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 purchase price 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 considers 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.

To test goodwill for impairment, Applied first performs 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, Applied then performs 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 determines the fair value of each of its reporting units based on a weighting of income and market approaches. If the carrying value of a reporting unit exceeds its fair value, Applied would then perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If Applied determines that the carrying value of a reporting unit’s goodwill exceeds its implied fair value, Applied would record an impairment charge equal to the difference.

As of July 31, 2016, Applied's reporting units include Transistor and Interconnect Group, Patterning and Packaging Group, and Imaging and Process Control Group, which combine to form the Semiconductor Systems reporting segment, Applied Global Services, and Display and Adjacent Markets.

Effective in the third quarter of fiscal 2016, Applied began to account for its roll-to-roll web coating systems (previously included in the Energy and Environmental Solutions segment) and display upgrade equipment (previously included in the Applied Global Services segment) under the Display and Adjacent Markets segment (previously Display). See Note 14, Industry Segment Operations. These changes did not affect the Semiconductor Systems reporting segment.

Due to this change, Applied performed a goodwill impairment test for Applied Global Services and Display and Adjacent Markets immediately before the changes in the composition of the segments, reallocated $31 million of goodwill from Applied Global Services associated with the display upgrade equipment business to Display and Adjacent Markets based on the estimated relative fair value of each business unit and, then performed another goodwill impairment test for Applied Global Services and Display and Adjacent Markets after the change. There was no goodwill associated with the roll-to-roll web coating systems business. Prior period information in the tables below has been reclassified to conform to current presentation, which reflects the new organizational structure.

In performing the goodwill impairment test, Applied utilized both the discounted cash flow method (weighted 75%) and the guideline company method (weighted 25%) to estimate the fair value of the reporting units. The estimates used in the impairment testing were consistent with the discrete forecasts that Applied uses to manage its business, and considered any significant developments that occurred during the quarter. Under the discounted cash flow method, cash flows beyond the discrete forecast were estimated using a terminal growth rate, which considered the long-term earnings growth rate specific to the reporting units. The estimated future cash flows were discounted to present value using each reporting unit's weighted average cost of capital. The weighted average cost of capital measures a reporting unit's cost of debt and equity financing weighted by the percentage of debt and equity in a reporting unit's target capital structure. In addition, the weighted average cost of capital was derived using both known and estimated market metrics, and was adjusted to reflect both the timing and risks associated with the estimated cash flows. The tax rate used in the discounted cash flow method was the median tax rate of comparable companies which reflected Applied's current international structure, 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 and considered each reporting unit's size, growth and profitability relative to its comparable companies. Based on Applied's analysis, the estimated fair value exceeded the carrying value for Applied Global Services and Display and Adjacent Markets segments before and after the change in their compositions, and therefore, the second step of the goodwill impairment test was not required.

The evaluation of goodwill and intangible assets 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 future analyses are lower than current estimates, a material impairment charge may result at that time.

Details of goodwill and other indefinite-lived intangible assets as of July 31, 2016 and October 25, 2015 were as follows:



	July 31, 2016						October 25, 2015
	Goodwill		Other Intangible Assets		Total		Goodwill		Other Intangible Assets		Total

	(In millions)
Semiconductor Systems	$	2,151	$	—	$	2,151	$	2,151	$	—	$	2,151
Applied Global Services	999		5		1,004		996		5		1,001
Display and Adjacent Markets	155		20		175		155		20		175
Carrying amount	$	3,305	$	25	$	3,330	$	3,302	$	25	$	3,327

From time to time, Applied makes acquisitions of and investments in companies related to existing or new markets for Applied.

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 taking into account 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.

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



	July 31, 2016		October 25, 2015

	(In millions)
Purchased technology, net	$	450	$	575
Intangible assets - finite-lived, net	146		162
Intangible assets - indefinite-lived	25		25
Total	$	621	$	762

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 environments, technological advances, and changes in cost structure.

Details of finite-lived intangible assets were as follows:



	July 31, 2016									October 25, 2015
	Purchased Technology			Other Intangible Assets			Total			Purchased Technology			Other Intangible Assets			Total

	(In millions)
Gross carrying amount:
Semiconductor Systems	$	1,449		$	252		$	1,701		$	1,449		$	252		$	1,701
Applied Global Services	28			44			72			28			44			72
Display and Adjacent Markets	113			36			149			113			36			149
Corporate and Other	2			9			11			1			9			10
Gross carrying amount	$	1,592		$	341		$	1,933		$	1,591		$	341		$	1,932
Accumulated amortization:
Semiconductor Systems	$	(1,001	)	$	(109	)	$	(1,110	)	$	(876	)	$	(95	)	$	(971	)
Applied Global Services	(27		)	(44		)	(71		)	(26		)	(44		)	(70		)
Display and Adjacent Markets	(113		)	(34		)	(147		)	(113		)	(34		)	(147		)
Corporate and Other	(1		)	$	(8	)	(9		)	(1		)	(6		)	(7		)
Accumulated amortization	$	(1,142	)	$	(195	)	$	(1,337	)	$	(1,016	)	$	(179	)	$	(1,195	)
Carrying amount	$	450		$	146		$	596		$	575		$	162		$	737

Details of amortization expense by segment were as follows:



	Three Months Ended				Nine Months Ended
	July 31, 2016		July 26, 2015		July 31, 2016		July 26, 2015

	(In millions)
Semiconductor Systems	$	47	$	45	$	139	$	132
Applied Global Services	—		—		1		1
Display and Adjacent Markets	—		1		—		3
Corporate & Other	—		—		2		2
Total	$	47	$	46	$	142	$	138

Amortization expense was charged to the following categories:



	Three Months Ended				Nine Months Ended
	July 31, 2016		July 26, 2015		July 31, 2016		July 26, 2015

	(In millions)
Cost of products sold	$	42	$	40	$	126	$	120
Research, development and engineering	—		1		1		1
Marketing and selling	5		5		15		15
General and administrative	—		—		—		2
Total	$	47	$	46	$	142	$	138

As of July 31, 2016, future estimated amortization expense is expected to be as follows:



	Amortization Expense
	(In millions)
2016 (remaining 3 months)	$	47
2017	187
2018	185
2019	44
2020	39
Thereafter	94
Total	$	596