Annual Report and Accounts 2010

15Goodwill

 

£000

At 1 January 2009

567,844

Revision to consideration and intangible assets – Logipard

103

Exchange differences

(51,149)

At 31 December 2009

516,798

Exchange differences

15,487

At 31 December 2010

532,285

During the fourth quarter of 2010, 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 2010 are summarised below:

Processor
Division
£000

Physical IP
Division
£000

System
Design
Division
£000

Group
£000

Goodwill relating to Artisan

125,923

377,767

503,690

Goodwill relating to Falanx

9,400

9,400

Goodwill relating to Axys

7,777

7,777

Goodwill relating to KEG and KSI

7,150

7,150

Goodwill relating to Logipard

2,177

2,177

Goodwill relating to other acquisitions

2,060

31

2,091

Goodwill at 31 December 2010

139,560

377,767

14,958

532,285

Goodwill at 31 December 2009

135,723

366,258

14,817

516,798

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 2020 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 acquired businesses to the Processor Division are expected to accrue.

Revenue growth Revenue growth assumptions are based on financial budgets and forecasts approved by senior management, taking into account typical semiconductor industry growth rates and ARM’s historical experience in the context of wider industry and economic conditions.

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

The development of faster and more power-efficient microprocessors as a result of collaboration between PD and PIPD engineering teams. This is expected to generate more PD licensing deals at higher prices;

The potential for PD to win more microprocessor licensing business as a result of ARM being able to offer both processor and physical IP in-house; and

The improvement in PD operating margins as a result of being able to transfer a number of engineering tasks to the Bangalore design centre acquired with Artisan.

Operating margins Operating margins have been assumed to grow steadily over the period of the calculation.

Discount rate Future cash flows are discounted at a rate of 10% per annum post tax.

The directors are confident that the amount of goodwill allocated to PD 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 2020 of 3% per annum. Given the long-term nature of the ARM licensing and royalty business model, it is considered appropriate to use a ten-year forecast period to assess the expected future cash flows to be generated from the assets under review. 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.

Revenue growth Revenue is assumed to grow by approximately 12% per annum on average for the next five years, falling to 4% per annum by 2020, reflecting the uncertainty of estimating revenues in the years further in the future. Since the acquisition of Artisan at the end of 2004, PIPD has accelerated the development of leading-edge physical IP technology. As semiconductor process geometries shrink, PIPD is expected to have more licensing opportunities across a broader range of foundries and other semiconductor companies. Royalty revenues are expected to increase going forward as a result of the growth in the installed licence base, both before and after the acquisition of Artisan.

 US dollar licence revenues increased by 15% year-on-year in 2010 and royalty revenues increased by 21%. The increase in revenues was due not only to the improved economic climate during 2010 but also further success in signing licences for leading edge physical IP technology. As a result, backlog increased by 34% in 2010 compared with the beginning of the year. The directors believe that the investment of the past few years 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. Further evidence of this was seen in 2010 with a number of licences being signed for Processor Optimisation Packages (POPs). These POPs enable an enhanced performance in PD processors.

Operating margins Operating margins are assumed to increase gradually over time to around 30% by the end of the forecast period. In 2010, PIPD made a loss, mostly as a result of the continued level of investment in the development of leading-edge technology in advance of the revenues from both licensing and royalties being received. 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 remain relatively flat in real terms.

This timescale is consistent with ARM’s experience in developing the processor licensing and royalty model. ARM has signed over 700 processor licences with more than 250 customers over the last 20 years with less than half of these paying 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 $291 million in 2010.

Discount rate Future cash flows are discounted at a rate of 10% per annum post 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 changes in the assumed revenues. Although an overall compound annual growth rate of 12% for the next five years, dropping to 4% by 2020 is anticipated by the directors in reaching their conclusions, an annual growth rate of 7% would support the carrying value of goodwill within the division.

System Design Division (SDD)

The System 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 2015 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.

Revenue growth Revenue growth assumptions are based on financial budgets and forecasts approved by senior management, taking into account typical semiconductor industry growth rates and ARM’s historical experience in the context of wider industry and economic conditions.

Operating margins Operating margins are assumed to be around 14% on average during the period.

Discount rate Future cash flows are discounted at a rate of 10% per annum post 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.