Fair Value Measurements

9 Months Ended

Sep. 29, 2012

Fair Value Measurements

Note J – Fair Value Measurements

The company measures fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In developing its fair value estimates, the company uses the following hierarchy:

Level 1: Quoted prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Significant unobservable inputs that are not corroborated by market data. Generally, these fair value measures are model-based valuation techniques such as discounted cash flows or option pricing models using our own estimates and assumptions or those expected to be used by market participants.

The fair values of cash and cash equivalents, receivables, accounts payable and accrued expenses and other current liabilities approximate their carrying values because of their short-term nature.

The fair values of our interest rate swaps, foreign currency contracts and fuel contracts are the amounts receivable or payable to terminate the agreements at the reporting date, taking into account current interest rates, exchange rates and commodity prices. The values are based on market-based inputs or unobservable inputs that are corroborated by market data. There were no interest rate swap agreements in place at the end of the third quarter of 2012 and the amounts receivable or payable under foreign currency and fuel contracts were not significant. See Note K for additional information on our derivative instruments and hedging activities.

The following table summarizes the company’s financial assets and liabilities measured at fair value on a recurring basis:

(In thousands)	Fair Value Measurement Category Level 2
	September 29, 2012		December 31, 2011		September 24, 2011
Assets
Commodity contracts – fuel	$	79	$	—	$	725
Foreign exchange contracts		67		341		952
Liabilities:
Commodity contracts – fuel		—		251		—
Foreign exchange contracts	$	430	$	92	$	38

The company records its senior notes payable at par value, adjusted for amortization of a fair value hedge which was cancelled in 2005. The fair value of the senior notes and the senior secured notes are considered Level 2 fair value measurements and are based on market trades of these securities on or about the dates below.

	September 29, 2012				December 31, 2011				September 24, 2011
(In thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value
6.25% senior notes	$	149,953	$	149,984	$	399,953	$	381,067	$	399,998	$	388,000
9.75% senior secured notes	$	250,000	$	255,938	$	—	$	—	$	—	$	—

Fair Value Estimates Used in Impairment Analyses

North American Retail Division

During 2012, the company announced it would be conducting a complete review of its North American Retail Division real estate strategy. That review was completed in the third quarter of 2012 and approved by the company’s board of directors. The retail strategy, which involves the review of each location in the current store portfolio to downsize to either small or mid-size format, relocate, remodel, or close at the end of the base lease term, and continued store performance served as a basis for the company’s quarterly asset impairment review. The quarterly impairment analysis uses input from retail store operations and the company’s accounting and finance personnel that organizationally report to the chief financial officer to assess the performance of retail stores quarterly against historical patterns and projections of future profitability for evidence of possible asset impairment. For the retail business, these projections are based on management’s estimates of store-level sales, gross margins, direct expenses, exercise of future lease renewal options, where applicable, and resulting cash flows and, by their nature, include judgments about how current initiatives will impact future performance. If the anticipated cash flows of a store cannot support the carrying value of its assets, the assets are impaired and written down to estimated fair value using Level 3 inputs. Most store locations in the U.S. are accounted for as operating leases with a term at lease inception of a base non-cancellable period, generally ten years, and one or more renewal options.

The retail strategy provides a plan to downsize approximately 245 locations to small-format stores at the end of their lease term over the next three years and an additional 150 locations over the following two years. Approximately 70 locations will be downsized or relocated to the mid-sized format over the next three years and another 20 over the following two years. The company anticipates closing approximately 60 stores as their base lease period ends. The remaining stores in the portfolio are anticipated to remain as configured, be remodeled or have base lease periods more than five years in the future. Future market conditions could impact any of these decisions used in this analysis. This retail strategy includes capital expenditures of approximately $60 million per year for the next five years.

Approximately 36% of the store leases will be at the optional renewal period within the next three years and 57% within the next five years. The individual cash flow time horizon for stores expected to be closed, relocated or downsized has been reduced to the base lease period, eliminating renewal option periods from the calculation, where applicable. Additionally, projected sales trends included in the impairment calculation model in prior periods have been reduced. The quarterly impairment analyses in recent periods have contemplated short-term negative sales trends, a period of no growth, turning positive in the second and later years. However, the actual quarterly results have declined more than included in the model and we have recognized asset impairment charges each quarter since the third quarter of 2011, even though we continued to lower our projected sales trends for these tests. Each period reflected the company’s best estimate at the time. The current outlook on comparable store sales is a decline of 4% in the first year, consistent with our second and third quarter 2012 results. The projected sales continue to be negative for the second year, but are on an improving trend. Gross margin assumptions have been held constant at our current actual levels and we have assumed operating costs consistent with recent actual results and planned activities. We have lowered our residual value estimate based on the experience from recent closures and estimates from liquidators. The resulting asset impairment charge of $73 million has been recorded in the North American Retail Division results for the third quarter of 2012. Year-to-date 2012 asset impairment charges for the Division totaled $115 million.

The third quarter 2012 charge relates to 360 store locations. Of these store locations, approximately 230 were reduced to estimated salvage value of $7 million and assets for the remaining 130 locations were reduced to estimated fair value of $39 million based on their projected cash flows, discounted at 13%. For locations subject to the real estate strategy, any remaining value after asset impairment charges will be depreciated over the remaining base lease period for the locations. These locations are particularly sensitive to changes in projected cash flows over the forecast period and additional impairment is possible in future periods if results are below projections. A 100 basis point decrease in sales used in these estimates would have increased impairment by approximately $4.1 million. Independent of the sensitivity on sales assumptions, a 50 basis point decrease in gross margin would have increased the impairment by approximately $6.3 million. The interrelationship of having both of those inputs change as indicated would have resulted in impairment approximately $0.5 million less than the sum of the two individual inputs.

The company will continue to evaluate initiatives to improve performance and lower operating costs. To the extent that forward-looking sales and operating assumptions are not achieved and are subsequently reduced, or if the company commits to a more extensive store downsizing strategy, additional impairment charges may result. However, at the end of the third 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.

International Division

During 2011, we acquired an office supply company in Sweden to supplement the existing business in that market. As a result of slowing economic conditions in Sweden after the acquisition, difficulties in the consolidation of multiple distribution centers and the adoption of new warehousing systems which impacted customer service and delayed or undermined planned marketing activities, the company re-evaluated remaining balances of acquisition-related intangible assets of customer relationships and short-lived tradename values. The acquisition-date intangible asset valuation anticipated customer attrition of approximately 11% to 13% per year through 2013. The cash flow analysis consistent with the original valuation of the amortizing intangible assets was updated by accounting and finance department personnel to reflect the decline experienced in 2012, as well as projected sales declines of 8% in for acquisition-date retail customer relationships and 2% for acquisition-date contract relationships in 2013 and costs necessary to successfully complete the warehouse integration and re-launch the marketing initiatives. Cash flows related to these acquired customer relationships with the updated Level 3 inputs were projected to be negative, then recovering, but were insufficient to recover the intangible assets’ remaining carrying values. Accordingly, an impairment charge of approximately $14 million was recognized during the third quarter of 2012 and is presented in Asset impairment in the Condensed Consolidated Statements of Operations.

Fair Value Estimates Used for Paid-in-Kind Dividends

The company’s board of directors can elect to pay quarterly dividends on its preferred stock in cash or in-kind. Paid-in-kind dividends are measured at fair value, using Level 3 inputs. The company uses a Monte Carlo simulation that captures the call, conversion, and interest rate reset features as well the optionality of paying the dividend in-kind or in cash. The board of directors and company’s management consider then-current and estimated future liquidity factors in making that quarterly decision. For the third quarter of 2012 valuation, the simulation was based on a beginning stock price of $2.56, stock price volatility of 64.2%, a risk free rate of 2.8%, and a credit spread of 13.5%. The calculation resulted in a fair value estimate of approximately $7.7 million for the third quarter of 2012. A stock price volatility of 55% or 75% would have increased the estimate by $0.7 million or decreased the estimate by $0.6 million, respectively. Using a beginning of period stock price of $1.50 or $3.50 would have decreased the estimate by $1.7 million or increased the estimate by $1.1 million, respectively. Assuming that all future dividends would be paid in cash would have increased the estimate by $1.3 million. Assuming all future dividends would be paid-in-kind had no significant impact on the estimate.