This excerpt taken from the WYN 10-K filed Feb 27, 2009.
In accordance with SFAS No. 142, the Company tests goodwill for potential impairment annually (during the fourth quarter of each year subsequent to completing the Companys annual forecasting process) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The process of evaluating goodwill for impairment involves the determination of the fair value of the Companys reporting units as described in Note 2Summary of Significant Accounting Policies. Because quoted market prices for the Companys reporting units are not available, management must apply judgment in determining the estimated fair value of these reporting units for purposes of performing the annual goodwill impairment test. Management uses all available information to make these fair value determinations, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets. Inherent in such fair value determinations are certain judgments and estimates relating to future cash flows, including the Companys interpretation of current economic indicators and market valuations, and assumptions about the Companys strategic plans with regard to its operations. Due to the uncertainties associated with such estimates, actual results could differ from such estimates. In performing its impairment analysis, the Company developed the estimated fair values for its reporting units using a combination of the discounted cash flow methodology and the market multiple methodology.
The discounted cash flow methodology establishes fair value by estimating the present value of the projected future cash flows to be generated from the reporting unit. The discount rate applied to the projected future cash flows to arrive at the present value is intended to reflect all risks of ownership and the associated risks of realizing the stream of projected future cash flows. The discounted cash flow methodology uses the Companys projections of financial performance for a five-year period. The most significant assumptions used in the discounted cash flow methodology are the discount rate, the terminal value and expected future revenues, gross margins and operating margins, which vary among reporting units.
The Company uses a market multiple methodology to estimate the terminal value of each reporting unit by comparing such reporting unit to other publicly traded companies that are similar to it from an operational and economic standpoint. The market multiple methodology compares each reporting unit to the comparable companies on the basis of risk characteristics in order to determine the risk profile relative to the comparable companies as a group. This analysis generally focuses on quantitative considerations, which include financial performance and other quantifiable data, and qualitative considerations, which include any factors which are expected to impact future financial performance. The most significant assumption affecting the Companys estimate of the terminal value of each reporting unit is the multiple of the enterprise value to earnings before interest, tax, depreciation and amortization.
To support the Companys estimate of the individual reporting unit fair values, a comparison is performed between the sum of the fair values of the reporting units and the Companys market capitalization. The Company uses an average of its market capitalization over a reasonable period preceding the impairment testing date as being
more reflective of the Companys stock price trend than a single day, point-in-time market price. The difference is an implied control premium, which represents the acknowledgment that the observed market prices of individual trades of a companys stock may not be representative of the fair value of the company as a whole. Estimates of a companys control premium are highly judgmental and depend on capital market and macro-economic conditions overall. The Company concluded that the implied control premium estimated from its analysis is reasonable.
During the fourth quarter of 2008, after estimating the fair values of the Companys three reporting units as of December 31, 2008, the Company determined that its lodging and vacation exchange and rentals reporting units passed the first step of the goodwill impairment test, while the vacation ownership reporting unit did not pass the first step. The lodging and vacation exchange and rentals reporting units had goodwill balances of $297 million and $1,056 million, respectively at December 31, 2008.
As described in Note 2Summary of Significant Accounting Policies, the second step of the goodwill impairment test uses the estimated fair value of the Companys vacation ownership segment from the first step as the purchase price in a hypothetical acquisition of the reporting unit. The significant hypothetical purchase price allocation adjustments made to the assets and liabilities of the vacation ownership segment in this second step calculation were in the areas of:
(1) Adjusting the carrying value of Vacation Ownership Contract Receivables to their estimated fair values,
(2) Adjusting the carrying value of customer related intangible assets to their estimated fair values,
(3) Adjusting the carrying value of debt to the estimate fair value, and
(4) Recalculating deferred income taxes under Financial Accounting Standards Board Statement No. 109, Accounting for Income Taxes, after considering the likely tax basis a hypothetical buyer would have in the assets and liabilities.
As a result of the above analysis, during the fourth quarter of 2008 the Company recorded a goodwill impairment charge of $1,342 million ($1,337 million, after-tax) representing a write-off of the entire amount of the vacation ownership reporting units previously recorded goodwill. Such impairment was a result of plans that the Company announced during (i) October 2008, in which it refocused its vacation ownership sales and marketing efforts on consumers with higher credit quality beginning the fourth quarter of 2008, which reduced future revenue and growth rates, and (ii) December 2008, in which it decided to eliminate the vacation ownership reporting units reliance of the asset-backed securities market by reducing its VOI sales pace during 2009 by approximately 40% from 2008 to approximately $1.2 billion.