Goodwill impairment

Our East Tennessee Materials & Energy Corporation (“M&EC”) subsidiary was awarded the CH Plateau Remediation Company (“CHPRC”) subcontract by CH2M Hill Plateau Remediation Company (“CH2M Hill”), effective June 19, 2008, in connection with CH2M Hill’s prime contract with the U.S. Department of Energy (“DOE”), relating to waste management and facility operations at the DOE’s Hanford, Washington site. The CHPRC subcontract provided for a base contract period from October 1, 2008 through September 30, 2013, with an option of renewal for an additional five years.  During the second quarter of 2013, our M&EC subsidiary was notified by CH2M Hill that the subcontract will expire on September 30, 2013 and will not be renewed.  As permitted by ASC Topic 350 “Intangibles – Goodwill and Other,” when an impairment indicator arises toward the end of an interim reporting period, the Company may recognize its best estimate of that impairment loss; accordingly, based on the Company’s analysis prepared as of June 30, 2013, we recorded a goodwill impairment charge of $1,149,000 during the three months ended June 30, 2013.  This amount represented the total goodwill for our CHPRC reporting unit – our operations under the CHPRC subcontract. The goodwill impairment charge is noncash in nature and did not affect the Company’s liquidity or cash flows from operating activities. Additionally, the goodwill impairment had no effect on the Company’s borrowing availability or covenants under its credit facility agreement. The CHPRC subcontract expired on September 30, 2013.

 

The Company’s goodwill balances at September 30, 2013 are as follows: $13,690,000 for the Treatment reporting unit, $1,330,000 for the SYA reporting unit and $13,017,000 for the Safety and Ecology Corporation reporting unit.  The Company performed a preliminary internal step 1 analysis as of September 30, 2013 that indicated that the Treatment reporting unit passed step 1 by approximately 23.0%, that the SYA reporting unit passed step 1 by approximately 224.0% and the Safety and Ecology Corporation reporting unit passed step 1 by approximately 18.0%. As part of this Step 1 analysis, the Company estimated the fair values of each reporting unit based solely on the income approach, specifically the discounted cash flow (“DCF”) method, which estimates the fair value of each reporting unit. The revenue assumptions were based on projected growth rates varying from 2.0% to 85.0% over the next four years. To achieve these projections, the model assumes a recovery from the government sequestration downturn over the next four years, beginning in the fourth quarter of 2013.

The DCF model was prepared using revenue and expense projections based on the Company’s current operating plan. Management considered the current experience of lower than expected levels of revenues and operating income. As such, a number of significant assumptions and estimates are involved in the application of the DCF model to forecast revenue growth, price changes, gross profits, operating expenses and operating cash flows. The cash flows were discounted using a weighted average cost of capital of 15%, which was management’s best estimate based on the capital structure of the Company and external industry data. The Company used a terminal growth rate of four percent.  Management also considered that the Company’s total stockholders’ equity at September 30, 2013 was significantly greater than the Company’s market capitalization, which was approximately $41,775,000 based on 11,384,490 shares of common stock outstanding at September 30, 2013. While the market capitalization of approximately $41,775,000 is significantly below the Company’s stockholders’ equity, the market capitalization metric is only one indicator of fair value. In the Company’s opinion, the market capitalization approach, by itself, is not a reliable indicator of the value for the Company. The analysis prepared as of September 30, 2013 is preliminary and subject to the completion of the Company’s annual impairment test as of October 1, 2013. The completion of this analysis may result in an impairment loss being recorded in the fourth quarter of 2013.

We believe demand for our services will continue to be subject to fluctuations due to a variety of factors beyond our control, including without limitation, the current economic conditions that drive both commercial and government clients to reduce spending, adverse federal governmental clients operating under reduced budgets due to Continuing Resolutions (“CR”) and government sequestration.  We believe that this has negatively impacted the amount of waste shipped to our treatment facilities, as well as jobs available in our Services Segment. Significant uncertainty exists regarding how sequestration cuts are being implemented and the challenges it is having for our industry. While members of Congress and the Administration continue to discuss various options to address sequestration and the U.S. Government’s overall fiscal challenges, we cannot predict the outcome of these efforts.  This continued financial uncertainty makes it difficult to determine the full impact on our 2013 results of operations and cash flows, including the potential impact on our goodwill balances.

 

Other Intangible Assets

The following table summarizes information relating to the Company’s other intangible assets:

 

The intangible assets are amortized on a straight-line basis over their useful lives with the exception of customer relationships which are being amortized using an accelerated method.

The following table summarizes the expected amortization over the next five years for our definite-lived intangible assets noted above and also includes the only definite-lived permit, which is at our Diversified Scientific Services, Inc. (“DSSI”) subsidiary:

Amortization expense relating to intangible assets noted above and our one definite-lived permit for the Company was $185,000 and $528,000 for the three and nine months ended September 30, 2013, respectively, and $159,000 and $480,000 for the three and nine months ended September 30, 2012, respectively.