Earthlink 2015 Annual Report Download - page 56

Table of Contents
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 or when
events or circumstances indicate our reporting units might
change.
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. For our fiscal
year 2014 and 2015 annual goodwill impairment tests, we only
used the income approach. For our fiscal year 2013 annual
goodwill impairment test, we used a weighting of both models.
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.
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 past 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 legacy 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.
During the third quarter of 2015, we performed an interim
goodwill test as a result of a change in reporting units. The
impairment test indicated the estimated fair value of our
reporting units exceeded their carrying values and did not
result in any goodwill impairment charge.
As of December 31, 2015, we had approximately $137.8
million of goodwill. Our fiscal 2015 annual impairment test
indicated the estimated fair value of our reporting units
exceeded their carrying values. 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 our reporting
units 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
fiscal 2015 annual impairment test that would have triggered
additional impairment testing.
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