NOTE 16. DERIVATIVE INSTRUMENTS AND FAIR VALUE MEASUREMENTS

Derivative Instruments and Hedging Activities

As a global supplier of office products and services the Company is exposed to risks associated with changes in foreign currency exchange rates, fuel and other commodity prices and interest rates. Depending on the exposure, settlement timeframe and other factors, the Company may enter into derivative transactions to mitigate those risks. The Company may designate and account for such qualifying arrangements as hedges. Historically, the Company has not entered into transactions to hedge its net investment in foreign operations but may in future periods.

Financial instruments authorized under the Company’s established risk management policy include spot trades, swaps, options, caps, collars, forwards and futures. Use of derivative financial instruments for speculative purposes is expressly prohibited. The fair value and activity of derivative financial instruments were not material as of and for the periods ended December 28, 2013 or December 29, 2012. The existing designated hedge contracts are highly effective and the ineffective portion is considered immaterial. As of December 28, 2013, the foreign exchange contracts extend through February 2014. Losses currently deferred in OCI are expected to be recognized in income within the next twelve months.

The fair values of the Company’s 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.

Financial Instruments

The following table presents information about financial instruments at the balance sheet dates indicated. The Senior Notes matured in 2013.


	2013				2012
(In millions)	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Timber notes receivables	$	945	$	933	$	—	$	—
Boise investment	$	46	$	47	$	—	$	—
Financial liabilities:
Recourse debt:
6.25% Senior Notes	$	—	$	—	$	150	$	154
9.75% Senior Secured Notes		250		290		250		266
7.35% debentures, due 2016		18		19		—		—
Revenue bonds, due in varying amounts periodically through 2029		186		186		—		—
American & Foreign Power Company, Inc. 5% debentures, due 2030		13		13		—		—
Non-recourse debt	$	859	$	851	$	—	$	—

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

•

Timber notes receivable: Fair value is determined as the present value of expected future cash flows discounted at the current interest rate for loans of similar terms with comparable credit risk (Level 2 inputs).

•

Boise Investment: Fair value is calculated as the sum of the market value of the Company’s indirect investment in Boise Cascade Company, the primary investment of Boise Cascade Holdings, LLC, plus the Company’s portion of any cash held by Boise Cascade Holdings, LLC as of the balance sheet date (together, Level 2 inputs). The Company’s indirect investment in Boise Cascade Company is calculated using the number of shares the Company indirectly holds in Boise Cascade Company multiplied by its closing stock price as of the last trading day prior to the balance sheet date.

•

Recourse debt: Recourse debt for which there were no transactions on the measurement date was valued based on quoted market prices near the measurement date when available or by discounting the future cash flows of each instrument using rates based on the most recently observable trade or using rates currently offered to the Company for similar debt instruments of comparable maturities (Level 2 inputs).

•

Non-recourse debt: Fair value is estimated by discounting the future cash flows of the instrument at rates currently available to the Company for similar instruments of comparable maturities (Level 2 inputs).

Fair Value Estimates Used in Impairment Analyses

Retail Stores

Because of declining sales in recent periods, the Company has conducted a detailed quarterly store impairment analysis. The analysis uses input from retail store operations and the Company’s accounting and finance personnel that organizationally report to the Chief Financial Officer. 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. The Company recognized store asset impairment charges of $26 million, $124 million and $11 million in 2013, 2012 and 2011, respectively.

A review of the North American Retail portfolio during 2012 concluded with a plan for each location to maintain its current configuration, downsize to either small or mid-size format, relocate, remodel, renew or close at the end of the base lease term. The asset impairment analysis previously had assumed at least one optional lease renewal. Additionally, projected sales trends included in the impairment calculation model in prior periods were reduced. These changes, and continued store performance, served as a basis for the Company’s asset impairment review for 2012.

In February 2013, the Company announced its intent to merge with OfficeMax. The prospect of combining the two companies impacted the pace of implementing the plan developed in 2012, but did not alter the overall view that future size and locations were likely to be modified. The store impairment analysis for 2013 continued to project sales declines for several years, then stabilizing. Currently the analysis assumes a sales decline next year similar to recent experience, with negative but improving trends for later years. Gross margin assumptions have been held constant at current actual levels and operating costs have been assumed to be consistent with recent actual results and planned activities. For the 2013 impairment analysis, 53 locations were reduced to estimated fair value of $10 million based on their projected cash flows, discounted at 13% and 222 locations were reduced to estimated salvage value of $7 million. A 100 basis point decrease in next year sales used in these estimates would have increased impairment by approximately $2 million. Independent of the sensitivity on sales assumptions, a 50 basis point decrease in next year gross margin would have increased the impairment by approximately $1 million. The interrelationship of having both of those inputs change as indicated would have resulted in impairment approximately equal to the sum of the two individual inputs. Further, a 100 basis point decrease in sales for all future periods would increase the impairment by approximately $4 million.

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 in certain circumstances, even if store performance is as anticipated, additional impairment charges may result. However, at the end of 2013, the impairment analysis reflects the Company’s best estimate of future performance.

Intangible Assets

Indefinite-lived intangible assets — As noted in prior years, Goodwill of $45 million (at then-current exchange rates) was included in the International Division in a reporting unit comprised of wholly-owned operating subsidiaries in Europe and ownership of the joint venture operating in Mexico. The total estimated fair value of the reporting unit exceeded its carrying value by approximately 30%, however, a substantial majority of that excess value was associated with the joint venture. When the reporting unit sold its investment in the joint venture and distributed essentially all of the after tax proceeds to its U.S. parent, the fair value fell below its carrying value. Because the investment was accounted for under the equity method, no goodwill was allocated to the gain on disposition of joint venture calculation. However, concurrent with the sale and gain recognition, a goodwill impairment charge of $44 million was recognized and is reported on the Asset impairments line in the Consolidated Statements of Operations. The assessment of fair value of the operating subsidiaries was primarily based on a discounted cash flow analysis, including an estimated residual value. The analysis is prepared by the Company’s finance and accounting personnel that organizationally report to the Chief Financial Officer. The cash flows were projected to decrease, level and then trend positive, with an ending year growth rate of 1.5%. These amounts were discounted at 13%. Market data was used to corroborate this estimated value.

Goodwill associated with the Merger was established based on the preliminary allocation of consideration to the fair value of assets acquired and liabilities assumed at the transaction date of November 5, 2013. The purchase price allocation is not yet complete and the goodwill has not yet been allocated to the reporting units. The Company expects to adopt an annual testing period of the first day of the third quarter for this Merger-related goodwill. Nothing has come to the Company’s attention since the acquisition date that would cause the Company to test at an earlier period.

The estimated value of the indefinite lived tradename included in the International Division was based on an estimated royalty rate of 0.5% applied to projected sales and discounted at 13%. No indication of impairment was identified. As the Company assesses its global brand strategy during 2014 in connection with integration of the Merger, the appropriateness of indefinite life for this tradename may change.

Definite-lived intangible assets — During 2011, the Company 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 definite-lived 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% 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 impairments in the Consolidated Statements of Operations.

Fair Value Estimates Used for Paid-in-Kind Dividends

Prior to redemption of the Company’s Redeemable Preferred Stock in 2013, any dividends paid-in-kind were measured at fair value, using Level 3 inputs. The Company used a binomial simulation to capture the call, conversion, and interest rate reset features as well the optionality of paying the dividend in-kind or in cash. Dividends were paid in kind for the fourth quarter of 2011 and the first three quarters of 2012.

For the 2011 dividends paid-in-kind, the simulation was based on stock price volatility of 70%, a risk free rate of 1.49%, and a risk adjusted rate of 14.6%. The fair value calculation of $7.7 million was approximately $1.6 million below the amount added to the liquidation preference. For dividends paid-in-kind for the three quarters of 2012, the average stock price volatility was 63%, the risk free rate was 3.0% and the risk adjusted rate was 14.5%. The aggregate fair value calculated for these three quarters was $22.8 million, $6.3 million below the amount added to the liquidation preference. For the dividend paid-in-kind 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. See Note 11for additional information.

There were no significant differences between the carrying values and fair values of the Company’s financial instruments as of December 28, 2013 and December 29, 2012, except as disclosed above.