Note O – Fair Value Measurements

Financial assets and financial liabilities measured and reported at fair value are classified in a three-level hierarchy that prioritizes the inputs used in the valuation process. A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The hierarchy is based on the observability and objectivity of the pricing inputs, as follows:

 

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Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

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Level 2 — Significant directly observable data (other than Level 1 quoted prices) or significant indirectly observable data through corroboration with observable market data. Inputs would normally be (i) quoted prices in active markets for similar assets or liabilities, (ii) quoted prices in inactive markets for identical or similar assets or liabilities, or (iii) information derived from or corroborated by observable market data.

 

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Level 3 — Prices or valuation techniques that require significant unobservable data inputs. Inputs would normally be VF’s own data and judgments about assumptions that market participants would use in pricing the asset or liability.

The following table summarizes financial assets and financial liabilities that are measured and recorded in the consolidated financial statements at fair value on a recurring basis:

 

		Total				Fair Value Measurement Using (a)
In thousands		Fair Value				Level 1				Level 2				Level 3
September 2016
Financial assets:
Cash equivalents:
Money market funds		$	460,504			$	460,504			$	—			$	—
Time deposits			32,987				32,987				—				—
Derivative financial instruments			75,497				—				75,497				—
Investment securities			204,384				186,176				18,208				—
Financial liabilities:
Derivative financial instruments			32,181				—				32,181				—
Deferred compensation			237,175				—				237,175				—
December 2015
Financial assets:
Cash equivalents:
Money market funds		$	495,264			$	495,264			$	—			$	—
Time deposits			39,813				39,813				—				—
Derivative financial instruments			105,791				—				105,791				—
Investment securities			203,797				190,792				13,005				—
Financial liabilities:
Derivative financial instruments			28,032				—				28,032				—
Deferred compensation			252,723				—				252,723				—

 

(a)	There were no transfers among the levels within the fair value hierarchy during the first nine months of 2016 or the year ended December 2015.

VF’s cash equivalents include money market funds and short-term time deposits that approximate fair value based on Level 1 measurements. The fair value of derivative financial instruments, which consist of forward foreign currency exchange contracts, is determined based on observable market inputs (Level 2), including spot and forward exchange rates for foreign currencies, and considers the credit risk of the Company and its counterparties. Investment securities are held in VF’s deferred compensation plans as an economic hedge of the related deferred compensation liabilities. These investments are classified as trading securities and primarily include mutual funds (Level 1) that are valued based on quoted prices in active markets and a separately managed fixed-income fund (Level 2) with underlying investments that are valued based on quoted prices for similar assets in active markets or quoted prices in inactive markets for identical assets. Liabilities related to VF’s deferred compensation plans are recorded at amounts due to participants, based on the fair value of the participants’ selection of hypothetical investments.

 

Prior to the second quarter of 2015, other marketable securities consisted of common stock investments classified as available-for-sale, the fair value of which was based on quoted prices in active markets. During the second quarter of 2015, VF sold all of its available-for-sale securities for $5.9 million in cash proceeds and recognized a gain of $1.5 million, which is included in other income (expense), net, in the 2015 Consolidated Statement of Income.

All other financial assets and financial liabilities are recorded in the consolidated financial statements at cost, except life insurance contracts which are recorded at cash surrender value. These other financial assets and financial liabilities include cash held as demand deposits, accounts receivable, short-term borrowings, accounts payable and accrued liabilities. At September 2016 and December 2015, their carrying values approximated their fair values. Additionally, at September 2016 and December 2015, the carrying values of VF’s long-term debt, including the current portion, were $2,350.8 million and $1,405.2 million, respectively, compared with fair values of $2,647.0 million and $1,582.5 million at those respective dates. Fair value for long-term debt is a Level 2 estimate based on quoted market prices or values of comparable borrowings.

Nonrecurring Fair Value Measurements

During the third quarter of 2016, management determined that the continued revenue and profitability decline in the Nautica^® brand, combined with a downward revision to the forecast for the remainder of the year, was a triggering event that required an interim impairment analysis of the goodwill and trademark intangible assets. TheNautica^® brand is part of the Sportswear coalition and represents primarily all of the coalition’s goodwill value. Based on the quantitative impairment analysis performed, VF determined the goodwill and trademark intangible assets of Nautica^® were not impaired. For goodwill, the fair value of the reporting unit exceeded the carrying value by 45%. The fair value of the trademark intangible asset exceeded its carrying value by a significant amount.

The impairment testing of goodwill and trademark intangible assets utilized significant unobservable inputs (Level 3) to determine fair value.

The fair value of the Nautica^® reporting unit for goodwill impairment testing was determined using a combination of two valuation methods: an income approach and a market approach. The income approach was based on projected future (debt-free) cash flows that were discounted to present value. The discount rate was based on the reporting unit’s calculated weighted average cost of capital (“WACC”), which takes into consideration the characteristics of relevant peer companies, market observable data, and company-specific risk factors. For the market approach, management used both the guideline company and similar transaction methods. The guideline company method analyzed market multiples of revenues and earnings before interest, taxes, depreciation and amortization (“EBITDA”) for a group of comparable public companies. The market multiples used in the valuation were based on the relative strengths and weaknesses of the reporting unit compared to the selected guideline companies. Under the similar transactions method, valuation multiples were calculated utilizing actual transaction prices and revenue/EBITDA data from target companies deemed similar to the reporting unit.

VF used the income-based relief-from-royalty method to value the Nautica^® trademark intangible asset. In applying this method, revenues expected to be generated by the trademark were multiplied by a selected royalty rate. The royalty rate was selected based on consideration of i) royalty rates included in active license agreements, if applicable, ii) royalty rates received by market participants in the apparel industry, and iii) the current performance of the reporting unit. The estimated after-tax royalty revenue stream was then discounted to present value using the reporting unit’s WACC plus a spread that factors in the risk of the intangible asset.

Management’s revenue and profitability forecasts used in the Nautica^® reporting unit and intangible asset valuations considered recent performance and trends, strategic initiatives and negative industry trends. Assumptions used in the valuations were similar to those that would be used by market participants performing independent valuations of these businesses.

Key assumptions developed by VF management and used in the quantitative analysis include:

 

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Long-term growth in revenues primarily due to expanded distribution channels, including conversion of licensing arrangements in key international markets.

 

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A gradual return to historical profitability rates over the remaining forecast period.

 

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Royalty rates based on active license agreements of the brand.

 

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Market-based discount rates.

 

Management performed sensitivity analyses on the goodwill impairment model and determined that neither a 100 basis point decrease in the compounded annual growth rate for EBITDA nor a 100 basis point increase in the discount rate caused the estimated fair value of the reporting unit to decline below its carrying value.

It is possible VF’s conclusions regarding impairment of the Nautica^® reporting unit goodwill or intangible assets could change in future periods. There can be no assurance the estimates and assumptions used in our goodwill and intangible asset impairment testing performed in the third quarter of 2016 will prove to be accurate predictions of the future. For example, variations in our assumptions related to discount rates, comparable company market approach inputs, business performance and execution of planned growth strategies could impact future conclusions. A future impairment charge for goodwill or intangible assets could have a material effect on VF’s consolidated financial position and results of operations.