Classmates.com 2004 Annual Report Download - page 44

Goodwill
We adopted SFAS No. 142 on July 1, 2002. Under SFAS No. 142, goodwill is not amortized, but is tested for impairment at a reporting unit
level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying value amount. Events or circumstances which could trigger an impairment review include a
significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a
loss of key personnel, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, significant
negative industry or economic trends, significant declines in our stock price for a sustained period or significant underperformance relative to
expected historical or projected future results of operations.
In testing for a potential impairment of goodwill, the estimated fair values of our reporting units are compared with their respective book
values, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are
necessary. If, however, the fair value of the reporting unit is less than book value, then we are required to compare the carrying amount of the
goodwill with its implied fair value. The estimate of implied fair value of goodwill may require independent valuations of certain internally
generated and unrecognized intangible assets such as our pay account base, software and technology, and patents and trademarks. If the carrying
amount of our goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to the
excess. In accordance with SFAS No. 142, we performed an annual goodwill impairment test during the June 2004 quarter and concluded that, at
that time, there was no impairment of our goodwill.
Goodwill increased by $76.5 million during the year ended December 31, 2004 as a result of acquisitions (see Note 2 to the consolidated
financial statements). We recorded reductions in goodwill of $9.5 million and $1.4 million during the December 2004 and December 2003
quarters, respectively, in connection with the release of the deferred tax valuation allowance (see Note 4 to the consolidated financial
statements).
Business Combinations
Our acquisitions to date have all been accounted for as purchase business combinations. Under the purchase method of accounting, the cost,
including transaction costs, is allocated to the underlying net assets, based on their respective estimated fair values. The excess of the purchase
price over the estimated fair values of the net assets acquired is recorded as goodwill.
The judgments made in determining the estimated fair values and expected useful lives assigned to each class of assets and liabilities
acquired can significantly impact net income. For example, different classes of assets will have useful lives that differ (e.g., the useful life of
acquired users may not be the same as the useful life of acquired technologies). Consequently, to the extent a longer-lived asset is ascribed
greater value under the purchase method than a shorter-lived asset, there may be less amortization recorded in a given period. Definite-lived
identifiable intangible assets are amortized on either a straight-line basis or an accelerated basis. We determine the appropriate amortization
method by performing an analysis of expected cash flows over the expected useful life of the asset and match the amortization expense to the
expected cash flows from those assets.
Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates
and assumptions. We use a one-year period following the consummation of acquisitions to finalize estimates of the fair values of assets and
liabilities acquired. Two areas, in particular, that require significant judgment are estimating the fair values and related useful lives of identifiable
intangible assets. To assist in this process, we may obtain appraisals from valuation specialists for certain intangible assets. While there are a
number of different methods used in estimating the value of acquired intangibles, there are two approaches primarily used: the discounted cash
flow and market comparison approaches. Some of the more significant estimates and assumptions
42