ARM Holdings plc - Results For The Quarter Ended 31 March 2006

CAMBRIDGE, UK, 19 April 2006 — ARM Holdings plc [(LSE: ARM); (Nasdaq: ARMHY)] announces its unaudited financial results for the first quarter ended 31 March 2006 with total sterling revenues up 17% and normalised EPS up 34% compared to Q1 2005.

Financial Highlights – Q1 2006

• Total revenues £64.6m (Q1 2005: £55.0m) up 17%
• Record normalised operating margin 35.6% (Q1 2005: 32.4%)
• Normalised income before tax £24.7m (Q1 2005: £18.9m) up 31%
• Normalised EPS 1.27p (Q1 2005: 0.95p) up 34%
• £7m returned to shareholders via rolling share buyback program

Operating Highlights – Q1 2006

• Long-term technology agreement signed with TSMC for physical IP at leading-edge process nodes
• Record 572 million ARM Powered® products shipped, up 47% on comparable period last year
• Unit growth in non-mobile segments at 68% continues to outpace growth in mobile at 37%
• Record underlying PIPD royalties of £4.5 million
• 15 processor and 9 physical IP licenses signed in the quarter
• Order backlog flat sequentially at quarter end
• Order backlog today higher than at start of year following early Q2 licensing activity
• Development Systems revenues up 38%

Commenting on the first quarter, Warren East, Chief Executive Officer, said:

“We have seen encouraging activity in both licensing and royalties this quarter.  Interest in our new Cortex family of processors continues to grow with a further license signed in Q1 and a number of licensing discussions in progress. Our first license agreement for the most advanced (45nm) process technology has further strengthened our position as a leading provider of physical IP. We continued to extend our market penetration across the span of digital products with royalty units increasing 47% compared to the same period last year. Q1’s result further underpins our confidence that ARM will achieve another strong performance in 2006 in line with current market expectations.”

Tim Score, Chief Financial Officer, added:

“Year-on-year growth in revenue and earnings per share of 17% and 34% respectively has again yielded strong cash generation in the quarter. With royalty revenues continuing to grow as a proportion of total revenues, operating margin and cash flow are expected to increase, leaving us well-placed both to invest in the innovative technology that drives future growth in licensing revenue and to continue the return of cash to shareholders through share buybacks and dividends.” 

Q1 2006 - Finanical Summary and Revenue Summary Tables (14Kb PDF)

Current trading and prospects
During Q1, we have continued to see strong interest across the range of products in our technology portfolio, including the new processor and physical IP technology that ARM is bringing to market. As well as signing a strategically important long-term technology license for 65nm and 45nm processes with TSMC, we also signed a significant number of license agreements for a wide range of processor cores.  With a healthy sales pipeline for licensing across the business, ongoing momentum in royalties and continued growth in development systems sales, we remain confident in achieving another strong performance in 2006 in line with current market expectations.

CONTACTS:

                                        
* Normalised figures are before acquisition-related charges and other share-based remuneration charges. For reconciliation of GAAP measures to normalised non-GAAP measures detailed in this document, see notes 5.1 to 5.18.
** Before dividends, net cash inflow from share option exercises and share buybacks and acquisition consideration - see notes 5.11 to 5.14.
*** Dollar revenues are based on the group’s actual dollar invoicing, where applicable, and using the rate of exchange applicable on the date of the transaction for invoicing in currencies other than dollars.  Approximately 95% of invoicing is in dollars.
**** Each American Depositary Share (ADS) represents three shares.
 
Financial review
(US GAAP unless otherwise stated)

First quarter ended 31 March 2006

Total revenues
Total revenues for the first quarter of 2006 amounted to £64.6 million, up 17% versus the same period in 2005. In US dollar terms***, first quarter revenues were $112.9 million with an effective US dollar to sterling exchange rate in Q1 2006 of $1.75 compared to $1.88 in Q1 2005.

License revenues
Total license revenues in the first quarter were £25.2 million, representing 39% of group revenues, compared to £24.7 million in Q1 2005. License revenues comprised £17.3 million from the Processor Division (“PD”) and £7.9 million from the Physical IP Division (“PIPD”).

Royalty revenues
Total royalty revenues in Q1 2006 were £28.1 million, representing 44% of total group revenues, compared to £20.9 million in Q1 2005, an increase of 35%. Royalty revenues comprised £23.2 million from PD and £4.9 million from PIPD. Within the total of £23.2 million for PD royalties, there was approximately £1.1 million of catch-up royalties, giving underlying royalties of £22.1 million (approximately $39 million). Total PIPD royalties of £4.9 million included £0.4 million of catch-up royalties. 

Development Systems and Service revenues
Sales of development systems in Q1 2006 were £7.9 million, representing 12% of total group revenue, compared to £5.8 million in Q1 2005, an uplift of 38%. Service revenues in Q1 2006 were £3.4 million, representing 5% of total group revenues, compared to £3.6 million in Q1 2005. 

Gross margins
Gross margins for the first quarter, excluding the FAS123(R) charge of £0.2 million (see below), were 89.0% compared to 88.5% in Q1 2005. The positive impact on gross margin arising from the higher proportion of total revenues made up by royalties (44% in Q1 2006 compared to 38% in Q1 2005) is partially offset by the higher proportion of revenues represented by development systems and by the higher proportion of total PIPD costs charged to cost of revenues in Q1 2006.  

Operating expenses and operating margin
Total operating expenses in Q1 2006 are £42.8 million compared to £37.2 million in Q1 2005. Total operating expenses of £42.8 million in Q1 2006 include amortisation of intangible assets of £4.6 million (Q1 2005: £4.0 million) and £3.8 million in relation to the fair value of share-based remuneration in accordance with FAS123(R) – “Share-Based Payment”. As FAS123(R) is effective for the first time in Q1 2006 and as ARM is applying the standard on the “modified prospective” basis, there is no directly equivalent charge in Q1 2005. Total operating expenses of £37.2 million in Q1 2005 did, however, include a deferred stock-based compensation charge of £2.4 million.

The total FAS123(R) charge of £4.0 million in Q1 2006 is included within cost of revenues (£0.2 million), research and development (£2.3 million), sales and marketing (£0.8 million) and general and administrative (£0.7 million). The commentary on operating expenses below excludes amortisation and share-based remuneration charges.

Operating expenses in Q1 2006 were £34.5 million compared to £35.0 million in Q4 2005 and £30.8 million in Q1 2005. The sequential reduction is partly due to a net gain arising from foreign exchange impacts in Q1 2006 compared to a net loss in Q4 2005.

Research and development expenses were £15.1 million in Q1 2006, representing 23% of revenues, compared to £14.7 million or 27% of revenues in Q1 2005. Sales and marketing costs in Q1 2006 were £9.4 million, being 15% of revenues, compared to £8.3 million or 15% of revenues in Q1 2005. General and administrative expenses in Q1 2006 were £10.0 million, representing 15% of revenues, compared to £7.8 million or 14% of revenues in Q1 2005.

Record normalised operating margin was achieved in Q1 2006 at 35.6%(5.1) compared to 32.4%(5.3) in Q1 2005. 

Interest receivable
Interest receivable increased to £1.7 million in Q1 2006 compared to £1.0 million in Q1 2005, due to higher average cash balances.

Earnings and taxation
Income before income tax in Q1 2006 was £16.1 million compared to £12.5 million in Q1 2005. Normalised income before income tax in Q1 2006 was £24.7 million(5.5) compared to £18.9 million(5.7) in Q1 2005.  The group’s effective tax rate under US GAAP in Q1 2006 was 25.7% reflecting the availability of research and development tax credits and taking into account the benefits arising from the structuring of the Artisan acquisition. 

First quarter fully diluted earnings per share prepared under US GAAP were 0.8 pence (4.4 cents per ADS****) compared to earnings per share of 0.6 pence (3.6 cents per ADS****) in Q1 2005. Normalised earnings per fully diluted share in Q1 2006 were 1.27 pence(5.15) per share (6.6 cents per ADS****) compared to 0.95 pence(5.17) (5.4 cents per ADS****) in Q1 2005.
 
Balance sheet and cash flow
Intangible assets at 31 March 2006 were £448.6 million, comprising goodwill of £381.7 million and other intangible assets of £66.9 million, compared to £385.6 million and £72.3 million respectively at 31 December 2005. Goodwill is no longer amortised under US GAAP, but is subject to review for impairment on at least an annual basis.  The intangible assets from acquisition are being amortised through the profit and loss account over a weighted average period of five years. 

Accounts receivable increased to £61.0 million at 31 March 2006 from £55.5 million at 31 December 2005. The allowance against receivables was £2.5 million at 31 March 2006 compared to £2.2 million at 31 December 2005. Deferred revenues were £25.2 million at 31 March 2006 compared to £20.4 million at 31 December 2005.

After net cash generation of £17.3 million(5.11) in Q1 2006, total cash, cash equivalents, short-term investments and marketable securities amounted to £182.3 million(5.9) at 31 March 2006.

Share buyback program
In Q1 2006, the Company purchased 5,150,000 shares at a total cost of £7.0 million. It is anticipated that the buyback program will resume after the announcement of these results.

Operating review

Backlog
At the end of Q1 2006, group order backlog was flat sequentially with the PIPD portion of the backlog up again on the record level reported at the end of last quarter. Due to licensing activity early in Q2, including an additional license being signed for the Cortex-A8 product, group order backlog is now higher than at the beginning of the year. Whilst a small proportion of the revenue from the Cortex-A8 processor license will be recognisable in Q2, the majority will be recognised in future quarters.

PD licensing
15 licenses for microprocessors were signed in Q1 2006 bringing the total cumulative number of licenses signed to 413.  The mix of licenses signed in the quarter demonstrated a healthy demand for our technologies across the portfolio of processor cores, from the ARM7™ family to our latest technology, the Cortex family.  Of the 15 licenses, five new partners took one license each: one per-use license for the ARM7TDMI® processor, two per-use licenses for the ARM946E-S^TM processor and two licenses for the ARM926EJ-S^TM processor.

The remaining 10 licenses were signed with 8 of our existing partners, comprising four upgrade licenses and six derivative licenses.  The four upgrade licenses comprised one per-use license for the ARM922T^TM , one term license for the ARM968E-S^TM processor, one license for the ARM1176JZ(F)-S^TM processor,  and one term license for our latest Cortex technology, code named “Serval-E”.  The six derivative licenses consisted of one per-use license for the ARM7TDMI processor, one license for  the ARM7TDMI-S^TM processor, two term licenses for the ARM926EJ-S processor, one license for the ARM11^TM MPCore^TM processor and one license for the ARM1176JZ(F)-S processor.

During the quarter, two significant announcements were made by ARM partners introducing new lines of products based on our Cortex family of processors. Firstly, at 3GSM, Texas Instruments introduced their OMAP™ 3 line of application processors that incorporate the Cortex-A8 processor (Texas Instruments New OMAP™ 3 Architecture Will Spark Development of a New Class of Mobile Phone, 14 Feb 2006). This represents the first announced product to use the Cortex-A8 processor. It is expected to sample before the end of the year with volume production commencing in 2007. Secondly, Luminary Micro’s announcement of their Stellaris^TM family of 32-bit microcontrollers (Luminary Micro Announces 32-bit Microcontrollers for $1 - First to Launch Products Based on the ARM Cortex-M3 Processor, 27 Mar 2006), represents the first product to be announced using the Cortex-M3 processor.  Products within the Stellaris family are available today and address the needs of low cost embedded applications migrating to 32-bit technology.
     
PD royalties
ARM partners shipped 572 million units in Q4 2005 (we report royalties one quarter in arrears), up 47% on the comparable period last year. Of those unit shipments, 35% related to units based on ARM9™ family technology and 2% related to products based on the SecurCore^TM family of processors. Shipments of ARM926 processor-based product accounted for 9% of total shipments. By the end of Q4 2005 more than 2 million ARM11-based products had been shipped, representing the newest ARM technology to ship in any meaningful volume. Shipments of ARM11 family-based products are expected to increase gradually throughout 2006.  One new partner commenced shipping ARM technology-based products in Q4 2005 bringing the total number of shippers to 69.

The mobile and non-mobile segments accounted for 63% and 37% of total shipments respectively in Q1 2006, compared to 67% and 33% in Q1 2005. Non-mobile growth of 68% versus the same period in 2005 continues to outpace the growth of mobile shipments due primarily to increased shipments of applications such as hard disk drives, home networking devices, printers, smartcards and microcontrollers. The average royalty rate (“ARR”) of 7.2 cents was marginally down on the 7.3 cents reported in Q4 2005 due to strong growth in certain lower cost product categories including low cost mobile handsets and Bluetooth products as well as smartcards and microcontrollers.

PIPD licensing
In Q1, ARM signed a further nine licenses for Physical IP bringing the total number of licenses to 219.  Of the nine licenses, three were for platform licenses to two foundries consisting of a 130nm Classic Platform and a long-term technology agreement for physical IP on the leading edge 65nm and 45nm processes with Taiwan Semiconductor Manufacturing Company (TSMC).  This represents a significant milestone, being the first announcement of a foundry planning to offer ARM Physical IP for the 45nm processor node.  It also serves to enhance the long term commercial relationship between ARM and TSMC. This brings the total number of physical IP platforms licensed to foundries and IDMs to 70. 
 
The remaining six licenses were end-user licenses consisting of one 250nm Classic memory compiler, one 180nm Metro™ cell library, two 130nm Metro™ cell libraries and two 90nm Velocity high speed PHYs.  This brings the total number of end-user licensees for these technologies to 149.
 
PIPD royalties
Record underlying royalties of £4.5 million (approximately $7.8 million) were up 22% sequentially (Q4 2005: £3.7m). This further sequential growth in underlying royalty revenues results both from the strengthening trend in wafer pricing and capacity in Q4 2005 and the growing number of designs being manufactured by our foundry partners.

Development Systems
In Q1 2006, we introduced the first synergistic product combining the technology acquired with Keil in Q4 2005 with our existing tools technology. The ARM RealView® Microcontroller Development Kit (RVMDK) was launched to facilitate the migration of microcontroller development from 8-bit to ARM technology-based 32-bit microcontrollers. In the quarter, there were approximately 10,000 downloads of the free trial version of the product, giving us confidence that incremental sales will accrue in future quarters.

Further, at the end of Q1, we introduced the next generation of our market-leading tools technology, the ARM RealView Development Suite version 3.0 for end-to-end pre-silicon development. Version 3.0 incorporates many enhancements which we expect to serve as a catalyst for both existing ARM customers to upgrade their ARM development tools and for new customers to engage with ARM. We have also seen increasing traction for our Electronic System Level (“ESL”) design tools illustrated by the announcement in Q1 that Renesas has adopted ARM ESL tools for system-on-chip (“SoC”) development.

People
At 31 March 2006 we had 1,371 full time employees compared to 1,324 at the end of 2005. Of the net increase in headcount of 47 in Q1, 20 occurred in our Bangalore Design Centre. At 31 March 2006, the group had 588 employees based in the UK, 499 in the US, 101 in Continental Europe, 136 in India and 47 in the Asia Pacific Region.

Legal matters
In May 2002, Nazomi Communications, Inc. (“Nazomi”) filed suit against ARM alleging willful infringement of Nazomi’s US Patent No. 6,332,215.  ARM answered Nazomi’s complaint in July 2002 denying infringement.  ARM moved for summary judgment and a ruling that the technology does not infringe Nazomi’s patent.  The United States District Court for the Northern District of California granted ARM’s motion, and Nazomi appealed the District Court’s ruling.  On 7 September 2004, the Court of Appeals for the Federal Circuit heard the appeal and issued its decision on 11 April 2005.  Because, in the opinion of the Court of Appeals for the Federal Circuit, the District Court did not construe the disputed claim term in sufficient detail for appellate review, the Court of Appeals for the Federal Circuit remanded the dispute back to the District Court for further analysis.  A supplementary “Markman” hearing was held on 11 October 2005 and we are presently awaiting the ruling of the District Court.  Based on legal advice received to date, ARM has no cause to believe that the effect of the original ruling by the District Court will not be upheld.

Download ARM Holdings plc Q1 2006 Results Tables  (34Kb PDF)

ARM designs the technology that lies at the heart of advanced digital products, from wireless, networking and consumer entertainment solutions to imaging, automotive, security and storage devices. ARM's comprehensive product offering includes 16/32-bit RISC microprocessors, data engines, 3D processors, digital libraries, embedded memories, peripherals, software and development tools, as well as analog functions and high-speed connectivity products. Combined with the company's broad Partner community, they provide a total system solution that offers a fast, reliable path to market for leading electronics companies. More information on ARM is available at http://www.arm.com/