Goodwill and Intangible Assets

9 Months Ended

Sep. 30, 2013

2. Goodwill and Intangible Assets

Goodwill

The following table presents an analysis of the changes in goodwill by segment for the nine months ended September 30, 2013 (in thousands):

	Guitar			Music
	Center			& Arts		Total
Balance at December 31, 2012
Goodwill	$	706,182		$	—	$	706,182
Accumulated impairment losses	(123,804		)			(123,804		)
	582,378			—		582,378

Goodwill resulting from acquisitions	—			239		239
Goodwill impairment	(360,100		)	—		(360,100		)

Balance at September 30, 2013
Goodwill	706,182			239		706,421
Accumulated impairment losses	(483,904		)	—		(483,904		)
	$	222,278		$	239	$	222,517

We perform a qualitative assessment annually on the first day of the fourth quarter to determine if facts and circumstances indicate that goodwill is more likely than not impaired. We also test goodwill for impairment upon the occurrence of events or substantive changes in circumstances that indicate that goodwill is more likely than not impaired.

During the second quarter of 2013, operating income decreased significantly at our Guitar Center segment, which is also a reporting unit for purposes of testing goodwill for impairment. We concluded that there were sufficient indicators that goodwill at our Guitar Center segment may be impaired.

We performed step 1 of the goodwill impairment test for our Guitar Center reporting unit as of June 30, 2013. We used a discounted cash flow analysis and a market multiple analysis, equally weighted, to estimate the fair value of our Guitar Center reporting unit. Based on the step 1 analysis as of June 30, 2013, no goodwill impairment was indicated and we did not proceed to step 2 of the goodwill impairment test.

During the third quarter of 2013, operating income at our Guitar Center segment fell significantly below our expectations. Based on a forward projection of our recent operating performance, we determined that if current trends were to continue there would be uncertainty as to when or whether our Guitar Center business would be able to achieve historical operating results. Given these uncertainties, we determined it was appropriate to revise our projections of future cash flows from the segment. Management concluded that these changes in facts and circumstances represented a triggering event, requiring us to again test the reporting unit’s goodwill for impairment.

We performed step 1 of the goodwill impairment test as of September 30, 2013 and determined that the carrying amount of the Guitar Center reporting unit exceeded its estimated fair value. Step 2 of the impairment test requires us to estimate the fair value of all of the reporting unit’s assets and liabilities, including identifiable intangible assets, and compare the implied fair value of goodwill to its carrying value. We are in the process of performing step 2 of the goodwill impairment test and we expect to complete our analysis during the fourth quarter of 2013. We recorded an estimated goodwill impairment charge of $360.1 million in the third quarter of 2013. Given the complexity of the step 2 analyses, the calculation of the fair value of certain assets, primarily property and equipment, amortizable intangible assets and favorable leases, among others, is still preliminary. The estimated impairment charge will be revised, if necessary, after the step 2 analysis is completed during the fourth quarter of fiscal 2013.

We use a discounted cash flow analysis and a market multiple analysis to estimate the fair value of our Guitar Center reporting unit for step 1 of the goodwill impairment test. The discounted cash flow analysis included assumptions for, among others, forecasted revenues, gross profit margins, operating profit margins, working capital requirements, perpetual growth rates and long term discount rates, all of which require significant judgments by management.

We also use discounted cash flow analyses and market-based techniques to estimate the fair values of the reporting unit’s assets and liabilities in step 2 of the goodwill impairment test. Significant management judgment is required in forecasting the future operating results and cash flows that are used in these analyses.

The non-cash impairment charge has no impact on our compliance with debt covenants, our cash flows or available liquidity, however it does have a material impact on our consolidated financial statements.

Other intangible assets

Our other intangible assets are comprised of indefinite-lived trademarks and trade names and finite-lived intangible assets, primarily related to customer relationships and below-market leases.

We perform a qualitative assessment annually on the first day of the fourth quarter to determine if facts and circumstances indicate that our indefinite-lived intangible assets are more likely than not impaired. We also test indefinite-lived intangible assets for impairment whenever events and circumstances indicate that the fair value of the asset is more likely than not less than its carrying amount.

Because we tested Guitar Center goodwill for impairment, we also evaluated the indefinite-lived intangible assets and amortizable intangible asset group of our Guitar Center segment for impairment as of June 30 and September 30, 2013. There was no impairment of the Guitar Center segment’s indefinite-lived intangible assets, as their estimated fair values exceeded their carrying amounts. Similarly, there was no impairment of the Guitar Center segment’s finite-lived intangible assets, as the projected future undiscounted cash flows from the asset group exceeded its carrying amount.

In the second quarter of 2013, we evaluated our direct response indefinite-lived trademarks and trade names for impairment after continued decreases in net sales at our direct response segment. Because net sales are the primary driver of fair value for our indefinite-lived trademarks and trade names, we determined that the decrease in net sales indicated possible impairment of these assets. We revised our revenue projections for the direct response brands based on net sales achieved through the first half of 2013 and expectations about our initiatives to improve the brands’ performance. As a result of the impairment analysis, we recognized an impairment charge of $2.3 million in the second quarter of 2013 related to certain of our direct response indefinite-lived trademarks and trade names.

The direct response segment’s amortizing customer relationship intangible asset was not considered impaired in the second quarter, as the projected future undiscounted cash flows from the asset group significantly exceeded its carrying amount.

During the third quarter, we did not test the direct response segment’s indefinite-lived intangible assets for impairment. Facts and circumstances did not indicate further impairment of these assets, as the segment’s net sales were within our revised revenue projections included in the impairment analysis performed as of the end of the second quarter.

See Note 5 for more information about fair value measurements for our intangible assets.

The following tables present a summary of our intangible assets other than goodwill (dollars in thousands, life in years):

		September 30, 2013
	Weighted-	Gross
	Average Useful	Carrying		Accumulated			Intangible
	Life	Amount		Amortization			Assets, Net
Unamortized trademarks	—	$	206,201	$	—		$	206,201
Amortized
Customer relationships	13.1	221,538		(158,790		)	62,748
Favorable lease terms	7.6	25,941		(22,580		)	3,361
Covenants not to compete and other	4.6	946		(646		)	300
		$	454,626	$	(182,016	)	$	272,610

		December 31, 2012
	Weighted-	Gross
	Average Useful	Carrying		Accumulated			Intangible
	Life	Amount		Amortization			Assets, Net
Unamortized trademarks	—	$	208,501	$	—		$	208,501
Amortized
Customer relationships	13.0	224,302		(148,042		)	76,260
Favorable lease terms	7.5	57,721		(51,323		)	6,398
Covenants not to compete and other	4.3	785		(675		)	110
		$	491,309	$	(200,040	)	$	291,269

We include amortization of favorable leases in cost of goods sold, buying and occupancy. We include amortization of other intangible assets such as customer relationships and non-compete agreements in selling, general and administrative expenses.

Amortization expense is classified in our condensed consolidated statements of comprehensive loss as follows (in thousands):

	Three months ended September 30,				Nine months ended September 30,
	2013		2012		2013		2012
Cost of goods sold, buying and occupancy	$	936	$	1,423	$	3,118	$	4,563
Selling, general and administrative expenses	4,693		5,776		13,872		17,331

The future estimated amortization expense related to intangible assets as of September 30, 2013 was as follows (in thousands):

Year
Remainder of 2013	$	5,428
2014	16,549
2015	12,583
2016	9,717
2017	7,663
Thereafter	14,469
Total	$	66,409

- Definition

The entire disclosure for the aggregate amount of goodwill and a description of intangible assets, which may include (a) for amortizable intangible assets (also referred to as finite-lived intangible assets), the carrying amount, the amount of any significant residual value, and the weighted-average amortization period, (b) for intangible assets not subject to amortization (also referred to as indefinite-lived intangible assets), the carrying amount, and (c) the amount of research and development assets acquired and written off in the period, including the line item in the income statement in which the amounts written off are aggregated, if not readily apparent from the income statement. Also discloses (a) for amortizable intangibles assets in total and by major class, the gross carrying amount and accumulated amortization, the total amortization expense for the period, and the estimated aggregate amortization expense for each of the five succeeding fiscal years, (b) for intangible assets not subject to amortization the carrying amount in total and by major class, and (c) for goodwill, in total and for each reportable segment, the changes in the carrying amount of goodwill during the period (including the aggregate amount of goodwill acquired, the aggregate amount of impairment losses recognized, and the amount of goodwill included in the gain (loss) on disposal of a reporting unit). If any part of goodwill has not been allocated to a reportable segment, discloses the unallocated amount and the reasons for not allocating. For each impairment loss recognized related to an intangible asset (excluding goodwill), discloses: (a) a description of the impaired intangible asset and the facts and circumstances leading to the impairment, (b) the amount of the impairment loss and the method for determining fair value, (c) the caption in the income statement or the statement of activities in which the impairment loss is aggregated, and (d) the segment in which the impaired intangible asset is reported. For each goodwill impairment loss recognized, discloses: (a) a description of the facts and circumstances leading to the impairment, (b) the amount of the impairment loss and the method of determining the fair value of the associated reporting unit, and (c) if a recognized impairment loss is an estimate not finalized and the reasons why the estimate is not final. May also disclose the nature and amount of any significant adjustments made to a previous estimate of an impairment loss.

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