Staples 2006 Annual Report Download - page 100

STAPLES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
B-6
Business unit income increased $36.9 million in fiscal 2006 and decreased $55.6 million in fiscal 2005. The
improvement for 2006 reflects prior year costs associated with the integration of the Office World stores and the
integration of our two delivery businesses in the United Kingdom, which reduced business unit income for 2005, as well
as improved sales and focus on expense management across our international businesses. The decrease in business unit
income in 2005 reflects lower sales in our retail business in the United Kingdom and our delivery business in France as well
as increased investments in our European delivery business during the first half of 2005 and the continued costs associated
with the integration of the Office World stores, and our two delivery businesses in the United Kingdom. We believe that we
have a significant opportunity to grow our International business by expanding our multi-channel offering in our existing
European businesses and making targeted investments in high growth markets in Asia and South America.
Stock-Based Compensation: Stock-based compensation increased to $168.7 million in fiscal 2006 from $129.8
million in fiscal 2005 and $114.9 million in fiscal 2004. Stock-based compensation includes expenses associated with our
employee stock purchase plans, the issuance of stock options, restricted shares, performance shares, as well as the
company match in the employee 401(K) savings plan. The increase in this expense for 2006 reflects an increase in the
market value of our common stock, changes in the mix of stock awards granted and the correction of measurement dates
used to calculate prior years’ stock-based compensation (see Note H). The increase in this expense for 2005 reflects an
increase in the market value of our common stock.
Critical Accounting Policies and Significant Estimates
Our financial statements are based on the application of significant accounting policies, many of which require
management to make significant estimates and assumptions (see Note A to the Consolidated Financial Statements). We
believe that the following are some of the more critical judgment areas in the application of our accounting policies that
currently affect our financial condition and results of operations.
Inventory: We record inventory at the lower of weighted-average cost or market value. We reserve for obsolete,
overstocked and inactive inventory based on the difference between the weighted-average cost of the inventory and the
estimated market value using assumptions of future demand and market conditions. If actual market conditions are less
favorable than those projected by management, additional reserves may be required.
Purchase and Advertising Rebates: We earn rebates from our vendors, which are based on various quantitative
contract terms that can be complex and subject to interpretation. Amounts expected to be received from vendors relating
to the purchase of merchandise inventories and reimbursement of incremental costs, such as advertising, are recognized
as a reduction of inventory cost and realized as part of cost of goods sold as the merchandise is sold. Several controls are
in place, including direct confirmation with vendors, that we believe allow us to ensure that these amounts are recorded
in accordance with the terms of the contracts.
Impairment of Long-Lived Assets: We review our long-lived assets for impairment when indicators of impairment
are present and the undiscounted cash flow estimated to be generated by those assets is less than the assets’ carrying
amount. Our policy is to evaluate long-lived assets for impairment at a store level for retail operations and an operating
unit level for our other operations. If actual market conditions are less favorable than management’s projections, future
write-offs may be necessary.
Impairment of Goodwill and Indefinite Lived Intangible Assets: Statement of Financial Accounting Standards
No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”) requires that we annually review goodwill and other
intangible assets that have indefinite lives for impairment and when events or changes in circumstances indicate the
carrying value of these assets might exceed their current fair values. We determine fair value using discounted cash flow
analysis, which requires us to make certain assumptions and estimates regarding industry economic factors and future
profitability of acquired businesses. It is our policy to allocate goodwill and conduct impairment testing at the individual
business unit level based on our most current business plans, which reflect changes we anticipate in the economy and the
industry. If actual results are not consistent with our assumptions and judgments, we could be exposed to a material
impairment charge.