#impairments

Damage to the cornea affects millions of people worldwide. Empa researchers are working on a transparent, biocompatible implant from the 3D printer. This allows defects to be repaired seamlessly and permanently. The project could now be started thanks to a generous donation from a foundation. Like a windowpane, the transparent cornea, is the outermost layer of tissue that protects our eyes. If…

Noisy brain activity contributes to aging-related navigation impairments

In younger adults, hippocampal activity decreases and acitivty in other navigational areas increases. The pattern is not seen in older adults. Credit: Diersch et al., JNeurosci 2021 Too much activity in the hippocampus may cause navigation impairments seen in aging adults, according to new research published in JNeurosci. Spatial navigation is one of the cognitive abilities that declines…

We all know that airlines have suffered mightily since coronavirus grounded international travel at the start of this year. Now Delta Airlines ($DAL) has filed its report for Q2 2020, and we discovered a secondary crisis: investments Delta made in other airlines, which have since fallen apart and led to more than $2 billion impairments.

Tucked away in the Investments portion of its quarterly report, Delta detailed its three investments in smaller airlines: Virgin Atlantic, LATAM ($LTM), and Grupo Aeroméxico. The latter two filed for bankruptcy reorganization earlier this spring, essentially wiping out Delta’s influence over either one.

Virgin Atlantic averted its own bankruptcy with emergency funding arranged by Richard Branson, but is still sputtering so much that Delta had to impair that investment too.

What happened, exactly? Let’s take a look.

LATAM. Delta acquired 20 percent of LATAM for $1.9 billion in January to forge a strategic alliance with the Chilean airline. The company also promised to give LATAM $350 million in “transition payments,” including $200 million paid in 2019 and the remaining $150 million delivered in quarterly payments from September 2020 through 2021.

Alas, LATAM filed for Chapter 11 bankruptcy in May. That prompted Delta to terminate a deal to buy four A350 aircraft from LATAM, with Delta paying a $62 million termination fee. That fee is recorded as a restructuring charge on the income statement.

Moreover, Delta recorded an expense of $1.1 billion in impairments and equity method losses. That item is folded into the $2.06 billion in impairments and equity method losses Delta reported as “Non-Operating Expense” on the income statement. See Figure 1, below; the impairments line is shaded grey.

Grupo Aeroméxico. Delta also has a 51 percent ownership stake in Grupo Aeroméxico, but thanks to a quirk of Mexican corporate law Delta’s voting control is limited to only 49 percent. Hence Delta still reports for its Aeroméxico holding using equity method accounting.

Anyway, Aeroméxico filed Chapter 11 in June. As a result, Delta says, “We no longer have significant influence over Grupo Aeroméxico” and Delta is now accounting for its holding using the fair value method — which included a $770 million impairment.

Virgin Atlantic. Delta had long had a 49 percent investment in Virgin Atlantic, and as recently as Q4 2019 had valued that holding at $375 million. Then came coronavirus, and “Virgin Atlantic has incurred significant losses during 2020,” as Delta so blandly described the situation.

That prompted Delta to record a $200 million impairment for its Virgin Atlantic investment, and to reduce the basis in its investment to zero dollars going forward.

Add up those three impairments, and you get a total of $2.07 billion — which is actually more than the $2.058 billion listed above in Figure 1, thanks to a few other investments that increased in value.

Delta also lost $4.8 billion from its regular operations, for a total pretax loss in Q2 of (gulp) $7.014 billion. The impairments on its investments in other airlines account for 29.3 percent of that loss.

For comparison purposes, Delta had equity investment impairments of only $17 million in second-quarter 2019, and no such losses in the three intervening quarters. The it coughed up (no pun intended) this $2.058 billion impairment monster.

Corporate America will start publishing its Q2 2020 earnings releases any day now, followed by complete 10-Q filings by end of the month. These will be the first reports to encompass one full quarter in the era of coronavirus, and we’ll all be looking for numbers, narratives, and other disclosures about how Covid-19 is affecting corporate performance.

To help with that, Calcbench offers this list of tips and tricks to help find relevant disclosures quickly.

First, above all, know that companies you want to follow and set up email alerts for when they file something. Calcbench indexes all manner of filings, usually within minutes of those documents hitting the Securities & Exchange Commission database. So your first step is to be in position to receive news of a new filing when it happens.

To establish a peer group of companies you want to follow, just press the “Choose Companies” button you see at the top of most Calcbench search pages, and follow the instructions from there. We also have a detailed post dedicated to peer groups that is worth reading if you’re new to the service.

You can set up email alerts from your account preferences page. We have a detailed post dedicated to this task, too.

Second, rely on the Interactive Disclosures page and our text search capability. Our Interactive Disclosures page is where we index the footnotes and similar disclosures, and remember this law of financial analysis: the most important and juicy stuff is in the footnotes, always!

We recently expanded how subscribers can search corporate disclosures, giving you more ability to narrow the date range. So for example, you could search for all filings from one company (or a set of companies) within the last week or the last month. And you guessed it, we have a detailed post on this feature.

We also urge subscribers to use the text search capability on this page, which is the field on the right side of your screen. There, you can search for terms such as “COVID-19” (all capital letters seems to be the style that filers use), “impairments,” “coronavirus,” or whatever else is on your mind.

Analysts’ best bet might be to combine several of these search features, to get precise, highly relevant results. For example, you could search for “impairment” in earnings releases filed within the last month for whatever peer group of firms you follow, and immediately find who has been taking a write-down since coronavirus began.

Third, when in doubt, visit our Recent Filings page and see who has been updating earnings guidance. We added that category earlier this year, along with all the other types of filings we track — 10-Ks or 10-Qs, proxy statements, earnings releases, and 8-K filings of other news. As always, we have a detailed post dedicated to this subject.

A few other thoughts…

Don’t be surprised to see firms report something like “earnings before covid,” with an adjustment to net income. Early research shows that this is indeed happening — and in many instances, the logic behind that move is solid.

Expect to see much discussion of impairments to goodwill and other assets. Accounting rules require a test of possible impairment at least once a year, plus whenever extraordinary circumstances demand an interim test. Well, coronavirus is certainly that. Even if a firm decides impairment isn’t necessary, it probably will still explain why it reached that conclusion. Williams Sonoma ($WSM), for example, had an impressive discussion of impairments in June.

Look for clues in obscure places. Real estate firms talking about rent payments; retailers talking about same-store sales; impairments for right-of-use operating assets — all those disclosures are one more tile in the economic mosaic everyone is trying to piece together right now.

Impairments related to coronavirus have been on lots of people’s minds this quarter. Now, for the first time, we have a specific glimpse into the SEC’s thoughts on the issue too. Carlisle Companies Inc. ($CSL), a manufacturing business with about $4.8 billion in annual sales, seems to be the first company to have an SEC comment letter asking about Covid-19 impairments.

The letter and Carlisle’s reply were exchanged in May, but SEC comment letters typically don’t become public for several weeks after that. Special thanks to eagle-eyed Olga Usvyatsky, who noticed the comment letter while poking around the SEC comment letter database and posted the news to Twitter.

So what happened? In Carlisle’s first-quarter report (filed on April 23), the company said that it had assessed its goodwill and intangible assets and concluded that despite the likelihood of reduced revenue for the rest of 2020, coronavirus had not affected the value of those assets, so no impairment charges were necessary.

Carlisle even disclosed its valuation methodology and key assumptions it used. See Figure 1, below.

Fair enough; it’s not Calcbench’s place to judge a firm’s statements about impairment. The SEC, on the other hand, has warned firms that impairments related to Covid-19 are a priority item.

Perhaps it’s no surprise, then, that the SEC dashed off a comment letter to Carlisle asking for more clarity about how much the carrying value of its goodwill and intangible assets exceeded book value. Here’s what the SEC had to say:

To provide investors with information to better assess the probability of future goodwill impairment charges, please disclose, if accurate, that the estimated fair values of the intangible assets you quantitatively tested for impairment substantially exceeded their carrying values. For any asset whose estimated fair value did not substantially exceed its carrying value, please disclose the percentage by which fair value exceeded carrying value at the date of the most recent test.

You can see the SEC’s logic here, and it’s a fair point to raise. If its intangible assets were only a hair above book value in Q1 2020, with more Covid-19 disruptions likely to come later this year — then yes, it’s possible that an impairment charge will be necessary sometime soon. On the other hand, if the assets are well above book value, then impairment would be less likely, even with Covid-19.

Carlisle heard the SEC’s message and promised more fulsome disclosure in filings to come. It gave the text below as a sample response, with the relevant material underlined:

In the first quarter of 2020, changes in facts and circumstances and general market declines from COVID-19 resulted in reduced expectations of future operating results. We considered these circumstances and the potential long-term impact on cash flows associated with our reporting units and determined that an indicator of possible impairment existed within our CFT and CBF reporting units. Accordingly, we tested our goodwill for impairment as of March 31, 2020. Those reporting units were tested for impairment using the quantitative approach described above, resulting in fair value that exceeded the carrying amount for each of the reporting units by approximately 10 percent. The carrying amount of goodwill for the CFT and CBF reporting units was $185.6 million and $96.4 million, respectively.

Just food for thought for financial analysts and corporate disclosure executives out there, wondering what you should say about financial risks and Covid-19. You can learn a lot by reading other firms’ correspondence.

Don’t forget, Calcbench subscribers can search SEC comment letters and firms’ responses (once the letters become public on the SEC website, which takes a few weeks).

We noted in a previous post that both the Securities and Exchange Commission and the audit world are paying more attention to several items in the financial statements that are likely to be hit particularly hard by Covid-19.

Among those items was impairment of goodwill or intangible assets. Today in its first-quarter earnings release, United Airlines ($UAL) gave us a great example of that headache.

United declared a $50 million impairment on the value of its flight routes to China. Here’s what the company had to say:

The company recorded $63 million of special charges, primarily associated with a $50 million impairment for its China routes. The company conducted impairment reviews of certain intangible assets in the first quarter of 2020, which consisted of a comparison of the book value of those assets to their fair value calculated using the discounted cash flow method. Due to the COVID-19 pandemic and the subsequent suspension of flights to China, the company determined that the value of its China routes had been impaired.

One might assume that this $50 million impairment is unwelcome, but not terribly significant considering United’s many other business challenges at the moment. After all, United listed $3 billion in intangible assets as of Dec. 31, and $1.15 billion of that sum was specifically related to flight routes.

A $50 million impairment does qualify as material (4.4 percent of that $1.15 billion), but not by much.

This isn’t the first time United has impaired intangible assets related to flight routes, either. In 2018 it recorded a $105 million charge for routes in Brazil, and another charge of $206 million for flights to Hong Kong.

But here’s where it gets interesting — United’s impairment analysis for flight routes was flagged as a Critical Audit Matter.

CAMs: A Refresher

CAMs, as you may recall, are new disclosures that audit firms are required to make about their clients. CAMs are any line-item that can be material to the financial statements, and also relies heavily on complex, subjective judgment.

Declaring something a CAM doesn’t necessarily mean something is amiss in that line item, although that can be the case. It’s more akin to the audit firm telling investors, “This line item here is material, but it’s really hard for us to get an empirical, data-driven assessment of how reliable it is. There’s a lot of judgment involved.”

As we were sifting through United’s 10-K for more detail about its intangible assets, we found that CAM disclosure from the firm’s auditor, Ernst & Young. Here’s what EY had to say:

Auditing management's annual route authorities indefinite-lived intangibles impairment test was complex and highly judgmental due to the significant estimation required in determining the fair value. The fair value estimate was sensitive to significant assumptions such as revenue growth rate, cost per available seat mile and the discount rate, each of which is affected by expectations about future market or economic conditions. As a result of the subjectivity of the assumptions, adverse changes to management's estimates could reduce the underlying cash flows used to estimate fair value and trigger impairment charges.

That’s disclosure of the CAM itself. EY also had to explain the steps it took to address the complexity of the disclosure:

To test the estimated fair value of the Company's route authorities indefinite-lived intangibles, we performed audit procedures that included, among others, assessing the fair value methodology used by management and evaluating the significant assumptions used in the valuation model. We compared significant assumptions to current industry, market and economic trends, and to the Company's historical results. We assessed the historical accuracy of management's estimates and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the intangible assets that would result from changes in assumptions. We also involved a valuation specialist to assist in our evaluation of the Company's valuation methodology and discount rate.