Description
Office Depot Inc. 10% Owner Value LP Starboard bought 4,094,119 shares on 10-11-2012 at $ 2.29
BUSINESS OVERVIEW
North American Business Solutions Division
Our North American Business Solutions Division sells nationally branded and our own brand office supplies, technology products, furniture and services by means of a dedicated sales force, through catalogs and electronically through our internet sites. We strive to ensure that our customers’ needs are satisfied through various channel offerings. Our direct business is tailored to serve small- to medium-sized customers. Our direct customers can order products from our catalogs, by phone or through our public web sites (www.officedepot.com), including our public web site devoted to technology products (www.techdepot.com).
We use catalogs and the internet to market directly to both existing and prospective customers. Large catalogs with our full listing of products are typically distributed annually and supplemented periodically with focused offerings. Prospecting catalogs with special offers designed to attract new customers also are mailed at certain intervals. In addition, specialty and promotional catalogs may be delivered more frequently to selected customers based on their past or potential future purchases. We also produce a Green Book ® catalog, which features products that are recyclable, energy efficient, or otherwise have a reduced impact on the environment. We continually evaluate our catalog offerings for efficiency and effectiveness at generating incremental revenues. Products purchased through our catalogs and over the internet are fulfilled through our North American Supply Chain from DCs throughout the U.S. and occasionally through wholesalers.
Our contract business employs a dedicated sales force that services the office supply needs of predominantly medium-sized to large customers. We believe sales representatives contribute to customer loyalty by building relationships with customers and providing information, business tools and problem-solving solutions to them. We offer contract customers the convenience of shopping on dedicated web sites and in our retail locations, while honoring their contract pricing in lieu of retail pricing. We also use an inside sales organization that is staffed by Office Depot employees who support select existing and new small business customers who prefer or require a more personalized experience, primarily by telephone. This function, previously outsourced, was brought back in house at our new inside sales office in Austin, Texas in 2012. Sales to our contract customers that are fulfilled at retail locations are included in the results of our North American Retail Division. Part of our contract business is with various local, state and national governmental agencies. We also enter into agreements with consortiums of governmental and non-profit entities for non-exclusive buying arrangements.
North American Supply Chain
The company operates a network of DCs, crossdock, and combination facilities across the United States. In prior years, retail stores were largely replenished through our crossdock flow-through facilities where bulk merchandise was sorted for distribution and shipped to the requesting stores about three times per week. Based on our supply chain consolidation, we closed six crossdock facilities in 2009, three in 2010, and one during 2011. The crossdock function has been transitioned to the existing DCs within the same market. These combination facilities, which share real estate, technology, labor costs and inventory, satisfy the needs of both retail stores and delivery customers. Costs are allocated to the North American Retail Division and North American Business Solutions Division based on the relative services provided. Benefits of this consolidation include improved inventory management and greater operational efficiency, as well as improved service.
North American Business Solutions Division
Our North American Business Solutions Division sells nationally branded and our own brand office supplies, technology products, furniture and services by means of a dedicated sales force, through catalogs and electronically through our internet sites. We strive to ensure that our customers’ needs are satisfied through various channel offerings. Our direct business is tailored to serve small- to medium-sized customers. Our direct customers can order products from our catalogs, by phone or through our public web sites (www.officedepot.com), including our public web site devoted to technology products (www.techdepot.com).
We use catalogs and the internet to market directly to both existing and prospective customers. Large catalogs with our full listing of products are typically distributed annually and supplemented periodically with focused offerings. Prospecting catalogs with special offers designed to attract new customers also are mailed at certain intervals. In addition, specialty and promotional catalogs may be delivered more frequently to selected customers based on their past or potential future purchases. We also produce a Green Book ® catalog, which features products that are recyclable, energy efficient, or otherwise have a reduced impact on the environment. We continually evaluate our catalog offerings for efficiency and effectiveness at generating incremental revenues. Products purchased through our catalogs and over the internet are fulfilled through our North American Supply Chain from DCs throughout the U.S. and occasionally through wholesalers.
Our contract business employs a dedicated sales force that services the office supply needs of predominantly medium-sized to large customers. We believe sales representatives contribute to customer loyalty by building relationships with customers and providing information, business tools and problem-solving solutions to them. We offer contract customers the convenience of shopping on dedicated web sites and in our retail locations, while honoring their contract pricing in lieu of retail pricing. We also use an inside sales organization that is staffed by Office Depot employees who support select existing and new small business customers who prefer or require a more personalized experience, primarily by telephone. This function, previously outsourced, was brought back in house at our new inside sales office in Austin, Texas in 2012. Sales to our contract customers that are fulfilled at retail locations are included in the results of our North American Retail Division. Part of our contract business is with various local, state and national governmental agencies. We also enter into agreements with consortiums of governmental and non-profit entities for non-exclusive buying arrangements.
North American Supply Chain
The company operates a network of DCs, crossdock, and combination facilities across the United States. In prior years, retail stores were largely replenished through our crossdock flow-through facilities where bulk merchandise was sorted for distribution and shipped to the requesting stores about three times per week. Based on our supply chain consolidation, we closed six crossdock facilities in 2009, three in 2010, and one during 2011. The crossdock function has been transitioned to the existing DCs within the same market. These combination facilities, which share real estate, technology, labor costs and inventory, satisfy the needs of both retail stores and delivery customers. Costs are allocated to the North American Retail Division and North American Business Solutions Division based on the relative services provided. Benefits of this consolidation include improved inventory management and greater operational efficiency, as well as improved service.
We buy substantially all of our merchandise directly from manufacturers and other primary suppliers, including direct sourcing of our own brand products from domestic and offshore sources. We also enter into arrangements with vendors that can lower our unit product costs if certain volume thresholds or other criteria are met. For additional discussion regarding these arrangements, see the Critical Accounting Policies section of MD&A.
We operate separate merchandising functions in North America, Europe and Asia as well as in our joint ventures. Each group is responsible for selecting, purchasing and pricing merchandise as well as managing the product life cycle of our inventory. In recent years, we have increasingly used global offerings across all regions to further reduce our product cost while maintaining product quality.
We operate global sourcing offices in Shenzhen and Hangzhou, China, which allows us to take more direct control of our product sourcing, logistics and quality assurance. These offices consolidate our purchasing power with Asian factories and, in turn, help us to increase the scope of our own brand offerings.
Sales and Marketing
Our marketing programs are designed to attract new customers and to drive frequency of customer visits to our stores and web sites. We regularly advertise in major newspapers in most of our North American markets. We also advertise through local and national radio, network and cable television advertising campaigns, and direct marketing efforts, such as the internet and social networking.
We offer customer loyalty programs that provide customers with rewards that can be applied against future Office Depot purchases or other incentives. These programs have provided us with valuable information enabling us to market more effectively to our customers. These programs may change in popularity in the future, and we may make alterations to them from time to time.
We perform periodic competitive pricing analyses to monitor each market, and prices are adjusted as necessary to adhere to our pricing philosophy and further our competitive positioning. We generally expect our everyday prices to be highly competitive with other resellers of office products.
We acquire new customers by selectively mailing specially designed catalogs and by making on-premises sales calls to prospective customers. We also make outbound sales calls using dedicated agents through our telephone account management program. We obtain the names of prospective customers in new and existing markets through the purchase of selected lists from outside marketing information services and other sources as well as through the use of a proprietary mailing list system. We also acquire customers through e-mail marketing campaigns and online affiliates. We are an official sponsor of NASCAR® and are currently designated NASCAR®’s official office products partner. No single customer in any of our segments accounts for more than 10% of our total sales.
We consider our business to be only somewhat seasonal, with sales generally trending lower in the second quarter, following the “back-to-business” sales cycle in the first quarter and preceding the “back-to-school” sales cycle in the third quarter and the holiday sales cycle in the fourth quarter. Certain working capital components may build and recede during the year reflecting established selling cycles. Business cycles can and have impacted our operations and financial position when compared to other periods.
Copy and Print
Our North American retail stores contain a Copy & Print Depot TM offering printing, reproduction, mailing, shipping, and other services. This includes Xerox Certified Print Specialist associates to assist with digital imaging and printing and shipping services through UPS and the U.S. Postal Service. In addition to the in-store locations, we operate nine regional print facilities, which support copy and print orders taken in our North American Retail and North American Business Solutions Divisions. We also offer copy and print services to our customers in Europe through our e-commerce business.
Intellectual Property
We hold trademark registrations domestically and worldwide and have numerous other applications pending worldwide for the names “Office Depot”, “Viking”, “Ativa”, “Foray”, “Realspace”, and others. We consider the trademark for the Office Depot name the most significant trademark held by us because of its impact on market awareness across all of our businesses and on customers’ identification with us. As with all domestic trademarks, our trademark registrations in the United States are for a ten year period and are renewable every ten years, prior to their respective expirations, as long as the trademarks are used in the regular course of trade.
Industry and Competition
We operate in a highly competitive environment in all three of our segments. We believe that we compete favorably on the basis of price, service, relationships and selection. We compete with office supply stores, wholesale clubs, discount stores, mass merchandisers, food and drug stores, computer and electronics superstores, internet-based companies and direct marketing companies. These companies, in varying degrees, compete with us in substantially all of our current markets.
Other office supply retail companies market similarly to us in terms of store format, pricing strategy, product selection and product availability in the markets where we operate, primarily those in the U.S. We anticipate that in the future we will face increased competition from these chains.
Internationally, we compete on a similar basis to North America. Outside of the U.S., we sell through contract and catalog channels in 17 countries and operate retail stores in four countries through wholly-owned or majority-owned entities. Additionally, our International Division provides office products and services in 41 countries through joint ventures, licensing and franchise agreements, cross-border transactions, alliances and other arrangements.
Employees
As of January 28, 2012, we had approximately 39,000 employees worldwide. Our workforce is largely non-union and our labor relations are generally good. In certain international locations, changes in staffing or work arrangements may need approval of local works councils or other bodies.
Environmental Activities
As both a significant user and seller of paper products, we have developed environmental practices that are values-based and market-driven. Our environmental initiatives center on three guiding principles: (1) recycling and pollution reduction; (2) sustainable forest management; and (3) issue awareness and market development for environmentally preferable products. We offer thousands of different products containing recycled content, including from 35% to 100% post-consumer waste content paper and technology recycling services in our retail stores.
Office Depot continues to implement environmental programs in line with our stated environmental vision to “increasingly buy green, be green and sell green” – including environmental sensitivity in our packaging, operations and sales offerings. Our ‘Green’ retail store prototype design is based on our Austin, Texas store, which received a Leadership in Energy and Environmental Design (LEED) Gold Certification from the U.S. Green Building Council in December 2008. In 2010, it awarded our global headquarters in Boca Raton, Florida a LEED Gold Certification under the Operations and Maintenance rating system and we were the first office supplies retailer with a headquarters building certified under any of the LEED rating systems. Additional information on our green product offerings can be found at www.officedepot.com/buygreen .
Available Information
We maintain a web site at www.officedepot.com. We make available, free of charge, on the “Investor Relations” section of our web site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). In addition, the public may read and copy any of the materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330 . The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers, such as the company, that file electronically with the SEC. The address of that website is www.sec.gov .
Additionally, our corporate governance materials, including governance guidelines; the charters of the Audit, Compensation, Finance, and Corporate Governance and Nominating Committees; and the code of ethical behavior may also be found under the “Investor Relations” section of our web site at www.officedepot.com.
CEO BACKGROUND
NEIL R. AUSTRIAN
AGE: 72
Mr. Austrian has served as a Director on our Board since 1998. Mr. Austrian has served as Chair and Chief Executive Officer (“Chair and CEO”) of the Company since May 2011, prior to which he was Interim Chair and CEO since November 2010. He also served in the Interim role from October 2004 through March 2005. Mr. Austrian has in-depth insights into the Company’s operations and its management which uniquely qualifies him for serving on our Company’s Board. In addition, Mr. Austrian’s experience as President and Chief Operating Officer of the National Football League from April 1991 until December 1999, makes him well suited to understand and oversee the complex managerial, strategic and financial considerations necessary to serve on the board of a corporation such as Office Depot. His experience at Dillon Reed & Co. Inc. as Managing Director from October 1987 until March 1991 provided him with a sound footing in finance, investment banking and deal negotiation. In addition, Mr. Austrian served as the Chief Financial Officer of Doyle Berbach Advertising, a public advertising agency, from 1974 until 1978, which enhanced his finance, marketing, and strategic experience. Mr. Austrian’s knowledge of all aspects of the direct sales business gained while serving as a director of Viking Office Products from 1988 until August 1998 when it merged with Office Depot, further strengthens his knowledge of our industry. Mr. Austrian also serves as a director of the DirecTV Group.
JUSTIN BATEMAN
AGE: 38
Mr. Bateman has served as a Director on our Board since June 2009. He is a senior Partner with BC Partners, the U.S. investment arm of which he co-established in early 2008, and is based in the firm’s New York office. Mr. Bateman initially joined BC Partners’ London office in 2000 from PricewaterhouseCoopers, where he spent three years in Transaction Services working on due diligence projects for both financial investors and corporate clients. In 2002 he left BC Partners to complete his MBA at INSEAD before rejoining the BC Partners London office. Over the years Mr. Bateman has participated in or been a board member of General Healthcare Group, Baxi Holdings, Ltd. and Regency Entertainment. He is currently a director of Intelsat S.A., the leading international provider of fixed satellite services. Mr. Bateman was appointed as a Director of the Company pursuant to the terms of the Investor Rights Agreement in connection with the Company’s private equity investment transaction with BC Partners. Mr. Bateman serves as a non-voting observer on the Audit Committee and his experience as a chartered accountant and understanding of accounting issues is helpful in fulfilling the committee’s oversight responsibilities. Mr. Bateman’s analysis of and participation in the oversight of BC Partners portfolio companies provides him with the skills he needs to assist the Company with its strategic planning process. Mr. Bateman’s education and experience in business and finance allows him to provide the Board significant managerial, strategic, financial and compliance-based expertise.
THOMAS J. COLLIGAN
AGE: 67
Mr. Colligan has served as a Director on our Board since January 2010. He served as Vice Dean of The Wharton School’s Aresty Institute of Executive Education from 2007 to June 2010 where he was responsible for the non-degree executive education programs. From 2004 to 2007, Mr. Colligan served as a managing director at Duke Corporate Education, a corporation that provides custom executive education and is affiliated with Duke University’s Fuqua School of Business. Prior to joining Duke Corporate Education, he was Vice Chairman of PricewaterhouseCoopers LLP from 2001 to 2004 and served there in other capacities from 1969 to 2004, including as a partner. Mr. Colligan also has advised Fortune 500 companies in various industries, including technology, telecommunications, pharmaceuticals and consumer products. Mr. Colligan is currently a director of CNH Global, N.V., and Targus Group International, Inc., a non-public company and leading global supplier of notebook carrying cases and accessories. He previously served as a director of Schering-Plough Corporation, Anesiva, Inc. and Educational Management Corporation. Mr. Colligan’s experience as a former audit partner and Vice Chairman of PricewaterhouseCoopers qualifies him to serve on the Board of Directors and to provide guidance to the Company’s internal audit function. In addition, Mr. Colligan’s former position as Vice Dean of The Wharton School’s Aresty Institute of Executive Education and his previous position as Managing Director at Duke Corporate Education have provided him a broad based understanding of new and developing business strategies that are helpful to our Board.
MARSHA J. EVANS
AGE: 64
Ms. Evans has served as a Director on our Board since 2006. Ms. Evans was acting Commissioner of the Ladies Professional Golf Association from July 2009 to January 2010, President and Chief Executive Officer of the American Red Cross from 2002 to 2005, and National Executive Director of The Girl Scouts of the USA from 1998 to 2002. Ms. Evans retired from the U.S. Navy in 1998 with the rank of Rear Admiral. From 1995 to 1998 Ms. Evans served as superintendent of the Naval Postgraduate School in Monterey, California and from 1993 to 1995 she led the Navy’s worldwide recruitment organization, during which time she developed extensive human resources experience. Ms. Evans also served as a director of Huntsman Corporation from 2005 to 2011. Currently, she is also a Director of Weight Watchers International, the North Highland Company and The Estate of Lehman Brothers Holdings. Ms. Evans brings significant leadership experience to our Board of Directors and the Board relies on her perspectives on human resources and governance issues.
BRENDA J. GAINES
AGE: 62
Ms. Gaines has been a Director on our Board since 2002. Ms. Gaines retired in 2004 from her position as President and Chief Executive Officer of Diners Club North America, a Division of Citigroup, a position she held since 2002. She served as President of Diners Club North America from 1999 until 2002 and from 1994 until 1999, she served as Executive Vice President, Corporate Card Sales. Prior to that she served in various positions of increasing responsibility within Citigroup or its predecessor corporations since 1988. From 1985 until 1987, Ms. Gaines was Deputy Chief of Staff for the Mayor of the City of Chicago. She is currently a director of AGL Resources, the Federal National Mortgage Association (Fannie Mae) and Tenet Healthcare Corporation, and is on the National Board of the Smithsonian Institution. Ms. Gaines also served as a director of CNA Financial Corp. from 2004 to 2007 and NICOR, Inc. from 2006 to 2011 and has served as a board member of the non-profit organization March of Dimes. Ms. Gaines has significant experience in financial services, including the credit card and payment industry. As Chief Executive Officer of Diners Club North America, she managed a company with three distinct customer groups, that included retail consumers, small businesses and large multinational corporations. While working as the Deputy Chief of Staff for the Mayor of the City of Chicago, Ms. Gaines developed valuable experience working with public agencies, which represent one of the Company’s larger customer segments. This experience enables her to provide insights into the Company’s core customers as well as the Company’s products and services. Ms. Gaines has held a number of executive and board leadership positions in a number of public companies. Ms. Gaines’ service on other public company boards allows her to provide the Board of Directors with a variety of perspectives on corporate governance issues.
W. SCOTT HEDRICK
AGE: 66
Mr. Hedrick has been a Director on our Board since 1991. From November 1986 until April 1991, he was a Director of The Office Club, Inc., which was acquired by Office Depot in 1991. Mr. Hedrick was appointed Lead Director in February 2011. He was a founder and has been a general partner of InterWest Partners, a venture capital fund, since 1979. Mr. Hedrick is also a director of Hot Topic, Inc. and a cluster of mutual funds managed by Capital Research and Management Company. As one of our longest-serving non-executive Directors, Mr. Hedrick brings an important institutional knowledge to our Board. His work with InterWest provides him with a solid basis for his analysis of our financial strategies. Mr. Hedrick’s service on the board of Hot Topic, Inc. gives him another view of the issues affecting retailers, which is useful to our Board of Directors.
KATHLEEN MASON
AGE: 62
Ms. Mason has served as a Director on our Board since 2006. She currently serves as President and Chief Executive Officer of Tuesday Morning Corporation and has served in that position since July 2000. From July 1999 to November 1999, Ms. Mason served as President of Filene’s Basement, a department store chain. From January 1997 to June 1999, Ms. Mason was President of HomeGoods, an off-price home fashion store and a subsidiary of TJX Companies. Ms. Mason was Chair and Chief Executive Officer of Cherry & Webb, a women’s specialty store, from February 1987 to December 1996. Prior to those dates, she held management positions at Kaufmann’s Division of the May Company, Mervyn’s Division of Target, Inc. and the Limited. She is currently a director of Genesco, Inc. and previously served as a director of The Men’s Warehouse, Inc., and of Hot Topic, Inc. Ms. Mason’s senior executive positions at various large national retail companies gives her the experience to critically review the various business considerations necessary to run a successful consumer-driven business such as our North American Retail Division. Ms. Mason’s broad exposure to numerous retailers provides our Board with relevant comparisons and her extensive retail knowledge gives her an insight into a number of issues facing Office Depot. As a sitting chief executive officer of a public retail company, Ms. Mason is able to offer our Board of Directors sound business and financial strategies to address evolving complex audit issues.
JAMES S. RUBIN
AGE: 44
Mr. Rubin has served as a Director on our Board since June 2009. He is a Senior Partner of BC Partners, which he joined in May 2008 from One Equity Partners, where he was a founding partner since its inception in 2001. Mr. Rubin originated and executed transactions in a variety of industries with a particular focus on healthcare and business services and was also responsible for building One Equity’s practice in India. Prior to forming One Equity, Mr. Rubin was a Vice President with Allen & Company Incorporated, a New York merchant bank specializing in media and entertainment transactions and advisory work. From 1996 to 1998, he held a number of senior policy positions with the Federal Communications Commission. Mr. Rubin is currently a board member of ATI Enterprises, a private post-secondary education company, and MultiPlan, one of the largest independent preferred provider organizations in the U.S. He is a member of the board of trustees of the Brookings Institute and the New York City non-profit Common Ground Communities, and serves on the board of The Dalton School. Mr. Rubin was appointed as a Director pursuant to the terms of the Investor Rights Agreement in connection with the Company’s private equity investment transaction with BC Partners. Mr. Rubin’s extensive background in the financial services industry allows him to provide proven financial advice to our Board. Mr. Rubin brings significant business and finance experience to our Board of Directors and provides new strategies and solutions to address an increasingly complex business environment.
RAYMOND SVIDER
AGE: 49
Mr. Svider has served as a Director on our Board since June 2009. He has been co-Chairman of BC Partners since December 2008 and has been a Managing Partner of the firm since 2003. Mr. Svider joined BC Partners in 1992 in Paris before moving to London in 2000 to lead its investments in the technology and telecoms industries. Over the years, Mr. Svider has participated in or led a variety of investments including Tubesca, Nutreco, UTL, Neopost, Polyconcept, Neuf Telecom, Unity Media/Tele Columbus, and Intelsat S.A. He is currently Chairman of the board, the audit and compensation committees of Intelsat S.A., and a member of the board of ATI Enterprises, a private post-secondary education company, and MultiPlan, one of the largest independent preferred provider organizations in the U.S. Prior to joining BC Partners, Mr. Svider worked in investment banking at Wasserstein Perella in New York and Paris, and at the Boston Consulting Group in Chicago. Mr. Svider was appointed as a Director on our Board pursuant to the terms of the Investor Rights Agreement in connection with the Company’s private equity investment transaction with BC Partners. As a Managing Partner of BC Partners since 2003, Mr. Svider has demonstrated significant leadership abilities and extensive knowledge of complex financial and operational issues facing large organizations. He brings an expertise in international operations and financial strategy to our Board of Directors. In addition, through his oversight of BC Partners portfolio companies, Mr. Svider has significant experience in developing various strategies to motivate and compensate executives.
NIGEL TRAVIS
AGE: 62
Mr. Travis has served as a Director on our Board since March 2012. He has been Chief Executive Officer of Dunkin’ Brands Group Inc. since January 2009 and serves as President of Dunkin’ Donuts since October 2009. From 2005 through 2008 Mr. Travis served as President and Chief Executive Officer of Papa John’s International, Inc. From 1994 to 2005 he had executive roles in Europe, International and Retail divisions of Blockbuster, Inc., culminating with the role of President and Chief Operating Officer from 2001 – 2005. Mr. Travis also held human resources and international roles for Burger King Holdings, Inc. from 1989 – 1994, prior to which he worked for Grand Metropolitan PLC since 1985. Mr. Travis currently serves on the Board of Dunkin’ Brands Group and Lorillard, Inc. Previous board service includes Papa Johns International, Inc. from 2005 – 2008, Bombay Company from 2000 – 2007, and Limelight Group from 1996 – 2000. Mr. Travis brings significant international, retail, human resources and operations experience to our Board.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
Our business is comprised of three segments. The North American Retail Division includes our retail stores in the U.S. which offer office supplies and services, computers and business machines and related supplies, and office furniture. Most stores also have a copy and print center offering printing, reproduction, mailing and shipping. The North American Business Solutions Division sells office supply products and services in the U.S. and Canada directly to businesses through catalogs, internet web sites and a dedicated sales force. Our International Division sells office products and services through catalogs, internet web sites, a dedicated sales force and retail stores in Europe and Asia.
Our fiscal year results are based on a 52- or 53-week retail calendar ending on the last Saturday in December. Fiscal year 2011 is based on 53 weeks, with a 14-week fourth quarter. Fiscal years 2010 and 2009 include 52 weeks. Our comparable store sales relate to stores that have been open for at least one year. A summary of factors important to understanding our results for 2011 is provided below. The comparisons to prior years are discussed in the narrative that follows this overview.
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Total company sales were $11.5 billion in 2011, down 1% compared to 2010. Total company sales decreased 4% in 2010 compared to 2009.
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Sales for 2011 declined 2% in the North American Retail Division and 1% in the North American Business Solutions Division. Comparable store sales in the North American Retail Division decreased 2%. International Division sales decreased 1% in U.S. dollars and 5% in constant currencies.
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Gross margin for 2011 improved approximately 100 basis points compared to 2010, following an approximately 90 basis point increase from 2009. The increase in 2011 primarily reflects improvement from reduced promotional activity, lower property costs and changes in the mix of sales channels and products sold.
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We recognized charges of approximately $58 million in 2011, primarily related to restructuring-related activity in the International Division, store closures in the North American Retail Division and process improvement actions at the corporate level. Charges recognized in 2010 and 2009 totaled approximately $87 million and $253 million, respectively.
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Tax and related interest benefits of approximately $123 million were recognized in 2011 from the reversal of uncertain tax position accruals and the release of valuation allowances in certain jurisdictions based on positive earnings. Tax settlements and related interest reversal were also recognized in 2010. The company continues to operate in the U.S. with full valuation allowances on deferred tax assets, contributing to significant effective tax rate volatility within the year and across years.
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At the end of 2011, we had $571 million in cash and approximately $734 million available on our asset based credit facility. Cash flow from operating activities was $200 million for 2011.
OPERATING RESULTS
Discussion of other income and expense items, including material Charges and changes in interest and taxes follows our review of segment results.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
During the second quarter of 2011, the company entered into a $1.0 billion amended and restated credit agreement (the “Amended Credit Agreement”) with a group of lenders, most of whom participated in the company’s previously existing $1.25 billion credit agreement. The Amended Credit Agreement expires May 25, 2016. The Amended Credit Agreement reduces the applicable borrowing spread, permits the company to redeem, tender or otherwise repurchase its existing 6.25% Senior Notes, subject to a $600 million minimum liquidity requirement, and modifies certain covenants. See Note E of the Notes to the Condensed Consolidated Financial Statements for additional information.
At December 31, 2011, we had approximately $570.7 million in cash and equivalents and another $734.4 million available under the Amended Credit Agreement based on the December borrowing base certificate, for a total liquidity of approximately $1.3 billion. We consider our resources adequate to satisfy our cash needs for at least the next twelve months.
At December 31, 2011, no amounts were drawn under the Amended Credit Agreement. The maximum month end amount outstanding during 2011 occurred in May at approximately $117.5 million. There were letters of credit outstanding under the Amended Credit Agreement at the end of the year totaling approximately $111.2 million. An additional $0.2 million of letters of credit were outstanding under separate agreements. Average borrowings under the Amended Credit Agreement during 2011 were approximately $61.9 million at an average interest rate of 3.5%. The maximum monthly average borrowings during 2011 occurred in May at approximately $121.5 million.
We also had short-term borrowings of $15.1 million at December 31, 2011 under various local currency credit facilities for our international subsidiaries that had an effective interest rate at the end of the year of approximately 2.2%. The maximum month end amount occurred in May at approximately $17.6 million and the maximum monthly average amount occurred in June at approximately $17.0 million. The majority of these short-term borrowings represent outstanding balances on uncommitted lines of credit, which do not contain financial covenants.
The company was in compliance with all applicable financial covenants at December 31, 2011. On March 30, 2011, the company obtained from the lending institutions participating in the previously-existing credit agreement a waiver of default following identification of the need to restate the financial statements in our original Annual Report on Form 10-K filed on February 22, 2011. For additional information see Note A to Notes to Consolidated Financial Statements.
Dividends on the company’s redeemable preferred stock are payable quarterly, and will be paid in-kind or in cash, only to the extent that the company has funds legally available for such payment and a cash dividend is declared by the company’s board of directors. Dividends for the first three quarters of 2011 were paid in cash. The dividend due on January 1, 2012 was paid-in-kind, totaling approximately $7.7 million, measured at fair value.
On February 17, 2012, the company announced commencement of a cash tender offer to purchase up to $250.0 million aggregate principal amount of its outstanding 6.25% Senior Notes due 2013. The tender offer is scheduled to expire at midnight, New York City time, on March 16, 2012, unless extended or earlier terminated.
On February 24, 2012, the company, together with certain of its European subsidiaries, as borrowers and certain of its domestic subsidiaries as guarantors, entered into an amendment (the “Amendment”) to the Amended Credit Agreement with the lenders party thereto, JPMorgan Chase Bank, N.A., London Branch, as European Administrative Agent and European Collateral Agent, JPMorgan Chase Bank, N.A., as Administrative Agent and US Collateral Agent, Bank of America, N.A., as Syndication Agent and Citibank, N.A. and Wells Fargo Bank, N.A., as Documentation Agents. The Amendment amends the Amended Credit Agreement to provide the company flexibility with regard to certain restrictive covenants in any possible future refinancings and other transactions. In addition, the Amendment releases one of the company’s subsidiaries from its guarantee obligations under the Amended Credit Agreement.
The foregoing description of the Amendment which describes the primary changes to the Amended Credit Agreement, does not purport to be complete and is subject to and qualified in its entirety by reference to the full text of the Amendment, which is filed as an Exhibit to this Form 10-K.
Also on February 24, 2012, the company entered into a two-year committed factoring arrangement that allows us to sell certain foreign trade receivables to a third party which provides up to approximately $75 million additional liquidity, depending on the level of eligible receivables and currency exchange rates. As of February 27, 2012, no trade receivables had been sold under this agreement.
Investing Activities
Net cash used in investing activities was $157 million in 2011, $192 million in 2010, and a $25 million source of cash in 2009. We invested $130 million, $169 million and $131 million in capital expenditures during 2011, 2010 and 2009, respectively. The 2011 capital expenditures relate to new stores and relocations, internal initiatives and various capital projects. The $73 million of acquisition, net of cash acquired was for the acquisition of an entity in Sweden that occurred during the first quarter of 2011. Approximately $47 million was placed in a restricted cash escrow account in 2010 and released in 2011 to fund this acquisition. During 2010, we used approximately $11 million to complete an acquisition. Proceeds from disposition of assets amounted to $8 million in 2011 compared to $35 million in 2010 and $150 million in 2009. Proceeds from the disposition of assets in 2010 included $25 million from the sale of a data center and $8 million from the sale of two operating subsidiaries in the International Division. Proceeds from the disposition of assets in 2009 included proceeds of sale-leaseback transactions of approximately $116 million. In 2009, we also completed the sale of an asset previously classified as a capital lease, resulting in proceeds of approximately $29 million. We placed $9 million of restricted cash on deposit in 2011 relating to an advance received on a dispute that was settled in January 2012.
Financing Activities
Net cash used in financing activities totaled $99 million and $31 million in 2011 and 2010, compared to a source of cash of $173 million in 2009. The use of cash in 2011 included the cash dividends paid on our convertible preferred stock of approximately $37 million, repayments of long and short term borrowings of $69 million, and $10 million in fees related to the Amended Credit Agreement. The dividend on our convertible preferred stock for the fourth quarter of 2011 was paid in-kind in January 2012. The sources of cash in 2011 included proceeds from issuance of borrowings of $10 million, as well as an advance of $9 million was received relating to a dispute associated with a prior year acquisition in Europe. A final settlement of this dispute was reached in January 2012; see Note R of Notes to Consolidated Financial Statements for additional discussion. The use of cash in 2010 resulted from the cash dividends paid on our convertible preferred stock of approximately $28 million and $22 million to acquire certain noncontrolling interests. The 2010 period included short-term borrowings under the Facility offset by payments of approximately $30 million. The source of cash in 2009 resulted from our issuance of redeemable preferred stock during the second quarter, partially offset by repayments of borrowing on our asset based credit facility and capital lease payments. The company has evaluated, and expects to continue to evaluate, possible refinancings and other transactions. Such transactions may be material and may involve cash, the company’s securities or the assumption of additional indebtedness.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies can be found in Note A of the Notes to Consolidated Financial Statements. We have also identified certain accounting policies that we consider critical to understanding our business and our results of operations and we have provided below additional information on those policies.
Vendor arrangements — Our inventory purchases from vendors are generally under arrangements that automatically renew until cancelled with periodic updates or annual negotiated agreements. Many of these arrangements require the vendors to make payments to us or provide credits to be used against purchases if and when certain conditions are met. We generally refer to these arrangements as “vendor programs,” and they typically fall into two broad categories, with some underlying sub-categories. The first category is volume-based rebates. Generally, our product costs per unit decline as higher volumes of purchases are reached. Certain of our vendor agreements provide that we pay higher per unit costs prior to reaching a predetermined tier, at which time the vendor rebates the per unit differential on past purchases, and also applies the lower cost to future purchases until the next milestone is reached. Current accounting rules provide that companies with a sound basis for estimating their full year purchases, and therefore the ultimate rebate level, can use that estimate to value inventory and cost of goods sold throughout the year. We believe our history of purchases with many vendors provides us with a sound basis for our estimates of purchase volume. If the anticipated volume of purchases is not reached, however, or if we form the belief at any given point in the year that it is not likely to be reached, cost of goods sold and the remaining inventory balances are adjusted to reflect that change in our outlook. We review sales projections and related purchases against vendor program estimates at least quarterly and adjust these balances accordingly. In recent years, the company has reduced the number of arrangements that contain this tiered purchase rebate mechanism in exchange for a lower product cost throughout the year. Continued elimination of tiered arrangements could further reduce the potential variability in gross margin from changes in volume-based estimates.
The second broad category of arrangements with our vendors is event-based programs. These arrangements can take many forms, including advertising support, special pricing offered by certain of our vendors for a limited time, payments for special placement or promotion of a product, reimbursement of costs incurred to launch a vendor’s product, and various other special programs. These payments are classified as a reduction of costs of goods sold or inventory, as appropriate for the program. Some arrangements may meet the specific, incremental, identifiable cost criteria that allow for direct operating expense offset, but such arrangements are not significant.
Vendor rebates are recognized throughout the year based on judgment and estimates and amounts due from vendors are generally settled throughout the year based on purchase volumes. The final amounts due from vendors are generally known soon after year-end. Substantially all vendor program receivables outstanding at the end of the year are settled within the three months immediately following year-end. We believe that our historic collection rates of these receivables provide a sound basis for our estimates of anticipated vendor payments throughout the year.
Inventory valuation — Inventories are valued at the lower of cost or market value. We monitor active inventory for excessive quantities and slow-moving items and record adjustments as necessary to lower the value if the anticipated realizable amount is below cost. We also identify merchandise that we plan to discontinue or have begun to phase out and assess the estimated recoverability of the carrying value. This includes consideration of the quantity of the merchandise, the rate of sale, and our assessment of current and projected market conditions and anticipated vendor rebates. If necessary, we record a charge to cost of sales to reduce the carrying value of this merchandise to our estimate of the lower of cost or realizable amount. Additional promotional activities may be initiated and markdowns may be taken as considered appropriate until the product is sold or otherwise disposed. Estimates and judgments are required in determining what items to stock and at what level, and what items to discontinue and how to value them prior to sale.
We also recognize an expense in cost of sales for our estimate of physical inventory loss from theft, short shipment and other factors – referred to as inventory shrink. During the year, we adjust the estimate of our shrink rate accrual following on-hand adjustments and our physical inventory results. These changes in estimates may result in volatility within the year or impact comparisons to other periods.
Closed store accruals and asset impairments — We regularly assess the performance of each retail store against historic patterns and projections of future profitability. These assessments are based on management’s estimates for sales levels, gross margin attainments, and cash flow generation. If, as a result of these evaluations, management determines that a store will not achieve certain operating performance targets, we may decide to close the store. At the point of closure, we recognize a liability for the remaining costs related to the property, reduced by an estimate of any sublease income. The calculation of this liability requires us to make assumptions and to apply judgment regarding the remaining term of the lease (including vacancy period), anticipated sublease income, and costs associated with vacating the premises. Lease commitments with no economic benefit to the company are discounted at the credit-adjusted discount rate at the time of each location closure. With assistance from independent third parties to assess market conditions, we periodically review these judgments and estimates and adjust the liability accordingly. Future fluctuations in the economy and the market demand for commercial properties could result in material changes in this liability. Costs associated with facility closures are included in store and warehouse operating and selling expenses in our Consolidated Statements of Operations. The accretion of the discounted lease liability and potential future positive and negative adjustments to the recorded amounts from settlements or changes in market conditions related to a company-wide business review are recognized at the corporate level, outside of the determination of Division operating profit. Residual costs and benefits of closures from other periods are included in Division operating profit.
In addition to the decision about whether or not to close a store, store assets are regularly reviewed for recoverability of their carrying amounts. The recoverability assessment requires judgment and estimates of a store’s future cash flows. Our impairment analysis builds a cash flow model at the individual store level, beginning with recent store performance and trending the anticipated future results based on chain-wide and individual store initiatives. If the anticipated undiscounted cash flows of a store cannot support the carrying amount of the store’s assets, an impairment charge is recorded to operations as a component of store and warehouse operating and selling expenses. That charge is measured as the difference between the carrying value of the assets and their estimated fair value, typically calculated as the discounted amount of the estimated cash flow. The store-level estimated cash flows, by their nature, include uncertain projections and assumptions about future performance. Important assumptions used in these projections include an assessment of future overall economic conditions, the company’s ability to control future costs, maintain aspects of positive performance, and successfully implement initiatives designed to enhance sales and gross margins. To the extent that management’s estimates of future performance are not realized, future assessments could result in material impairment charges.
Goodwill and other intangible assets — At December 31, 2011, we had goodwill of $62 million, indefinite lived intangible assets of $6 million and definite lived intangible assets of $30 million. We review amortization periods and goodwill and indefinite lived intangible assets for impairment annually in the fourth quarter of the year, or sooner if indicators of potential impairment are identified. We use a discounted cash flow approach in assessing the estimated fair value of the reporting units with goodwill and a relief from royalty approach for the indefinite lived trade name. The discounted cash flow analysis begins with the ensuing year’s business plan and requires estimates of future sales, profitability, capital expenditures and related cash flows. We include a residual value and discount the aggregate cash flow at an estimated cost of capital for the related unit. We also review the results against a measurement of market capitalization and, to the extent available, market data. These calculations require significant judgment. Of the goodwill recognized at December 31, 2011, approximately $42 million was in the International Division’s European reporting unit and $19 million was in the North American Business Solutions Division’s direct reporting unit. The European reporting unit has the greatest sensitivity to potential changes in economic conditions, company performance and the related impacts on estimated fair value. Should future performance be below our projections, goodwill and other intangible asset impairment changes could result. While the quantitative assessment described above was used for our 2011 assessment, the accounting rules for goodwill testing will change in 2012 to allow for a qualitative assessment of potential impairment if certain conditions are met or the continued use of this quantitative approach.
Income taxes — Income tax accounting requires management to make estimates and apply judgments to events that will be recognized in one period under rules that apply to financial reporting and in a different period in our tax returns. In particular, judgment is required when estimating the value of future tax deductions, tax credits, and the realizability of net operating loss carryforwards (NOLs), as represented by deferred tax assets. When we believe the realization of all or a portion of a deferred tax asset is not likely, we establish a valuation allowance. Changes in judgments that increase or decrease these valuation allowances impact current earnings.
Because of the downturn in our performance during this recessionary period, as well as the significant restructuring activities and charges we have taken in response, we established valuation allowances totaling approximately $322 million during 2009. The charge to establish the valuation allowance followed the third quarter 2009 condition of reaching or nearly reaching a 36 month cumulative loss position in two taxing jurisdictions. Judgment is required in projecting when operations will be sufficiently positive to allow a conclusion that utilization of the deferred tax assets will once again be more likely than not. Positive performance in subsequent periods and projections of future positive performance will need to be evaluated against existing negative evidence. Valuation allowances in certain foreign jurisdictions were removed during 2010 and 2011 because sufficient positive financial information existed, resulting in tax benefit recognition of $10 million and $9 million, respectively. Our effective tax rate in future periods may be positively or negatively impacted by changes in related judgments about valuation allowances or pre-tax operations. At December 31, 2011, approximately $387 million of valuation allowances remain relating to U.S. businesses and approximately $235 million relating to foreign jurisdictions.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
OVERVIEW
A summary of certain factors impacting results for the second quarter of 2012 is provided below and further discussed in the narrative that follows this overview.
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Sales in the second quarter of 2012 decreased 7% compared to the second quarter of 2011.
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Sales in the North American Retail Division decreased 8%; comparable store sales decreased 4%.
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Sales in the North American Business Solutions Division decreased 1%.
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International Division sales decreased 13% in U.S. dollars, and decreased 6% in constant currencies.
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Total company gross profit margin increased approximately 40 basis points comparing the second quarter of 2012 to the same period of the prior year, with increases in all three Divisions.
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The North American Retail Division recognized non-cash asset impairment charges of $24 million in the second quarter of 2012 and $42 million for the first half of 2012, compared to approximately $1 million in the first half of 2011. The 2012 impairment charges reflect greater than anticipated sales declines in certain of the Division’s lower-performing stores.
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The effective tax rate for the second quarter of 2012 includes approximately $16 million of discrete benefits from approval to carryback a tax method change to 2009. Recovery of this receivable is not anticipated prior to settlement of open matters relating to that tax year.
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Loss per share was $0.23 for the second quarter of 2012 compared to loss per share of $0.11 for the same period in 2011. .
Second quarter sales in the North American Retail Division were approximately $994 million, a decrease of 8% compared to the second quarter of 2011. The decline in total sales reflects a decrease of approximately 200 basis points related to the closing of stores in Canada last year and additional closures in the U.S. since the second quarter of 2011, and another 200 basis points from the calendar shift impacts in 2012 because 2011 was a 53 week fiscal period. Comparable store sales in the 1,094 stores that have been open for more than one year, and aligned to match the same selling weeks, decreased 4% for the second quarter of 2012, a sequential improvement from the 6% decline in the first quarter of 2012. The decline in comparable sales of computers and related products largely explains the Division’s overall comparable sales decline for the second quarter and first half of this year. Customers switching from laptop computers to tablets contributed to lower sales but improved product margins. Sales in our Copy and Print Depot and office furniture and seating increased. Sales in the supplies category were flat, while sales of ink and toner increased slightly. Average order value was slightly negative in the second quarter and customer transaction counts declined approximately 3% compared to the same period last year. Total sales for the first half of 2012 decreased 8% also reflecting store closures and the net impact of the calendar shift; comparable store sales declined 5%, aligned to match the same selling weeks.
The North American Retail Division reported an operating loss of approximately $22 million in the second quarter of 2012, compared to operating profit of approximately $3 million in the same period of 2011.
The Division recognized non-cash asset impairment charges of approximately $24 million and $18 million in the second and first quarters of 2012, respectively. These charges followed impairment charges of $6 million and $4 million in the fourth and third quarters of 2011, respectively, and an additional $1 million recognized in the first half of 2011. During these periods, total Division comparable store sales declined 4%, 6%, 5%, 2% and 1%, respectively. At the same time of these sales declines, Division gross profit margins increased each quarter compared to the same period of the prior year. These two factors moving in opposite directions have impacted our impairment analyses.
The impairment analysis begins with a rolling twelve-month base of actual store-level cash flow data which is then projected over the remaining individual facility lease horizon, taking into account known, planned, and forecasted activities, changes and factors. The second quarter 2012 impairment charge relates to 74 stores, 23 of which had some level of impairment recognized in the first quarter of 2012. The second quarter impairment primarily relates to locations with sales declines of 5% or more, and to a lesser extent, some stores with gross margins below projections. The impairment analysis model currently includes another year of projected sales decline followed by 1% to 1.5% sales growth in subsequent years.
The company is currently formulating a new retail store strategy that will address a store portfolio designed to better satisfy anticipated consumer shopping trends. The strategy development will entail reviewing each store location and store size to assess the customer demands in that location. The company has 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. We will consider a number of alternatives and potential activities including, but not limited to, whether over this period individual stores should be retained in their current format and location, downsized to one of the smaller store formats, relocated within the same market or be closed at the end of the lease term. The company currently has 11 locations in its newer smaller store formats of approximately 6,000 to 8,000 square feet and others of approximately 15,000 square feet. These stores compare to the current Division average of approximately 23,500 square feet. The smaller store formats have generally shown to be effective in certain markets. In addition to meeting customer needs as evidenced by sales volumes, they require less working capital and have lower rent and operating expenses. However, it is uncertain whether the performance-to-date in the existing locations can be repeated in all markets and, downsizing and relocating stores requires significant incremental capital investment. To the extent that forward-looking sales and operating assumptions in the current portfolio are not achieved and are subsequently reduced, or if the company commits to a more aggressive store downsizing strategy, including allocating capital to modify store formats and not renewing existing lease options, additional impairment charges, possibly even more significant in amount than have been recognized to date, may result. However, at the end of the second quarter 2012, the impairment analysis reflects the company’s best estimate of future performance, including the intended future use of the company’s retail store assets.
Division operating profit for the second quarter of 2011 included charges of approximately $12 million related to the closure of 10 stores in Canada. The charges relate to accrued lease costs as well as severance and other closure costs.
Excluding the impairment charge in 2012 and store closure charges in 2011, Division operating profit for the second quarter was $2 million and $15 million, respectively. This decline primarily reflects the negative flow through effect of lower sales, promotional activity, the clearance of inventory in advance of receiving new products, and the absence in 2012 of benefits recognized in 2011 from removing recourse provisions in our private label credit card program. These factors were partially offset by gross margin improvement of approximately 80 basis points, lower payroll and general and administrative expenses. The change in year-to-date operating income of 2012 compared to 2011 reflects the impairment charges in 2012 and store closure costs in 2011, as well as the negative flow through effect of lower sales and the 2011 private label credit card benefit partially offset by lower property and payroll costs and the mix of sales away from lower-margin technology.
CORPORATE AND OTHER
Recovery of Purchase Price
The sale and purchase agreement (“SPA”) associated with a 2003 European acquisition included a provision whereby the seller was required to pay an amount to the company if a specified acquired pension plan was calculated to be underfunded based on 2008 plan data. The amount calculated by the plan’s actuary was disputed by the seller but upheld by an independent arbitrator. The seller continued to dispute the award until both parties reached a settlement agreement in January 2012 and the seller paid approximately GBP 37.7 million to the company, including GBP 5.5 million placed in escrow in 2011. Under the terms of the SPA, and in agreement with the pension plan trustees, the company contributed the cash received, net of certain fees, to the pension plan. This contribution caused the plan to go from a net liability position at the end of 2011 to a net asset position of approximately $9.0 million at June 30, 2012. Because the goodwill associated with this transaction was fully impaired in 2008, this recovery is recognized in the 2012 statement of operations. Also, consistent with the presentation in 2008, this recovery is reported at the corporate level and not included in the determination of International Division operating profit.
The $68.3 million Recovery of purchase price includes recognition of the cash received from the seller, certain fees incurred and reimbursed, as well as the release of an accrued liability as the settlement agreement releases any and all claims under the SPA. An additional expense of approximately $5.2 million related to this arrangement is included in General and administrative expenses, resulting in a net increase in operating profit for the first half of 2012 of $63.1 million. The transaction is treated as a non-taxable return of purchase price for tax purposes.
The cash payment from the seller was received by a subsidiary of the company with the Euro as its functional currency and the pension plan funding was made by a subsidiary with Pound Sterling as its functional currency, resulting in certain translation differences between amounts reflected in the Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Cash Flows for the first half of 2012. The receipt of cash from the seller is presented as a source of cash in investing activities. The contribution of cash to the pension plan is presented as a use of cash in operating activities. See Note C of the Notes to Condensed Consolidated Financial Statements.
General and Administrative Expenses
The portion of General and Administrative (“G&A”) expenses considered directly or closely related to unit activity is included in the measurement of Division operating profit. Other companies may charge more or less G&A expenses and other costs to their segments, and our results therefore may not be comparable to similarly titled measures used by other entities. Our measure of Division operating profit should not be considered as an alternative to operating income or net earnings determined in accordance with accounting principles generally accepted in the United States of America.
Other Income (Expense)
The decrease in interest expense for the second quarter and first half of 2012 compared to the same periods of 2011 reflects lower deferred debt issue costs following the expensing of approximately $3 million in 2011 following a change in the lending group for our Amended and Restated Credit Agreement (the “Amended Credit Agreement”). The decrease in the first half of 2012 also results from lower interest accruals on uncertain tax positions following settlements recognized in 2011. The decrease in the second quarter and first half of 2012 are partially offset by higher interest rates resulting from the new debt issued in the first quarter of 2012, as discussed below.
On March 15, 2012, the company completed the early settlement of its previously announced cash tender offer to purchase up to $250 million aggregate principal amount of its outstanding 6.25% senior notes due 2013. The total consideration for each $1,000.00 note surrendered was $1,050.00. Additionally, tender fees and a proportionate amount of deferred debt issue costs and a deferred cash flow hedge gain were included in the measurement of the $12.1 million extinguishment costs reported in the Condensed Consolidated Statements of Operations for the first quarter of 2012.
Miscellaneous income, net for all periods presented is primarily attributable to earnings from our joint venture in Mexico, Office Depot de Mexico. The company accounts for this joint venture on the equity method and summarized financial information is included in Note L of the Notes to the Condensed Consolidated Financial Statements. Joint venture sales for the second quarter of 2012 decreased 4% in U.S. dollars but increased 11% in constant currency. Joint venture sales for the first half of 2012 were flat in U.S. dollars but increased 12% in constant currencies. The joint venture added two stores during the second quarter and 11 stores in Mexico, Central America, and Colombia in the first half of 2012 for a total of 252 stores and distribution facilities. Second quarter 2012 net income was approximately $10 million with 50% of that amount included in our Miscellaneous income, net. Reported earnings in U.S. dollars for the second quarter of 2012 reflect negative foreign currency translation impacts as well as additional costs incurred associated with store expansion. Our 50% of joint venture earnings for the first half of 2012 was approximately $13 million compared to approximately $16 million in the same period of 2011. In addition to results from Office Depot de Mexico, and results from another equity method investment, Miscellaneous income, net includes gains and losses on our deferred compensation plan and foreign currency transactions.
Income Taxes
The effective tax rate for the second quarter and first half of 2012 was 20% and 28%, respectively, compared to 27% and -32%, respectively, for the same periods of 2011. The second quarter 2012 rate includes a $16 million accrued benefit based on a ruling from the U.S. Internal Revenue Service (“IRS”) allowing the company to carryback certain accounting method changes to the 2009 tax year. Receipt of cash related to this ruling is not expected prior to resolution of the previously-disclosed dispute with the IRS relating to a foreign royalty assessment as discussed below. The year-to-date effective tax rate includes this benefit and is also impacted by the Recovery of purchase price that is treated as a purchase price adjustment for tax purposes. As discussed in Note C of the Notes to the Condensed Consolidated Financial Statements, this recovery would have been a reduction of related goodwill for financial reporting purposes, but the related goodwill was impaired in 2008.
Additionally, the loss on extinguishment of debt in the United States during the quarter ended March 31, 2012 did not generate a financial statement tax benefit because of existing valuation allowances. Similarly, operating losses in other jurisdictions with valuation allowances do not result in deferred tax benefits being recognized in the Condensed Consolidated Statements of Operations. Accordingly, tax expense recognized in jurisdictions with positive earnings, and no tax benefit on certain jurisdictions with losses, can cause the effective rate to be different from blended statutory rates and, in the case of the first half of 2011, to result in tax expense in periods of pre-tax losses. This interim accounting is likely to result in significant variability of the effective tax rate throughout the course of the year. Changes in income projections and the mix of income across jurisdictions could impact the effective tax rate each quarter.
We file a U.S. federal income tax return and other income tax returns in various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations for years before 2009. Our U.S. federal filings for 2009, 2010 and 2011 are under routine examination, and it is reasonably possible that audits for some of these periods will be closed prior to the end of 2012. Significant international tax jurisdictions include the UK, the Netherlands, France and Germany. Generally, we are subject to routine examination for years 2006 and forward in these jurisdictions. It is reasonably possible that certain of these audits will close within the next 12 months, which could result in a decrease of as much as $2.1 million or an increase of as much as $1.0 million to our accrued uncertain tax positions. Additionally, we anticipate that it is reasonably possible that new issues will be raised or resolved by tax authorities that may require changes to the balance of unrecognized tax benefits, however, an estimate of such changes cannot reasonably be made.
As part of the ongoing 2009 and 2010 audits, the IRS has proposed a deemed royalty assessment from our foreign operations with a tax and penalty amount of approximately $126 million. The company disagrees with this assessment and, based on the technical merits of this issue, believes that no accrual is required at this time. The company is working with its outside tax advisors and the IRS to resolve this dispute in a timely manner. To the extent the IRS prevails on this issue, the income statement impact may be lowered because of available net operating losses and other deferred tax assets.
New Accounting Pronouncements
There are no recently issued accounting standards that are expected to have a material effect on our financial condition, results of operations or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2012, we had approximately $423 million in cash and equivalents and another $729 million available under the Amended Credit Agreement based on the June borrowing base certificate, for a total liquidity of approximately $1.2 billion. Additionally, the company has approximately $50 million available under an accounts receivable factoring agreement in Europe that is available but has not been used. We currently believe that available funds and cash flows generated from operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months.
At June 30, 2012, no amounts were drawn under the Amended Credit Agreement. There were no amounts outstanding during the second quarter of 2012 at any month end. There were letters of credit outstanding under the Amended Credit Agreement at the end of the quarter totaling approximately $110 million. An additional $0.2 million of letters of credit were outstanding under separate agreements. Average borrowings under the Amended Credit Agreement in the second quarter of 2012 were approximately $2 million at an average interest rate of 2.6%. The maximum monthly average in the second quarter of 2012 occurred in April at approximately $4 million.
We also had short-term borrowings of $14 million at June 30, 2012 under various local currency credit facilities for our international subsidiaries that had an effective interest rate at the end of the second quarter of approximately 1.8%. The maximum month end amount and maximum monthly average amount occurred in April at approximately $15 million. The majority of these short-term borrowings represent outstanding balances on uncommitted lines of credit, which do not contain financial covenants.
The $150 million of 6.25% senior notes due August 2013 becomes a current liability in the third quarter of 2012.
The company was in compliance with all applicable financial covenants at June 30, 2012.
Dividends on the company’s redeemable preferred stock are payable quarterly, and will be paid in-kind or in cash, only to the extent that the company has funds legally available for such payment and a cash dividend is declared by the company’s board of directors. Dividends during 2012 have been paid in-kind. The company anticipates paying dividends in-kind for the remainder of 2012.
During the first half of 2012, cash used by operating activities was approximately $132 million, compared to a use of approximately $148 million during the same period last year. During the 2012 period, the company recognized a credit in earnings as the recovery from a business combination. The cash portion of this recovery is reclassified out of earnings and reflected as a source of cash in investing activities. That cash was required by the original purchase agreement to be contributed to the acquired pension plan. That pension funding of $58 million during the first quarter of 2012 is presented as a use of cash in operating activities. Additionally, the company recorded non-cash fixed asset impairment charges in the North America Retail Division of approximately $42 million, as discussed above.
Changes in net working capital and other components for the first half of 2012 resulted in a $197 million use of cash compared to a $257 million use in the same period last year. This lesser use of cash in 2012 reflects a lower decrease in accounts payable and accrued expenses, partially offset by a lower decrease in accounts receivable, lower decrease in prepaid assets and other assets and a $25 million dividend received from our joint venture in Mexico, Office Depot de Mexico, in the second quarter of 2011. No dividends were received in 2012. Working capital is influenced by a number of factors including the flow of goods, credit terms, timing of promotions, vendor production planning, new product introductions and working capital management. For our accounting policy on cash management, see Note A of the Notes to Condensed Consolidated Financial Statements.
Cash provided by investing activities was approximately $17 million in the first half of 2012, compared to a use of cash of approximately $79 million in the same period last year. The source of cash for the 2012 period reflects the Recovery of purchase price of $50 million discussed above, release of restricted cash associated with the same business combination of $9 million, and proceeds from assets sold of $21 million. Capital expenditures were $62 million in the first half of 2012. Cash used by investing activities in the first half of 2011 of $79 million reflects capital expenditures of approximately $60 million and approximately $73 million to complete the acquisition of an entity in Sweden, partially offset by the release of restricted cash related to the Sweden acquisition that was held in escrow at December 25, 2010. During the first half of 2011, we received approximately $7 million of proceeds from the disposition of assets.
Cash used in financing activities was approximately $32 million for the first half of 2012, compared to a use of cash of $39 million in the same period last year. During the first half of 2012 the company completed the early settlement of its previously announced cash tender offer to purchase up to $250 million aggregate principal amount of its outstanding 6.25% senior notes due 2013. The company also issued $250 million aggregate principal amount of 9.75% senior secured notes due March 15, 2019. The tender activity resulted in a $13 million cash loss on extinguishment of debt. Additionally, new issuance costs and costs related to the Amended Credit Agreement totaled $8 million. Net payments on other long and short-term borrowings for the period amounted to $11 million. The dividends on preferred stock were paid in kind during the first half of 2012. The use of cash from financing activities during the first half of 2011 of $39 million resulted primarily from payment of approximately $18 million cash dividends on our preferred stock, net payments of approximately $9 million on short-term and long-term borrowings as well as an additional $10 million in fees related to the Amended Credit Agreement.
CONF CALL
Brian Turcotte - Vice President of Investor Relations
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 Stephen Schmidt, President of International.
Before we begin, I’d 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 Office Depot’s second quarter 2012 results. Neil?
Neil Austrian - Chairman and Chief Executive Officer
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 a $0.11 of 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 a 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 design to better satisfy consumer shopping trends.
Kevin and Michael will cover this strategic process in greater detail later in the call. So excluding these charges in 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 of 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 to the charges negatively impacted second quarter 2011 earnings by about $0.05 of share. Total company growth 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 EBIT of a $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 our second quarter 2000 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 planned to proactively address the downturn through the execution of our key initiatives that we expect will both drive profitable sales and reduce non-customer 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 myths 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 we’re in the process of evaluating the capital and expense requirements along with the related investments we need to make in our ecommerce and IT infrastructure to drive growth in the business.
The North American retail store strategy will address the store portfolio design 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 planned to remodel our 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 cost 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 this 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.
Kevin Peters - President of North America
Thanks, Neil, and good morning. The North America 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 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 1,094 stores that have been opened for more than one year decreased 4% for the second quarter 2012. The year-over-year decline in the second quarter improved by about 200 basis points from the 6% same stores sales decline reported in the first quarter of 2012. If we look at our performance by product category Copy & Print Depot continue 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 seeding 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 increase sales in Tablets and eReaders in the second quarter versus prior year while sales of computers and the related products were down significantly. We believe that there are some pent-up demand for laptops and desktops as our customers are way to 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 today 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 the related products in the second quarter our same store sales for the division would have been slightly positive versus prior year.
North America retails 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 or 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 import of products continues to go well in North America as retail division as DI penetration increased 80 basis points to a 11% in the second quarter of 2012 versus prior year. We believe that we can continue to significantly increase this level of penetration to our global sourcing organization.
The North America Retail store count at the end of the second quarter was 1,117 stores. During the quarter we opened no new stores and closed six. In 2012, we still planned to close 25 to 30 stores in total. We also remodeled seven stores and relocated three in the second quarter, successfully reducing the square footage of those locations by over 40% on average. North America retail reported an operating profit excluding a store asset impairment charge of approximately $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 non-recurring benefits in 2011. The negative impact on operating profit from these factors were partially offset by year-over-year gross margin improvements of about 80 basis points and lower payroll and G&A cost.
As Neil mentioned, we expect to have a 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 these individuals 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 and amount that have occurred to date may resolve. We also continue to make progress on other key initiatives which we anticipate we’ll drive profitable sales and reduce cost for North America retail.
In regard to the same store, in regard to 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 or stores have the potential to trend towards a similar increase in comp sales as they hit full maturity.
The third quarter is 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 is teamed up with Nick Cannon and Monster to provide the new lineup of incredible Monster headphones, which are now available nationwide 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 America retail’s outlook, we anticipated 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 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 successful customer acquisitions in the back half of 2011 and in the first quarter of 2012. We are pleased with the progress made in this important customer segment and encouraged by the current pipeline of large accounts.
The healthcare vertical has been 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 size 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’ve reported positive year-over-year growth in furniture, Copy & 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 improving at a high single digit rate, while total second quarter sales in the office supplies remained relatively flat year-over-year.
Second quarter 2012 operating profit for BSD was $40 million, down $5 million from the same quarter period one year ago. Gross margin improvement of about 60 basis points and lower supply chain cost were offset by a number of factors including the unfavorable impact of approximately $10 million of non-recurring benefits reported last year and higher payroll cost 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 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 moved through 2012, we anticipate improved performances for both channels.
In regard to BSDs 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.
Stephen Schmidt - President of International Operations
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 U.S. dollars and a decrease of 6% in constant currency. I should note that the second quarter of 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 will 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 is relatively small. As I have mentioned in the past, our greatest sales concentration 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 to 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 reported a high single digit increase in year-over-year sales in the second quarter of 2012.
Second quarter sales in the European direct channel were 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’ve 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 remainder, we own an operator 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 have already launched Apple products in 10 of our retail superstores in France and we’ll 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 expense 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 sales 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 on 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 remained very pleased with the performance of this outstanding business and are excited about the significant multi-channel growth opportunities throughout Latin America. Although we currently have a leading position in office supplies in Mexico and Central America, our penetration in 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 is correct that we are proactively addressing the downturn in Europe by executing our key initiatives to drive both profitable sales and reduced costs while still investing to drive our business.
I would like to share one of those initiatives with you. As I mentioned, we need to improve the 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 in the more effective ecommerce 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 acquisition. 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?
Michael Newman
Thanks, Steve. As Neil mentioned earlier, the second quarter 2012 total company EBIT loss excluding restructuring charges and the impairment charge, it was $22 million versus EBIT of $11 million in 2011. As I discussed last quarter, the second quarter of 2011 included significant discreet 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 and 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 non-recurring discreet items in 2011 along with changes in G&A and lower 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 I 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 to 2011, again mostly due to the over $20 million in favorable second quarter 2011 non-recurring items.
Turning to slide 11, free cash flow for the second quarter of 2012 was a use of $66 million, which was $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 of free cash flow for full-year 2012 from an operational perspective. This excludes a negative $50 million impact of 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 are 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-Based Lending facility or ABL for a total liquidity of $1.2 billion.
No amounts withdrawn 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 drawn to date.
Total Company’s second quarter 2012 operating expenses adjusted for restructuring and asset impairment charges were down $18 million versus prior year. The year over reduction in operating expenses which driven by productivity improvements in both North America and Europe.
The effective tax rate for the quarter on a reported basis was 20%. This tax rate included $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 discreet 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 1st. We anticipate paying the 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 in North American Retail. We believe that foreign exchange will continue to have a negative 200 to 300 basis points 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 $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.
With that I’ll now turn the call back over to Neil.
Neil Austrian - Chairman and Chief Executive Officer
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 the challenging global economic environment by executing the key initiatives to drive profitable sales and reduce non-customer-facing costs in all channels globally. I’m pleased with the progress we’ve made on many fronts and I would 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. Thank you.
Brian Turcotte - Vice President of Investor Relations
Operator, we’re now ready to take questions.
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Fund Letters
