Staples 2013 Annual Report Download - page 125

STAPLES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
B-11
current and projected sales mix, profit improvement opportunities and market conditions. If the business climate
deteriorates, or if we fail to manage our businesses successfully, then actual results may not be consistent with these
assumptions and estimates, and our goodwill may become impaired.
• The discount rate, which is used to measure the present value of the reporting unit’s projected future cash flows, including
those relating to the reporting unit's terminal value. The discount rate is based on a weighted-average cost of capital
("WACC") that reflects market and industry data as well as our specific risk factors that are likely to be considered by a
market participant. The WACC is our estimate of the overall after-tax rate of return required by equity and debt holders
of a business enterprise. The reporting units' WACC's in future periods may be impacted by adverse changes in market
and economic conditions 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 discount rates for the majority
of our reporting units declined in 2013 versus the prior year, reflecting increased stability in global financial markets.
• The reporting unit's perpetual growth rate, which is based on projections for long-term GDP growth in the reporting unit’s
local economy and a consideration of trends that indicate its long-term market opportunity. While we believe our growth
assumptions are reasonable, actual growth rates may be lower due to a variety of potential causes, such as a secular decline
in demand for our products and services, unforeseen competition, long-term GDP growth rates in established economies
being lower than projected growth rates, or a long-term deceleration in the growth rates of emerging markets.
The fair values 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 experience 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. This exercise
required a greater degree of judgment in 2013 compared with prior years, given that we did not perform step one of the impairment
test for our North American reporting units, and therefore we had to estimate their fair values for the purpose of the reconciliation.
Based on the results of our testing in 2013, all of our international reporting units passed step one of the impairment test,
and therefore we concluded that no impairment charges were required in 2013. However, two of our reporting units with significant
goodwill continue to be at risk for impairment:
• Our Australia reporting unit, which has $362.5 million of goodwill as of the end of 2013, reported declines in revenue
and operating profits during 2012 and 2013 as a result of a weak economy and the loss of certain significant customers,
and our near-term projections for this business are below our earlier expectations.
• Our China reporting unit, which has $200.6 million of goodwill as of the end of 2013, experienced weaker than expected
growth in 2013. The valuation for this reporting unit is predicated on the business achieving significant growth in the
future, and therefore it is at risk of impairment if sales growth doesn’t begin to accelerate in the near-to-mid term future.
In response to the trends for these two reporting units, we continue to undertake initiatives to help them drive sales,
streamline business activities and restructure their business operations, which we believe will enable them to achieve levels of
operating performance consistent with our long-term projections for these businesses. However, there is risk that these reporting
units may continue to sustain challenging economic, industry, and operating pressures, which in turn would increase the risk
associated with their goodwill balances. Additionally, if our stock price were to experience a sustained and significant decline,
we could incur impairment charges.
Impairment of Long-Lived Assets: We evaluate long-lived assets for impairment whenever events and circumstances
indicate that the carrying value of an asset may not be recoverable. 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. 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. Our cash flow projections are based
on historical cash flows and our latest forecasts. An impairment loss is recognized if an asset's carrying value is not recoverable
and if it exceeds its fair value. We estimate the undiscounted cash flows that will be generated over the asset's remaining useful
life, or, in the case of an asset group, over the remaining useful life of the primary asset from which the group derives its cash flow
generating capacity. Upon the occurrence of indicators of impairment, we reassess the remaining useful life of the asset or primary
asset in the case of an asset group. The projections, estimates and assumptions reflected in our long-lived asset impairment testing
require a significant degree of judgment on the part of management. If actual results are less favorable than management's
projections, estimates and assumptions, future write-offs may be necessary.