Staples 2014 Annual Report Download - page 148

APPENDIX C
C-16 STAPLES Form 10-K
STAPLES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
As disclosed in the Company’s prior year annual report on
form 10-K and in its quarterly report on form 10-Q for the
thirteen weeks ended November 1, 2014, the Company has
been monitoring the performance of its Australia and China
reporting units, which have material amounts of goodwill that
were deemed to be at risk of impairment. At the time of the
impairment test, these reporting units had $337 million and
$198 million of associated goodwill, respectively.
The Company’s Australia reporting unit experienced unusually
high customer attrition in 2011 and 2012, and operating
challenges continued in 2013. In 2014, sales and profits were
again below plan, and challenges remain in generating the
levels of growth sufficient to improve the long-term profitability
of the business.
The Company has previously projected significant growth for
its China reporting unit. However, sales growth in 2013 was
weaker than expected, and in 2014 sales declined as the
business decided to exit certain unprofitable arrangements,
and growth in ecommerce sales was not sufficient to offset the
loss of these arrangements.
In addition, the Company’s South America reporting unit,
which had $13 million of goodwill at the time of the impairment
test, has also experienced weaker than expected growth.
In conjunction with the Company’s annual cycle for planning and
budgeting, in the fourth quarter of 2014 the Company updated
its fiscal 2015 and long-term financial projections for its reporting
units. The resulting sales growth outlook for the Australia,
China and South America reporting units is lower than prior
expectations. Considering the lower near-term outlook and the
recent history of operating shortfalls, the Company incorporated
reductions into its long-term sales growth projections for these
three reporting units, resulting in lower long-term profit rates due
to lower operating leverage. As a result, these three reporting
units failed step one of the impairment test.
In the second step of the impairment test, the Company
assigned the reporting units’ fair values to their individual assets
and liabilities, including any unrecognized assets or liabilities,
in a hypothetical analysis that calculates the implied fair value
of goodwill in the same manner as if the reporting unit was
being acquired in a business combination. If the implied fair
value of the reporting unit’s goodwill is less than the carrying
value, the difference is recorded as an impairment charge. The
fair value estimates incorporated in step two were primarily
based on the income approach, specifically the multi-period
excess earnings method. Based on the results of this second
step, during the fourth quarter of 2014 the Company recorded
total goodwill impairment charges of $409.5 million, including
$280.2 million related to Australia, $116.3 million related to
China, and $13.0 million related to South America. These
reporting units are components of the Company’s International
Operations segment.
The valuation methodologies used to measure the impairment
charges incorporated unobservable inputs reflecting significant
estimates and assumptions made by management. Accordingly,
the Company classified these measurements as Level 3 within
the fair value hierarchy. Key inputs included expected sales
growth rates, customer attrition rates, operating income
margins, market-based royalty rates, and discount rates.
Due to the inherent uncertainty associated with forming
the estimates described above, actual results could differ
from those estimates. Future events and changing market
conditions may impact the Company’s key inputs and may
result in future goodwill impairment charges that, if incurred,
could have a material adverse effect on the Company’s results
of operations. As of January 31, 2015, taking into account the
charges recorded during the fourth quarter of 2014 as well as
the impact of currency translation adjustments, the remaining
amount of goodwill associated with the Company’s Australia,
China, and South America reporting units was $51.3 million,
$80.2 million, and $0, respectively.
2012 Goodwill Impairment
In 2012 the Company recorded goodwill impairment charges
of $303.3 million related to its Europe Retail reporting unit
and $468.1 million related to its Europe Catalog reporting
unit. These reporting units are components of the Company’s
International Operations segment. The impairment charges
stemmed from a history of declining sales and profits for these
businesses, combined with political and economic instability
in Europe and a sustained decline of the Company’s stock
price at that time. As a result of these trends, the Company
developed a strategic plan in 2012 to restructure its operations
in Europe (see Note B - Restructuring Charges).
To derive the fair value of these reporting units in step one of
the impairment test, the Company used the DCF method. The
fair value estimates incorporated in step two were primarily
based on third-party appraisals and the income approach,
specifically the relief from royalty and the multi-period excess
earnings methods.
The valuation methodologies used in the 2012 goodwill
and long-lived asset (see further below) impairment testing
incorporated unobservable inputs reflecting significant
estimates and assumptions made by management.
Accordingly, the Company classified these measurements
as Level 3 within the fair value hierarchy. The charges were
also based, in part, on property appraisals prepared by third-
party valuation specialists. The appraisals incorporate a
significant amount of judgment on the part of the valuation
specialists regarding appropriate comparable properties and
an assessment of current market conditions. The Company
has also classified these measurements as Level 3 within the
fair value hierarchy.