ARM Holdings plc Reports Results For The Third Quarter and Nine Months Ended 30 September 2006

CAMBRIDGE, UK, 31 October   2006—ARM Holdings plc [(LSE: ARM); (Nasdaq: ARMHY)] announces its unaudited financial results to 30 September 2006 with total sterling revenues up 15% and normalised EPS up 18% for the first nine months of 2006 compared to the same period in 2005

Highlights

• Record dollar revenue quarter, up 20% to $120.7m

• Sequential dollar revenue growth over strong Q2 in seasonally weaker third quarter

• Record revenue quarter for the Physical IP Division (“PIPD”), up 20% to $25.6m

• Record underlying royalties for PIPD, up 24% sequentially and up 40% on Q3 05

• 26% growth in PD royalty revenue on record unit shipments

• Further Cortex™ family and 65nm physical IP licenses signed in the quarter

• Early in Q4, licensed leading-edge 45nm physical IP to IBM, Samsung and Chartered

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

“Having reported a strong second quarter in July, we are pleased to have achieved record dollar revenues, up 20% year on year, in the third quarter. We continue to execute well on licensing across the business with three more Cortex family licenses and three more 65nm physical IP licenses being signed in the quarter.  Additionally early in Q4, the Physical IP division completed the licensing of leading-edge 45nm technology to IBM, Samsung and Chartered, representing a further significant milestone towards our longer term goal of licensing our Physical IP products on the most advanced processes to the wider semiconductor industry.

With licensing and royalties performing well, we are confident of achieving a solid Q4 in line with current market expectations.”

* Normalised figures are US GAAP before acquisition-related charges and other share-based remuneration charges and profit on disposal of available-for-sale securities. For reconciliation of GAAP measures to normalised non-GAAP measures detailed in this document, see notes 5.1 to 5.26.

Financial review

(US GAAP unless otherwise stated)

Third quarter ended 30 September 2006

¹ Includes catch-up royalties in Q3 2006 of £0.4m ($0.7m) (Q3 2005: nil). 

Total revenues

Total revenues for the third quarter of 2006 amounted to £64.8 million, up 14% versus the same period in 2005. In US dollar terms***, third quarter revenues were $120.7 million, up 20% versus Q3 2005.  The effective US dollar to sterling exchange rate in Q3 2006 was $1.86 compared to $1.78 in Q3 2005.

License revenues

Total license revenues in the third quarter grew by 8% to £27.9 million, representing 43% of group revenues, compared to £25.9 million in Q3 2005 which represented 46% of revenues. License revenues comprised £19.0 million from the Processor Division (“PD”) and £8.9 million from the Physical IP Division (“PIPD”).    In US dollar terms, license revenues grew by 12%.

Royalty revenues

Total royalty revenues in Q3 2006 grew 23% to £26.2 million, representing 40% of group revenues, compared to £21.4 million in Q3 2005, representing 38% of revenues, continuing the long term trend of royalty revenues increasing as a proportion of total group revenue.   

Royalty revenues comprised £21.4 million from PD and £4.8 million from PIPD.   Total PIPD royalties of £4.8 million included £0.4 million of catch-up royalties. In US dollar terms, PD royalties were $40.3 million and PIPD royalties were $9.1 million which represented an increase of 26% and 50% respectively on Q3 last year. 

Development Systems and Service revenues

Sales of development systems in Q3 2006 were £6.5 million, representing 10% of group revenue, compared to £5.8 million in Q3 2005, an increase of 12%. Service revenues in Q3 2006 were £4.2 million, representing 7% of group revenues, compared to £3.6 million in Q3 2005. 

Gross margins

Gross margins for the third quarter, excluding the FAS123(R) charge of £0.2 million (see below), were 87.7%, the same level as in Q3 2005. The gross margin this quarter was lower than the 89.1% reported in Q2 2006, reflecting the higher proportion of group revenues accounted for by the conversion of PIPD order backlog in Q3 and the impact of the weaker dollar on the gross margin of the Development Systems business which has a predominantly sterling cost base.

Operating expenses and operating margin

Total operating expenses in Q3 2006 were £45.7 million compared to £39.1 million in Q3 2005. Total operating expenses of £45.7 million in Q3 2006 include amortisation of intangible assets of £4.6 million (Q3 2005: £4.3 million) and £3.7 million in relation to the fair value of share-based remuneration in accordance with FAS123(R) – “Share-Based Payment”.  The total FAS123(R) charge of £3.9 million in Q3 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 (£0.6 million). As FAS123(R) was 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 Q3 2005. Total operating expenses of £39.1 million in Q3 2005 did, however, include a deferred stock-based compensation charge of £2.8 million. Pro forma income statements for Q3 2006 and Q3 2005 are set out in notes 5.25 and 5.26 below which reconcile US GAAP to the normalised non-GAAP measures referred to in this earnings release.

The commentary on operating expenses below excludes amortisation and share-based remuneration charges. Operating expenses in Q3 2006 were £37.4 million, the same level as in Q2 2006, compared to £32.0 million in Q3 2005. The increase year over year is primarily due to investment in new people. The number of full-time employees has increased by 212 since the start of the year, the majority being added to PIPD and the emerging business units (Data Engines, Embedded Software, Fabrics and Graphics). 30% of new heads have been recruited in our Bangalore Design Centre.

Operating expenses for the nine months year to date are now £109.3(5.24) million and, as previously indicated, are expected to be approximately £150 million in the full year 2006.

Research and development expenses were £15.5 million in Q3 2006, representing 24% of revenues, compared to £15.0 million in Q2 2006 and £13.9 million in Q3 2005. Sales and marketing costs in Q3 2006 were £10.0 million, being 15% of revenues, compared to £9.8 million in Q2 2006 and £8.5 million in Q3 2005. General and administrative expenses in Q3 2006 were £11.9 million, representing 18% of revenues, compared to £12.6 million in Q2 2006 and £9.6 million in Q3 2005.

Normalised operating margin in Q3 2006 was 30.1%(5.1) compared to 32.2%(5.2) in Q2 2006 and 31.3%(5.3)in Q3 2005.Operating margins in Q3 2006 were lower than in Q2 2006 due primarily to the weakening of the US dollar against sterling.

Interest receivable

Interest receivable was £1.7 million in Q3 2006 compared to £1.4 million in Q3 2005.

Earnings and taxation

Income before income tax in Q3 2006 was £12.6 million compared to £12.0 million in Q3 2005. After adjusting for amortisation of intangibles and stock-based compensation, normalised income before income tax in Q3 2006 was £21.2 million(5.6)The group’s effective tax rate under US GAAP in Q3 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. 

compared to £19.1 million(5.8) in Q3 2005, an increase of 11%.  

Third quarter fully diluted earnings per share prepared under US GAAP were 0.67 pence (3.77 cents per ADS****) compared to earnings per share of 0.68 pence (3.61 cents per ADS****) in Q3 2005. Normalised earnings per fully diluted share in Q3 2006 were 1.12 pence(5.19,5.25) per share (6.25 cents per ADS****) compared to 1.05 pence(5.21,5.26) (5.55 cents per ADS****) in Q3 2005.

Balance sheet, cash flow and share buyback

Intangible assets at 30 September 2006 were £422.6 million, comprising goodwill of £364.0 million and other intangible assets of £58.6 million, compared to £366.6 million and £64.8 million respectively at 30 June 2006.

Total accounts receivable increased to £73.1 million at 30 September 2006, comprising £46.6 million of trade receivables and £26.5 million of amounts recoverable on contracts, compared to £72.0 million at 30 June 2006, comprising £47.2 million of trade receivables and £24.8 million of amounts recoverable on contracts. Days sales outstanding (DSOs) were 52 at 30 September 2006 compared to 49 at 30 June 2006 and 54 at 31 December 2005. Payments received shortly after the end of the quarter brought DSOs down to 44. Deferred revenues were £33.6 million at 30 September 2006 compared to £28.3 million at 30 June 2006.

In Q3 2006, the Company purchased 18.5 million shares at a total cost of £21.5 million.  Over the past 2 quarters, ARM has returned more than £43 million to shareholders via the buyback program, representing 65% of the total returned to shareholders via this program since its inception in July 2005. Partly as a result of the share buyback, the fully diluted shares in issue have reduced from 1,431 million in Q4 2005 to 1,396 million in Q3 2006. We intend to resume the buyback program after the publication of these results.

Net cash at 30 September 2006 was £147.4(5.11) million compared to £148.8(5.12) million at 30 June 2006.

Current trading and prospects

Strong licensing and royalty momentum enabled us to grow dollar revenues 20% in Q3, building on the progress made in the first half of 2006. Further, we enter Q4 with a healthy opportunity pipeline for licensing across the portfolio.

With licensing and royalties performing well, we are confident of achieving a solid Q4 in line with current market expectations.

Operating review

PD licensing

14 processor licenses were signed in Q3 2006 bringing the total cumulative number of licenses signed to 448. Licensing activity in the quarter again demonstrated a good mix between our newer and more mature technologies. We signed a total of five licenses to Cortex and ARM11 family processors, being three multi-use upgrades to the newly-released Cortex-R4 product and two multi-use upgrades to ARM11™ family processors.

Of the other nine licenses, seven were for ARM9™ family processors including four per-use licenses to new partners.  Three further ARM9 family licenses were signed as derivative licenses, one being a term license and two being per-use licenses. Two derivative licenses were signed for ARM7TM family processors, being one multi-use license and one per-use license.      

PD royalties

ARM partners shipped 621 million units in Q2 2006 (we report royalties one quarter in arrears), up 53% on the comparable period last year and up 12% sequentially.  This significant volume growth was driven primarily by products incorporating lower-priced chips including ultra low-cost handsets, connectivity semiconductors such as Bluetooth and WiFi, smartcards and microcontrollers. As a result, the 26% year-on-year growth in dollar royalty revenues was achieved with an average royalty rate of 6.5 cents per unit, compared to 7.2 cents per unit last quarter.

Of total shipments of 621 million, 37% related to units based on ARM9 family technology, including 12% relating to shipments of ARM926™ processor-based products, and just under 1% from the ARM11family technology (up 42% sequentially). As at the end of Q3, 70 of our 187 semiconductor partners are shipping ARM technology-based products. The mobile and non-mobile segments accounted for 67% and 33% of total shipments respectively. 

PIPD licensing

In Q3, ARM signed a further 20 licenses for physical IP bringing the total number of licenses to 263.  Of the 20 licenses, four were platform licenses to foundries consisting of three 65nm AdvantageTM Platforms and one 90nm ClassicTM Platform.  This brings the total number of physical IP platforms licensed to foundries and integrated device manufacturers (IDMs) to 79 and the total number of platform licenses at 65nm to 14. 

The remaining 16 licenses were end-user licenses consisting of seven standard cell libraries (one Advantage at 90nm, three Classic at 130nm, and two MetroTM and one Classic at 180nm), three memory compilers (two Classic at 130nm and one Classic at 180nm), and six VelocityTM high speed PHYs at 90nm. This brings the total number of end-user licenses for these technologies to 184.

In October 2006, ARM announced the licensing of leading edge 45nm technology to IBM, Samsung and Chartered.  There are now seven 45nm licensees in total, including one with TSMC.  The licensing of 45nm technology to the world’s leading semiconductor foundries and ASIC service providers is further proof of the attractiveness of ARM physical IP products at leading edge process technologies.  In conjunction with the traditional physical IP business, this also positions ARM to enable the leading IDMs and big fabless chip companies to outsource their physical IP development to ARM in due course.

PIPD royalties

PIPD royalties in Q3 were $9.1 million compared to $6.0 million in Q3 2005, representing a 50% increase. Q3 2006 royalties included catch-up royalties of approximately $0.7 million, giving underlying royalties in the quarter of $8.4 million, a record underlying royalty quarter for the PIPD business.  Growth of underlying royalties of 40% versus Q3 2005 and 24% sequentially is indicative of the increased penetration and use of ARM physical IP in chip designs.

Acquisition of Soisic SA

In October 2006, ARM has acquired Soisic SA, a leading company in physical IP based on Silicon on Insulator (SOI) technology.  The company has offices in Grenoble, France and Santa Clara, California. At the same time we have entered into a joint development agreement with SOITEC, the world’s leading innovator and provider of SOI substrates, to support our future development of SOI libraries for the fabless/foundry arenas. 

The acquisition of SOI technology adds a new capability to ARM’s physical IP portfolio, offering the potential to address the power and performance scaling issues associated with traditional bulk CMOS processes as they migrate to ever smaller geometries.  Soisic has helped some of the world’s leading companies to begin their SOI development and to use SOI for low power applications. We believe that SOI technology will play an increasing role in extracting the performance increases and power savings required to make new generation mobile, home and enterprise applications economically viable.

Development Systems

Development Systems dollar revenues in Q3 2006 were $12.1 million, up 17% from $10.3 million in Q3 2005. In the quarter, Development Systems achieved a record bookings quarter, reflecting the desire of a growing number of customers to enter into long-term commercial and technical relationships for Development Systems products.   

Backlog

Group order backlog was lower at the end of Q3 than at the half year, due partly to higher conversion of PIPD backlog into revenue in the third quarter. However, after a strong start to licensing activity across the business in the early weeks of Q4, group order backlog has now returned to the half-year level. Most of the licenses signed early in Q4 were for newer technologies and therefore we have not changed our license revenue expectations for Q4.

People

At 30 September 2006 we had 1,536 full-time employees compared to 1,471 at the end of Q2 2006.  At 30 September 2006, the group had 620 employees based in the UK, 552 in the US, 136 in Continental Europe, 178 in India and 50 in the Asia Pacific Region. 

Board changes

As announced in May this year, Sir Robin Saxby retired from the board on 1 October 2006, when he became President of the Institute of Engineering and Technology (IET). During his year as President of the IET he will remain associated with ARM as Chairman Emeritus.

He was succeeded as Chairman by Doug Dunn, who joined the board in December 1998 as an independent non-executive director. Mr Dunn was previously President and Chief Executive Officer of ASM Lithography Holding N.V. until his retirement in December 2004. He is a non-executive director of ST Microelectronics N.V., Soitec S.A., LG. Philips LCD Co. Ltd and TomTom NV.  

Kathleen O'Donovan will join the board as an independent non-executive director and a member of the Audit Committee on 7 December 2006.  She is a non-executive director and Chairman of the Audit Committees of Prudential plc and Great Portland Estates PLC and a non-executive director of EMI Group plc.  She is also Chairman of the Invensys Pension Scheme.  Previously she was a non-executive director and Chairman of the Audit Committee of the Court of the Bank of England and a non-executive director of O2 plc.  Prior to that, she was Chief Financial Officer of BTR and Invensys and before that she was a partner at Ernst & Young.There are no further details required to be disclosed under paragraph 16.4 of the Listing Rules.

Legal matters

Nazomi

In May 2002, Nazomi Communications, Inc. (“Nazomi”) filed suit against ARM alleging wilful infringement of Nazomi’s US Patent No. 6,332,215 ("'215 Patent").  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.  In September 2004, the Court of Appeals for the Federal Circuit heard the appeal and issued its decision in 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 in October 2005 to decide the construction of a fundamental term in the '215 Patent and a decision on claim construction was delivered on 6 September 2006. The decision emphatically supports ARM's construction of the relevant term and consequently strongly supports ARM's non-infringement arguments. Based on this decision, ARM is now pursuing the necessary steps to obtain a final ruling that ARM’s technology does not infringe the ‘215 patent.

TPL Group

In October 2005, Technology Properties Limited, Inc. (“TPL”)  filed suit, in the United States District Court for the Eastern District of Texas (Marshall Division), against certain companies in the Fujitsu, Matsushita, NEC and Toshiba groups of companies alleging infringement of TPL’s US Patents Nos. 5,809,336; 5,784,584 and 6,598,148 (the “Litigation”). All of the defendants are licensees of various ARM technologies. It was revealed as part of the preliminary infringement contentions in the Litigation, filed in July 2006, that certain ARM technology is alleged to infringe a single claim in US Patent No. 5,784,584 (the "'584 Patent"). In September 2006 ARM filed a motion to intervene in the Litigation and that motion has been granted; ARM is now a defendant party in the Litigation. The claim construction (or “Markman”) hearing is scheduled for May 2007 and the trial date is scheduled for November 2007. Based on legal advice and written opinions received from external counsel, ARM is confident that the accused ARM technology does not infringe any of the claims of the '584 Patent or that the patent is invalid. ARM has voluntarily joined as a party to the Litigation to proactively defend its technology against ill conceived and false infringement allegations and fully expects to prove the case for non-infringement or invalidity in the course of the Litigation.

ARM Holdings plc Q3 2006 Earnings Release Financial Tables (43Kb PDF)

About ARM

ARM designs the technology that lies at the heart of advanced digital products, from mobile, home and enterprise solutions to embedded and emerging applications. ARM’s comprehensive product offering includes 16/32-bit RISC microprocessors, data engines, graphics 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.