Staples 2015 Annual Report Download - page 111

APPENDIX B
STAPLES B-8
STAPLES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and
Results of Operations (continued)
the purchase of merchandise inventories are recognized as
a reduction of inventory cost and realized as part of cost of
goods sold as the merchandise is sold. Amounts that represent
reimbursement for specific, incremental costs we incur related
to selling a vendor’s products, such as advertising, are
recorded as an offset to those costs when they are recognized
in our consolidated statement of income. Several controls are
in place, including direct confirmation with vendors, which we
believe allows us to ensure that these amounts are recorded in
accordance with the terms of the contracts.
Past experience has shown little variability in purchase and
advertising rebate estimates, no collectibility issues and no
significant write-off history. Given the historical accuracy of
our estimates, we believe that a significant change in our
estimates is not likely.
Impairment of Goodwill: See our accounting policy related
to testing goodwill for impairment in Note A - Summary
of Significant Accounting Policies in the Notes to the
Consolidated Financial Statements.
For the annual test in 2015, we performed an optional
qualitative assessment for our North American reporting units
(combined goodwill of $1.9 billion at the time of the impairment
test) to determine whether it was more likely than not that
their fair values were less than their carrying amounts. The
assessment requires management to identify the key drivers
of fair value for the reporting units, to consider all significant
events and circumstances that are relevant to their fair
values, and then to weigh the positive and negative evidence.
Examples of factors considered include trends and conditions
in the macro economy, industry, and financial markets, as well
as Staples-specific factors that would likely be considered by
market participants, such as recent financial results and our
latest forecasts, our current strategic plans, and our stock
price. This process requires management to exercise a great
deal of judgment. Based on our assessment, we concluded
that it was more likely than not that the reporting units’ fair
values continued to exceed their carrying values by significant
margins, and accordingly that it was not necessary to perform
the quantitative impairment test for these reporting units.
For our international reporting units (combined goodwill of
$728 million at the time of the impairment test), we proceeded
directly to the quantitative impairment test. In step one, we
determined fair value using discounted cash flow (“DCF”)
analysis, which requires management to make assumptions
and develop estimates regarding industry and economic
factors and the future profitability of our businesses. The key
assumptions and estimates used in the discounted cash flow
approach include:
• The reporting unit’s projections of financial results over
periods that range from six to fifteen years, depending
on the maturity of the underlying business. Our reporting
units’ fair values are most sensitive to our sales growth
and operating profit rate assumptions, which represent
estimates based on our current and projected sales mix,
profit improvement opportunities and market conditions.
• 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 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
future 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 judgment for our 2015
impairment test, given that it incorporated high-level estimates
of the fair values of the reporting units for which we relied on
the optional qualitative screen.
Based on the results of our testing in 2015, we determined that
no impairment charges were required. See Note C - Goodwill
and Long-Lived Assets in the Notes to the Consolidated
Financial Statements for information related to the impairment
charges recorded in 2014.
Following are key factors that could potentially result in future
impairment charges:
• Deterioration in macroeconomic or industry conditions,
or a failure to manage our businesses successfully, could
result in our reporting units’ actual future financial results
to be lower than management’s projections;
• Adverse changes in market and economic conditions
could increase the reporting units’ WACC’s; and,
• A sustained and significant decline in our stock price
could result in a decline in the value of some or all of our
reporting units.
As of January 30, 2016, our Europe Online, China, and Australia
reporting units continue to be at an increased risk for future
impairment charges. These reporting units have associated
goodwill balances as of that date of $266 million, $76 million,
and $49 million, respectively. Our Europe Online reporting unit
has experienced ongoing challenges transitioning from its
legacy catalog business model to an online model. In 2014
we recorded goodwill impairment charges related to our
China and Australia reporting units of $280 million and $116
million, respectively. While our China and Australia reporting