Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note A
—
Basis of Presentation
The accompanying interim unaudited condensed consolidated financial statements include the accounts of Staples, Inc. and its subsidiaries (“Staples” or “the Company”). All intercompany accounts and transactions have been eliminated in consolidation. These financial statements are for the period covering the
13
and
26
weeks ended
July 30, 2016
(also referred to as the “
second quarter of
2016
" and "
first half of
2016
") and the period covering the
13
and
26
weeks ended
August 1, 2015
(also referred to as the “
second quarter of
2015
” and "
first half of
2015
").
These financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods. In the opinion of management, these financial statements reflect all normal recurring adjustments considered necessary to present fairly the financial position and the results of operations and cash flows for the interim periods presented. For a more complete discussion of significant accounting policies and certain other information, these financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended
January 30, 2016
("Annual Report").
The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year. Our business is somewhat seasonal, with sales and profitability historically higher during the second half of our fiscal year due to the back-to-school, holiday and January back-to-business seasons.
Note B
—
Recent Accounting Pronouncements
In March 2016, a pronouncement was issued that aims to simplify several aspects of accounting and reporting for share-based payment transactions. One provision requires that excess income tax benefits and tax deficiencies related to share-based payments be recognized within income tax expense in the statement of income, rather than within additional paid-in capital on the balance sheet. The Company is currently evaluating the potential impact that this provision, which is to be applied prospectively, will have on its financial statements. The Company does not expect the other provisions within the pronouncement will have a material impact on its financial statements. The guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods, with early adoption permitted.
Note C
—
Strategic Initiatives, Restructuring and Related Charges
Staples 20/20 Plan
In May 2016 the Company announced a strategic plan under which it plans to:
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•
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focus on mid-market customers in North America by accelerating growth in services and products beyond office supplies
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•
|
explore strategic alternatives for its European operations
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|
|
•
|
increase productivity and preserve profitability in its retail stores
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|
|
•
|
pursue acquisitions of business-to-business service providers and companies specializing in categories beyond office supplies
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|
|
•
|
execute a new multi-year cost savings plan which is expected to generate approximately
$300 million
of annualized pre-tax cost savings by the end of 2018, primarily by reducing product costs and increasing our mix of higher margin Staples Brand products, driving productivity in our supply chain, and evolving our pricing and promotional strategies.
|
Following the termination of its merger agreement with Office Depot and the announcement of the 20/20 Plan, the Company and Ron Sargent mutually agreed it was the right time to transition to new management, and therefore the Company announced in May 2016 that Mr. Sargent would step down from the position of Chief Executive Officer of the Company effective June 14, 2016. The Company and Mr. Sargent entered into a letter agreement providing for monthly payments of
$166,740
for a period of 24 months commencing February 2017, as well as certain benefits with an estimated cost of
$875,000
. The Company recorded a liability for the cost of these severance benefits in the second quarter of 2016.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
In connection with the
$300 million
cost savings plan, in the second quarter of 2016 the Company incurred charges of
$6 million
related to exiting certain product categories in its North American retail stores, of which
$4 million
is included in Cost of goods sold and occupancy costs and
$2 million
is included in Impairment of goodwill and long-lived assets in the condensed consolidated statement of comprehensive income (see
Note D
-
Impairment of Goodwill and Long-Lived Assets
).
In the second quarter of 2016, the Company also incurred
$6 million
of costs in connection with exploring strategic alternatives for its European operations. These costs are included in Selling, general and administrative expense in the condensed consolidated statement of comprehensive income.
As the Company continues to execute its 20/20 Plan additional charges may be incurred. The nature and timing of the charges will depend upon the actions that are taken and cannot be estimated at this time.
2014 Restructuring Plan
In 2014 the Company announced a plan to close at least
225
retail stores in North America by the end of fiscal year 2015. Pursuant to this plan, the Company closed
242
stores in 2014 and
2015
. This plan has been extended and the Company expects to close at least
50
additional stores in North America during
2016
. In connection with these additional closures, in 2016 the Company expects to incur charges of approximately
$30 million
to
$60 million
for contractual lease obligations, up to
$5 million
for impairment and accelerated depreciation of store assets, less than
$5 million
for severance and
$10 million
to
$15 million
in other associated costs. These charges relate to the Company's North American Stores & Online segment.
In
2014
the Company also initiated a cost savings plan to generate annualized pre-tax savings of approximately
$500 million
by the end of fiscal
2015
. Actions related to the cost saving plan were largely complete as of the end of 2015.
During the second quarter and first half of
2016
, the Company recorded restructuring charges of
$4 million
and
$14 million
, respectively, related to the 2014 Restructuring Plan, primarily related to lease obligations for closed retail stores. These charges relate to the Company's North American Stores & Online segment.
During the first half of 2016, the Company recorded adjustments to reduce the employee-related liabilities by
$5 million
, primarily as a result of certain changes to the scope of planned initiatives and actual forfeitures being higher than previous estimates. During the first half of 2016, the Company also recorded adjustments to reduce contractual obligations by
$4 million
, reflecting lease terminations that were negotiated during this period.
The table below shows a reconciliation of the beginning and ending liability balances for each major type of cost associated with the 2014 Restructuring Plan (in millions):
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2014 Plan
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Employee-Related
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Contractual Obligations
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Other
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Total
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Accrued restructuring balance as of January 30, 2016
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$
|
74
|
|
|
$
|
83
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$
|
1
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|
|
$
|
158
|
|
|
Charges
|
|
1
|
|
|
10
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|
|
3
|
|
|
14
|
|
|
Adjustments
|
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(5
|
)
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(4
|
)
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—
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|
(9
|
)
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|
Cash payments
|
|
(27
|
)
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|
(34
|
)
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|
(3
|
)
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(64
|
)
|
|
Foreign currency translations
|
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—
|
|
|
1
|
|
|
—
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|
|
1
|
|
|
Accrued restructuring balance as of July 30, 2016
|
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$
|
43
|
|
|
$
|
56
|
|
|
$
|
1
|
|
|
$
|
100
|
|
In addition to the contractual obligations shown in the table above, the Company also has a related liability of
$10 million
and
$8 million
recorded on the condensed consolidated balance sheet as of
July 30, 2016
and
January 30, 2016
, which primarily represents amounts previously accrued to reflect rent expense on a straight-line basis for leased properties which the Company has now ceased using.
For the restructuring liabilities associated with the 2014 Plan,
$33 million
of contractual obligations are included within Other long-term obligations and the remaining balances are included within Accrued expenses and other current liabilities in the Company's condensed consolidated balance sheet as of
July 30, 2016
. The Company expects that payments related to employee-related liabilities will be substantially completed by the end of the second quarter of fiscal 2017. The Company anticipates that payments related to facility lease obligations will be completed by the end of fiscal year 2025.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
During
the first half of
2015
, the Company recorded restructuring charges of
$66 million
related to the 2014 Restructuring Plan, including
$40 million
for lease obligations,
$20 million
for employee-related costs, and
$6 million
for other associated costs. These costs primarily related to the closure of North American retail stores. The Company also recorded
$6 million
of charges for accelerated depreciation and impairment of long-lived assets in the first half of 2015, primarily related to the closure of facilities supporting the Company's North American delivery operations.
The table below shows how the restructuring charges would have been allocated if the Company had recorded the expenses within the functional departments of the restructured activities (in millions):
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13 Weeks Ended
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26 Weeks Ended
|
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July 30, 2016
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August 1, 2015
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July 30, 2016
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August 1, 2015
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Cost of goods sold and occupancy costs
|
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$
|
2
|
|
|
$
|
9
|
|
|
$
|
13
|
|
|
$
|
40
|
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|
Selling, general and administrative
|
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2
|
|
|
14
|
|
|
1
|
|
|
26
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Total
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$
|
4
|
|
|
$
|
23
|
|
|
$
|
14
|
|
|
$
|
66
|
|
Note D
—
Impairment of Goodwill and Long-Lived Assets
Goodwill
In the fourth quarter of 2015, the Company performed its annual goodwill impairment testing and concluded that no impairment charges were required at that time. In the Company’s Annual Report on Form 10-K for its fiscal year 2015, the Company disclosed that its Europe Online reporting unit, which had
$266 million
of goodwill as of January 30, 2016, was at an increased risk for future impairment.
As a result of changes in its organizational structure and the centralization of certain functions, in the first quarter of 2016 the Company combined its Europe Online and Europe Contract businesses into a single reporting unit ("Europe Delivery"). In the first quarter of 2016 the Company disclosed that Europe Delivery, which is a component of the Company’s International Operations segment, was at an increased risk for future impairment charges. Europe Delivery had associated goodwill of
$630 million
as of the second quarter of 2016.
In the second quarter of 2016, based on continued adverse business trends and following changes in the Company’s strategic plans post termination of the proposed Office Depot merger, the Company identified certain factors that now indicated it was more likely than not that the fair value of the Europe Delivery reporting unit was lower than its carrying value. These factors include:
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•
|
Europe Delivery continued to experience operating challenges during the second quarter of 2016, and now expects further challenges in the near to mid-term as a result of delays in its restructuring and transformation activities.
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•
|
Britain’s decision in June 2016 to exit the European Union (“Brexit”) resulted in increased uncertainty in the economic and political environment in Europe.
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•
|
In May 2016, Staples announced a strategic plan under which it will focus on its North American businesses, reducing its emphasis on International Operations. The Company announced it was exploring strategic alternatives for its European operations, and hired outside advisors to evaluate a potential sale of the business.
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•
|
Information obtained in the second quarter during the process of marketing the European business for sale, including the likely absence of strategic buyers and the indications of value received from potential financial buyers.
|
The Company concluded its European operations do not meet the criteria to be classified as held for sale as of the end of the second quarter of 2016. Based on its consideration of the factors above, the Company concluded it was necessary to perform an interim goodwill impairment test for the Europe Delivery reporting unit pursuant to the guidelines of Accounting Standards Codification ("ASC") Topic 350, "Intangibles - Goodwill and Other".
In the first step of the impairment test, the Company determined the fair value of the reporting unit using a combination of the income and market approaches, specifically the discounted cash flow (“DCF”) and guideline public company methods. In the past the Company has not relied upon the market approach because it believed there was an insufficient number of relevant guideline companies and comparable transactions. As a result of additional information that became available in connection with
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Staples’ current efforts to evaluate a potential sale of its European operations, the Company concluded that the use of a market approach would be appropriate given objective evidence obtained regarding reasonable ranges of market multiples.
The key assumptions and estimates used in the DCF method included:
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•
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The reporting unit's projections for financial results over a fifteen year period, which reflects management's expectations of the development time for the reporting unit’s online businesses to grow to sufficient scale and replace the legacy catalog businesses. The reporting unit’s fair value is most sensitive to assumptions related to sales growth and operating profit rates, which represent estimates based on current and projected sales mix, profit improvement opportunities, and market conditions. The projections used in the current year model also now include estimates of the costs a financial buyer would incur to operate the business on a standalone basis, and reduced savings as a result of the delays in the execution of its restructuring and transformation plans.
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•
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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 risk factors specific to the reporting unit that are likely to be considered by a market participant. The WACC represents the Company’s estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise.
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The key assumptions and estimates used in the guideline public company method included:
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•
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Selection of guideline companies that are reasonably similar to the Europe Delivery reporting unit in terms of industry, financial and risk profiles. The Company concluded there was limited publicly available information related to European companies that are similar in nature to its European operations. Therefore, the Company used large multi-national companies in the guideline public company analysis.
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•
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Determination of an appropriate market multiple. The Company assessed the business enterprise values of the guideline companies in relation to earnings before interest, taxes, depreciation and amortization (“EBITDA”). The Company then evaluated an appropriate multiple to apply to its Europe Delivery reporting unit, taking into consideration differences between the guideline companies and the reporting unit in terms of growth trends and profitability.
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Based on its review of the valuations indicated by each of the income and market approaches, the Company concluded it was appropriate to weight each approach 50% to determine the valuation of the reporting unit. The resulting fair value of the reporting unit was lower than its carrying value, and therefore the reporting unit failed step one of the impairment test.
In the second step of the impairment test, the Company assigned the reporting unit’s fair value to its 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 for intangible assets were primarily based on the income approach, specifically the multi-period excess earnings and relief from royalty methods. For owned real property, the Company used a combination of the income and market approaches to determine fair value.
The valuation methodologies used in step two 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.
Based on the results of the second step in the impairment test, the Company determined that the reporting unit’s
$630 million
of goodwill was fully impaired, and therefore it recorded an impairment charge of this amount in the second quarter of 2016.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
The changes in the carrying amounts of goodwill during the first half of 2016 are as follows (in millions):
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Goodwill at January 30, 2016
|
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2016 Adjustments
|
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2016 Impairments
|
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2016 Disposals
|
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Foreign Exchange Fluctuations
|
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Goodwill at July 30, 2016
|
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North American Commercial
|
$
|
1,250
|
|
|
$
|
(2
|
)
|
|
$
|
—
|
|
|
$
|
(19
|
)
|
|
$
|
—
|
|
|
$
|
1,229
|
|
|
|
North American Stores & Online
|
657
|
|
|
—
|
|
|
—
|
|
|
—
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|
3
|
|
|
660
|
|
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International Operations
|
746
|
|
|
—
|
|
|
(630
|
)
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|
—
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|
|
9
|
|
|
125
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Consolidated
|
$
|
2,653
|
|
|
$
|
(2
|
)
|
|
$
|
(630
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)
|
|
$
|
(19
|
)
|
|
$
|
12
|
|
|
$
|
2,014
|
|
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The Company's International Operations segment had accumulated goodwill impairment charges of
$1.81 billion
and
$1.18 billion
as of July 30, 2016 and January 30, 2016, respectively.
As of the end of the second quarter of 2016, the Company was still in the process of evaluating a potential sale of its European operations, as well as other strategic options. Therefore, as of the end of the second quarter the Company concluded that its European operations did not meet the criteria to be classified as held for sale. A decision regarding a potential sale is expected in the third quarter of 2016. If the Company were to conclude in the third quarter of 2016 that its European operations qualified to be classified as held for sale, the Company would expect to record charges at that time, which could be material. As of July 30, 2016 the Company’s European operations had long-lived assets of
$318 million
which may become impaired at the time the business is classified as held for sale. In the event a transaction is completed, additional charges would be expected related to
$0.9 billion
that is currently recorded in accumulated other comprehensive income in the Company’s condensed consolidated balance sheet, reflecting cumulative translation losses and potential losses associated with the curtailment and settlement of pension obligations. These balances could change materially depending on, among other factors, the final sale price for the European operations, future changes in foreign exchange rates and market interest rates, the extent and form of disposition of the pension obligations, and the future operating results of the European operations.
Long-Lived Assets
In connection with the Company's North American retail store closure plan (see
Note C
-
Strategic Initiatives, Restructuring and Related Charges
), in the second quarter of 2016 the Company recorded long-lived asset impairment charges of
$3 million
, primarily related to leasehold improvements, fixtures, equipment and other fixed assets at the closing store locations; there were no material impairment charges recorded in the first quarter of 2016. In the first half of
2015
, the Company recorded long-lived asset impairment charges of
$1 million
related to store closures. These charges relate to the Company's North American Stores & Online segment.
In addition, in the second quarter of 2016 the Company recorded long-lived asset impairment charges of
$27 million
related to fixed assets at North American and European retail stores that have not been identified for closure. The Company determined the carrying values of these assets were not recoverable from future cash flows, primarily as a result of declining sales. Of this amount,
$12 million
relates to the North American Stores & Online segment and
$15 million
relates to the International Operations segment.
The charges related to retail stores were based on measurements of the fair value of the impaired assets derived using the income and market approaches. The measurements determined using the income approach incorporated Level 3 inputs as defined in ASC Topic 820, “Fair Value Measurements and Disclosures”. The Company considered the expected net cash flows to be generated by the use of the assets, as well as the expected cash proceeds from the disposition of the assets, if any.
Based on a strategic review the Company performed in the first quarter of 2015, the Company made a decision to dispose of certain information technology assets, incurring an impairment charge of
$22 million
. The assets were comprised of software for which the Company concluded the fair value was not material. This charge relates to the Company's North American Stores & Online segment.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Note E
—
Sale of Businesses and Assets
In April 2016, Staples entered into an agreement to sell substantially all of the assets and transfer certain liabilities related to its commercial printing solutions business (Staples Print Solutions, or “SPS”) for cash consideration of
$85 million
, subject to change based on a working capital adjustment. The transaction closed on July 5, 2016. The Company recognized a loss of
$48 million
on the sale of SPS, of which
$32 million
and
$16 million
was recognized in the first and second quarters of 2016, respectively. The loss recognized in the first quarter of 2016 represented a full write-down of the
$19 million
of goodwill and
$13 million
of long-lived assets associated with this business unit. The loss is included in (Loss) gain on sale of businesses and assets, net in the condensed consolidated statement of comprehensive income. The Company expects to finalize the working capital adjustment in the third quarter of 2016. SPS was a component of the Company’s North American Commercial segment.
In addition, as a result of the sale of SPS, the Company plans to settle SPS’s pension obligations and terminate its pension plan, the benefits under which were previously frozen. The Company expects to recognize aggregate losses of approximately
$17 million
to
$22 million
during the third and fourth quarters of 2016 as the settlements occur.
SPS’s pretax income in the
second quarter
and
first half of
2016
was
$5 million
and
$10 million
, respectively. SPS's pretax income in the
second quarter
and
first half of
2015 was
$5 million
and
$12 million
, respectively. The table below shows the major classes of SPS’s assets and liabilities at the time of the disposition (in millions):
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ASSETS
|
July 5, 2016
|
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Receivables
|
$
|
51
|
|
|
Inventories
|
57
|
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|
Other assets
|
4
|
|
|
Total assets
|
$
|
112
|
|
|
|
|
|
LIABILITIES
|
|
|
Accounts payable and other current liabilities
|
$
|
12
|
|
|
Total liabilities
|
$
|
12
|
|
During the
first half of
2015, the Company sold certain property and equipment, recognizing a net gain of
$3 million
. The net gain was primarily driven by the sale of a distribution facility in Europe.
Note F
—
Income Taxes
The Company's effective tax rate in the second quarter and first half of
2016
was
11.3%
and
8.6%
, respectively, which compares with
35.4%
and
32.2%
in the second quarter and first half of
2015
. The relatively low tax rate in the second quarter and first half of
2016
is primarily attributable to the impact of a
$630 million
goodwill impairment charge recognized in the second quarter of 2016 related to the Company's Europe Delivery reporting unit (see
Note D
-
Impairment of Goodwill and Long-Lived Assets
), the majority of which is not tax deductible.
Note G
—
Debt and Credit Agreements
The Company has a
$1 billion
revolving credit facility and a commercial paper program that allows it to issue up to
$1 billion
of unsecured commercial paper notes from time to time, and for which the revolving credit facility serves as a back-up. See Note F - Debt and Credit Agreements in the Notes to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 2016 for more information on the revolving credit facility and commercial paper program.
During the second quarter of 2016, the Company borrowed and repaid
$180 million
under the revolving credit facility. There were no borrowings outstanding under the revolving credit facility as of July 30, 2016. The Company also borrowed under its commercial paper program during the second quarter of 2016. As of July 30, 2016, the Company had
$188 million
of commercial paper outstanding, with a weighted average remaining maturity of
14
days and a weighted average interest rate of
1.3%
. The maximum amount outstanding under the commercial paper program during the second quarter of 2016 was
$233 million
. Borrowings outstanding under the Company's commercial paper program reduce the borrowing capacity available under the revolving credit facility by a commensurate amount.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Note H
—
Fair Value Measurements
ASC Topic 820, "Fair Value Measurements and Disclosures" establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1 measurement), then priority to quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market (Level 2 measurement), then the lowest priority to unobservable inputs (Level 3 measurement).
The fair values of cash and cash equivalents, receivables, accounts payable, accrued expenses, other current liabilities and short-term debt approximate their carrying values because of their short-term nature. The carrying values of the Company's capital lease and commercial paper obligations approximate fair value.
The following table shows the difference between the financial statement carrying value and fair value of the Company's debt obligations as of
July 30, 2016
and
January 30, 2016
(in millions). The fair values of these notes were determined based on quoted market prices and are classified as Level 1 measurements.
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|
July 30, 2016
|
|
January 30, 2016
|
|
|
Carrying Value
|
|
Fair Value
|
|
Carrying Value
|
|
Fair Value
|
|
January 2018 Notes
|
$
|
498
|
|
|
$
|
506
|
|
|
$
|
498
|
|
|
$
|
496
|
|
|
January 2023 Notes
|
497
|
|
|
520
|
|
|
496
|
|
|
488
|
|
From time to time, the Company invests in money market funds that are measured and recorded in the financial statements at fair value on a recurring basis. The fair values are based on quotes received from third-party banks and are classified as Level 1 measurements. As of
July 30, 2016
, the fair value of these investments, which are classified as Cash and cash equivalents in the condensed consolidated balance sheet, was
$39 million
. There were no material money market investments as of
January 30, 2016
.
There were no other material assets or liabilities measured at fair value.
Note I
—
Proposed Acquisition of Office Depot
On February 4, 2015, Staples announced that it had signed a definitive agreement to acquire Office Depot, a global supplier of office products, services and solutions for the workplace. On December 7, 2015, the U.S. Federal Trade Commission and Canadian Commissioner of Competition each filed lawsuits against the Company and Office Depot, seeking to block the proposed merger and prevent the acquisition from closing. On May 10, 2016, the U.S. District Court for the District of Columbia granted the Federal Trade Commission’s request for a preliminary injunction against the proposed acquisition, and as a result Staples and Office Depot terminated the merger agreement on May 16, 2016. Per the terms of the merger agreement, on May 19, 2016 Staples paid Office Depot a
$250 million
break-up fee.
In connection with the termination of the merger agreement, Staples also terminated the previously announced agreement to sell customer contracts representing more than
$550 million
of revenue and related assets to Essendant Inc.
In the first half of fiscal 2016 and 2015, the Company incurred expenses of
$24 million
and
$20 million
in connection with the proposed transaction, primarily related to professional services associated with seeking regulatory clearances. These amounts are included in selling, general and administrative expense in the consolidated statements of income. The Company also incurred fees and interest related to term loan financing for the transaction, as discussed below.
Transaction financing
In connection with the Company's proposed acquisition of Office Depot, during 2015 Staples obtained commitments for a
5
-year
$3 billion
asset-based revolving credit facility and a
6
-year
$2.75 billion
term loan. On February 2, 2016, the Company entered into a definitive term loan agreement with a syndicate of lenders, and Barclays as administrative agent and collateral agent, under which it borrowed
$2.5 billion
in the first quarter of 2016. The
$2.475 billion
of net proceeds from the term loan were deposited into escrow accounts.
As a result of the termination of the merger agreement, the agreements governing the term loan and commitments for the asset-based revolving credit facility were terminated, and on May 13, 2016 the
$2.5 billion
par value of the term loan was repaid to the lenders. The receipt of the
$2.475 billion
of net proceeds and subsequent repayment of the loan at par are not reflected in
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
the condensed consolidated statements of cash flows, given that the proceeds were deposited directly into escrow rather than into the Company's unrestricted cash accounts, and were repaid to the lenders directly from escrow.
The Company paid interest and fees related to these sources of financing of
$156 million
in the first half of 2016. Of this amount,
$91 million
was accrued in 2015;
$7 million
and
$39 million
were recorded as interest expense in the
second quarter
and
first half of
2016
, respectively; and
$26 million
was recorded as a loss on early extinguishment of debt in the second quarter of 2016, related to the acceleration of the unamortized balances of the
$25 million
original issue discount ("OID") and
$2 million
of deferred financing costs related to the term loan. The Company also earned
$2 million
of interest income on the amounts held in escrow.
During the first half of 2016 the Company made cash payments totaling
$66 million
into the escrow accounts, representing deposits for the
1.0%
OID and for the monthly interest payments related to the term loan. These amounts are included in Increase in restricted cash within the Investing Activities section of the condensed consolidated statement of cash flows for the first half of 2016. Of the
$156 million
of total interest and fees paid during the first half of 2016:
|
|
|
|
•
|
$68 million
was paid directly from the escrow accounts to the lenders (representing the
$66 million
paid into escrow plus the
$2 million
of interest income earned on the funds held therein). Because these payments were made directly from escrow, they are considered non-cash operating activities that are not reflected in the condensed consolidated statements of cash flows.
|
|
|
|
|
•
|
$88 million
was paid from Staples unrestricted cash accounts. This amount is reflected in the Operating activities section of the condensed consolidated statement of cash flows for the first half of 2016.
|
There were no amounts remaining in escrow as of July 30, 2016.
Note J
—
Equity Based Employee Benefit Plans
Staples offers its associates share ownership through certain equity-based employee compensation and benefit plans. In connection with these plans, Staples recognized
$16 million
and
$33 million
in compensation expense for the
second quarter
and
first half of
2016
, respectively, and
$17 million
and
$34 million
in compensation expense for the
second quarter
and
first half of
2015
, respectively. As of
July 30, 2016
, Staples had
$102 million
of unamortized stock compensation expense associated with these plans which will be expensed over the period through
July 2019
.
Under the 2014 Stock Incentive Plan, the Company may grant restricted stock and restricted stock units (collectively, “Restricted Shares”) and non-qualified stock options to associates.
Restricted shares
The following table summarizes the activity during the
first half of
2016
related to Restricted Shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Shares (1)
|
|
|
|
Number of Shares (Millions)
|
|
Weighted Average Grant Date Fair Value per Share
|
|
Outstanding at January 30, 2016
|
|
7
|
|
|
$
|
13.84
|
|
|
Granted
|
|
7
|
|
|
8.17
|
|
|
Vested
|
|
(3
|
)
|
|
13.74
|
|
|
Canceled
|
|
(1
|
)
|
|
13.39
|
|
|
Outstanding at July 30, 2016
|
|
10
|
|
|
$
|
10.07
|
|
|
|
|
|
(1)
|
Excludes performance share awards.
|
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Performance shares
The Company has entered into performance share arrangements with certain executives. Each arrangement covers a three year performance period. Payout under these arrangements may range from
25%
to
200%
of target for each performance metric, depending on actual performance. Any award earned based on performance achieved may be increased or decreased by
25%
if the Company's cumulative total shareholder return ("TSR") over the three year performance period is in the top or bottom one-third of the S&P 500 TSR, respectively. Shares earned, if any, will be issued on a fully-vested basis at the conclusion of the three-year performance period only if the grantee is still actively employed by or serving as a consultant to the Company at that time, with certain exceptions for retirement, death, disability, and termination without cause.
For the arrangements entered into in April 2016, vesting is based on cumulative performance over a three year period comprising fiscal years 2016 to 2018, and is
50%
based on achieving certain operating income growth targets and
50%
based on achieving certain return on net assets percentage targets. As of July 30, 2016, the aggregate target number of shares for this award is
1 million
, net of forfeitures, with a grant-date fair value of $
9 million
.
For the arrangements entered into in April of 2013 and March of 2014 and March of 2015, vesting for these awards is based on performance achieved in each fiscal year, with metrics established at the beginning of each year, and is
50%
based on satisfaction of certain sales growth metrics and
50%
based on achievement of certain return on net assets percentage targets. The following summarizes activity related to these awards during the first half of 2016:
|
|
|
|
•
|
April 2013 award: Upon completion of the three-year performance period, in April 2016 a total of
0.8 million
shares were issued on a fully vested basis, which reflects a
25%
reduction related to the TSR multiplier.
|
|
|
|
|
•
|
March 2014 and 2015 awards: For the tranches related to the fiscal 2016 performance period, the aggregate target number of shares is
0.9 million
with a grant date fair value of $
7 million
, both net of forfeitures, as of July 30, 2016.
|
Stock options
No stock options were granted during
the first half of
2016
. During
the first half of
2016
no stock options were exercised.
Employee Stock Purchase Plan
Staples offers its associates the opportunity for share ownership pursuant to the Amended and Restated Employee Stock Purchase Plan. During
the first half of
2016
and
2015
, the Company issued
2.1 million
shares and
1.3 million
shares, respectively, pursuant to this plan.
Note K
—
Pension and Other Post-Retirement Benefit Plans
The Company sponsors pension plans that cover certain employees in Europe and the U.S. The benefits due to U.S. plan participants are frozen. A number of the defined benefit plans outside the U.S. are funded with plan assets that have been segregated in trusts. Contributions are made to these trusts, as necessary, to meet legal and other requirements.
The Company also sponsors an unfunded post-retirement life insurance benefit plan, which provides benefits to eligible U.S. executives based on earnings, years of service and age at termination of employment.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
The total net cost recognized for the
second quarter
and
first half of
2016
and
2015
associated with the pension and other post-retirement benefit plans is based on actuarial estimates of such costs. The pension plan totals primarily relate to international pension plans. The following tables present a summary of the total net periodic (benefit) cost recorded in the condensed consolidated statement of comprehensive income for the
second quarter
and
first half of
2016
and
2015
related to the plans (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 Weeks Ended July 30, 2016
|
|
|
|
Pension Plans
|
|
Other
Post-Retirement Benefit Plan
|
|
Service cost
|
|
$
|
3
|
|
|
$
|
1
|
|
|
Interest cost
|
|
6
|
|
|
—
|
|
|
Expected return on plan assets
|
|
(13
|
)
|
|
—
|
|
|
Amortization of unrecognized losses and prior service costs
|
|
4
|
|
|
—
|
|
|
Total cost
|
|
$
|
—
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 Weeks Ended August 1, 2015
|
|
|
|
Pension Plans
|
|
Other
Post-Retirement Benefit Plan
|
|
Service cost
|
|
$
|
4
|
|
|
$
|
—
|
|
|
Interest cost
|
|
7
|
|
|
1
|
|
|
Expected return on plan assets
|
|
(15
|
)
|
|
—
|
|
|
Amortization of unrecognized losses and prior service costs
|
|
4
|
|
|
—
|
|
|
Total cost
|
|
$
|
—
|
|
|
$
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26 Weeks Ended July 30, 2016
|
|
|
|
Pension Plans
|
|
Other
Post-Retirement Benefit Plan Total
|
|
Service cost
|
|
$
|
6
|
|
|
$
|
1
|
|
|
Interest cost
|
|
11
|
|
|
1
|
|
|
Expected return on plan assets
|
|
(25
|
)
|
|
—
|
|
|
Amortization of unrecognized losses and prior service costs
|
|
7
|
|
|
1
|
|
|
Total (benefit) cost
|
|
$
|
(1
|
)
|
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26 Weeks Ended August 1, 2015
|
|
|
|
Pension Plans
|
|
Other
Post-Retirement Benefit Plan Total
|
|
Service cost
|
|
$
|
9
|
|
|
$
|
—
|
|
|
Interest cost
|
|
13
|
|
|
2
|
|
|
Expected return on plan assets
|
|
(29
|
)
|
|
—
|
|
|
Amortization of unrecognized losses and prior service costs
|
|
7
|
|
|
—
|
|
|
Total cost
|
|
$
|
—
|
|
|
$
|
2
|
|
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Note L
—
Stockholders' Equity
Accumulated Other Comprehensive Loss
The following table details the changes in Accumulated other comprehensive loss ("AOCL") for
the first half of
2016
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency Translation Adjustment
|
|
Deferred Benefit Costs
|
|
Accumulated Other Comprehensive Loss
|
|
Balance at January 30, 2016
|
|
$
|
(792
|
)
|
|
$
|
(324
|
)
|
|
$
|
(1,116
|
)
|
|
Foreign currency translation adjustment
|
|
40
|
|
|
—
|
|
|
40
|
|
|
Reclassification adjustments:
|
|
|
|
|
|
|
|
Amortization of deferred benefit costs (net of taxes of $0)
|
|
—
|
|
|
8
|
|
|
8
|
|
|
Balance at July 30, 2016
|
|
$
|
(752
|
)
|
|
$
|
(316
|
)
|
|
$
|
(1,068
|
)
|
There were no material amounts reclassified from accumulated other comprehensive loss into net income during the first quarter or first half of 2016 and 2015.
Other items
The changes in the amounts of stockholders' equity attributable to noncontrolling interests during
first half of
2016 and 2015 related solely to foreign currency translation adjustments.
The Company plans to balance its allocation of capital for open-market share repurchases with allocations for merger and acquisition opportunities. The remaining authorization under the Company's existing share repurchase program is
$373 million
.
Note M
—
Computation of Earnings per Common Share
The computation of basic and diluted earnings per share for the
second quarter
and
first half of
2016
and
2015
is as follows (in millions, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 Weeks Ended
|
|
26 Weeks Ended
|
|
|
July 30, 2016
|
|
August 1, 2015
|
|
July 30, 2016
|
|
August 1, 2015
|
|
Net (loss) income
|
$
|
(766
|
)
|
|
$
|
36
|
|
|
$
|
(725
|
)
|
|
$
|
95
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding
|
648
|
|
|
641
|
|
|
647
|
|
|
640
|
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Employee stock options and restricted shares (including performance-based awards)
|
—
|
|
|
6
|
|
|
—
|
|
|
6
|
|
|
Weighted-average common shares outstanding assuming dilution
|
648
|
|
|
647
|
|
|
647
|
|
|
646
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings Per Common Share
|
$
|
(1.18
|
)
|
|
$
|
0.06
|
|
|
$
|
(1.12
|
)
|
|
$
|
0.15
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Earnings Per Common Share
|
$
|
(1.18
|
)
|
|
$
|
0.06
|
|
|
$
|
(1.12
|
)
|
|
$
|
0.15
|
|
For the
second quarter
and
first half of
2016
, approximately
31 million
and
34 million
equity instruments, respectively, were excluded from the calculation of diluted earnings per share as the Company has recorded net losses for those periods. For the
second quarter
and
first half of
2015
, approximately
19 million
and
21 million
equity instruments, respectively, were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
Note N
—
Segment Reporting
Staples has
three
reportable segments: North American Commercial, North American Stores & Online and International Operations.
The following is a summary of sales and business unit income by reportable segment and a reconciliation of business unit income to income before income taxes for the
second quarter
and
first half of
2016
and
2015
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 Weeks Ended
|
|
26 Weeks Ended
|
|
|
July 30, 2016
|
|
August 1, 2015
|
|
July 30, 2016
|
|
August 1, 2015
|
|
|
Sales
|
|
North American Commercial
|
$
|
2,044
|
|
|
$
|
2,049
|
|
|
$
|
4,160
|
|
|
$
|
4,157
|
|
|
North American Stores & Online
|
1,987
|
|
|
2,108
|
|
|
4,234
|
|
|
4,479
|
|
|
International Operations
|
721
|
|
|
780
|
|
|
1,459
|
|
|
1,562
|
|
|
Total segment sales
|
$
|
4,752
|
|
|
$
|
4,937
|
|
|
$
|
9,853
|
|
|
$
|
10,198
|
|
|
|
|
|
|
|
|
|
|
|
|
Business Unit Income (Loss)
|
|
North American Commercial
|
$
|
146
|
|
|
$
|
138
|
|
|
$
|
294
|
|
|
$
|
272
|
|
|
North American Stores & Online
|
12
|
|
|
28
|
|
|
74
|
|
|
103
|
|
|
International Operations
|
(14
|
)
|
|
(22
|
)
|
|
(32
|
)
|
|
(42
|
)
|
|
Business unit income
|
144
|
|
|
144
|
|
|
336
|
|
|
333
|
|
|
Merger termination fee
|
(250
|
)
|
|
—
|
|
|
(250
|
)
|
|
—
|
|
|
Stock-based compensation
|
(16
|
)
|
|
(17
|
)
|
|
(33
|
)
|
|
(34
|
)
|
|
Impairment of goodwill and long-lived assets
|
(660
|
)
|
|
(1
|
)
|
|
(660
|
)
|
|
(23
|
)
|
|
Litigation costs
|
(16
|
)
|
|
—
|
|
|
(16
|
)
|
|
—
|
|
|
Restructuring charges and costs related to strategic plans
|
(11
|
)
|
|
(24
|
)
|
|
(21
|
)
|
|
(69
|
)
|
|
(Loss) gain related to sale of businesses and assets, net
|
(16
|
)
|
|
—
|
|
|
(49
|
)
|
|
3
|
|
|
Interest and other expense, net
|
(13
|
)
|
|
(36
|
)
|
|
(50
|
)
|
|
(50
|
)
|
|
Loss on early extinguishment of debt
|
(26
|
)
|
|
—
|
|
|
(26
|
)
|
|
—
|
|
|
Merger-related costs
|
—
|
|
|
(10
|
)
|
|
(24
|
)
|
|
(20
|
)
|
|
(Loss) income before income taxes
|
$
|
(864
|
)
|
|
$
|
56
|
|
|
$
|
(793
|
)
|
|
$
|
140
|
|
Note O
—
Commitments and Contingencies
The Company has investigated, with the assistance of outside experts, a data security incident involving unauthorized access into the computer systems of PNI Digital Media Ltd ("PNI"), a subsidiary of the Company, which the Company acquired in July 2014. PNI, which is based in Vancouver, British Columbia, provides a software platform that enables retailers to sell personalized products such as photo prints, photo books, calendars, business cards, stationery and other similar products. PNI’s customers include a number of major third party retailers, as well as affiliates of the Company. The investigation determined that an unauthorized party entered PNI’s systems and was able to deploy malware on some of PNI’s servers supporting its clients. The malware was designed to capture data that end users input on the photosites. Some of PNI's affected customers have notified certain of their users of a potential compromise of the users' payment card information and/or other personal information. PNI took prompt steps to contain the incident, including disabling the retailer photosites or online payment transactions for a period while the incident was being investigated, and to further enhance the security of its retailer customers' data. To date the Company has incurred incremental expenses of
$18 million
related to the incident. The expenses reflect professional service fees incurred by the Company and claims by PNI's retailer customers. Additional losses and expenses relating to the incident are probable; however, at this stage, the Company does not have sufficient information to reasonably estimate such losses and expenses. The types of losses and expenses that may result from the incident include, without limitation: claims by PNI’s retailer customers, including indemnification claims for losses and damages incurred by them; claims by end-users of PNI’s services, including class action lawsuits that have been filed, and further class action lawsuits that may be filed, in Canada and the United States; investigations and claims by various regulatory authorities in Canada and the United States; investigation costs; remediation costs; and legal fees. The Company will continue to evaluate information as it becomes known and will record an estimate for additional losses
STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)
or expenses at the time or times when it is both probable that any loss has been incurred and the amount of such loss is reasonably estimable. Such losses may be material to our results of operations and financial condition. The Company maintains network security insurance coverage, which the Company expects would help mitigate the financial impact of the incident.
In December 2014, the Company announced that the investigation into its previously announced data security incident had determined that malware deployed by criminals to some point of sale systems at
115
of the Company’s more than
1,400
U.S. retail stores may have allowed access to transaction data at those affected stores. As a result, cardholder names, payment card numbers, expiration dates, and card verification codes for approximately
1.16 million
payment cards may have been affected. Upon detection, the Company immediately took action to eradicate the malware and commenced an investigation into the incident, working closely with payment card companies and law enforcement and with the assistance of outside data security experts. The Company also has taken steps to further enhance the security of its point of sale systems, including the use of new encryption tools. The Company continues to evaluate cybersecurity policies and practices to mitigate the risk of future incidents. Expenses incurred to date related to this incident have not been material. It is reasonably possible that the Company may incur additional expenses or losses in connection with the incident; however, at this time the Company is unable to reasonably estimate any such additional expenses or losses. In addition, the Company maintains network-security insurance coverage, which it expects would help mitigate any material financial impact.
In 2013 the Company completed the sale of its European Printing Systems Division ("PSD"), recognizing a preliminary loss on disposal of
$81 million
that is subject to the impact of a working capital adjustment to the purchase price. On April 22, 2015, the purchaser commenced litigation in Amsterdam District Court claiming that it was entitled to a purchase price adjustment of €
60 million
. On April 22, 2015, the Company made a payment to the purchaser of approximately €
4 million
(the amount of the purchase price adjustment it believed was appropriate) and the purchaser reduced its claim accordingly. The purchaser further reduced its claim to €
52 million
in response to expert reports submitted by the Company in the court case. The court held a hearing on December 1, 2015, and on January 13, 2016, it issued a judgment rejecting the purchaser's claims in their entirety and awarding costs to the Company. The purchaser filed a notice of appeal on February 15, 2016, which the Company intends to vigorously defend. The Court has scheduled a hearing on the appeal for September 14, 2016. If the purchaser prevails on appeal, it could result in an adjustment, which may be material, to the loss we recorded for the transaction.
In 2012, plaintiff Bobby Dean Nickel filed an employment discrimination lawsuit against the Company and its subsidiary, Staples Contract & Commercial, Inc. The lawsuit alleged that Nickel’s 2011 termination was based on his age (over 40). In August 2013, the trial court denied summary judgment on the age discrimination claim, but granted it as to all other claims. On February 26, 2014, after trial, the jury returned a verdict in plaintiff’s favor, awarding him approximately
$3 million
in compensatory damages and approximately
$22 million
in punitive damages. The Company filed a series of post-trial motions asking the trial court to vacate the jury verdict and order a new trial or, if the verdict is not vacated, to reduce the amount of damages awarded through the process of remittitur. The trial court granted judgment notwithstanding the verdict as to the punitive damages assessed against Staples, Inc., reducing the total judgment to approximately
$16 million
. The trial court also awarded Nickel approximately
$1 million
in attorneys’ fees and costs. The Company filed an appeal with the California Court of Appeal in November 2015 and the matter was heard in April 2016. On May 26, 2016, the Court of Appeal ruled against the Company, and subsequently denied the Company’s Request for Rehearing. On July 5, 2016, Staples filed a Petition for Review with the California Supreme Court. On July 19, 2016, Nickel filed his Answer to the Petition for Review and on July 28, 2016, Staples filed its Reply to Nickel’s Answer to the Petition for Review. The Supreme Court denied the petition for review on August 10, 2016. The total amount of the estimated loss to date, including interest, but excluding Nickel’s attorney’s fees and costs on appeal, is approximately
$21 million
, which has been accrued for as of July 30, 2016.
From time to time, the Company is involved in litigation arising from the operation of its business that is considered routine and incidental to its business. The Company estimates exposures and establishes reserves for our estimated significant liabilities that are probable and can be reasonably estimated. However, litigation is inherently unpredictable and the outcome of legal proceedings and other contingencies could be unexpected or differ from the Company’s reserves. The Company does not believe it is reasonably possible that a loss in excess of the amounts recognized in the condensed consolidated financial statements as of
July 30, 2016
would have a material adverse effect on its business, results of operations or financial condition, or cash flows.
STAPLES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis
of Financial Condition and Results of Operations