Staples 2012 Annual Report Download - page 106

B-10
STAPLES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
are likely to be considered by a market participant. The weighted-average cost of capital is our estimate of the overall
after-tax rate of return required by equity and debt holders of a business enterprise. The reporting units' weighted-average
costs of capital in future periods may be impacted by adverse changes in market and economic conditions, including risk-
free interest rates, and are subject to change based on the facts and circumstances that exist at the time of the valuation,
which may increase the possibility of a potential future impairment charge.
The fair values of all of our reporting units are based on underlying assumptions that represent our best estimates. Many
of the factors used in assessing fair value are outside of the control of management and if actual results are not consistent with our
assumptions and judgments, we could be exposed to further impairment charges. To validate the reasonableness of our reporting
units' estimated fair values, we reconcile the aggregate fair values of our reporting units to our total market capitalization.
During 2012, we continued to monitor our European businesses, which we had disclosed were at risk for impairment.
With the continued political and economic instability in Europe, recent history of declining sales and profits for our businesses in
that region, a sustained decline of our stock price and revised short-term and long-term outlooks for our European businesses, we
determined in our third fiscal quarter that sufficient indicators of impairment existed to require an interim goodwill impairment
analysis for our Europe Retail and Europe Catalog reporting units, both of which are included in our International Operations
segment.
In September 2012, management presented, and the Board of Directors approved, a strategic plan to accelerate growth
across the Company and to reposition our operations and stem losses in Europe. In connection with the development of this plan,
we analyzed each of our European businesses in light of ongoing industry trends, economic conditions, and long-term sales and
profit projections. The Company's management and board of directors concluded a strategic shift in the business was crucial to
Staples' long-term business prospects in Europe. As a result, we made strategic decisions and announced a plan to restructure our
operations in Europe, divest our printing systems division and more fully integrate our retail and online offerings.
The outcome of this strategic review in the third quarter included significant changes in the long-range financial projections
for Europe Retail and Europe Catalog compared with previous projections. We now project long-term sales declines in our Europe
Retail business, stemming from a decision, in light of industry trends, to allocate more resources and capital to the expansion of
online capabilities. We also project declines in our legacy Europe Catalog business, which is projected to be replaced with the
growing, but less profitable, online business. Based on the results of the impairment testing, we recorded impairment charges of
$303.3 million and $468.1 million related to Europe Retail and Europe Catalog, respectively, in the third quarter of 2012.
During the fourth quarter of 2012, we performed our annual goodwill impairment testing, and determined that no further
impairment charges were required in 2012. As of the end of 2012, taking into account the charges recorded during 2012, there is
$331 million of remaining goodwill associated with Europe Catalog, and none associated with Europe Retail. If macroeconomic
or industry conditions in Europe continue to deteriorate or if management is unable to successfully execute our strategic plan, then
we could incur additional goodwill impairment charges in the future related to Europe Catalog. Additionally, if our stock price
experiences a further sustained and significant decline, we could incur additional impairment charges related to Europe Catalog
or our other reporting units.
As of the end of 2012, we had two reporting units with material goodwill balances for which the reporting unit's fair value
was less than 10% greater than its carrying value - Europe Contract, with $441 million of goodwill, and China with $195 million
of goodwill. Europe Contract is at increased risk of an impairment charge given the ongoing economic weakness in Europe, and
China is at increased risk given its early stage of development and the volatile nature of the emerging market in which it operates.
Despite the increased risk associated with these reporting units, we do not believe there will be a significant change in the key
estimates or assumptions driving the fair value of these reporting units that would lead to a material impairment charge.
Impairment of Long-Lived Assets: We evaluate long-lived assets held for use for impairment whenever events and
circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability is measured based upon the
estimated undiscounted cash flows expected to be generated from the use of an asset plus any net proceeds expected to be realized
upon its eventual disposition. An impairment loss is recognized if an asset's carrying value is not recoverable and if it exceeds its
fair value. Our policy is to evaluate long-lived assets for impairment at the lowest level for which there are clearly identifiable
cash flows that are largely independent of the cash flows of other assets and liabilities. Our cash flow projections are based on
historical cash flows and our latest forecasts. These projections and our estimates regarding proceeds to be received upon an
asset's disposition reflect numerous assumptions and a significant degree of judgment on the part of management. If actual results
are less favorable than management's projections, future write-offs may be necessary.
Prior to performing the interim goodwill impairment tests for Europe Retail and Europe Catalog in the third quarter of
2012, we tested long-lived assets to be held and used by these reporting units for impairment on an undiscounted cash flow basis.