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Executives

Simon Segars - President, Chief Executive Officer, Executive Director

Tim Score - Chief Financial Officer, Executive Director

Analysts

Didier Scemama - Merrill Lynch

Sumant Wahi - Redburn Partners

Francois Meunier - Morgan Stanley

Nick James - Numis

Simon Schafer - Goldman

Achal Sultania - Crédit Suisse

Janardan Menon - Liberum Capital

Jerome Ramel - Exane BNP Paribas

ARM Holdings, plc (ARMH) Q2 2013 Earnings Call July 24, 2013 4:30 AM ET

Simon Segars

Okay. Good morning everyone. Thanks for joining us today and welcome to ARM's Q2 and H1 2013 results. Before we start, I would like to direct you to the customary cautionary statements which I am sure you are all very familiar with and we can take that as right.

What I am going to do today is talk about some of the progress we are making towards our strategic goals. Tim is going to talk through the detail behind the numbers. But let me, before we start, just give you some of the highlights. So Q2 was a very strong quarter for ARM, driven by very strong licensing result. We licensed 25 processor licenses, 70 Mali licenses and this is really driven by leaders in the semiconductor industry, connecting to ARM into the long range roadmaps.

Royalties also grew strongly, 24% year-on-year growth significantly outperforming the industry which only grew by 2% in the same time period. What that leads to is total revenues of $264 million and that enables us to continue investing in our roadmaps in hiring people to drive our R&D, also at the same time delivering profits and cash and being able to increase our dividend return to our shareholders. So we are very pleased with the way Q2 has developed.

What I am going to do now, is look at some of the key markets and progress that we have made starting by looking at smartphones. At the beginning of the year, we were forecasting a very strong growth for us mark-by-market anticipating about a 1 billion units in additional sales through the year and it was seen from the industry statistics gathered so far that we are pretty much on track to deliver against that.

Smartphones themselves, of course, of not just one type of device, we are seeing a hearing of smartphones. We have premium super phones. We have mid-range devices and we have a low cost entry-level phones. You need to look at each of these markets separately when considering the smartphone space.

At the high-end, we have seen in the quarter the first big.LITTLE devices actually on sale and delivering great performance and low power. Recently, we have just seen Samsung announce the second device based on big.LITTLE, the 5420, also incorporating Mali T628 in a 6-4 configuration. So another device based around big.LITTLE technology.

The mid range, we see as particularly interesting space with just high growth potential for that market. We see that growing to over 0.5 billion units out in 2017. At COMPUTEX in June, we launched a family of product specifically targeted at that market. We launched the Cortex-A12 which we have four licenses now, the Mali-T622 and the Mali-V500 which is a video accelerator. Together those processors form a very power efficient processing sub-system which we think is ideally suited for mid-range phones.

At the low-end, in entry-level phones, we are seeing greater adoption of Cortex-A and Mali which together are providing high processing performance giving a great user experience even though the device itself might be next to sophisticated than some other products. So smartphones performing very well.

Now what we are seeing across the range is an increasing attach rate of Mali. So in the entry level, in the mid range and in the high end, all we are seeing devices contain Mali as well. That's led to a very strong unit shipments of our Mali graphics processor through the year. So far in 2013, unit shipments have already outpaced all of 2012. So a round of very strong growth through this year.

Now, smartphone market itself, as I said is developing in quite interesting ways, and it's easy to think that everybody on the planet has a smartphone, but actually when you look at global penetration of smartphones it's actually quite low.

This is industry data that we have taken for 2012 and you are seeing developed regions such as North America and Europe a smartphone penetration around 50%, but in other countries, in other regions of the world, much lower.

The portfolio of technology the ARM is producing allows devices to be built at different performance points, different price points, to allow smartphone penetration globally to increase by having the right product for the right economics of a given market.

We are particularly excited by growth in the entry-level phones, the low cost devices. And, although, many people say these are a bad thing, actually we see this as a very good thing, because it enables many more people, billions of people to get access to smartphone, which they just wouldn't be able to if the industry only produce very high cost premium phones.

So, smartphone penetration, say, across the world is quite low. If you look at Russia, Russia has got a population of over 140 million people and penetration there is only about 9%, very low.

When you look forward to 2017, just taking Russia's example, we see smartphone penetration going up to 70%. That's about another 85 million people getting access to smartphones.

When you consider that the average monthly income there is about $800, clearly few people are going to spend $600, $700 on a smartphone. Penetration there is only going to increase through the availability of low cost devices and we are designing products specifically to address those expanding markets.

If you look at 2017 as a whole, we see growing smartphone usage in all areas of the world. And in very large populous countries, we are seeing significant increase in use of the technology.

China and Brazil, we are seeing roughly a doubling of smartphone usage. And in India, you are seeing a factor of 10 increased from 4% today to about 40% out in 2017. Even if you factor out increased population in that time period, is about another 0.5 billion people using smartphones.

Now, as I said that wouldn't happen without the availability of low cost devices, so we wouldn't have access to this additional market without progress in that technology space. To understand that bit further about what's going on behind it, we need to look at some of the silicon content and the devices themselves.

So, here we have that bar graph showing 2017 breakdown of devices from premium phones, mid-range and entry-level compared to today in 2012; and you see significant growth there. When you look at the devices at the entry-level, we are expecting phones at below $200, probably significantly below $200 containing multi-core processes, Mali GPUs and build on silicon, potentially using our physical IP as well.

In the mid-range where the price goes up anything up to about $400, we would start to see big.LITTLE processors adding GPU compute, so there are numerous algorithms which can benefit from GPU compute. If you take for example, taking a photo of the group of people and you want to change the color or the contrast of it, you can do that today. But when you do that using a GPU compute, those algorithms are very well suited for running on a GPU, and so you can do it more quickly and use less of the phone's battery along the way. So, GPU compute an important technology and we would expect to see that in the mid-range phones.

In the high-end, we would expect to see processors based on Version 8 of the ARM architecture that adds support to 64-bit. That's going to enable more memory in devices, more sophisticated algorithms to run. Again, GPU compute probably in a greater core configuration. And across the range, the silicon can be built using on ARM's physical IP. So, a lot of ARM content and obviously different ARM content in different devices across the tiers here.

So, when you look at that silicon content, you will see different application processors designed specifically for these different market tiers and different numbers of companionships based on the amount of connectivity, the number of sensors and so on that will be found in the end device. What that leads to is, a different royalty opportunity for ARM in each of these different tiers, but a significant one.

What we have done here is, compare against the royalty opportunity of a basic voice only phone and you can see we have four times the royalty opportunity there in the entry-level all the way up to 20 times in the super phones. But, again, the market wouldn't grow in this way without the availability of these lower cost devices.

So when you run those number through, we expect to see compound annual growth rates of about 20% for handsets themselves. That leads to a silicon value CAGR of about more than 10% leading to a royalty CAGR for ARM in this period for handsets, for smartphones in the 15% to 25% range.

So what we are doing is designing products specifically for targeted market. We mentioned Cortex-A12 and the T622, specifically targeted at mid-range. Cortex-A7, we designed that for entry-level phones. The adoption there has been quite strong. Cortex-A50 series, we designed for the higher end phones. So we are developing a portfolio to address these growing markets as they grow in different ways.

So, what we are doing is designing products specifically in targeted market as we mentioned Cortex-A12 and the T622, specifically targeted of mid-range Cortex-A7, we designed that for entry-level phones and that's the adoption there has been quite strong, Cortex-A15 series which is actually a higher end phones. So we are developing a portfolio to address these growing markets as they grow in different ways.

Now, smartphones aren't the only device that's evolved quite a lot over time. When we look at mobile computing, we see lot of interesting changes in the dynamics of the market. Computing used to be something that you did at your best in front of a keyboard and plugged into the wall. Of course, computing now is something you do or can do whilst on the move, driven significantly by tablets which really have revolutionized the way that people access the internet and access technology as a whole. So tablets really are dominant in this mobile computing space.

We see lots and lots of designs around ARM processors in tablets and again price points are changing. Prices are coming down. Low cost devices are being produced in this sub $100 category. I booked one myself recently in California, a $100 tablet. It's very good for reading on, for example. These different tiers, these different prices, again is going to enable access to billions of people across the world. Again we are seeing good opportunity for our Mali graphics processor in tablets. Today we see about a 25% attach rate of Mali graphics in tablets and we expect that to grow.

Overall, we are expecting our market share in mobile computing which we categorize as the sum of tablets and networks and laptops to grow to over 50% through this year. It isn't just about tablets for us, we are starting to see plans for other form factor devices based on ARM. It wasn't recently a lot, it's interesting to note that the Samsung Chromebook is still the number one selling laptop on Amazon in the U.S. and that's been there over 260 days. It's proving to be a very popular device based on ARM, great performance, very low power, long battery life.

Now ARM is more than just about mobile. We spend a lot of our time developing products for mobile devices and that's given us lot of expertise in low power design and low power is useful across the entire spectrum of embedded processors. If we look at embedded, we see growth progress in the use of ARM technology in this market. The Cortex-M series has proven very, very popular amongst companies wanting to produce very low cost, very low power microcontrollers. We added nine new licenses of Cortex-M in Q2, taking the total up to around 180 and five of those nine new licenses are with companies who had never licensed on technology before.

The microcontroller space is very active right now and new companies are coming into this space because there is a vast range of end applications that can benefit from embedded intelligence, anything from washing machines, obviously cars, dish washers, energy control embedded in light bulb, there is just a good (inaudible), different end applications for embedded technology. The chips are so low power, so small, so low cost that they can be used in many different applications with very little impact to the end price or whatever it's getting designed into.

Obviously, the interesting area right now is using wearable electronics and even ingestible electronics. Freescale has produced a microcontroller about two millimeters on its side. It is tiny. That's been driven by U.S. medical industry looking at embedded chips in something that you swallow for monitoring and data collection and whatever. Interesting application, again driven by very low power, very small die size. So this space is really rightful explosive growth.

If we look at our 180 licenses that we have, what we see today is only about 50 are shipping and contributing to royalty. But, cumulatively, that side is up to 4.7 billion Cortex-M based chips so far. So, the other 130 licenses we signed, most of those are being designed into end products right now and we would expect to contribute more to royalty to overtime, so we see huge potential for growth in the microcontroller space, based off its continued success with the Cortex-M family, which again we are continuing to invest in.

Now, the other end of the spectrum are servers, and Q2 was very busy quarter for ARM and our partners' progress tools delivering on this promise of again lowering the power and disrupting the data center, particularly Calxeda and Applied Micro have been very active in Q2, talking about the design wins they have had and that's great to see the progress there. We also saw AMD announce two products their Seattle roadmap, which is an 8-core and a 16-core Cortex-A57-based devices, two chips there. I am very bullish about the prospect of ARM in the data center. This is a quote from Andrew Feldman. He is General Manager over AMD, long history of developing servers, knows what he is talking about and he seeing great prospects there for the products that they have developed.

Now, we get asked a lot about progress on software for servers, a lot of the infrastructure, a lot of the software that's running on the data centers right now is based on open source and that's obviously contributed by in many, many different companies and it's been great to see Oracle just recently announced their support the Java SE for both, 32-bit and 64-bit ARM architectures, specifically targeting enterprise and in fact embedded as well, so great progress on both, the hardware side and the software side in servers.

Then connecting servers to sensors, the smartphones and tables is billions of dollars worth of networking equipment and we are seeing strong designed wins over the last period, so we are anticipating a lot of the next generation of network infrastructure to be based on low power ARM technology. We have had our first royalties in Q2 from base stations and we are seeing LSI who has been very active in this space with wins sockets two of the three largest base station vendors in the world based on their Cortex-A15 devices.

Again, software is key, and Linaro, which is activity we set up to create a community around developing Linux infrastructure, Linux software for ARM. Linaro has formed a special interest group for networking with LNG, Linaro Networking Group, and in the quarter we saw that Cisco and Nokia Siemens Network joined Linaro Networking Group. What that's going to do is, provide a key software building blocks, but not in a very industry-efficient way. No one company has sort of built all of this. It's shared amongst everyone and the results are shared amongst everyone, so a great partnership way of solving the problem of software migration.

Networking, we see as a big opportunity looking out at 2017. Again, we see a chip TAM of 700 million devices. That's the revenue implications there are $17 billion silicon TAM and we would expect to win about a 20% to 30% market share in that timeframe, so this is a big silicon market and we do expect growth there as these design wins start to come to fruition and the royalties start to flow from that.

Now, all of the markets I have been talking about benefit from high performance and low power and all the emphasis that ARM has had in the last 22, nearly 23 years now on mobile and low power, is paying off and enabling us to target all of these different markets. Everything can benefit from lower power, smaller dye size and lower cost. So, that heritage in mobile is giving us a lot of expertise.

When we look at how we compare, we believe that we are prepared very well. Obviously the size of these markets there is competition, so when you look at how see stand out against some of our competitors taking different marketing turn, I think we are in a very strong position. If we look at entry-level phones, which today are being based designed around Cortex-A57, I mean really Intel don't have a products that are suitable for that market. Clover Trail Plus is the smallest thing they have but it is enormous in comparison to Cortex-A7. Cortex-A7 delivers roughly the same performance but at considerably less power and crucially in a really small die size.

The benefit of that die size is that every thing else that you need to put into, effectively a single chip application process with modem can be integrated onto one device at low cost. So the modem, the connectivity, the GPU, the memory can all be integrated on to one SoC. That build on a foundry process can sell for as low as $5 and our customer who is doing that today, these devices are shipping today.

When you look in the mid range, which again, devices are shipping today based on ARM, based on Cortex-A9. Cortex-A9 outperforms Clover Trail Plus. Again, its lower power. Its considerably smaller. So again, it can be built into an SoC with everything else you need and build on a foundry process and sell for around $10. Very low cost. Very low power. Great performance. Shipping Now.

In the premium end, as I mentioned in the beginning, we are seeing big.LITTLE devices shipping now that adds significant performance in comparison to Clover Trail Plus but at the same time, allows power to be lower because of the big.LITTLE architecture. Again, relative size wise, the cluster configuration is still very small. So build out on a foundry process you can build a whole SoC and sell it for $15. So you can deliver the performance at a very low power, and we can hit these very low price points that require these large volume markets.

The same extends out to servers. On the server side, it is all about total cost of ownership and how much it cost you to acquire the equipment in the first place and how much it cost you to run it based on the electricity the server themselves are going to use and all the air conditioning that you need to power your data center. Today, we have 32 bit ARM processors, based on Version 7 of our architecture shipping today in scale out server applications that are lower in power, lower in that total cost of ownership. Again build on a foundry process, our licensees can sell chips that is sub-$100 point which, if you are building servers, is a very low cost.

So all of those examples are based on processors which have been designed and are shipping today. We of course have a next generation of technology coming through, Cortex-A12. Last year we announced the Cortex-A50 series, the Cortex-A57, Cortex-A53, there's big.LITTLE 64-bit configuration. As that technology delivers into these markets, you are going to more performance taking that to the next level while at the same time maintaining the focus on low power, low cost. So our partners can reduce these very aggressively priced SoCs to address these very large markets.

So before I hand over to Tim then, let me just summarize the quarter. It has been a very successful quarter for us characterized by major semiconductor companies making long-term commitments to ARM technology. That licensing has delivered great financial results allowing us to continue to invest in our R&D, whilst returning cash flow to shareholders and increasing our dividend.

So with that, I am going to hand it over to Tim.

Tim Score

Thanks, Simon. Good morning, everyone. Quick run through the numbers, a little bit of color. I will talk a little bit about guidance. Simon has already gone through the headlines of ARM in too much detail but a 24% overall revenue growth in the quarter. The very strong licensing that we have seen in last three plus years continues, up 32%. Lots of new licensees, lots of existing licensees, either upgrading in the vertical or broadening their use of ARM into other end markets.

Royalties up 24%. We are up 33% in Q1 but you will probably recall that we called that probably a slightly inflated level based on the inventory correction a year ago. So, a 24% and 22% outperformance versus the industry at the top-end of our normal experience. That's driven normalized PBT growth and earnings growth that you can see there, 30% and 37%, respectively. Encouragingly, perhaps what you would expect with the margin expansion that we have seen, £96 million in Q2. That's the highest net cash generation we have seen in an individual quarter. Now just over £600 million of net cash at the end of June. We have announced an increase in the interim dividend this moving of 26%.

Looking a bit more at licensing and royalty. You remember, no doubt that my guidance for licensing in April was $75 million plus or minus. So the $88 million, we are at the top end of that. When we made the statement and very positive 25 licenses. As you have heard us say before, we typically do this installed license base. That's about a 100 licenses a year. Completely consistent.

For the second quarter, running the take all the contribution from order backlog into the license revenue at the top end of the normal range, which is typically 40% to 60%, at 60%, so quite a high draw down from backlog given the percentage of recognition of our engineering milestones, but as you can see at the bottom there, the backlog in itself is still up more than 10% sequentially. So obviously a very strong bookings quarter which has more than replenished the backlog, notwithstanding the 60% contribution into revenue this quarter.

Physical IP licensing, also strong, up 23% year-on-year. Five POP IP licensees signed which, again, is encouraging for future contribution from physical IP royalties. Of course, the importance of all this licensing activity and the accelerating build of the installed base is what it means for our royalties going forwards. You can see from the chart on the bottom right, which you have seen before, that this licensing activity, the 450 licenses in the last 3.5 years, barely moving the dial really on royalties. So there's a lot of royalties in the can yet to be recognized.

In this particular quarter, $119 million, as I said, up 24% year-on-year. 22% outperformance in the quarter. Mostly market share gains. Cortex-A is now 17% of total shipments versus 8% a year ago. Simon talked about the accelerating trajectory of Mali shipments also contributing.

On the bottom right, you can see the historical outperformance. We have often talked in these meetings about 10% to 15% outperformance as was noted in the last analyst presentation by one of the analyst that that has actually expanded in recent times to be really at the 15% to 20% and slightly north as we can see this quarter.

So encouraging trajectory. Similarly, in physical IP, smaller numbers but a good trend. Up 17% in headline level and up 20% in quarter, excluding all the catch-up royalties from this year and last. So good trends.

Looking at costs and tax, this is just sort of a help with the models. Normalized OpEx in Q2, $78 million. That's pretty much inline with guidance last time and consensus, as you would expect. Expect it to grow a little bit in Q3. We continue in investment mode. We are investing in R&D. We are investing in the back office of the infrastructure of the company to make sure that this growth opportunity is supported by a resilient infrastructure. So $79 million to $81 million, broadly in line with consensus for Q3. I think was about $80 million. You can see that in the first half of the year, operating margin is up about four points, year-on-year, over the six months.

So most of you would have noticed, I am sure, from the release this morning, there is a fairly significant litigation related costs sitting in the IFRS numbers. Just a little bit of a color on that. Most of you will be aware of patent trials, non-patenting entities, building portfolios of patents, searching around the industry. So this is actually in the normal course of business. This is going on time of all the time.

ARM is rarely, and not in this case, party to litigation but does provide indemnities under certain conditions to our licensees. Usually these things close by settlements or cross licensing and typically the contribution from ARM and the impact on ARM is really under the hood and goes through our numbers and you wouldn't really notice it because its from time-to-time small single digits, millions, ongoing cost of running an IP business and protecting your technology and protecting your ecosystem.

In this particular situation, where patents were searched against a number of our licensees towards the end of the second quarter. For all of those licensees, some together, some individually settled and ARM had a contribution in total of £42 million which was a combination of some indemnity payments to certain licensees and thus buying a license to the whole patent portfolio of this non-patent entity, which protects the ARM ecosystem and about this matter is now closed. So that's a full and final settlement.

As I say, these things came up from time-to-time. I think about five years ago, we had a case related to Nazomi that stuck its head above the reporting (inaudible). About five years before that we had one with an outfit called picoTurbo. So, again, these will happen from time-to-time. We don't see anything in view of this magnitude, but we should all be aware that the power control exists, and it is something that we have to manage on ongoing basis with our partners and with our ecosystem.

No change to tax really. You remember the Q1 rate just under 17% was kind of artificially low, because we recognized the benefit of the U.S. R&D tax credit in Q1, the 2012 tax credit, because the legislation was enacted in January and not as known in December. This quarter more normal just over 20%. They are still guiding the full year tax to be just under 20%, which is pretty much (Inaudible) on tax rate.

In summary, looking into the second half, the backlog is obviously in good shape. Record level, the opportunity pipeline for licensing which obviously we have fairly good visibility into on a three to six-month basis is looking healthy. And, based on our product portfolio and the new markets that Simon explained, our licenses taking it into, so that looks good.

License revenue expectations, 25 license a quarter, lumpy business, but the base line goes up based on this backlog, so you are probably not that surprised to hear me say the 75 plus or minus moves to 80 plus or minus as I think a realistic base. Could it start with a seven? Yes. Could it be north of 80? Yes, but this looks like a sensible way because this is trying to look forward in a way multiple quarters, I am not just trying to forecast one quarter, but that looks to be the right base I think to be thinking over this stage.

Looking to royalties, obviously, some mixed messages going around the industry for the second half. Our data suggests that in Q2, which is our development period throughout Q3 royalties, there was a small sequential increase in overall industry revenues, which is obviously the context for our Q3 royalties. As I said before, OpEx in the range of $79 million to $81 million, just growing up, continue to increase slightly as we keep investing in our people.

So, full year, we have had a strong first half and we expect the full year revenues to be at least in line with the current expectations which are just under 10.80 and 1.08.

I think with that, we will open up the floor.

Question-and-Answer Session

Operator

Didier Scemama - Merrill Lynch

Didier Scemama of Merrill Lynch. Three quick questions. First on the outlook for the second half, clearly, Tim you are guiding about $80 million plus or minus I guess although you are 88 in Q2 on licensing. Also, for the full year for PD royalty, I think that's at 520, so do you think that it's appropriate to have still $80 million per quarter in the second half or can that be maybe slightly better than that? Royalty front, obviously, we see some mix messages from the premium smartphone market et cetera sent them very strong growth in the low priced smartphone market, so how do you feel about sort of those numbers. Would you we usually expect the 10.80 number to move up, I guess, that's my question.

Second question is on the benchmarks. You have sort of given us some interesting data there of A7, A9, big.LITTLE versus Clover Trail Plus. I guess, what people are wondering is why you think it will be versus Silvermont. Then my final question is on the announcement made by Samsung yesterday of the Exynos 5420 using your graphic solution, which I think is a big surprise to everybody since they launched the first big.LITTLE chip, with the imagination, only less than six months ago, so I was just trying to understand why you think Samsung has done that? What are the benefits of switching so quickly? Thank you.

Tim Score

Yes. As I said, I mean current consensus is going to result just under 10.80. You know as well as I do, that if I say the licensing is going to be 80 plus or minus, consensus is going to be little bit north of 80 in both quarters and we feel comfortable with that. I think the royalty outlook is much harder to call. I mean the consensus is currently plus $12 million, plus $13 million in Q3 and plus $17 million in Q4. Reasonably chunky uplifts. In the last two years, our Q4 royalties have been up $17 million in each quarter.

So, not unprecedented but clearly we will have to see whether some of this noise around actually manifests itself in lower sales. So what I would expect to happen is the overall consensus to increase broadly by our outperformance on Q2, may be with some re-balancing between licensing and royalty for Q3 and Q4. That's kind of what I would expect.

Simon Segars

So on your question about Silvermont. You have got to remember, there is actually very little data actually out there to say what Silvermont is going to do. From what we have heard and from what we are seeing from the analysis we have done, we are pretty confident that today the solutions around big.LITTLE is going to continue to give ARM performance in power efficiency lead. We will have to see what happens when it comes out.

Of course, I think, over the last few weeks, they have shown they are being very cautious about how much benchmark data they use and where it comes from and how its being created. So a big health warning around benchmark. What ultimately matters at the end of the day is the user experience. How good is the phone is going to sell. Is the combination of lots of parts in there, we think our technology is in good shape.

Which kind of leads quite nicely on to the question about Samsung's choice of Mali in the 5420. You said that comes as surprise. I mean that hasn't really come as much of the surprise to us and potentially we think we have been signaling that for a while. Obviously, you need to ask them about specific reasons why they choose different devices.

They produce a lot of silicon in the year. They are constantly updating their devices. Their graphics processors don't have as much stickiness as the CPU's because of the way the code is written and you know all about that. So it is a relatively easy thing to switch from one architecture to another and back again of course. So this is one has to make sure we have got the best technology available to our customers at the time at which they are going to make that decision for these next generation device from Samsung. We did.

Sumant Wahi - Redburn Partners

It's Sumant from Redburn. Thanks very much for taking the questions. Potentially, I have three questions. One is to do with the license big potentially in the Q2. I was just wondering whether that was driven by licensing from the Greater China customer base. If that is so, is that a growing trend or do we expect that to happen going further as well?

The second one is to do with the PIPD division. Congratulations, as for the first time you have hit profitability on that one. I am just wondering if there is a sort of operating profit margin guidance or something of that sort? Looking forward, what should we consider should be the sustainable margins coming out of this division?

Finally, the third part is on the smartphone chip growth. May be I am completely mistaken on this but I was wondering, is there sort of a slowdown you are expecting in terms of the overall chip growth? I remember 30% CAGR being talked about and if I look through slides, this is now 20% on ARM's addressable market chip growth. May be I mistaken on this but just a bit of color on that would be really helpful?

Simon Segars

The licensing big wasn't really China. We drew out China in the release because we had our first subscription license there but as you know subscription license is recognized rightly over time. So that doesn't have much impact on short-term revenue.

But having said that, I mean China has become, over the last few years, an increasingly important part of our overall licensing activity. Now the general beat was, it was a combination of the terms licensees yielding revenue in the quarter and obviously reasonably material draw dawns based on engineering milestones being hit on the newer technology releasing revenue in to the P&L. So business as usual but 60% contribution from that was at the upper end and 25 licenses is probably on average slightly at the upper end as well.

I am sorry. So there is two reasons why we have a physical IP business. One is to drive revenues and profitability anytime, right. The other is to enable us, strategically, to create best way implementations of ARM CPUs. The two are both important although we are more focused on the strategic benefits ahead of the business spent driving it for profit and its own right and obviously that would lead you to drive the business in very different directions. So, what we have seen is continued uptake of our POP IP.

That's the product line we created specifically to enable our licensees to get better, higher performance, lower power implementations of their ARM CPUs. The licensing from that has been of great success. We have got nearly 50 licensees now also licenses of the POPs and we are starting to see the impacts of that and design wins generally for advanced technology flowing through to the royalties.

So, we do want to drive this as a profitable business. But at the same time, the real focus is on the strategic benefits there, so we don't have any formal guidance for how we see that growing, but as those design wins continue, I would hope that that we are going on in positive direction.

Your last question was about smartphone growth. I don't think we have changed the numbers there.

Sumant Wahi - Redburn Partners

Thanks. One follow-up on the drivers of license. Just wondered if you could talk about the products driving is 64-bit? Is it V500? What's the kind of key driver of that? Second, I just wonder if you could talked to the royalty rates that you expect for V500 as you ramp in to next year with 4K coming on top less potentially? Then finally just on the attach rates you hopefully gave the attach rates for Mali on top list, so I just wondered if you could give us a sense in the lower end smartphone market. What your attach rates for Mali? Are they higher or lower than the current broader range of smartphones? Thank you.

Simon Segars

In terms of the technologies driving the licensing, I think it was pretty broad really. And I would think, Cortex-A end licensing and a bit of subscription as well and Mali, so it's been fairly across the board there and there is not one area that particularly stands out. Your second question was about the royalty there. We expect to see some incremental royalty on top of the royalty that we get from Mali. We might think of that as another percentage on the overall royalty. Your third question was on so okay, is the attach rate higher in the lower end than others. I think, it's early to tell. I think right now it's fairly consistent across the entire tiers of the smartphone market.

Sumant Wahi - Redburn Partners

Just one question again on the Silvermont. The supply change seems to be indicating at this point that Intel has been very aggressive on the pricing of their processors in the fourth quarter whenever they are going to come I guess some point in the fourth quarter. Could you comment on, and you have talked about these three tiers. I guess Intel is initially going to play in the tablet market rather than the smartphone market given the lack of an integrated product. Where your ASP is at this point? Will you be impacted by a very, very aggressive ASP from Intel associated with their initial Silvermont processors?

Tim Score

Well, hard to predict. Obviously I don't know what Intel is going to do in terms of pricing and that's a price competition is more of an issue for our licensees that it is for us directly. I think in terms of as uptake of those products or not, it's going to come down to the handset makers or the tablet makers looking at what they can get from Intel, looking at what they can get from the ARM partnership and weighing up multiple factors, software compatibility, performance, power, cost. All of this is going to come into play, but particularly that software ecosystem and the amount of applications written for an optimized around ARM, I think is going to be a big factor in our favor for long time to come, but we will see how it pans out.

Sumant Wahi - Redburn Partners

What is your ASP at this point? I mean, a couple of (Inaudible) though I remember it opportunity dollar. Where is it today?

Tim Score

For a tablet?

Sumant Wahi - Redburn Partners

For application processing using Cortex-A9, or Cortex-A50 that are there?

Tim Score

We are having the chart there some different price points, but $5, $10, $15 for the different tiers. Beyond that, it's really that pricing. That's a kind of generalization of the pricing that we see in those tiers and exactly the spot price is what our customers see.

Francois Meunier - Morgan Stanley

Thank you. It's Francois from Morgan Stanley. I have got a few questions. So may be the first one is, I am trying to understand the guidance. I am trying to read between the lines. So as you were saying, you feel more confident about licensing and maybe you think that royalties should be a bit lower. Is that because you see some inventory correction in the high-end of the smartphone market? Or is it because you think that some people in the sell side got ahead of themselves in terms of number and maybe the 2014 royalties are bit too high as well? That's my first question.

Tim Score

I think that's actually an extrapolation of, all we are saying right now is that if you look at the consensus and royalties in the second half, it's plus $13 million in Q3 and plus $17 million in Q4. Those are seasonal shapes that we have seen before. There is some mix messages around the industry. It's hard to put your hand up and say that's in the bag right now, because it isn't but we are not making any comment on the numbers on royalty trajectories.

We are not making any comment on 2014 royalties. As you can see from the charts, our performance in royalties versus the industry as a whole has been on improving trend and the gap has been expanding. We see nothing fundamental that changes that dynamic. We think we are just pointing to the fact that the sequential increase is delivering the market for the second half which are, as I say, pretty close in normal seasonality and not in the bag as of July 24.

Francois Meunier - Morgan Stanley

Okay, thank you. Second question is about the licensing which is, as you explained at the beginning more and more to Asia, may a bit Mainland China. So I think, for us its a bit difficult because high growth revenue TI, Qualcomm, and these type of companies and now it maybe names that I am not familiar with today.

So of course we know that we get a spectrum maybe albeit one is off the air. So what I would like to understand is, as we are moving from Western chip players to Asian type players, how do you see this having an impact on the pricing because I think your belief that if you have more customers in Asia, then it could have more pricing pressure down for all the industry.

Tim Score

(Inaudible), and I am getting this as far as I hit generally as of that last decade. I think this is not a new phenomena. This has been going on for a while. You will note that, in that time our license revenue, on a quarterly basis, have gone up. So looking at these two things, if you correlate them, would not suggest that we are under increasing price pressure because of that shift to Asian markets.

Francois Meunier - Morgan Stanley

Okay. Another question would be, I am sorry about Intel and I hope I am not bringing you too much on this but I have been very surprised myself to see the MacBook Air from Intel which is not even Silvermont. It has a big chip. It's Haswell. Of course it's much more expensive than yours but still getting a very good battery life for the MacBook Air to 13 hour. If you basically compare on the same battery size basis as the iPad then you can get 11 hour of browsing time versus anywhere else for the iPad. I am really surprised because, well maybe because ARM is so much better in telecom gadget. So where do you think the progress have we made and where do you think you can that you have probably done before?

Simon Segars

Well, obviously the chip isn't the macro here. It is a really very different chip to the kind that you put in a phone or in a tablet and it's built on a different kind of manufacturing process used for a phone or a tablet. MacBook Air is a great products. I could say that one m\y experience one of using one of these MacBook will claim the battery life is as statistics are but its still very good at the end of the day. I think the technology that we have been delivering on big.LITTLE, very energy efficient graphics and now with video accelerated as well and the approach we are taking to system design and the approach our partners are taking to an SoC level power control is going to enable the solutions that ideally target tablets and phones.

Francois Meunier - Morgan Stanley

Okay, thank you.

Simon Segars

Gentleman behind you.

Jerome Ramel - Exane BNP Paribas

Jerome Ramel, Exane BNP Paribas. Can you update us on big.LITTLE and Cortex-A15? Beyond Samsung and potentially at the end of this year when do you expect a meaningful shipment of Cortex-A15 big.LITTLE?

Simon Segars

Well, there are a number of customers who have licensed Cortex-A15 and Cortex-A7 big.LITTLE combination. Exactly when they are going to shift is hard to say, but I would expect to see the volumes to grow through next year.

Nick James - Numis

Thanks. Good morning. It's Nick James from Numis. A couple of questions. One was on the benchmarks. You have given us health warning on benchmark and then you turned attention your own benchmarks and I guess I am little bit surprised you kind of used big.LITTLE over there. There is one implementation of big.LITTLE on the market, which they have been reported overheating issues I think criticism is that the size of the chip, so if you could kind of just address those in the context of the benchmarks that you have set out there?

Then second question was on the exception from patent litigation. We had a big kind of investment last year, which is basically something about being a patent troll for the mixed patent to protect ARM. We have got this unexpected thing come through in Q2. I know you didn't foresee more of these, but I don't know that you have foresaw this one, so what is the assurance that we are not going to see more and more of this type of patent litigation cash outflows?

Simon Segars

Okay. I will take big.LITTLE. So, in terms of big.LITTLE options as I said that there is a number of customers who are designing products there. I would say yes. You really have to take a look [help] with benchmarks. You do have to look at what is being compared and I don't see what we are showing on the chart there is a synthesis of what we think is important when looking at comparing one chip against another. There is a lot of data behind that importantly today. In terms of big.LITTLE implementation, what we provide to our customers is a very flexible set of component that can be build in big clusters, smaller clusters mix and match. And depending on the level of performance at one of our licensees want to produce, they can use that technology in however they see fit.

So, you are going to get some larger implementations. You are going to get some smaller implementations, but it's all about what we provide is flexibility and choice in how customers put their chips together and how they are investing and they are going to target market. That's what Samsung had done.

Nick James - Numis

So, those benchmarks reflect shipping ARM chips, because that's kind of what you said, right?

Simon Segars

Yes.

Tim Score

Then real chip shipping there, real time. (Inaudible) we can't take that (Inaudible). There's a slide in the appendix.

Nick James - Numis

Yes. Around patents. As I said in the remarks there, the existence of non-patent entities and patent trolls and the reality that some time in this space operating companies fail and investors want to monetize what's left in the form of patents and this is the reality. The business that's been going on for a long time and clearly our long-term interest is to protect ARM and the ARM ecosystem from the disruption, irrespective of the merit of these claims regarding infringement or not they require time and money to deal with. They usually end up as I say in settlements that you don't know just because the number is so small. But, from time-to-time, you will get a patent portfolio that requires more to close down.

As I say, this is the first one that we have seen and that's kind of material to ARM to go out in this way for many years, and typically when these things do emerge, you get quite a long sight on them, because actually being a patent troll is not all easy money. It takes a long time to get the money, so usually we have good visibility if there's anything in the pipeline, right? So, when we say we can't see anything material in view, that's based on what we can see. Now, something can emerge and it could end up in a quick settlement, but the ARM ecosystem, the ARM partners and ARM consider to be in the best interest of our business and for those our public and our shareholders, so I can't guarantee that the landscape is clean, but I am not expecting to be talking about this type of thing in the foreseeable future.

Nick James - Numis

Then, one of the exceptional charges for Linaro which has been $7 million in this quarter, $7 million last year. I understand it not for profit organization but it's not for profit under IFR. So why isn't this an expense does of ARM business given this fees is ongoing.

Simon Segars

It doesn't extend the ARM business but the reason we draw it out separately is because it only occurs every two years. So last time it was two years ago, in fact. Not one year ago. So every two years, based on the current membership and the current, if you like, price list, ARM will be spending $7 million over two years. Now, given that that gets paid in one lump and recognizing one lump it is obviously a cost that gets charged to the P&L but we draw it out separately because it doesn't appear in all the other quarters. So we sit here explaining why next quarter it wasn't there. So it kind of just need you to be have it transparent

Simon Schafer - Goldman

Thanks so much. It's Simon Schafer from Goldman. Just want to ask about slide 10 which is about your growth in embedded computing. How big is this opportunity for you in terms of machine-to-machine? Most of us have had (inaudible), and a lot of Telco infrastructure guys talking about this opportunity more broadly whether it's 30 billion, 50 billion, I guess no one really knows but it's certainly a big opportunity. So structurally given that there's still a 130 licensees, I think you called out, that will start to ship, what's the structural run rate across in this market and then more importantly going forward, is that still going to be very low price points or actually is there a chance that these guys require higher value technologies from you and your partners?

Simon Segars

So, in terms of that market size, as you say it's in billions, tens of billions. Exactly how big? A bit hard to say. We can think of new applications and things all day long and hopefully they are going to come to fruition, I think, initially, you are going to see to quite closed system where some data is collected, it is processed.

Eventually, I would expect, you are going to see much more open systems where data collected from different places can be made accessible to different people to process in different ways. I think that's where they start to become very interesting. I think those devices would be the kind of end node where the sensor is going to be a very low cost device forever.

In fact, I think the 10s of billions of units relies on it being a very low cost device. All that's going to do though, is create an awful lot of data that's going to need aggregating, maybe process and locate along the way and then up into the cloud.

So I think its going to drive local aggregation points. I think its going to drive network infrastructure. It is going to drive the expansion of the cloud which are, of course, higher cost ASP devices.

So that's how, I think, this is going to plan out. Of course, we are all sort of crystal ball gazing here slightly but when you look at the kind of applications people are already starting to build. It is not a hugely out of place to see some of this coming together.

Gentleman next to you. Next one?

Achal Sultania - Crédit Suisse

Achal Sultania from Crédit Suisse. Just to follow up on the Mali business. Obviously we have seen very strong volume growth. I am just trying to understand what part of that growth has come from the smartphone market and what part is coming from the tablet market? Also just trying to get understanding of, obviously, we are seeing higher core GPUs being implemented in some of the, for example, as seen last year. What does that mean for your royalty attach rates for Mali, specially going forward? Thank you.

Tim Score

So in terms of growth. Mali has pretty good market share in smartphones, in tablets. Right about half of all Android tablets, we are now believe about 20% of Android smartphones and about 70% of digital TVs. These markets will have different growth trajectories but we have pretty good established market share there.

I am sorry, the second half of your question was?

Achal Sultania - Crédit Suisse

It's about, thinking of higher core graphics in your GPU. What does that mean, as we move towards higher core GPUs, what does that mean for your royalty attach rates for Mali, specifically?

Simon Segars

Okay. So in terms of the royalty rate or in terms of the royalty from those chips. Graphics royalty tend to be fairly large in comparison with CPUs. Every design has to be as small as possible. But still graphics processing just takes a lot of silicon area. So if you put a large number of cores down, the silicon device tends to get larger and therefore the silicon dye costs more. So that would drive higher royalties into ARM.

Achal Sultania - Crédit Suisse

Does that mean that the potential for royalty rate potential will increase?

Simon Segars

There is substantial growth in royalty increase with more use of cores then.

Achal Sultania - Crédit Suisse

In percentage terms?

Simon Segars

In percentage terms. Yes. So we are going to have to wrap up fairly shortly. So may be a last question.

Tim Score

One more question and happy to take up some.

Janardan Menon - Liberum Capital

It's Janardan Menon from Liberum Capital. A few short questions. One is, going to your licensing trajectory, you have always said that licensing is a precursor of royalties to come and historically it has been true. But today, given that you are getting so many licenses being signed in markets like China by a large number of new entrants, all trying to get into the same market, a similar markets, which is tablets and smartphones to a lot of extent and also some of the other little markets. Is that really true, because they are all going to chase the same market and it is just more and more fragmenting market at the end of the day so would it not necessarily change the overall royalty number. In fact, it may add to price pressure on the end device and bring down a little bit?

Second question is on the benchmarking. Once again, which is, you benchmarked big.LITTLE with Clover Trail Plus. I was just wondering how does Cortex-A15 stack up with the Clover Trail Plus on its own. Would you foresee that pretty much all of your implementations in due course of time on the Cortex-A15 and the Cortex-A57 would be big.LITTLE implementations because that is what is competitive with the Intel chips at the end of the day from power consumption point of view.

Last question is, the industry is quite dependent on Qualcomm for LTE modems and increasingly sold the factor supplier. To what extent do you see the factor they want in alternative and Intel provides that alternative, because they are one of the leading suppliers of 3G modems today, especially to Samsung and other players. Would that edge market share towards them just because someone like Samsung wants the LTE modem from someone apart from Qualcomm then Intel is the best alternative?

Tim Score

I don't expect actually to have material difference in the conversion of China licensees to royalty from the rest of the field really. I mean as Simon said, we have been licensing companies in China now for a long time. And, actually a number of the leading players are now reasonably significant contributors to royalty. By the same token there are one or two who don't make or get bored or disappear in the same way as and when we show our charts of in a number of licensees. Now, remember those are licensees who are still in the game. They are not licensees that we have never licensed and these are licensees who are expected to generate royalties. Okay? Our experience so far in China is that the conversion rate has been pretty good. And as I say, we now have a number of significant contributors to royalties from China.

Simon Segars

So, your question on big.LITTLE and Cortex-A15. When we are looking at the performance graph of those benchmarks, that use A15 powered up. I would expect to see devices which just use A15 and don't use the big.LITTLE combination. There are going to be some applications that don't need to either switch like that or don't have the benefits of varying work rates.

Now the thing about phone and tablets is sometimes you need a lot of performance, sometimes you don't and there are other applications like networking for example, where it's about constant throughput. You don't have that variability, so big.LITTLE doesn't help you there, which is why we designed our all our processors with power efficiency in mind is just there are degrees.

So, I think, A15 [is one design] and I think it would be used on its own independent of big.LITTLE. Your last question was about LTE. I think, generally people building things or any one wants choice of suppliers, so more people providing LTE is not a bad thing. Intel solution does actually ARM technology in it, so that's certainly not the end of the world for us. It's actually chips and volume.

Tim Score

Okay. I think we are going to wrap it up there. Thank you for joining us today.

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