Goodwill, Purchased Technology and Other Intangible Assets

Goodwill and Purchased Intangible Assets

Applied’s methodology for allocating the purchase price relating to purchase acquisitions is determined through established and generally accepted valuation techniques. Goodwill is measured as the excess of the cost of the acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. Applied assigns assets acquired (including goodwill) and liabilities assumed to one or more reporting units as of the date of acquisition. Typically, acquisitions relate to a single reporting unit and thus do not require the allocation of goodwill to multiple reporting units. If the products obtained in an acquisition are assigned to multiple reporting units, the goodwill is distributed to the respective reporting units as part of the purchase price allocation process.

Goodwill and purchased intangible assets with indefinite useful lives are not amortized, but are reviewed for impairment annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The process of evaluating the potential impairment of goodwill and intangible assets requires significant judgment, especially in emerging markets. Applied regularly monitors current business conditions and other factors including, but not limited to, adverse industry or economic trends, restructuring actions and lower projections of profitability that may impact future operating results.

In fiscal 2011, Applied adopted authoritative guidance which allows entities to use a qualitative approach to test goodwill for impairment. This authoritative guidance permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. Under the two-step goodwill impairment test, Applied would in the first step compare the estimated fair value of each reporting unit to its carrying value. Applied’s reporting units are consistent with the reportable segments identified in Note 16, Industry Segment Operations, which are based on the manner in which Applied operates its business and the nature of those operations. Applied determines the fair value of each of its reporting units based on a weighting of income and market approaches. Under the income approach, Applied calculates the fair value of a reporting unit based on the present value of estimated future cash flows. Estimated future cash flows will be impacted by a number of factors including anticipated future operating results, estimated cost of capital and/or discount rates. Under the market approach, Applied estimates the fair value based on market multiples of revenue or earnings for comparable companies, as appropriate. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and no further testing is performed. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then Applied would perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. In the second step, Applied would then allocate the reporting unit's fair value to all of the assets and liabilities of that unit including the fair value of unrecorded intangible assets, in a hypothetical analysis, as if Applied had acquired the reporting unit in a business combination, with the fair value of the reporting unit being the “purchase price.” The excess of the “purchase price” over the carrying amounts assigned to assets and liabilities represents the implied fair value of goodwill. If Applied determined that the carrying value of a reporting unit’s goodwill exceeded its implied fair value, Applied would record an impairment charge equal to the difference.

In the fourth quarter of fiscal 2012, Applied performed a qualitative assessment to test goodwill for all reporting units for impairment and determined that it was more likely than not that each of the Silicon Systems Group, Applied Global Services, and Display reporting units' fair values exceeded its respective carrying values and that it was not necessary to perform the two-step goodwill impairment test for these reporting units.

Applied tested goodwill of the Energy and Environmental Solutions reporting unit for potential impairment during the second quarter of fiscal 2012 in light of second quarter developments that included current industry trends, financial performance, weaker short-term outlooks, and other adverse operating conditions within the solar industry. The results of the first step of the impairment test indicated that goodwill of the Energy and Environmental Solutions reporting unit was not impaired at that time. During the third quarter of fiscal 2012, Applied noted no events that would significantly impact the results of the impairment test performed in the second quarter of fiscal 2012. However, during the fourth quarter, the solar industry faced increasing challenges of solar panel manufacturing overcapacity and weaker operating performance and outlook, leading to the deterioration of the solar equipment market and Applied's customers' financial condition, coupled with lower market valuations. Taking these factors into account, Applied reassessed its financial outlook of the Energy and Environmental Solutions reporting unit, and consequently reevaluated the recoverability of Energy and Environmental Solutions' goodwill and performed the two-step impairment test.

Applied utilized an equal weighting of both the discounted cash flow method of the income approach and the guideline company method of the market approach to estimate the fair value of the Energy and Environmental Solutions reporting unit. The estimates used in the impairment testing were consistent with the discrete forecasts that Applied uses to manage its business, and considered the significant developments that occurred during the quarter. Under the discounted cash flow method, cash flows beyond the discrete forecasts were estimated using a terminal growth rate, which considered the long-term earnings growth rate specific to the Energy and Environmental Solutions reporting unit. The estimated future cash flows were discounted to present value using a discount rate that was the value-weighted average of the reporting unit's estimated cost of equity and debt derived using both known and estimated market metrics, and was adjusted to reflect risk factors that considered both the timing and risks associated with the estimated cash flows. The tax rate used in the discounted cash flow method reflected the international structure currently in place, which is consistent with the market participant perspective. Under the guideline company method, market multiples were applied to forecasted revenues and earnings before interest, taxes, depreciation and amortization. The market multiples used were consistent with comparable publicly-traded companies.

Applied then allocated the fair value of the reporting unit to all of the assets and liabilities of the Energy and Environmental Solutions reporting unit. Based on Applied's analyses, the implied fair value of goodwill was substantially lower than the carrying value of goodwill for the Energy and Environmental Solutions reporting unit. As a result, Applied recorded a $421 million goodwill impairment charge in the fourth quarter of fiscal 2012.

The evaluation of goodwill for impairment requires the exercise of significant judgment. In the event of future changes in business conditions, Applied will be required to reassess and update its forecasts and estimates used in future impairment analyses. If the results of these analyses are lower than current estimates, a material impairment charge may result at that time.

A summary of Applied's purchased technology and intangible assets is set forth below:



	October 28, 2012		October 30, 2011

	(In millions)
Purchased technology, net	$	945	$	127
Intangible assets - finite-lived, net	268		84
Intangible assets - indefinite-lived	142		—
Total	$	1,355	$	211

Details of goodwill and other indefinite-lived intangible assets were as follows:



	October 28, 2012						October 30, 2011
	Goodwill		Other Intangible Assets		Total		Goodwill		Other Intangible Assets		Total

	(In millions)
Silicon Systems Group	$	2,151	$	142	$	2,293	$	381	$	—	$	381
Applied Global Services	1,027		—		1,027		193		—		193
Display	116		—		116		116		—		116
Energy and Environmental Solutions	224		—		224		645		—		645
Carrying amount	$	3,518	$	142	$	3,660	$	1,335	$	—	$	1,335

During fiscal 2012, goodwill and other indefinite-lived intangible assets increased by $2.3 billion due to the acquisition of Varian as discussed in Note 8, Business Combinations, partially offset by the impairment of goodwill recorded in the fourth quarter of fiscal 2012.

In fiscal 2011, Applied negotiated the divestiture of certain assets and determined the trade name, which was included in assets held for sale, to be impaired, and, accordingly, recorded $18 million of impairment charges.

Other intangible assets that are not subject to amortization consist primarily of in-process technology, which will be subject to amortization upon commercialization. The fair value assigned to in-process technology was determined using the income approach based on estimates and judgments regarding risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. If an in-process technology project is abandoned, the acquired technology attributable to the project will be written-off.

Finite-Lived Purchased Intangible Assets

Applied amortizes purchased intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from 1 to 15 years.

Applied evaluates long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. Applied assesses the fair value of the assets based on the amount of the undiscounted future cash flow that the assets are expected to generate and recognizes an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset, plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When Applied identifies an impairment, Applied reduces the carrying value of the group of assets to comparable market values, when available and appropriate, or to its estimated fair value based on a discounted cash flow approach.

Intangible assets, such as purchased technology, are generally recorded in connection with a business acquisition. The value assigned to intangible assets is usually based on estimates and judgments regarding expectations for the success and life cycle of products and technology acquired. Applied evaluates the useful lives of its intangible assets each reporting period to determine whether events and circumstances require revising the remaining period of amortization. In addition, Applied reviews intangible assets for impairment when events or changes in circumstances indicate their carrying value may not be recoverable. Management considers such indicators as significant differences in actual product acceptance from the estimates, changes in the competitive and economic environment, technological advances, and changes in cost structure. In the fourth quarter of fiscal 2012, Applied performed an impairment analysis on the carrying value of its intangible assets and determined that there was no impairment.

Details of finite-lived intangible assets were as follows:



	October 28, 2012									October 30, 2011
	Purchased Technology			Other Intangible Assets			Total			Purchased Technology			Other Intangible Assets			Total

	(In millions)
Gross carrying amount:
Silicon Systems Group	$	1,300		$	252		$	1,552		$	310		$	20		$	330
Applied Global Services	28			44			72			28			40			68
Display	110			33			143			110			33			143
Energy and Environmental Solutions	105			232			337			105			232			337
Gross carrying amount	$	1,543		$	561		$	2,104		$	553		$	325		$	878
Accumulated amortization:
Silicon Systems Group	$	(411	)	$	(36	)	$	(447	)	$	(256	)	$	(8	)	$	(264	)
Applied Global Services	(22		)	(39		)	(61		)	(20		)	(31		)	(51		)
Display	(106		)	(27		)	(133		)	(102		)	(25		)	(127		)
Energy and Environmental Solutions	(59		)	(191		)	(250		)	(48		)	(177		)	(225		)
Accumulated amortization	$	(598	)	$	(293	)	$	(891	)	$	(426	)	$	(241	)	$	(667	)
Carrying amount	$	945		$	268		$	1,213		$	127		$	84		$	211

During fiscal 2012, the change in gross carrying amount of the finite-lived intangible assets was $1.2 billion due to the acquisition of Varian as discussed in Note 8, Business Combinations.

In fiscal 2011, Applied entered into an agreement to divest certain assets held in the Applied Global Services segment and determined certain identified purchased technology and finite-lived intangible assets, which were included in the assets held for sale, to be impaired, and, accordingly, recorded $6 million of impairment charges. The gross carrying amount of the divested amortized intangible assets was approximately $25 million. In fiscal 2010, Applied incurred intangible impairment charges of $31 million related to a plan to restructure its Energy and Environmental Solutions segment.

Details of amortization expense by segment for fiscal 2012, 2011 and 2010 were as follows:



	2012		2011		2010

	(In millions)
Silicon Systems Group	$	183	$	13	$	21
Applied Global Services	9		7		9
Display	7		8		8
Energy and Environmental Solutions	25		24		44
Total	$	224	$	52	$	82

For fiscal 2012, 2011 and 2010, amortization expense was charged to the following categories:



	2012		2011		2010

	(In millions)
Cost of products sold	$	185	$	36	$	63
Research, development and engineering	1		—		1
Selling, general and administrative	38		16		18
Total	$	224	$	52	$	82

As of October 28, 2012, future estimated amortization expense is expected to be as follows:



	Amortization Expense
	(In millions)
2013	214
2014	198
2015	184
2016	175
2017	171
Thereafter	271
Total	$	1,213