Goodwill and Intangibles
|9 Months Ended|
Sep. 30, 2019
|Goodwill and Intangibles|
|Goodwill and Intangibles||
Note 6 – Goodwill and Intangibles
The Company tests its goodwill and indefinite-lived intangible asset allocated to its reporting units for impairment annually on October 1, or more frequently if events or circumstances indicate that it is more likely than not that the fair value of its reporting units and indefinite-lived intangible asset are less than their carrying amount.
For the Company’s goodwill, management performed an impairment test as of December 31, 2018 using a weighted average of (1) an income approach and (2) a market approach to determine the fair value of each reporting unit and concluded that its goodwill was not impaired since the estimated fair value of each reporting unit exceeded its respective net book value. In addition, the Company determined the implied control premium (the excess of the aggregated fair values of its reporting units over its market capitalization) was consistent with and within a reasonable range of actual premiums paid in industry-specific merger and acquisition (“M&A”) transactions over a sustained period of time. For the Company’s indefinite-lived intangible asset, management performed an impairment test as of December 31, 2018 using the relief-from-royalty method.
During the interim periods since the date of the last quantitative impairment test, and prior to the third quarter of 2019, the Company concluded that no triggering events had occurred. In the third quarter of 2019, in connection with the preparation of its quarterly financial statements, the Company assessed the changes in circumstances that occurred during the quarter to determine whether it was more likely than not that the fair values of both of its reporting units were below their carrying amounts and whether the fair value of its indefinite-lived intangible asset was below its carrying amount. While there was no single determinative event or factor, potential triggering events identified in the accounting guidance (ASC 350, Intangibles – Goodwill and Other) developed during the third quarter of 2019 which led the Company to conclude that a quantitative impairment test was necessary. The triggering factors included:
As the Company determined that the fair value of its construction reporting unit was below its carrying amount, the Company performed an interim impairment test as of September 30, 2019 (the “Interim Test”) and, as described below, recognized a non-cash impairment charge for its construction reporting unit of $4.4 million. In addition, the Interim Test indicated that the fair value of the service reporting unit exceeded its carrying value by 101% and the fair value of the indefinite-lived intangible asset exceeded its carrying value by 58%.
The impairment of the construction reporting unit’s goodwill was primarily driven by the valuation effects of management decreasing its forecasted cash flows within the construction reporting unit as a result of the following:
As a result, when performing the Interim Test, the Company decreased its discounted cash flows related to the construction reporting unit as compared to the December 31, 2018 test.
Consistent with the previous December 31, 2018 test, the Company utilized a weighted average of (1) an income approach and (2) a market approach to determine the fair value of the Company and each of its reporting units for the Interim Test. The income approach is based on estimated present value of future cash flows for each reporting unit. The market approach is based on assumptions about how market data relates to each reporting unit. The weighting of these two approaches is based on their individual correlation to the economics of each reporting unit and is impacted by factors such as the availability of comparable market data for each reporting unit.
Assessing impairment inherently involves management judgments as to the assumptions used to calculate fair value of the reporting units and the impact of market conditions on those assumptions. The key inputs that the Company uses in its assumptions to estimate the fair value of its reporting units under the income-based approach are as follows:
Expected future after-tax operating cash flows of each reporting unit are discounted to a present value using a risk-adjusted discount rate. Estimates of future cash flows require management to make significant assumptions concerning future operating performance including cash flows generated from existing work and new awards, projected operating margins, variations in the amount and timing of cash flows and the probability of achieving the estimated cash flows, as well as future economic conditions, which may differ from actual future cash flows. The discount rate, which is intended to reflect the risks inherent in future cash flow projections, used in estimating the present value of future cash flows, is based on estimates of the WACC of market participants relative to the reporting units. Financial and credit market volatility can directly impact certain inputs and assumptions used to develop the WACC.
To develop the cash flows generated from new awards and future operating margins, the Company tracks known prospects of significance for each of its reporting units and considers the estimated timing of when the work is expected to be bid, started and completed. The Company also gives consideration to its relationships with the prospective owners; the pool of competitors that are capable of performing large, complex work; business strategy; and the Company’s history of success in winning new work in each reporting unit. With regard to operating margins, the Company gives consideration to its historical reporting unit operating margins in the end markets that the prospective work opportunities are most significant, expected margins from existing work, current market trends in recent new work procurement, and business strategy.
The Company also estimated the fair value of its reporting units under a market-based approach by applying industry-comparable multiples of revenues and operating earnings to its reporting units’ revenues and operating earnings. The conditions and prospects of companies in the engineering and construction industry depend on common factors such as overall demand for services.
The Company believes that the discount rates, timing of cash flows and other inputs and assumptions used in the Interim Test are consistent with those that a market participant would use based on the events described above which occurred during the third quarter of 2019 and are reflective of the current market assessment of the fair value of its reporting units. As an additional step to corroborate the Interim Test results, the Company compared its implied control premium with those of recent comparable market transactions and concluded that the implied control premium was within the range of control premiums observed in prior industry-specific M&A transactions. Similar to previous valuations, small changes to valuation assumptions could have a significant impact on the concluded value.
As noted above, Management also completed an Interim Test of its indefinite-lived intangible asset during the third quarter of 2019 using the relief-from-royalty method. Assumptions used under this approach are based on a combination of historical results, current forecasts, market data and recent economic events.
The Company will continue to monitor events occurring or circumstances changing which may suggest that the remaining goodwill and indefinite-lived intangible asset should be reevaluated.
Changes in the carrying amount of goodwill, by segment, consist of the following:
Definite-lived and indefinite-lived intangible assets consist of the following:
The definite-lived intangible assets are amortized over the period the Company expects to receive the related economic benefit, which for customer relationships is based upon estimated future net cash inflows. The Company has previously determined that its trade name has an indefinite useful life. The Limbach trade name has been in existence since the Company’s founding in 1901 and is an established brand within the construction industry.
Total amortization expense for these amortizable intangible assets was $0.1 million for the three months ended September 30, 2019 and $0.3 million for the three months ended September 30, 2018. Total amortization expense for these amortizable intangible assets was $0.5 million for the nine months ended September 30, 2019 and $1.0 million for the nine months ended September 30, 2018.
The entire disclosure for goodwill and intangible assets.
Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef