16Goodwill

During the fourth quarter of 2008, the Group tested its balance of goodwill for impairment in accordance with IAS 36, “Impairment of assets”. No impairment charge was recorded as a result of this annual impairment test.

Goodwill is allocated to the Group’s CGUs according to business segment. The carrying amounts of goodwill by CGU at 31 December 2008 are summarised below:

The recoverable amount for each CGU has been measured based on a value in use calculation.

Processor Division (PD)

The Processor Division encompasses those resources that are centred around microprocessor cores, including specific functions such as graphics IP, fabric IP, embedded software IP and configurable digital signal processing (DSP) IP.

The key assumptions in the value in use calculations were:

Period over which the directors have projected cash flows A ten-year forecast period is used with an assumed terminal growth rate after 2018 of 3% per annum. It is considered appropriate to use a ten-year forecast period to properly reflect the period over which the benefits of the acquisition of Artisan to the Processor Division are expected to accrue.

Forecast revenue growth Revenue is forecast to grow by an amount consistent with the Group’s five-year plan as well as analysts’ expectations. These have proved to be reliable guides in the past and the directors believe that these estimates are appropriate.

Revenue attributable to the benefits afforded by owning the PIPD unit The directors believe that revenue will accrue to the Processor Division as a result of the ownership of the Physical IP Division for the following reasons:

Operating margins Operating margins have been assumed to remain consistent with current operating margins over the period of the calculation.

Discount rate Future cash flows are discounted in line with ARM’s estimated weighted average cost of capital of approximately 10% pre-tax.

The directors are confident that the amount of goodwill allocated to the Processor Division is appropriate and that the assumptions used in estimating its fair value are appropriate. Whilst it is conceivable that a key assumption in the calculation could change, the directors believe that no reasonably foreseeable changes to key assumptions would result in an impairment of goodwill, such is the margin by which the estimated fair value exceeds the carrying value.

Physical IP Division (PIPD)

The Physical IP Division is concerned with the building blocks necessary for translation of a circuit design into actual silicon.

The key assumptions in the value in use calculations were:

Period over which the directors have projected cash flows A ten-year forecast period is used with an assumed terminal growth rate after 2018 of 3% per annum. It is considered appropriate to use a ten-year forecast period to properly reflect the period over which the benefits of the acquisition of Artisan are expected to accrue. It is expected that it will take between four and seven years from acquisition before a meaningful proportion of ARM’s larger semiconductor Partners are licensing some of their physical IP technology needs from the Group, with royalties being generated from these licences a further two to four years later, i.e. a total period of six to 11 years. Further, the Group’s experience in PD indicates that the base of licences grows gradually over time as licensees outsource an increasing proportion of their physical IP needs, with royalties, which are a function of the cumulative licensing base, increasing accordingly.

Forecast revenue growth Although revenue growth is not forecast in 2009 due to the current global macroeconomic environment, thereafter revenue is expected to grow by approximately 18% per annum on average for the next five years, falling to 8% per annum by 2018, reflecting the uncertainty of forecasting revenues in the years further in the future. In assessing the appropriate valuation of Artisan in 2004, the directors assumed revenue growth of approximately 20% per annum was achievable in the Artisan stand-alone business based on process geometry shrinks bringing more licensing opportunities across a broader range of foundries and based on the significant increase in the usage of Artisan IP in 2003 and 2004 which is now contributing to royalty growth.

Licence revenues decreased by 18% year-on-year in 2008, with the order backlog at the end of the year being approximately 9% down on the level at the beginning of the year. Royalty revenues increased by 24%. During 2008, a significant proportion of engineering resource was deployed to accelerate the development of leading-edge physical IP technology rather than working on the conversion of order backlog into short-term revenue. This acceleration was seen as fundamental to the long-term growth potential of PIPD. During 2008, the initial licences of the leading-edge technology have been signed. The revenue from these licences will be recognised in 2009. The directors believe that the investment in the technology portfolio will not only bring growth in future years to PIPD but also contribute significantly to the success of PD as the synergistic benefits of the combined technologies begin to accrue. Therefore the directors have confidence that the overall forecast growth rate attributable to PIPD is achievable.

Operating margins Operating margins are assumed to increase gradually over time towards 40% by the end of the forecast period. In 2008, PIPD’s operating margin as a standalone business was estimated at a loss of 3%, reflecting additional R&D investment in order to accelerate the development of leading edge products. Margins are expected to improve significantly in future years as licence revenues from leading edge products gather pace and royalties increase at effectively 100% margins. Costs are expected to grow broadly in line with licence revenue growth.

This timescale is consistent with ARM’s experience in developing the processor licensing and royalty model. ARM has signed nearly 600 processor licences over the last 18 years with less than half of these yielding royalties thus far. As royalty revenues are a function of cumulative licensing, royalty growth gathers momentum as the licensing base grows – ARM processor royalties have increased from $38 million in 2002 to $227 million in 2008.

Discount rate Future cash flows are discounted in line with ARM’s estimated weighted average cost of capital of approximately 10% pre-tax.

The directors are confident that the amount of goodwill allocated to PIPD and the assumptions used in estimating its fair value are appropriate.

Whilst it is conceivable that a key assumption in the calculation could change, the directors believe that no reasonably foreseeable changes to key assumptions would result in an impairment of goodwill, such is the margin by which the estimated fair value exceeds the carrying value. The overall assessment is most sensitive to any change in the forecast revenues. Although an overall compound annual growth rate of 12% is anticipated by the directors in reaching their conclusions, an annual growth rate of just 9% would still support the carrying value of goodwill within the division.

Systems Design Division (SDD)

The Systems Design Division is concerned with the tools and models used to create and debug software and system-on-chip (SoC) designs.

The key assumptions in the value in use calculations were:

Period over which the directors have projected cash flows A five-year forecast period is used with an assumed terminal growth rate after 2013 of 3% per annum. It is considered appropriate to use a five-year forecast period to properly reflect the weighted average period over which the benefits of the acquisitions of Axys, KEG and KSI are expected to accrue.

Forecast revenue growth Revenue is forecast to grow by an amount consistent with the Group’s five-year plan as well as analysts’ expectations. These have proved to be reliable guides in the past and the directors believe that these estimates are appropriate.

Operating margins Operating margins are assumed to grow by an amount consistent with the Group’s five-year plan.

Discount rate Future cash flows are discounted in line with ARM’s estimated weighted average cost of capital of approximately 10% pre-tax.

The directors are confident that the amount of goodwill allocated to SDD and the assumptions used in estimating its fair value are appropriate. Whilst it is conceivable that a key assumption in the calculation could change, the directors believe that no reasonably foreseeable changes to key assumptions would result in an impairment of goodwill, such is the margin by which the estimated fair value exceeds the carrying value.