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Impairment charges are confusing unless you’re an accountant. In the interest of saving others’ time, I’ll take a crack at explaining it with the caveat that I’m not accountant. If someone finds an inaccuracy they can correct it or affirm it if it is accurate. As I understand it, an impairment charge is the removal of goodwill from the balance sheet. Goodwill is the excess in dollars paid for the acquisition of an asset. In this case, it’s the amount of money paid for US Pipe and Mueller Co. that exceeds the dollar value of all its plants, property and equipment.Here’s an investopedia page that runs through it: http://www.investopedia.com/articles/analyst/110502.aspConsider a small company “Wachusett Widgets” with one plant and equipment worth $1MM in total, and no debt, generating $100K in profit annually. Another company, ABC Conglomerate, looks at the business as an opportunity to buy a new product line that it thinks it can expand. They do their due diligence and decide that the cash flows from WW are worth paying $1.5MM for. When ABC finishes the purchase of WW, they consolidate WW’s assets on to their own balance sheet. But, WW has only $1MM in assets, and ABC PAID $1.5MM. To make things match up correctly, ABC adds $1MM to PP&E (plants, property and equipmenty) and also records $0.5MM in “goodwill” to reflect the extra amount paid.At regular intervals, a company is required to verify that the goodwill assigned to their assets still makes sense. Let’s say that WW sales really got walloped in the recession, and they were operating at a loss. ABC is required by accounting regs to verify that WW is STILL worth $1.5MM. The tests are complicated and based on undisclosed estimates of future cash flow and comparison with the market value of other similar companies. If the accounting test reflects a lower value for WW, then ABC won’t be allowed to carry that goodwill on their balance sheet, since it inaccurately reflects the value of WW. They’ll have to write that goodwill down by taking an impairment charge. When they take that charge, they reduce the goodwill on ABC’s books by reducing goodwill $0.5MM and taking a one-time non-cash charge of $0.5MM against earnings. There’s no cash lost, but there is value lost from the balance sheet. The impairment charge is how that’s folded into the reporting of earnings.In this case, a quick scan reveals that MWD wrote off all of US Pipe’s goodwill and part of Mueller Co.’s goodwill, removing the excess above physical value of the PP&E that were originally paid to acquire those companies:Excerpt from pp.32-3 of 10-KWe test our goodwill and other noncurrent assets for possible impairment at least annually as of September 1 and more frequently in the event thatcertain conditions exist indicating impairment may have occurred. The testing is a two-step process. Step 1 compares the fair value of a reporting unit to itscarrying value. We have identified each of our segments as a reporting unit. Step 2 is a more detailed analysis of the fair value of each reporting unit’sindividual assets and liabilities and is performed if Step 1 indicates possible impairment. Our Step 1 testing as of September 1, 2008 did not indicatepossible impairment. Subsequent to September 1, 2008, equity markets in the United States and our stock market capitalization in particular decreasedsignificantly. We considered these decreases as such a condition to perform interim impairment testing. Our valuation for the Company was based on acombination of our estimate of our future cash flows and the market comparable valuations of similar companies. Our estimate of future cash flows extendsa number of years into the future. These estimates are complex, subjective and uncertain and reflect our estimate of the business conditions in the future,over which we may have very little control. Choosing an appropriate discount rate to apply to these estimated cash flows is also complex and subjective. Weuse our estimated future cash flows as the best information of future cash flows available to our investors. We use the market comparable valuations as areasonable method to value the risks investors perceive in companies like ours. We weight our cash flow estimates at least as heavily as the marketcomparable data. At December 31, 2008, our Step 1 testing indicated possible impairment so we proceeded to Step 2 testing.At December 31, 2008, we reported estimated goodwill impairment charges of $59.5 million for U.S. Pipe, completely impairing its goodwill, and$340.5 million against Mueller Co.’s prior goodwill balance of $718.4 million, subject to additional fair value analysis. Any additional impairment chargewas not expected to exceed $200 million. During the three months ended March 31, 2009, however, our common stock began trading at prices significantlylower than prior periods, especially beginning in February. Our lower market capitalization prompted us to perform a second interim impairment assessmentat March 31, 2009. This testing led to the conclusion that all of our remaining goodwill was fully impaired. During the three months ended March 31, 2009,we recorded additional goodwill impairment charges of $376.8 million for Mueller Co. and $92.7 million for Anvil.In conjunction with the testing of goodwill for impairment, we also compared the estimated fair values of our identified other intangible assets to theirrespective carrying values and determined that the carrying amount of trademarks and trade names at Mueller Co. had been impaired. At March 31, 2009,we recorded an impairment charge against these assets of $101.4 million. Mueller Co.’s trademarks and trade names have a remaining carrying value of$263.0 million at September 30, 2009. Hope it helps,PeterP.S. Remember that I'm NOT an accountant and not as experienced as others running around these boards. Just trying to pitch in to make less typing for others. Hopefully someone else can affirm the explanation or correct my gibberish if it's in error.
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