NOTE 2: Fair Value Measurements

Fair value is defined 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. The authoritative guidance for fair value measurements establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of the hierarchy are defined as follows:


•	Level 1 - inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities


•	Level 2 - inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly


•	Level 3 - inputs to the valuation techniques that are unobservable for the assets or liabilities

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis

The Company’s available-for-sale securities represented the only significant assets measured at fair value on a recurring basis for the years ended January 29, 2016 and January 30, 2015. The following table presents the Company’s financial assets measured at fair value on a recurring basis. The fair values of these instruments approximated amortized costs.



		Fair Value Measurements at
(In millions)	Measurement Level	January 29, 2016		January 30, 2015
Available-for-sale securities:
Money market funds	Level 1	$	192	$	81
Certificates of deposit	Level 1	56		17
Municipal obligations	Level 2	38		21
Municipal floating rate obligations	Level 2	21		6
Total short-term investments		$	307	$	125
Available-for-sale securities:
Municipal floating rate obligations	Level 2	$	212	$	348
Municipal obligations	Level 2	5		2
Certificates of deposit	Level 1	5		4
Total long-term investments		$	222	$	354

There were no transfers between Levels 1, 2 or 3 during any of the periods presented.

When available, quoted prices were used to determine fair value. When quoted prices in active markets were available, investments were classified within Level 1 of the fair value hierarchy. When quoted prices in active markets were not available, fair values were determined using pricing models, and the inputs to those pricing models were based on observable market inputs. The inputs to the pricing models were typically benchmark yields, reported trades, broker-dealer quotes, issuer spreads and benchmark securities, among others.

Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis

For the years ended January 29, 2016, and January 30, 2015, the Company’s only significant assets or liabilities measured at fair value on a nonrecurring basis subsequent to their initial recognition were certain long-lived assets and equity method investments.

Long-lived assets

The Company reviews the carrying amounts of long-lived assets whenever certain events or changes in circumstances indicate that the carrying amounts may not be recoverable. With input from retail store operations, the Company’s accounting and finance personnel that organizationally report to the chief financial officer, assess the performance of retail stores quarterly against historical patterns and projections of future profitability for evidence of possible impairment. An impairment loss is recognized when the carrying amount of the asset (disposal) group is not recoverable and exceeds its fair value. The Company estimated the fair values of assets subject to long-lived asset impairment based on the Company’s own judgments about the assumptions that market participants would use in pricing the assets and on observable market data, when available. The Company classified these fair value measurements as Level 3.

In the determination of impairment for operating locations, the Company determined the fair values of individual operating locations using an income approach, which required discounting projected future cash flows. When determining the stream of projected future cash flows associated with an individual operating location, management made assumptions, incorporating local market conditions and inputs from retail store operations, about key variables including the following unobservable inputs: sales growth rates, gross margin, controllable expenses, such as payroll and occupancy expense, and asset residual values. In order to calculate the present value of those future cash flows, the Company discounted cash flow estimates at a rate commensurate with the risk that selected market participants would assign to the cash flows. In general, the selected market participants represented a group of other retailers with a location footprint similar in size to the Company’s.

During 2015, two operating locations experienced a triggering event and were determined to be impaired due to a decline in recent cash flow trends and an unfavorable sales outlook, resulting in an impairment loss of $8 million. The discounted cash flow model used to estimate the fair value of the impaired operating locations assumed average annual sales growth rates ranging from 3.9% to 4.3% over the remaining life of the locations and applied a discount rate of approximately 6.3%.

In the determination of impairment for excess properties held-for-use and held-for-sale, which consisted of retail outparcels and property associated with relocated or closed locations, the fair values were determined using a market approach based on estimated selling prices. The Company determined the estimated selling prices by obtaining information from property brokers or appraisers in the specific markets being evaluated or negotiated non-binding offers to purchase. The information obtained from property brokers or appraisers included comparable sales of similar assets and assumptions about demand in the market for these assets.

During 2015, the Company incurred total impairment charges of $2 million for six excess property locations. A 10% reduction in the estimated selling prices for these excess properties at the dates the locations were evaluated for impairment would have increased impairment losses by an insignificant amount.

Equity method investments

Equity method investments are evaluated for impairment whenever events or changes in circumstances indicate that a decline in value has occurred that is other than temporary. Evidence considered in this evaluation includes, but would not necessarily be limited to, the financial condition and near-term prospects of the investee, recent operating trends and forecasted performance of the investee, market conditions in the geographic area or industry in which the investee operates, and the Company’s strategic plans for holding the investment in relation to the period of time expected for an anticipated recovery of its carrying value. Investments that are determined to have a decline in value deemed to be other than temporary are written down to estimated fair value.

In 2015, the Company decided to exit the Australian joint venture investment with Woolworths Limited (Woolworths) and recorded a $530 million impairment of its equity method investment due to a determination that there was a decrease in value that was other than temporary. The Company owns a one-third share in the joint venture, Hydrox Holdings Pty Ltd., which operates Masters Home Improvement stores and Home Timber and Hardware Group’s retail stores and wholesale distribution in Australia. As a result of the Company’s decision to exit, Woolworths will be required to purchase the Company’s one-third share in the joint venture at an agreed upon fair value as of January 18, 2016, the date on which notification of the Company’s intent to exit was received by Woolworths. The process for the two parties agreeing on fair value is prescribed in the Joint Venture Agreement. Finalization of the purchase price for the Company’s interest in the joint venture and completion of the sale is expected to occur in 2016. The $530 million non-cash impairment charge was based on the Company’s estimate of the value of its portion of the overall joint venture fair value. This value was determined using an income approach based on expected discounted cash flows, and was validated for reasonableness by comparison to similar transaction multiples. The Company’s equity method investment balance in the Australian joint venture is classified as Level 3 because the underlying estimate of value used unobservable inputs that were significant to the fair value measurements and required management judgment due to the absence of quoted market prices. The assumptions that most significantly affect the fair value determination include projected revenues and the discount rate. The discounted cash flow model used to estimate the fair value assumed a compound annual growth rate for sales of 6.2% over the 15-year forecast period, with a terminal year growth rate assumed of 3.0%, and applied a discount rate of approximately 10.7%.

The following table presents the Company’s assets measured at estimated fair value on a nonrecurring basis and the resulting impairment losses included in earnings, excluding costs to sell for excess properties held-for-sale. Because these assets subject to impairment were not measured at fair value on a recurring basis, certain fair value measurements presented in the table may reflect values at earlier measurement dates and may no longer represent the fair values at January 29, 2016 and January 30, 2015.

Fair Value Measurements - Nonrecurring Basis



	January 29, 2016					January 30, 2015
(In millions)	Fair Value Measurements		Impairment Losses			Fair Value Measurements		Impairment Losses
Assets-held-for-use:
Operating locations	$	4	$	(8	)	$	9	$	(26	)
Excess properties	4		(2		)	11		(2		)
Other assets:
Equity method investments	393		(530		)	N/A		N/A
Total	$	401	$	(540	)	$	20	$	(28	)

Fair Value of Financial Instruments

The Company’s financial instruments not measured at fair value on a recurring basis include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and long-term debt and are reflected in the financial statements at cost. With the exception of long-term debt, cost approximates fair value for these items due to their short-term nature. The fair values of the Company’s unsecured notes were estimated using quoted market prices. The fair values of the Company’s mortgage notes were estimated using discounted cash flow analyses, based on the future cash outflows associated with these arrangements and discounted using the applicable incremental borrowing rate.

Carrying amounts and the related estimated fair value of the Company’s long-term debt, excluding capitalized lease obligations, are as follows:



	January 29, 2016				January 30, 2015
(In millions)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Unsecured notes (Level 1) ¹	$	12,073	$	13,292	$	10,850	$	12,739
Mortgage notes (Level 2)	7		8		16		17
Long-term debt (excluding capitalized lease obligations)	$	12,080	$	13,300	$	10,866	$	12,756


¹	Prior period balances have been retrospectively adjusted as a result of the Company’s adoption of ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. The adoption of the accounting standard required reclassification of debt issuance costs from other assets to long-term debt.