Staples 2004 Annual Report Download - page 91

STAPLES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Our expanding International operations expose us to the unique risks inherent in foreign operations. In addition to our
recently expanding operations in Europe and our new operations in South America, we have a significant presence in
Canada through The Business Depot Ltd. As evidenced by our recent entry into the South American and Asian markets,
we may also seek to expand further into other international markets. Our foreign operations encounter risks similar to
those faced by our U.S. operations, as well as risks inherent in foreign operations, such as local customs, competitive
conditions and foreign currency fluctuations. Further, our recent acquisitions in Europe and South America have
increased our exposure to these foreign operating risks, which could have an adverse impact on our International income
and worldwide profitability.
Our debt level and operating lease commitments could impact our ability to obtain future financing and continue our
growth strategy. Our consolidated outstanding debt at January 29, 2005 was $543.7 million. Our future minimum lease
commitments due for retail store and support facilities and equipment leases under non-cancelable operating leases were
$5.03 billion at January 29, 2005. Our consolidated debt and operating lease obligations may have the effect generally of
restricting our flexibility in responding to changing market conditions and could make us more vulnerable in the event of
a downturn in our business. In addition, our level of indebtedness may have other important consequences, including:
restricting our growth; making it more difficult for us to satisfy our obligations; limiting our ability to borrow additional
amounts for working capital, capital expenditures, debt service requirements, future acquisitions or other corporate
purposes; and limiting our ability to use operating cash flow in other areas of our business. In such a situation, additional
funds may not be available on satisfactory terms when needed, or at all, whether in the next twelve months or thereafter.
California wage and hour class action lawsuit. Various class action lawsuits have been brought against us for alleged
violations of what is known as California’s ‘‘wage and hour’’ law. The plaintiffs have alleged that we improperly classified
both general and assistant store managers as exempt under the California wage and hour law, making such managers
ineligible for overtime wages. The plaintiffs are seeking to require us to pay overtime wages to the putative class for the
period from October 21, 1995 to the present. The plaintiffs have filed their motion to certify the class. We believe we
have meritorious defenses in the litigation. Accordingly, we believe the litigation will not have a material adverse effect
on us.
Quantitative and Qualitative Disclosures about Market Risks
We are exposed to market risk from changes in interest rates and foreign exchange rates. We have a risk
management control process to monitor our interest rate and foreign exchange risks. The risk management process uses
analytical techniques, including market value, sensitivity analysis, and value at risk estimates.
As more fully described in the notes to the consolidated financial statements, we use interest rate swap agreements
to modify fixed rate obligations to variable rate obligations, thereby adjusting the interest rates to current market rates
and ensuring that the debt instruments are always reflected at fair value. While our variable rate debt obligations,
approximately $525.0 million at January 29, 2005, expose us to the risk of rising interest rates, management does not
believe that the potential exposure is material to our overall financial performance or results of operations. Based on
January 29, 2005 borrowing levels, a 1.0% increase or decrease in current market interest rates would have the effect of
causing a $5.3 million additional pre-tax charge or credit to our statement of operations than otherwise would occur if
interest rates remain unchanged.
As more fully described in the notes to the consolidated financial statements, we are exposed to foreign exchange
risks through subsidiaries in Canada, the United Kingdom, Germany, Luxembourg, the Netherlands, Portugal, France,
Belgium, Spain, Italy, Sweden, Denmark, Switzerland, Austria, Hungary, Poland, the Czech Republic, Argentina and
Brazil. We have entered into a currency swap in Canadian dollars in order to hedge a portion of our foreign exchange
risk related to our net investment in foreign subsidiaries. Any increase or decrease in the fair value of our currency
exchange rate sensitive derivative instruments would be offset by a corresponding decrease or increase in the fair value of
the hedged underlying asset.
We account for our interest rate and currency swap agreements using hedge accounting treatment as the derivatives
have been determined to be highly effective in achieving offsetting changes in fair value of the hedged items. Under this
method of accounting, at January 29, 2005, we have recorded a $7.5 million asset representing gross unrealized gains on
two of our derivatives and a $42.4 million liability representing a gross unrealized loss on another derivative. During
fiscal 2001, we terminated an interest swap agreement resulting in a realized gain of $18.0 million which is being
amortized into income through August 2007, the remaining term of the original agreement. We do not enter into
derivative agreements for trading purposes.
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