Earthlink 2014 Annual Report Download - page 55

Table of Contents
50
Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions
Goodwill
We perform an impairment test of our goodwill annually
during the fourth quarter of our fiscal year (October 1) or
when events and circumstances indicate goodwill might be
impaired. Impairment testing of goodwill is required at the
reporting unit level and involves a two-step process.
However, we may first assess the qualitative factors to
determine whether it is necessary to perform the two-step
quantitative goodwill impairment test.
The first step of the impairment test involves comparing the
estimated fair value of our reporting units with the reporting
unit's carrying amount, including goodwill. If we determine
that the carrying value of a reporting unit exceeds its
estimated fair value, we perform a second step to compare
the carrying amount of goodwill to the implied fair value of
that goodwill. The implied fair value of goodwill is
determined in the same manner as utilized to recognize
goodwill in a business combination. If the carrying amount
of goodwill exceeds the implied fair value of that goodwill,
an impairment loss would be recognized in an amount equal
to the excess.
We evaluate our reporting units on an annual basis and
allocate goodwill to our reporting units based on the
reporting units expected to benefit from the acquisition
generating the goodwill.
Application of the goodwill impairment test requires
judgment, including performing the qualitative
assessment, the identification of reporting units, assigning
assets and liabilities to reporting units, assigning goodwill
to reporting units, and determining the fair value of each
reporting unit.
We estimate the fair values of our reporting units based on
weighting of the income and market approaches. These
models use significant unobservable inputs, or Level 3
inputs, as defined by the fair value hierarchy. Under the
income approach, we calculate the fair value of the
reporting unit based on the present value of estimated cash
flows using a discounted cash flow method. The
significant assumptions used in the discounted cash flow
method include internal forecasts and projections
developed by management for planning purposes,
available industry/market data, strategic plans, discount
rates and the growth rate to calculate the terminal value.
Under the market approach, we estimate the fair value
using the guideline company method. We select guideline
companies in the industry where each reporting unit
operates. We primarily use revenue and EBITDA
multiples based on the multiples of the selected guideline
companies. For our fiscal year 2014 annual goodwill
impairment test, we used the income approach.
The assumptions with the most significant impact on the
fair value of the reporting unit are those related to the
discount rate, the terminal value, future operating cash
flows and the growth rate.
These types of analyses contain uncertainties because they
require management to make assumptions and to apply
judgment to estimate industry economic factors and the
profitability of future business strategies.
We have not made any material changes in the accounting
methodology used to evaluate impairment of goodwill
during the last three years.
During the first quarter of 2013, we performed an interim
goodwill test and recognized a $256.7 million non-cash
impairment charge to goodwill related to our Business
Services reporting unit. The impairment was based on an
analysis of a number of factors after a decline in our
market capitalization following the announcement of our
fourth quarter 2012 earnings and 2013 financial guidance.
The primary factor contributing to the impairment was a
change in the discount rate and market multiples as a
result of the change in these market conditions, both key
assumptions used in the determination of fair value. We
did not record any impairment of goodwill during the
years ended 2012 or 2014.
As of December 31, 2014, we had approximately $137.8
million of goodwill. Of the total goodwill, $48.8 million
was allocated to our Business Services reporting unit and
$88.9 million was allocated to our Consumer Services
reporting unit. Our fiscal 2014 impairment test indicated
the estimated fair value of our Consumer Services
reporting unit and Business Services reporting unit
substantially exceeded their carrying values and therefore
was not at risk of future impairment. However,
deterioration in estimated future cash flows in our
reporting units could result in future goodwill impairment.
We continue to monitor events and circumstances which
may affect the fair value of this reporting unit.
Examples of events or circumstances that could have a
negative effect on the estimated fair value of the Business
Services reporting unit include (i) changes in technology
or customer demands that were not anticipated; (ii)
competition or regulatory developments in the industry
that may adversely affect profitability; (iii) a prolonged
weakness in general economic conditions; (iv) a sustained
decrease in share price; (v) volatility in the equity and debt
markets which could result in a higher discount rate; and
(vi) the inability to execute our strategy to grow our
growth products. If the assumptions used in the
impairment analysis are not met or materially change, we
may be required to recognize an impairment loss.
There have been no significant events since the timing of
our impairment test that would have triggered additional
impairment testing.