. On a constant currency basis, second-quarter sales declined about 5% versus prior year. We estimate that global store closures and openings and the calendar shift negatively impacted total Company sales by an additional 100 basis points.

The Company reported a net loss, after preferred stock dividends, of $64 million, or $0.23 per share in the second quarter of 2012, versus a net loss of $29 million or $0.11 a share in the same period a year ago. Second-quarter 2012 results included approximately $9 million of charges primarily related to restructuring activities and actions to improve future operating performance.

Second-quarter results also include non-cash store impairment charge of $24 million in North America Retail. We've changed our financial reporting on this matter from the method used for the first-quarter impairment charge of $18 million, and now exclude these impairment charges in our adjusted non-GAAP amounts. This is consistent with the way we, including our Board of Directors, view the business, as we formulate a new retail store strategy that will address a store portfolio designed to better satisfy consumer shopping trends.

Kevin and Mike will cover this strategic process in greater detail later in the call. So, excluding these charges, and a $16 million discrete tax benefit recognized in the second quarter, the net loss after preferred stock dividends would have been approximately $40 million, or $0.14 a share. I should note that our second-quarter 2011 reported earnings included $20 million in charges related to restructuring activities and actions to improve future operating performance.

The net after-tax impact of the charges negatively impacted second-quarter 2011 earnings by about $0.05 a share.

Total Company gross profit margins, excluding charges, increased about 40 basis points in the second quarter of 2012 compared to the prior year. This was the ninth quarter out of the past 10 that we increased total Company gross margin year over year. The gross margin improvement this quarter was driven by increases of 80 basis points in North American Retail, 60 basis points in North America Business Solutions, and 20 basis points in the International Division.

EBIT, adjusted for charges and the store impairment, was a loss of $22 million in the second quarter of 2012, compared to an EBIT of $11 million in the prior-year period. The year-over-year decline was attributable to weaker results in both North American Retail and International, as well as significant discrete benefits received in 2011 that did not recur in 2012.

Before Kevin and Steve review are second-quarter 2000 (sic) performance in North America and International, I would like to make clear we're not waiting for an economic recovery in the US and Europe to drive improved operating results at Office Depot. We plan to proactively address the downturn through the execution of our key initiatives that we expect will both drive profitable sales and reduce noncustomer facing costs in all channels globally.

It's important to note that although we're focusing on reducing costs, we're still investing capital and redeploying resources to drive growth in our business. On our first-quarter earnings call in May, we informed you that we were in the midst of evaluating a more aggressive go-forward set of actions, as it related to the downsizing and remodeling of our current US retail store fleet. At this point in time, we have prepared the store-by-store analysis phase of this endeavor, and are in the process of evaluating the capital and expense requirements along with the related investments we need to make in our e-commerce and IT infrastructure, to drive growth in the business.

The North American Retail store strategy will address a store portfolio designed to better satisfy consumer shopping trends. The strategy development entails reviewing each store location and store size to assess the customer demands in that location. We have almost 500 locations that will reach the end of their base lease period in the next three years, and another 250 locations in the following two years. That's over 60% of our entire North American store fleet over the next five years.

In 2012, we committed about $30 million of capital for the store downsizing effort. With this capital, we plan to remodel or downsize 30 to 35 stores and relocate 25 to 30 stores this year, resulting in approximately 50 to 60 stores being impacted in 2012. As a result of this investment, we believe we are on track to deliver occupancy savings of about $10 million in 2012.

I can envision significantly increasing the annual capital commitment in 2013 and beyond, by as much as double the current rate, to accelerate the process of reducing our occupancy costs while driving a better customer experience. As a result, we could impact over 100 stores in 2013, through both downsizes and relocations, with almost all of these stores seeing significant square footage reductions. If executed, the annual operating cost savings may double, and the return on this incremental allocation of capital could be well above our cost of capital.

We will update you on the strategy as soon as we have the definitive plan in place this fall.

I'll now ask Kevin to review our North American performance in the second quarter.

Thanks, Neil. And good morning. The North American Retail division reported second-quarter 2012 sales of $994 million, a decrease of 8% versus the prior year. The decline in total sales reflects a decrease of about 200 basis points related to store closures in Canada and the US, and an additional 200 basis point negative impact from the calendar shift in 2012 versus 2011.

Same-store sales, in the 1094 stores that have been open for more than one year, decreased 4% for the second quarter of 2012. The year-over-year decline in the second quarter improved by about 200 basis points from the 6% same-store sales decline reported in the first quarter of 2012.

If we look at our performance by product category, Copy and Print Depot continued to perform well again this quarter, achieving a double-digit increase in sales. Sales of furniture were also up year over year, as our own brand seating continues to perform very well. Although sales in the supply category were about flat, ink and toner sales were slightly positive versus the prior year. We also saw increased sales in tablets and e-readers in the second quarter versus prior year, while sales of computers and their related products were down significantly. We believe that there is some pent-up demand for laptops and desktops, as our customers await the release of Microsoft Windows 8, which may lead to a sales lift in software and hardware in the second half of 2012.

As I mentioned last quarter, we're fine-tuning the laptop assortment and completing the renovation of our peripheral assortment. Based on our progress to date, we're optimistic that we can grow this category profitably. While we work on this category, it's important to note that if we excluded sales of computers and their related products in the second quarter, our same-store sales for the division would have been slightly positive versus prior year.

North American Retail's average order value was slightly negative in the second quarter, and customer transaction counts declined approximately 3% compared to the same period last year. We believe that the transaction count decline was driven by a number of factors, including our focus on managing to margin in some of the competitive product areas, and pulling back on weekly inserts in an effort to realign our media mix to more productive vehicles.

Our goal to increase direct imported products continues to go well in North America's retail division, as DI penetration increased 80 basis points to 11% in the second quarter of 2012 versus prior year. We believe that we can continue to significantly increase this level of penetration through our global sourcing organization.

The North American Retail store count at end of the second quarter was 1117 stores. During the quarter, we opened no new stores and closed 6. In 2012, we still plan to close 25 to 30 stores in total. We also remodeled 7 stores and relocated 3 in the second quarter, successfully reducing the square footage of those locations by over 40% on average.

North American Retail reported an operating profit -- excluding a store asset impairment charge of a possibly $24 million -- of $2 million in the second quarter of 2012. This compares to an operating profit of $15 million in the same period last year, excluding approximately $12 million of charges related to the store closures in Canada.

Excluding the charges in both quarters, the year-over-year operating profit decline was driven primarily by the negative flow-through impact of lower sales; promotional activity; the clearancing of some inventory in advance of receiving new products; and nonrecurring benefits in 2011. The negative impact on operating profit from these factors was partially offset by year-over-year gross margin improvements of about 80 basis points, and lower payroll and G&A costs.

As Neil mentioned, we expect to have definitive real estate strategy in place in the fall, which may significantly accelerate the downsizing of stores coming off of lease over the next five years. And we look forward to sharing this plan with you.

The strategy will address a number of possible actions for these individual stores; including, one, being retained in their current format and location; two, downsize to one of the smaller-format stores; three, relocate it within the same market; or four, closed at the end of the lease term.

If we do commit to a more aggressive store downsizing strategy, additional non-cash impairment charges, possibly even more significant in amount that have occurred to date, may result. We also continue to make progress in other key initiatives, which we anticipate will drive profitable sales and reduced costs for North American Retail.

In regard the in-store customer experience, we completed the rollout of the associate training across the remaining stores in the fleet during the second quarter. As background, our pilot stores achieved approximately 300 basis points of comp sales improvement versus the control stores. And we believe that most of our stores have the potential to trend towards a similar increase in comp sales as they hit full maturity.

The third quarter as our back-to-school season, and we're offering a wide variety of great new products and have created some really exciting new partnerships. For example, Office Depot has teamed up with Nick Cannon and Monster to provide the new lineup of incredible Monster headphones, which are now available nationwide at Office Depot retail store locations and online. The new products bring next-level design and high performance audio to the most popular headphone styles.

Turning to North American Retail's third-quarter outlook, we anticipate our same-store sales rate to be down versus the prior year, but sequentially better, as we launch our exciting programs and continue to execute our new technology and peripheral assortment strategy. Our third-quarter operating profit is projected to be up versus prior year, due to gross margin improvement and lower SG&A expenses.

Let me at turn our attentions now to the North America Business Solutions Division. BSD reported second-quarter 2012 sales of $796 million, a 1% decrease versus the same period last year. Second-quarter 2012 sales in the Direct channel were roughly flat versus last year. Sales in the Contract channel decreased about 1%, as reported; but were approximately flat year-over-year, excluding a favorable adjustment to sales in the second quarter of 2011 related to customer incentives.

We continue to see sales growth in our large accounts, due to the successful customer acquisitions in the back half of 2011 and in the first quarter of 2012. We're pleased with the progress made in this important customer segment, and encouraged by the current pipeline of large accounts.

The healthcare vertical has been an area, in particular, where we've had success. Not surprising, we continue to see weakness in the public sector, as these customers continue to experience ongoing budgetary pressures.

Sales to small- to medium-sized contract customers increased slightly in the second quarter versus prior year, and we're excited about continued growth in this attractive customer category.

Looking at our second-quarter sales by product category, we reported positive, year-over-year growth in furniture, Copy and Print, printers and promotional products. We're very pleased that we continue to gain traction in cleaning and break room supplies as well in second-quarter, with sales improvement at a high single-digit rate; while total second-quarter sales in the office supplies category remained relatively flat year-over-year.

Second-quarter 2012 operating profit for BSD was $40 million, down $5 million from the same period one year ago. Gross margin improvement of about 60 basis points and lower supply-chain costs were offset by a number of factors, including the unfavorable impact of approximately $10 million of nonrecurring benefits recorded last year, and higher payroll costs to support investment in the sales organization.

As we mentioned on the first-quarter call, we are now lapping the bulk of our successful cost reduction efforts realized in 2011, and now seeing a shift towards gross profit dollar and margin rate of expansion in 2012, driven by our sales and margin initiatives. In summary, it was another solid quarter for the North American Business Solutions division, as we improved gross margins in both channels. We continue to win new business and retain existing customers in the Contract channel, and our Direct channel performed well once again. As we move through 2012, we anticipate improved performances for both channels.

In regard to BSD's third-quarter 2012 outlook, we expect sales to be flat to up slightly versus prior year, and operating profit to be up both on a year-over-year basis as well as sequentially.

I'll now turn the call over to Steve to review our second-quarter 2012 performance in the International division.

Thank you, Kevin. The International division reported second-quarter 2012 sales of $717 million, a decrease of 13% compared to the prior-year period in US dollars, and a decrease of 6% in constant currency. I should note that the second quarter 2012 consisted of fewer working days compared with last year, negatively impacting International sales by about 160 basis points.

As I speak to year-over-year comparisons by channel this morning, please note that I'll do so in constant currency. But before I begin reviewing the International results by channel, I'd like to address a topic often discussed while meeting with investors.

Our sales exposure to the most challenged economies in Europe -- such as Greece, Spain, Italy, Portugal and Ireland -- was relatively small. As I've mentioned in the past, our greatest sales concentrations are in the UK, France, Germany, Sweden and the Netherlands, countries where we have strong market positions.

It's interesting to note that although Ireland is included in the challenged group of countries, our business in that country is forecasted to grow on a constant currency basis in 2012, despite the economic headwinds, a tribute to our strong leadership in Ireland.

Turning to our channel results, European Contract sales decreased low-single-digits in the second quarter versus the prior year, as growth in the UK and Germany were more than offset by weaknesses in other countries. In Asia, our Contract channel recorded a high-single-digit increase in year-over-year sales in the second quarter of 2012. Second-quarter sales in the European Direct channel her lower than a year ago.

Our Viking business in Europe has been declining for a number of years. Since taking this role seven months ago, I recognized that we needed more focus and investment in our Direct channel, and I will review our plan to fix Direct in a moment.

European retail channel sales in the second quarter decreased by mid-single-digits compared to prior year. While sales in France were relatively flat, weaknesses in Sweden and Hungary drove the overall channel decline. As a reminder, we own and operate a total of 115 retail stores in France, Sweden and Hungary.

In Asia, we continued to see sales growth in our South Korean retail business. It's worth noting that we've already launched Apple products in 10 of our retail superstores in France, and will launch Apple in the remaining 21 superstores, and one city store in Paris shortly.

I mention this for two reasons -- one, we are very excited to be partnering with Apple in France; and, two, because our total computer hardware category sales in France have grown every month since the launch of Apple in March of this year. We also, by the way, carry Apple products in our core stores in Mexico, with similar positive results.

The International Division reported second-quarter 2012 operating profit of approximately $10 million, compared to $13 million reported in the same period the prior year. Excluding approximately $3 million of charges related to business restructuring actions and process improvement activities, adjusted operating profit in the second quarter was approximately $13 million, compared to $19 million in the same period in 2011.

The year-over-year decrease in adjusted operating profit was primarily volume-driven. While we increased our gross margin rate and made good progress on reducing operating expenses during the quarter, the deleveraging effect of lower sales volume on gross profit dollars more than offset the cost reductions.

In Latin America, Office Depot de Mexico reported second-quarter 2012 of $260 million, an increase of 11% in constant currency versus prior year, and net income of approximately $10 million. We don't consolidate sales from our joint venture, but Office Depot's portion of the net income was approximately $5 million for the quarter, and is reported in the Miscellaneous Income net line on the statement of operations.

The joint venture's net income in the second quarter was down from the prior year, due to unfavorable impact of currency translation and additional expenses related to new store openings. We expect the currency situation to stabilize in the back half of the year, and the new store expenses to be mitigated by increasing sales as they ramp up.

Office Depot de Mexico ended the second quarter with a total of 252 stores and distribution facilities throughout Latin America. We opened two new stores in Mexico during the second quarter; and a total of 11 stores in Mexico, Panama, and Guatemala in the first half of the year.

We remain very pleased with the performance of this outstanding business, and are excited about the significant multichannel growth opportunities throughout Latin America. Although we currently have a leading position in office supplies in Mexico and Central America, our penetration of South America is limited, offering attractive future opportunities.

I would like to go back to Neil's opening comment, that we're not waiting for an economic recovery to drive improved operating results at Office Depot. He's correct that we are proactively addressing the downturn in Europe by executing our key initiatives to drive both profitable sales and reduce costs, while still investing driver business. I'd like to share one of those initiatives with you.

As I mentioned, we need to improve performance of our Direct channel. To accomplish this, we have established a core team of Global Direct channel experts; with a mandate to establish and implement best practice customer acquisition, development, and retention strategies across our major European markets, to stop the sales decline and return to growth. This team will improve the customer experience by leveraging all of our advertising expense into more effective e-commerce marketing strategies.

Although we are in the very early stages of this initiative, we have been able to stabilize the rate of decline and are now focused on increasing our customer acquisitions. In addition, we continue to work on optimizing our European cost structure and developing an agile, high-performance organization.

In summary, the International Contract channel performed well in the second quarter, despite the economic pressures in Europe. And we're making progress on improving the performance of our Direct channel. As we look forward, we expect to continue executing our strategic initiatives and reversing the declining sales trend in our European business.

In regards to the European -- or, excuse me, International division's third-quarter 2012 outlook, we expect our sales in constant currency to decline low-single-digits versus the prior year due to the weak European economic conditions; and operating profit, excluding charges, to be down, as the negative sales trends more than offset our cost reduction efforts.

Mike will now review the Company's second-quarter 2012 financial results in more detail. Mike?

Thanks, Steve. As Neil mentioned earlier, the second-quarter 2012 total Company EBIT loss, excluding restructuring charges and the impairment charge, was $22 million versus EBIT of $11 million in 2011. As I discussed last quarter, the Second-quarter of 2011 included significant discrete benefits, totaling over $20 million in 2011 that did not recur in 2012.

The waterfall chart on slide 12 provides a snapshot of the additional factors driving the year-over-year decline in EBIT. On the plus side, we had approximately $34 million in benefits realized from our business initiatives. These benefits were more than offset by about $35 million from the negative impact of lower sales volume, and $32 million related to the significant, nonrecurring discrete items in 2011, along with changes in G&A and lowered joint venture incomes.

I'll now update you on restructuring charges. In the second quarter, we reported $9 million of restructuring-related charges and other costs intended to improve efficiency and benefit operations in future periods. These charges included about $3 million for European business restructuring and process improvements, and approximately $6 million for business process improvements at the corporate level.

To provide a clearer view of our comparative 2Q performance, I thought it would be helpful to discuss our first-half performance versus last year. Our first-half 2012 EBIT, adjusted for charges of $43 million, was approximately flat when compared with 2011; again, mostly due to the over $[200] million in favorable second-quarter 2011 nonrecurring items.

Turning to slide 11, free cash flow for the second quarter of 2012 was the use of $66 million, which was a $19 million lower use than a year ago, due to better working capital management. This use of cash primarily reflects an increase of direct import inventories, in preparation for back-to-school; an accrued tax benefit from an IRS ruling; and a decrease in trade payables. I would say that we still expect to generate $80 million to $100 million in free cash flow for full-year 2012 from an operational perspective. This excludes a negative $50 million impact to free cash flow, from a first-quarter pension settlement, that was offset by a positive impact of cash flow from investing activities of the same amount in Q1, with the net result of having no total cash flow impact on Office Depot.

Capital spending totaled $63 million in the first half of 2012, and we're now targeting about $140 million to $150 million of total spend for the year.

Turning to liquidity, we ended the second quarter with $423 million of cash and cash equivalents, and $729 million available from our asset base lending facility, or ABL, for total liquidity of $1.2 billion. No amounts were drawn on the ABL at quarter-end; and, additionally, we have approximately $50 million available under an accounts receivable factoring agreement in Europe that is available. But nothing has been drawn to date.

Total Company second-quarter 2012 operating expenses, adjusted for restructuring and asset impairment charges, were down $18 million versus prior year. The year-ago reduction in operating expenses was driven by productivity improvements in both North America and Europe. The effect of tax rates for the quarter, on a reported basis, was 20%. This tax rate included a $16 million benefit, based on a ruling we received from the IRS to carry back an accounting method change to the 2009 tax year. The effective tax rate on our earnings, adjusted for discrete items, was 15% for the second quarter. And for the full-year, I'd point out that we still project to pay cash taxes in the $11 million to $13 million range.

During the second quarter, we recorded a dividend on our convertible preferred stock of approximately $7 million, which was paid in kind on July 1. We anticipate paying a dividend in kind through 2012, and may see quarter-to-quarter fluctuations based on the fair value adjustments of that dividend each quarter.

Turning to our third-quarter and full-year outlook, we expect a decrease in total Company sales in the third quarter compared to last year, but improved sequentially from the second-quarter rate of decline, due in part to easier comparisons on technology and North American Retail. We believe that foreign exchange will continue to have a negative 200 to 300 basis point impact on total Company sales going forward, due to the weaker euro and pound versus a year ago.

We expect third-quarter EBIT, adjusted, to be up compared to last year despite lower sales, mostly due to our key initiative benefits. For the full year, we expect adjusted EBIT to be in the $125 million to $135 million range. Although this range is about $15 million lower than our original full-year guidance, due primarily to the recent weakness in Europe, it is still up $5 million to $10 million from 2011. I would also point out that the 53rd week in 2011 positively impacted total Company fourth-quarter EBIT by about $6 million, with $11 million of that coming in North America.

As a reminder, our definition of EBIT excludes the impact of any restructuring charges, as well as the $42 million of non-cash store impairment charges recorded in the first half of 2012. I should also note that, although our full-year EBIT guidance is lower, we still expect our free cash flow to be in the $80 million to $100 million range from an operational perspective, as mentioned earlier.

And with that, I'll now turn the call back over to Neil.

Thank you, Mike. I hope that we've made it clear that we're not waiting for an economic recovery to drive improved operating results at Office Depot. We're proactively dealing with challenging global economic environment by executing the key initiatives to drive profitable sales and reduce noncustomer facing costs and all channels, globally.

I'm pleased with the progress we've made on many fronts, and I'd like to thank our associates worldwide for all their hard work in making this happen. I believe that despite the economic headwinds we face, we have many levers to pull to continue to improve the performance of Office Depot going forward.

Thanks, Neil. Operator, we're now ready to take questions.

(Operator Instructions). Colin McGranahan. Please state your company name.

Good morning, it's Sanford Bernstein. First question for Neil. I guess just big picture, Neil, clearly you're not waiting for the economic environment to improve. But curious as to how you're thinking about the economic outlook through the rest of the year, and maybe into next year and the demand environment. And maybe you can compare and contrast that International versus North America; how are you feeling today versus maybe three, four, five, six months ago?

How I feel and how the rest of that consumers feel may be very different, Colin. But I haven't seen anything, in a major way, that reflects significant consumer confidence. And I'll stay with consumer for a minute, because it's a large part of our retail business. When I look at the last Bloomberg consumer confidence index that came out a few days ago, it's the lowest it has been in the last five or six months. Moody's Analytics just reported that they expect spending is going to remain pretty soft. GDP in Q2 was down from where was in Q1.

At the same time, as you look at our BSD business, our large global customers are spending significantly more. Where we've been hurt is looking at the mix in our public sector business and our federal government business. We expect to start lapping that next year, given the declines that they've had.

You look at Europe, and it's very hard for us to get a good grip. You've got unemployment, in the 17 nations that use the euro, of over 11%. Then you add in the UK, which is probably considered to be in a recession or depression, and it's very hard to see significant spending growth over the next year. So, from our standpoint, we think the timing is probably absolutely right to move forward aggressively -- as we tried to outline in this call -- both domestically and internationally. Both here, reducing the footprint in retail, and going far more aggressively than we have in the past; and in Europe, making the investments that Steve's done both in the IT infrastructure and in getting the Direct business back on track.

Okay, that's very helpful. And my second question would be for Steve. Just following up on the Direct business in Europe -- firstly, can you quantify how large the decline in that business was in 2Q? And then maybe just provide a little more insight as to what the turnaround plan is. I understand the focus on e-commerce and streamlining the marketing, but who are you losing share to, and how do you reverse that? What do you think has really been plaguing the business?

Yes, Colin, let me, first off, our talk about the market condition. First of all, the majority of our business in Direct is around the Viking brand. And when you think about that business, what happens is, it's primarily been a catalog business, direct mail business. And what is happening in Europe and happening around Rest Of World is consumers and small- to medium-sized businesses are shifting to the web.

And so, what you've got to be able to do is have a knowledge management system, a database management capability, to be able to track customers, to be able to target those customers with the right marketing messaging; and, then, to ensure that you've got the right product assortment and the right ability to communicate with them, in order to have the experience that makes them want to shop with you as a loyal customer base.

And so what we have in Europe today is we're operating off of multiple operating systems, and we're working to fix that through the investments that we've talked about in the past; through an ERP implementation, that's going to take several years across Europe, to harmonize our IT infrastructure. But what we're building is a knowledge management system.

We are sharing best demonstrated practices. We have a center of excellence in the UK. And we rolled that out across all of Europe, in terms of exactly what they're doing and how they are operating in the Direct business. We are significantly investing behind the web, and the infrastructure behind the web, to have a best-in-class customer experience. And so, when you bring all those things together, that's really where the focus has been.

Your first part of your question, relative to the revenue decline in the second quarter in the high-single-digit area, and it's one that we plan to improve on.

Okay, and then just final follow-up, Steve. Given the diagnosis there, would you say that there are new entrants that are better at e-commerce that have been stealing share, as Viking has been in this transition toward more of a web-based platform?

I wouldn't characterize it that way. What I would say is that what we are seeing is competition increasing, particularly on the web. Category killers, just as in North America, continued to pop up all over the world. So we see more and more competitors showing up on the web every single day. At the same time, the Amazons of the world and other companies continue to make progress, just as we are.

And so, what we have got to be able to do is provide a customer experience that is better than or equal to competition, so the customers would want to do business with us.

Colin, this is Neil. Let me just say a couple things to that. To a great degree, the situation in Europe in the Direct business mirrors what Steve inherited when he came here the first time, and was running the BSD business and our Direct business. The Viking business here, domestically, had been a catalog business, a direct-mail business. And when we integrated here domestically -- besides making a number of mistakes -- some of the things that Steve just talked about that we're doing in Europe, he did here in the US; which gives us a lot of confidence that what is going on in Europe, and has taken a long time to get to that point, that he really understands what has to be done to fix that business.

That makes sense. Okay, best of luck.

Are you ready for the next question?

Yes, please.

Dave Gober. Please state your company name.

Morgan Stanley. Thanks for taking the questions, guys. Had a couple on the retail business, for Kevin. Just a clarification on the comments about the non-competing categories. Would comps have been up if you excluded all of tech, or do you have to include tablets to get that number positive?

Yes, Dave. What we had talked about is, if you look at where the pressure is in the retail business, if you exclude technology -- which is inclusive of tablets, as well as their related accessories -- then the comps would have been positive. I think, for the retail business, there has been a significant decline in both laptop and desktop units. As it relates to laptops, we've been able to cover most but not all of that decline with a transition from laptop sales to tablet sales. As we've talked about before, the ASP of a tablet sale is roughly 40% to 50% of a laptop. So it puts comp pressure on the top line. But the good news is that the tablets deliver more IGN dollars than the laptops do.

Okay. And we've seen a lot of volatility from other retailers on a month-to-month, and even on a week-to-week basis, given the choppiness in the economy and the consumer right now. Just curious if you guys saw any differences month-to-month; and, maybe, as we head into the back-to-school season now, how are you feeling about trends in July?

I think, as you look across the US, when you -- one of the measures certainly would be just traffic in general. And for those stores that report traffic, we're seeing the same thing -- a fair amount of choppiness across all retailers. Specifically as it relates to Office Depot retail, if you look at our results by month, there was a little bit of variation, but not much. May was a little bit softer than April or June, but not significantly.

Okay. Just one final follow-up on the new store formats. Have you seen any significant divergence from the original plans that you guys have laid out a couple of times, in terms of sales productivity in the smaller store formats? And could you update us on how many of the 5Ks you have out there today?

Yes, we have roughly 12 or 13 5Ks. We've talked about having 26 or so by the end of the year. And I think, for us, I would continue to characterize it as a work in progress. I think we are -- we still feel like there are opportunities to improve the assortment. We also continue to believe that there are opportunities to enhance the service offering inside the store. So as we roll out both the 5Ks and the 15Ks, I think we'll continue to tweak the model. But I think we are encouraged enough about what we see so far, as that we feel it's a platform that will serve our consumer needs well into the future.

Okay, great. Thank you very much.

Kate McShane. Please state your company name.

Hi, thanks. Good morning. Citi. Just a question on the guidance for both Retail and Contract. It's encouraging to hear that you do see an improvement, quarter to quarter, from this quarter to next. And I wondered if you could comment at all about trends that you're seeing so far, if they have been better than what you've been seeing April through June, and how the back-to-school environment is so far?

Yes, Kate, we really can't comment on any trends that we've seen. I think with regard to our guidance, I think we are well-positioned for the third quarter. I think we feel good about our merchandising mix. I think we feel good about the marketing activities around supporting back-to-school. And as we mentioned, with regard to the BSD business, our Direct channel continues to perform well, and we've got some nice wins that will begin to find their way into the Contract portfolio in Q3. So I think that's largely the drivers of our guidance for Q3.

And I think, as it relates to back-to-school, we expect to be competitive.

Kate, the other thing I would point out is that when you look at Retail and BSD, in Q1 both of those businesses were up nicely to last year in operating profit. In Q2, both were down. And a lot of that had to do with one-timers from 2011 that were nonrecurring. In Retail, we had about seven; in BSD, we had about 10. So as we go -- we've talked going forward. And second quarter was really an anomaly. And we see more of a continuation of the types of trends we saw in Q1 into Q3 and Q4. So Q2 was -- these one-timers we're up against -- and the bulk of the one-timers was in those two North American businesses.

Okay, that's helpful, thanks. And just one further question on a comment you made, and another question about global accounts spending more. Can you give any more context around that comment, and what is driving that?

I think we've done a nice job with account acquisition and retention. So when you look at our large global business, as well as our SMB business, we are seeing a nice lift; not only in sales from new customers, but sales from existing customers. Unfortunately, that's being offset by pressure in the public sector, largely from state governments and education, higher education.

Okay, thank you.

Carla Casella. Please state your company name.

Hi. My company is JPMorgan. One clarification. You mentioned, on the free cash flow, you're targeting $80 million to $100 million from, it sounds like operating cash flow. And then CapEx, $140 million to $150 million. So, free cash flow, you're targeting the negative, correct?

No. If you strip out this pension gain that we had in Q1, which had a negative benefit in free cash and a positive impact in investing, for a net impact of $0. If you take that out, we're looking at $80 million to $100 million of free cash. And the pieces would be --

(multiple speakers) after CapEx, then?

Yes.

Okay, perfect. That's what I was trying to clarify. And then, on the Direct business in Europe, who are you losing sales to? Who's been aggressive over there in picking up sales?

Again, Carla, what we're seeing, two things -- one, we have an economic downturn in Europe. Where, across the board, we are seeing our customer base, both look large and small to medium, decrease overall purchasing. And we're seeing that across all channels, as our competitors are. We continue to feel very good about our Contract business, where we continue to gain share with our large customer segment. If we look at, specifically, in each of the markets, it will vary; whether we talk UK, Germany, France, we have different competitive base. But clearly, what we see is a real transition going on between customers who were using catalog to those going to the web.

And so what we are managing is that transition. We are seeing growth in our web, as catalog sales continue to decline. So at this point, as I mentioned prior, we see continued increase in competition, primarily coming from -- I'll call them category killers. Small companies that start up on the web; they continue to be penetrating web globally. And in addition to that, Amazon and everyone else that's out there continues to put pressure on the marketplace. But, again, we feel good about where we are at. We feel good about the work we're doing. We're making improvements every day. And we're confident that we're going to be able to compete with anybody, relative to that direct web environment.

Okay. And then you mentioned, in Europe, you've got your direct divergence and markets between the strong markets in the week markets. What percentage of your business comes from those stronger markets? France --

Yes, the majority -- we haven't really given specific guidance, relative to the mix of business, other than (multiple speakers). Yes.

Okay, great. Thanks a lot.

Dan Binder. Please state your company name.

Hi, good morning. It's Dan Binder from Jefferies. I had a few questions. First was around gross margins. In the past, we've seen you go through, as a Company, through cycles of gross margin increases, sometimes at the cost of sales, as we're seeing now. And other times, gross margin decline for the sake of market share gain. Just curious, as you look out in the environment, and the fact that your sales are struggling a bit in a tough environment, why you are willing to let gross margin ride as much as you have, rather than a reinvesting it in core categories on price, to try and take share?

Let me try, Dan. This is Neil. I think we've done a lot of analysis, from a marketing standpoint, on our customers. I think we've gotten to a point where we understand which categories we can be promotional in, and when; and which categories, from a promotional standpoint, all we do is increase comps for that period of time at the expense of gross margin. And those customers don't return, and they are not a valued customer.

The way we're looking at it on a promotional basis today, is what I'll call the lifetime value of the customer. And for those customers that we believe we can retain and have a profitable relationship with, on a long-term basis, we will deal promotionally, and with those products. On others, we're not. So we've looked at this; we've analyzed it; you may see some changes in the future on certain categories. But, to date, our feeling is that if we lose share today, it's a transient share shift, and it's not going to be permanent.

My second question was related to the delivery business. You've already commented a little bit on what your global customers are doing. If you look at across the delivery business in the US, what are you seeing in terms of customer acquisition versus existing customer purchases, and how that's impacting the sales results?

I think existing customer purchases have been flat to slightly up. We're seeing a little bit of movement from on-core to off-core. That's largely a function of work our sales organization is doing to try to reduce the size of core lifts and improve the margins in the Contract business. And I think that the large and global business has been fueled by account acquisition. And we have done -- had some nice wins in the healthcare vertical, as well as other SICs.

And then, lastly, you did comment on little bit on your review of the store portfolio. Just curious, as you run through this analysis, obviously considerations to capital. I mean, preliminarily, do you think that, with all of the leases you mentioned coming up, that you will have the capital to impact store closures, and shrink stores that you want, for those that are coming up in the next few years here?

Yes. We have, in the next few years, we have approximately 160 and 170 stores coming up for lease. We think that through downsizing of the smaller formats, we'll be able to hit over 100 in both years, probably -- rough numbers, 110 to 120 in those years. And what it requires is us taking -- we'll probably see -- you'll probably see us take our CapEx guidance up from a number that's been averaging $150 million for the past three or four years to $200 million.

Instead of guiding $80 million to $100 million of free cash, we'll guide a lower number, principally due to the change in the CapEx. And we think that we can manage that, from a liquidity perspective, with the rating agencies. And we think it's the right thing to do to invest in the business.

So the two places you'll see us invest is in store downsizes -- which, as Kevin pointed out, was about $30 million more a year of capital -- and also, probably, in areas like e-commerce and systems in Europe. So we think that's the right move. We think we can let handle it from a liquidity perspective. And particularly on the store size, where we have about a $450 million of occupancy in the store fleet if we were to do this and affect the significant number of stores we'll see in the next five years, we can see taking out as much as $100 million of that occupancy cost; which, on a base of $450 million, is substantial. And it's very substantial when you equate it to the current profitability of not only the Company, but of retail.

Thank you.

Michael Lasser. Please state your company name.

It's UBS. Good morning, everyone. Can you clarify the full-year EBIT guidance? How does that compare to the $120 million to $130 million that you offered in the first quarter?

Yes, the $120 million to $130 million in the first quarter had the impairment in it, because we had a different treatment. So it's really down slightly from the first-quarter guidance that we gave. And it's mostly due -- it's down, I think, 10 to 15?

Right. The $18 million impairment was in the first quarter.

-- was in the first quarter guidance. So add that back to the first quarter guidance, and compare it to what we just gave you, and those should be apples-to-apples.

Okay. And it's mostly due to the International business? The reduction from $138 million to --

Yes, we said International. But there's also a piece that relates to retail a little bit.

Okay. (multiple speakers). On the Retail business, Neil, can you give us some vision -- preliminarily, again -- what the retail business is going to look like a few years from now? And the reason why I think that's important is because, I think there will be a question about whether your current cost structure -- even after you've undertaken all these restructuring activities -- is sufficient to support what looks like it's going to be a smaller sales base, if you undertake pretty aggressive actions.

Well, the first comment you made, a significant sales reduction, I disagree with. Because what we've seen to date so far doesn't represent a significant sales decrease. I think, to look at out 3 to 5 years in retail, you'd have to be, I think, more of a mind reader then I'm prepared to be. But what I can say is the following -- all of our customers have told us that the smaller format makes more sense from a shopping perspective. At the same time, from a competitive standpoint, we believe that services and a highly-trained associate sales force inside can make a significant difference. When you look at where we have an advantage today, to the online people like an Amazon; it's clearly copy, print, shipping; it's in tech services; it's in fact, on the tech and peripheral side, having someone you can talk to when you make a purchase.

So from a cost standpoint, you do raise a good question. All I can say is, we're absolutely committed to getting a cost structure that will be in line with what the sales and profitability are. And I've long said we're prepared to be a smaller Company that's more highly profitable. So it goes back to Dan's question, in terms of grabbing sales just for the point of comps and market share in the short-term. We're just not prepared to do that. We've looked at the smaller store format in great detail. I think you're going to see a lot of experimenting, in terms of what that store looks like, how it's going to work. But, quite honestly, I don't think anyone who's in the retail business today can look ahead and say that a large box is what's going to make the most sense over time. And we have a unique opportunity, in the next five years, to change that.

I think, in the past, you said that the capture rate of the smaller boxes was about 90% of the nearby big location. So is that a safe assumption to use, moving forward?

Yes, I think essentially that what we've said is, that on stores that we've downsized in place, that we are retaining about 90% of the sales in the current format with the current setup. When we do relocate a store, that softens a bit. I think, to Neil's point, what I wouldn't lose sight of is -- keep in mind, this is on a base of 12 or so stores -- I think there's an opportunity to capture additional sales by simply allowing the stores to do a better job moving a transaction out of brick-and-mortar to online. So I think those are the kinds of things that we'll be continuing to work at, as we update and refresh the fleet going forward.

You also have a higher margin business in services than you do in products. And if we're successful in the smaller store format going forward, I think you'll see a margin difference, if we can get the service piece right.

Okay. Last question. Can you offer some clarity on how the calendar shift is going to impact the NAR business in the third and the fourth quarter? I think it was 200 basis points of a drag in the second quarter.

Yes, I think we said that it was a -- what? A $11 million benefit a year ago in North America.

53rd week.

The 53rd week, right. Yes. So 53rd --

I'm just talking from the actual shift of when the quarter ends. It sounds like it was a 200 basis point drag in the second quarter.

In Q3?

Yes. So what was the --

So his question is, what impact is that for the balance of the year?

For the sales?

Right. If it's -- I can get it from you off-line, if it's an issue.

Okay.

Thank you very much.

Christopher Horvers. Please state your company name.

Thanks -- JPMorgan. Jumping back to be free cash flow, a couple clarifications. So you kept the guidance for the year in terms of your free cash flow outlook. Were there changes to the constituent parts, in terms of capital spending now, versus what you had expected previously? And then, from a days inventory outstanding, how should we think about that, end-of-2012 versus end-of-2011?

Yes, I don't -- two things changed that -- obviously, you've got lower EBIT guidance, so two things changed. We've had some internal projects on inventory reduction that are better. And our CapEx is a little bit lower than it was previously. So those are the two areas that improved. And what was the second part of your question?

Days inventory outstanding.

Yes, I don't look at days so much. I think we probably are guiding that working capital -- which is mostly driven by inventory-payables combination -- is probably in the 40 to 50 range for the year now, which is a little stronger than what we had.

Okay. And then, on the BSD side, I don't know if you've broken it out this way, but can you talk about what the top line would've looked like if you had backed out the public sector downtrend? And maybe talk about what percentage of the mix it is today versus 12 months ago.

Chris, this is Kevin. I don't think we've broken it out. I think what we said last quarter is, the public sector was roughly 24% of the total BSD business. And I would say that, in terms of sequential trends, it's performing about where it was last quarter.

Okay. Thanks very much.

Are there any more questions?

There are no further questions.

Great. This concludes our webcast and conference call this morning. Thank you very much for participating, and I'll be available to take your calls later on today. Thank you.

That concludes today's conference. Please disconnect at this time.