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ARM Holdings Plc (NASDAQ:ARMH)

Q3 2013 Earnings Call

October 22, 2013 4:30 AM ET

Executives

Ian Thornton – Head, IR

Simon Segars – CEO

Tim Score – CFO

Analysts

Gareth Jenkins – UBS

Simon Schäfer – Goldman Sachs

Pierre Ferragu – Sanford Bernstein

Didier Scemama – Merrill Lynch

Amit Harchandani – Citigroup

Andrew Gardiner – Barclays

Sandeep Deshpande – JP Morgan

Francois Meunier – Morgan Stanley

Matt Ramsey – Canaccord Genuity

Johan Schiller – Deutsche Bank

Sumant Wahi – Redburn Partners

Jerome Ramel – Exane

Janardan Menon – Liberum Capital

Vijay Anand – Espirito Santos

Lee Simpson

Andrew Dunn – RBC

Andre Dunn – RBC

Brett Simpson – Arete Research

Kai Korschelt – Deutsche Bank

Operator

Thank you for standing by. And welcome to the ARM Holdings PLC Q3 Analyst Results Conference Call. At this time all participants are in listen-only mode. There will be a presentation followed by question-and-answer session. (Operator Instructions). I must suffice you this conference is being recorded today Tuesday, 22 October 2013.

I’d now like to hand the conference over to your speaker for today Ian Thornton. Please go ahead.

Ian Thornton

Thank you, Ron (ph). Good morning everyone. This is Ian Thornton, VP of Investor Relations at ARM. On today’s Q3 results conference call, we have Simon Segars, Chief Executive Officer and Tim Score, Chief Financial Officer.

On today’s call, Simon and Tim will take us through the highlights and comments from the quarter’s results. And then we’ll open up the call to Q&A session. As a reminder, the presentation and release can be found on the ARM Investor Relations website at www.arm.com/ir.

Before I hand over to them, I have to just read out a few words with respect to this conference call and what we are about to discuss. The contents of this conference call are being directed only to those of you who have professional experience in matters relating to investments and the information communicated on this call is being made available only to investment professionals. Any persons present on this call who does not have professional experience in matters relating to investments should not act or rely on the contents of this call.

The following conference call will contain forward-looking statements, which are other than statements of historical fact. The company’s actual results for future periods may differ materially from these statements, as they are based on current expectations and are subject to a number of risks and uncertainties.

And on this note, I’ll hand over to Simon.

Simon Segars

Thanks Ian. Good morning everyone and thank you for joining our Q3 2013 results conference call. What I’ll do this morning is run through the business highlights and then hand over to Tim to provide some more detail on the numbers. Following Tim, there will be some time for Q&A. So, let’s start with the business overview.

Three months ago, we highlighted how leading companies in multiple markets were licensing ARM technology and introducing new products into a wide range of end markets. We’ve seen this activity continue in Q3 and in the quarter we’ve seen very strong demand for our processor technology, which was resulted in record licensing revenue.

A record 48 processor licenses were signed in the quarter with 24 companies. This included 11 companies taking their first ever ARM license, many of whom are planning to take our technology into new and emerging markets such as fingerprint recognition and wearable devices.

Established food leading technology companies also continue to make long-term investments in ARM, and this quarter ARM signed four large multi-IP licensing deals including a significant licensing deal with MediaTek.

This quarter has also seen several important design-ins. MediaTek and Samsung, both announced chips that support ARM big.LITTLE technology. AMD, Broca, Mali, also announced ARM-based chips that support 64-bit for mobile infrastructure and enterprise networking applications.

In January 2013, we increased our medium term guidance on how ARM’s royalty revenues would outperform the wider semiconductor industry from 10% to 15%, to 15% to 20%. This was to take account of the increasing opportunity for ARM’s Cortex-A and Mali graphics technology, which yield a higher royalty.

Over the last few quarters, the rate of ARM’s out-performance significantly exceeded our raised guidance. These chips containing Cortex-A, and Mali graphics processors grew strongly. This quarter ARM’s royalties out-performed the semiconductor industry by 16 percentage points. This is in line with our raised guidance.

The revenue momentum in both licensing and royalties has enabled ARM to grow earnings by 38% and deliver record 40 cash generation in Q3. This has been another quarter that underpins the long-term growth opportunity of the business and enables us to continue to invest in our R&D capability, enhancing our ability to innovate and develop new products.

Looking forward to Q4, the combination of record order backlog and a robust opportunity pipeline points to another strong quarter for licensing revenue. We also expect to see a sequential increase in ARM’s royalty revenue of similar dollar value to previous years.

Assuming that the macroeconomic situation does not deteriorate significantly in the remainder of the quarter, we expect group dollar revenues for the fourth quarter to be in line with current market expectations of approximately $290 million.

Now I’ll discuss the revenue drivers in the different parts of the business in more detail starting with technology licensing. As I mentioned we signed 48 processor licenses this quarter. These licenses were signed with a view to ARM technology being deployed in a broad range of end markets. These included 14 licensees to mobile and computing applications including entry level smartphones, tablets and 2-in-1 laptops. 18 liceenses for microcontrollers and sensors for the internet of things applications, 7 licensees for wide wireless enterprise networking and 9 licensees for other consumer electronic applications such as digital TVs.

Included in these licensees were further three four Cortex-A50 series processors which includes above 64-bit computing. To date ARM has now signed 24 Cortex-A50 series licensees and we are in discussions with many of our partners who are considering licensing the latest technology.

Cortex-A50 series processors can be used in a multitude of high performance applications from mobile computing to enterprise networking and service. This quarter, ARM also signed another 18 Cortex-M series licensees. With close to 200 Cortex-M licensees now signed, ARM’s shares are well positioned to continue to gain share in the general purpose microcontroller market as well as to take advantage of the emerging internet of things opportunity.

Finally, ARM signed five more Mali graphics licensees and four more POPs during Q3. POP IP is physical IP that has been optimized to enhance the performance of Cortex-A and Mali processors.

Now, switching to royalty. ARM’s royalty revenues are reported one quarter in arrears. So our royalty for Q3 was generated from chips sold by our licensees in Q2. ARM continues to outperform the semiconductor industry and despite the industry being down 2% year-on-year in the relative period, process of royalty revenue was up by 14%.

Just over 2.5 billion ARM processor based chips were reported in the quarter. This 13% year-on-year increase was driven by growth across all target end-markets. Shipments of embedded ARM based chips well are particularly strongly a non-mobile chip shipments now account to more than half of ARM’s total royalty shipments.

ARM is also beginning to see traction of shipments in enterprise networking applications as the first of the early adopters start to ramp into high volume. In fact, more than 15 million Cortex-A enterprise networking chips were reported in Q3.

The growth and functionality of consumer devices such as smartphones, tablets and digital TV also continues to benefit ARM. This quarter, ARM saw a doubling of both its Cortex-A and Mali processor shipments year-on-year. Typically, ARM receives a higher royalty percentage for its Cortex A-class range of products and an additional royalty percentage for chips that contain Mali.

Notwithstanding the strong growth in both Cortex-A and Mali chip shipments, ARM’s average royalty revenue per chip was flat year-on-year, as the strong growth in the higher value lower volume applications, sorry lower volume application processors was balanced by the strong growth in shipments of high volume, lower cost chips such as microcontrollers, smartcards and touchscreen controllers.

Now turning to the operational side of business, we’ve continued to invest in our R&D and commercial teams and in our business infrastructure. So far, this year ARM has added an extra 364 people including 142 graduates. We expect to continue to invest across our business to ensure that we are well placed to seize the growth opportunities that lie ahead of us.

It was a busy quarter for marketing with record numbers attending our Annual Partner Meeting in Cambridge, where we shared our growth plans with over 500 representatives from our customers and key ecosystem partners.

Next week we will be holding our Annual Technology Conference in Silicon Valley in California, where we expect to host around 5,000 developers over three days. And where we will present new technologies and have exhibits and demonstrations from our engineering teams and across the ecosystem.

There is an Investor event on the Wednesday afternoon, if you can join us. And more information on that is on the IR website.

Now I’m going to hand over to Tim, to provide some further details on the numbers.

Tim Score

Thanks Simon, good morning everyone. Hopefully many of you’ll have the chance to have a quick look of the Q3 earnings release. I’ll just remind you that the quarterly slide-set is available on our website as usual.

Simon’s touched on a lot of the financial headlines, so I won’t repeat all of those. But I will add a little bit of color as we think about the sales side of bubbles going forward.

So, overall Q3 dollar revenues at $286.7 million up 26% year-on-year and you obviously had noted particularly strong growth coming from processor licensing up 52% year-on-year to $106 million, clearly well ahead of the $80 million that I pointed to at our Q2 results presentation.

As Simon noted, we signed 48 licensees in the quarter, much higher than the normal quarterly run rate where over multiple years, the average is more in sort of 25 to 30. And further these 48 licensees included some licensees which yielded significant revenue in the quarter. Approximately 50% of PD license revenue in Q3 was generated from backlog, so in the normal range of 40% to 60% but actually a lower contribution from backlog than we’ve seen in the last couple of quarters.

And the third quarter was also a strong bookings quarter and notwithstanding the strong license revenue result, we exited the quarter with backlog up about 3% sequentially. And given this healthy backlog position, and the quality of the licensing opportunity pipeline $90 million plus or minus looks to be a realistic base for Q4.

The usual analysis of backlog maturity and composition pie-chart included in the Q3 slides on our website and that shows that approximately 25% of total backlog is expected to be recognizable as revenue over the next two quarters.

Simon has gone into some detail on royalties. But again the headlines, up 14% year-on-year in the third quarter, about 16% ahead of the industry which was down 2% over the same period, consistent with our long-term guidance of out-performance of 15% to 20% albeit at the lower end and lower than the recent quarters.

At normalized OpEx in the third quarter headline was £85.6 million, this included a mark-to-market charge of £5.5 million in the quarter, which actually gives us a mark-to-market charge of nil in the nine-month to date but £5.5 million in the third quarter, reflecting the weaker dollar at the end of Q3 compared to the end of Q2.

So, underlying costs therefore were around £80 million, broadly in line with consensus. And normalized OpEx in the fourth quarter assuming effective exchange rates similar to current levels are expected to be in the range of £82 million to £84 million, again consistent with current market expectations.

The group’s normalized tax rates in the third quarter was 22%. Our guidance for the full year normalized effective tax rate remains unchanged at just under 20%. And as the patent box regime in the U.K. transitional implementation continues over the next few years, that tax rate is expected to actually reduce all up things being equal from the 2013 base of just under 20%.

Reiterating Simon’s comments on the outlook, we enter the final quarter of the year with a record order backlog, healthy opportunity pipeline for licensing. And as I say that points to a strong quarter of either $90 million or so for licensing.

And on the royalty side, yes, the relevant industry data that we’ve seen and some of the customer guidance data for the third quarter which is our shipment period for our Q4 royalties suggest the sequential increase – similar dollar value to prior years. Last couple of years it’s been up $15 million or so. Looking back over three to five year average, it’s somewhere in the region of $10 million to $15 million.

So, in this context, taking licensing and royalty together, we expect group revenues for the fourth quarter to be in line with current expectations of approximately $290 million.

And with that, we’ll try to open to questions.

Simon Segars

So, well, we have some time for questions now. If I could request please that when you come on the line to ask a question, if you ask just one question sort of we do have a chance to get through everyone on the call. So, with that, operator, could we have the first question please?

Question-and-Answer Session

Operator

Okay. Your first question comes from the line of Gareth Jenkins. Please ask your question.

Gareth Jenkins – UBS

Hi, thanks gentlemen. Just you’d probably hit more on this next week. But I just wanted to see if you could take on the server market and developments there. Obviously we’ve seen the recent developments at Broca also taking – exactly into the board. And I just wanted whether you can give us an update on how things like progress initially are coming and really the expectations around 64-bit in the market? Thank you.

Simon Segars

So, I think generally progress has been very good in server market over the last – little while. We’re seeing hardware platforms come to maturity. We’re seeing some of the software components that are going to be required to run on the server hardware become developed across the ecosystem. And I think through – over the next 12 months we should start to see some shipments of real server products, real customers being deployed in real applications. So I think progress is being good. And as you said you’ll see some more on that at next week’s tech con.

Operator

Your next question comes from the line of Simon Schäfer. Please ask your question.

Simon Schäfer – Goldman Sachs

Yes, thanks so much. I just want to get your sense on market share on non-mobile going forward. Obviously, a very strong breach once again on the core licensing side, so if anything I guess that should because of future market share. I think last year you had roughly 20% market share non-mobile. Any sense as to how that might look in sort of more like 2014, 2015 type timeframe based on the licensing that you’ve exceeded this year?

Simon Segars

Well, I’d like to think that overall there is healthy adoption of ARM technology in many markets. I mean, one of the particular standout features of our licensing in Q3 was the number of Cortex-M devices. In the microcontroller space, our market share is today relatively small. And I’d like to think that’s going to grow quite strongly over the next couple of years of the back of this licensing and the opportunity that IOT represents.

The other side, I would say, we’re poised to some good growth is in enterprise networking. We’ve already had early adopters such as LSI start to ship products. But you saw in the quarter that we saw in licensees – well, sorry, the products were announced by Mali, Qualcomm, Freescale, talking about new enterprise networking applications that they’re using on technology to develop with. And so, we should see some good market share going there.

Simon Schäfer – Goldman Sachs

Great. Thanks Simon.

Operator

Your next question comes from the line of Pierre Ferragu. Please ask your question.

Pierre Ferragu – Sanford Bernstein

Hi. Hi, good morning. Thank you for taking my question. I’d like to come back to the royalty growth as far as your 16% as opposed you had of your overall semiconductor market. But if you can talk about how your revenues come from smartphones, smartphones have been growing like in the high 30s this quarter, it’s kind of pressing because it doesn’t send up your actual royalty revenues have been growing faster than your addressed market even if it’s growing much faster than your addressable market?

And so the reason why I’m pointing to that is that next year we’ll probably have like a slowdown in smartphone growth and so for you to stay 15% to 20% of those – the overall semiconductor market in terms of growth where I need to see like something coming into play and relaying growth that is coming from smartphones today. And I’m not sure where we should see that coming like – are that showing to increased penetration in non-smartphone segments either quite a strongly share. So, do you expect like a steep acceleration and if that’s the case, what would be like as a segment where most of this acceleration would come from?

Simon Segars

Well, I think in smartphones generally we’re expecting quite strong growth next year. We’re expecting about 20% to 25% growth in smartphones. There is going to be a range of end devices there. There is going to be growth in the high end. But most growth will be in entry-level and mid-range phones where there is an opportunity for lot of ARM technology opportunity for Cortex processors, opportunity for Mali, opportunity for our physical IP.

So, the growth and once there may be lower cost devices, there is an opportunity for lot of silicon content there for ARM. So, we’re expecting mobile to represent strong growth in royalties through next year. And then in non-mobile, we’ve seen in this last quarter the overall split of unit shipments. Now it’s 52% in non-mobile devices, lot of growths there embedded where we’re seeing strong growth of our Cortex and based parts from many of our licensees. And we would expect that to continue as well through next year.

Tim Score

And I suppose that’s a sort of a more general point looking sort of longer term. License revenue has obviously been well above trend growth now for three and half years and continues into 2013. And really given the normal lag of three to four years between licensee and royalty, that looking further out into royalty we haven’t yet really seen the benefit of a much higher than trend licensing growth.

So I think this sort of long-term picture for royalty that is being painted by license revenue growth in the last three and half years is very encouraging.

Simon Segars

If the other end-market I would point to would be enterprise networking. I mean, we just touched on that with the licensing that’s going on and with the first products that are now being shipped. That is an area where we do expect to see some good market share gains and of course that translates to volume. And given that those devices tend to be the more expensive end of the spectrum. Then that should be a good dollar contributor to our overall royalties.

Pierre Ferragu – Sanford Bernstein

Thank you.

Operator

Your next question comes from the line of Didier Scemama. Please ask your question.

Didier Scemama – Merrill Lynch

Good morning gentlemen. Thanks for taking my question. Very simple question. You mentioned in your press release that you’ve got a major networking OEM signing license. So my question would be what sort of applications are we looking at? And number one, do you think that the trend did intermediating the semiconductor vendors and going straight to OEMs, is going to accelerate whether networking or in other applications going forward? Thank you.

Simon Segars

So, well, I think that the licensing we’ve done is with the silicon partners, we’re going to provide devices into OEMs. I mean, your question about OEMs taking licensing, that licensees. There are certainly some who want to be at a guide what their system products look like. But I think generally whilst that was a trend of people were anticipating a few years ago, I don’t actually think we’ve seen much of that.

I think the semiconductor partners are working closely with the OEMs on defining what the products need to look like. And then, going often doing what semiconductor companies do well, is designing semiconductors and providing them for their end customers.

Operator

Your next question comes from Amit Harchandani. Please ask your question.

Amit Harchandani – Citigroup

Good morning gentlemen. Amit Harchandani from Citigroup and thanks for taking my question. My question is around looking at licensing going forward. As Tim pointed out, we have been above the usual trend for close to three, three and half years now. And particularly when I look at 64-bit, and a scenario wherein given that one silicon maker out there is already got a 64-bit product in mobile and others looking to accelerate their attempt in 64-bit.

Does that potentially lead to an accelerated revenue recognition coming out of backlog as well as milestones that are achieved? And potentially how should we then think about the licensing revenue that you declare going forward over the next 12 to 18 months? Thank you.

Tim Score

Amit, its Tim. Yeah, I think generally when we discuss the trend that we’re seeing in licensing with investors. I mean, our message remains the same. If you look out medium and long-term, we do expect license revenue to grow in the sort of mid-to-high single digit. I think the thing that’s interesting is how we transition from the growth we’ve been seeing in the last three and half years to that steady state.

And I think that is quite a difficult transition to call. And obviously in recent quarters, we’ve been performing ahead of guidelines. But I don’t think the – I think the 64-bit licensing of version 8, I mean, it’s all a very strong driver for ARM’s licensing going forward.

I don’t think it really materially changes the overall profile of how backlog gets converted into revenue. New technology when it’s adopted by lead licensees, take a good few quarters to get into revenue. And when it becomes available for general licensing, it’s a much shorter period into revenue. And I don’t think that overall dynamic changes.

I mean, as I said earlier, there is the backlog pie-chart in the slides shows the recognition profile next couple of quarters, three and four quarterly up and more than 12 months. And the other thing to shake of that is particularly different from what has been in the past.

Operator

Your next question comes from Andrew Gardiner.

Andrew Gardiner – Barclays

Good morning, thank you. Tim, I was just looking at some of the comments that have come across the wires, where you’re acknowledging inventory correction in the mobile space. I’m just wondering if you can give us any more color on what you’re seeing through the early stages of the 3Q royalty reports coming through and signs of sort of confidence return, your confidence in our business coming back in the fourth quarter. If any further detail that would be helpful?

Tim Score

Well, I think Andrew the guidance we’ve given is that we expect a broadly similar seasonal picture than we’ve seen in recent years over an uptake in the sort of mid-teens area. I mean, actually 22 October, it’s even earlier than usual for us to be reporting. And therefore we’ve actually seen less royalty reports than we may, normally may have done by the time we report.

But obviously what we’re looking at as you do is, guidance from some of our big shipping partners and inevitably it’s the somewhat mixed picture and some strongly up, some less though. But yes taking that all in the round, we see a picture probably emerging similar shape to previous Q3 to Q4 transitions.

Andrew Gardiner – Barclays

Thank you.

Operator

Your next question comes from Sandeep Deshpande. Please ask your question.

Sandeep Deshpande – JP Morgan

Yes, hi, thanks. Can I ask a question about POPD royalties? I mean, POPD royalties were showing quite some nice signs of growth in the first half of the year. That grow seems – doesn’t seem to be shown in this report as such. So, what is exactly happening because you did seem to be showing some signs on traction associated with POPs. But at this point, it does seem very lumpy because normally historically your royalties have never been – I mean, licensing has been lumpy in ways. But royalties, once the royalties started coming in, they keep coming in. So, is there anything happening on the POPD royalty side?

Simon Segars

I think POP licensing continues to perform well. There were another four deals that we dated in Q3. And plenty of opportunities we see ahead of us. The royalties that – those licensees will generate and follow a similar trend to process of licensing as well. So, there is – with all the POP deals that we’ve done, over 50 now I believe. They will take time to come through on the royalty line.

The Q3 royalties in VIP last year were very strong. So, the comparison year-on-year is unhealthy in terms of percentage wise. But year-to-date POPD royalties are up 16%, which I think reflects the overall success we’ve had in design wins and delivering leading edge technology over the last five years or so.

Sandeep Deshpande – JP Morgan

So you’re saying that there is no reason why because you were almost at 51% year-on-year growth in Q1, and now it’s 5.6% year-on-year growth. So, something – it’s not just – is it just the base effect or is it nothing else happening there as such really?

Simon Segars

There is nothing else affecting that. It’s – if you’re really looking at a mathematical effect of the comparison.

Sandeep Deshpande – JP Morgan

Thank you.

Operator

Your next question comes from Francois Meunier. Please ask your question.

Francois Meunier – Morgan Stanley

Yes, thank you. I would like to ask a question about the monster license number you printed this quarter. If I understand well there has been a few big deals in this quarter maybe like three or four versus normally only one or two. I was wondering, is it basically big deals which have been pulled in into Q3, there are limited number of big deals you can sign every year. And did you give the normal rate of the normal level of discount for big deals this quarter or maybe more than usual?

I’m trying to understand basically because I think everyone here has been surprised with licensing numbers for the past three years. And I think the team has been quite good at managing expectations. But every quarter basically the number is way ahead of what we’ve been thinking?

Tim Score

Yes. Francois, you’re right. I mean, there are number of things to note. I mean, the most significant ones are there were 48 licenses and we haven’t really been sort of north of the mid-30s before so a lot of licensing across a very broad range of customers and end markets. There were some significant revenue contributors that there are in every quarter. There were two or three year.

But I can sort of categorize these state that none of these were brought into Q3 from future periods in terms – commercial arrangements to pull that in. I mean, just sort of underlying is a sense of where you’re trying very, very hard to offset the royalty shortfall with licensing. I mean, if we’ve been trying to do that we probably would have stopped well before we went to over.

So, that’s just not a fact at all. I mean, the reality is there is a very big demand for ARM technology at the moment. And whilst, I think 106 is clearly a high base. We are pointing now to a base of 90 rather than 80 coming into this quarter. So, this is not a one-quarter wonder. The licensing continues to be strong and the backlog drop and the pipelines do healthy.

Francois Meunier – Morgan Stanley

But are we going basically probably all the way up, because as you said many times before, you say maybe it’s going to be 90, 95 next quarter and then, you’re 105 again. So, it’s just like what’s your fitting now?

Tim Score

Well, I think the reality is, when you got a period – there is a really, really strong demand from technology. It is actually quite tough to call precisely which day was it going to close and in which period. Deals kind of close very quickly, they can take longer to negotiate. And yes, as I think I said earlier, I mean, I view a role around the quarter siding guiding. The quarter is a short period for licensing in this type of business model. So now I think we need to earn on decided caution when we’re trying to predict precisely which deals will close.

Francois Meunier – Morgan Stanley

Okay. Thank you, Tim.

Operator

Your next question comes from Matt Ramsey. Please ask your question.

Matt Ramsey – Canaccord Genuity

Yes, thank you very much. I just wanted to dig in a little bit further on the licensing. You guys mentioned that about half of the licenses signed in the period were from new licensees. Maybe you could give a bit more color of where new licensees are coming from? Are these processor makers that formally used a different instruction set architecture maybe Power PC or MIPS in the embedded space? Or are these sort of new upstart processor companies from Asian markets or whatever emerging market might be. A little color on that would be great. Thank you.

Simon Segars

So, it’s a pretty broad range of customers that we have licensed to. Of these 11 customers who have never taken license long – technology people. Broad range of end markets that people are looking at, although many are looking at microcontroller and IOT applications. But there are companies in the U.K., companies across Europe, companies in China, companies in other parts of Asia, companies in the U.S., so, a very wide range of end-customers who have licensed to addressing a broad range of markets.

Tim Score

Yeah. And Matt, many of these companies though are established semiconductor companies who just because they’re being developing say analog sensors or something that didn’t necessarily require any small processor before. Quite often I dig into these companies and find they’ve been around for years but they’ve just never needed to have any smart technology in their chip. So they’re coming to ARM and getting their efforts to have a processor.

Operator

Your next question comes from Johannes Schiller. Please ask your question.

Johan Schiller – Deutsche Bank

Yes, thank you. Thanks for taking my question. Just really one on 64-bit driving royalties. And maybe obviously one major smart device OEM that is shipping volumes here now. And probably see a few more 64-bit products on the networking service space in 2014. Just, if you could give us a bit of a feeling on how are your conversations with your licensees that are currently going on 64-bit, both smart devices and other areas? And how we should think about volume shipments here? I guess that and smart devices next year will super-dominantly be Apple. But then how should we think about the other markets and also into 2015 on the volume side? Thank you.

Simon Segars

So, we’re seeing demand from 64-bit compatible technology across a wide range of markets. I mean, in mobile, in smartphones and tablets. And we’ve said for quite some time that we see it as an inevitable shift to 64-bit at some point in the future. And this past quarter we’ve seen Apple come out of the 64-bit – the first 64-bit device. I think we’re going to see the start of the transition there. And how quickly that migrates in the high-end, the mid-range, the entry-level, time will tell.

But on the other side we see strong interest, 64-bit ARM processors in the service space and in enterprise networking. So, the technology, we’ve designed in a way that it can target a very wide range of end applications. We have different products to different markets. And we’re seeing strong uptake of that in the licensing.

In terms of volumes next year, I think realistically that’s going to be quite modest for 64-bit. These products do take time to design to deploy into the field and the volumes to grow. So I think 64-bit volumes would be quite modest in ‘14.

Johan Schiller – Deutsche Bank

But we should likely get more clarity on the 2015 outlook then, and maybe a few licensees giving us an update on new products over the course of next year. Is that fair to assume?

Simon Segars

Yes, I would expect that you would be seeing product announcements from our licensees talking about new devices featuring 64-bit ARM technology through the next year.

Johan Schiller – Deutsche Bank

And that should be both in mobile and outside?

Simon Segars

I would expect that across a wide range of markets, yes.

Johan Schiller – Deutsche Bank

Understood. Thank you very much.

Operator

Your next question comes from Sumant Wahi. Please ask your question.

Sumant Wahi – Redburn Partners

Good morning guys and thanks for taking my question. I have a bit of a broader, longer-term strategy question around Intel and set of that. In September, Intel announced that its entering the intern of Quark family, yet another market I suppose where you and Intel will compete head-to-head.

And what I was quite interested in that was their comment about the fact that they will offer Quark family or Quark Solution as a synthesizable product. So if I kind of compare that with the smartphone market, you’ve clearly won because of probably three reasons, the right technology, the right business model and of course that your codes are a standard by the time Intel really decided to come in.

But in the internal of things, when I look at it from to where we are today the standards are not set and they suggest that they’re probably emulating your model to a certain extent by selling IP essentially. So how do you think you’ll be able to defend yourself in that – I know that your technology is much further ahead. But is that the only focus which should help you stay ahead of them or is there anything else I should be looking at?

And while I think you are added, could you also tell us what you think is your latest view in how big in dollar terms is the intern of things today?

Simon Segars

So, think you have to be careful not to confuse a process of being synthesizable with a process of being licensable. I may be wrong but as far as I don’t I’ve heard Intel say that they’re going to be licensing their processes to other people to design chips with. So I think our business models remain very, very different.

I think the internet of things space is very broad. There will be a wide range of processes required to address in its entirety. Internet of things can mean processes connected to large piece of equipment sitting in factories which have been monitored to see when they need repairing. It can mean wearable devices which can require high performance processors or very small processors. It can mean sensors embedded in light house to work out when they’re going to need replacing and what color temperature that the light is going to be coming out of it.

So, there is a very wide range of end markets which comprise the internet of things. All of them pretty much have characteristics of they being a processor, a sensor of some sort and some while this technology all of which ARM has a very deep penetration of into already. And if you look at the microcontroller shipments by ARM licensees there is cumulatively over 5 billion of them that’s already been shipped.

So while the internet of things is a new space and there is scope for many people to go and play in it. And there is scope for new standards to be set. I think ARM is already being successful with our range of microcontroller processors and achieved very large penetration that Intel companies have produced chips for the internet of things or work these chips for the internet of things.

Sumant Wahi – Redburn Partners

Okay. And any view over the next five years how big this market could be in dollar terms, any new view essentially given the fact how quickly it’s growing?

Simon Segars

Well, I don’t think we’ve still changed our view on that. I mean, we exactly how big it’s going to be again kind of remains to be seen how quickly standards for security get deployed for example, how quickly services can be built up around these interconnected devices remains to be seen. But this is a tens of billions of unit opportunity. There are really small sensors in the light bulbs in the $0.50 and below. Products larger price, this is going into smart watches that are probably going to be in the $5 range. And industrial applications might be that and maybe more. Exactly the blend of that – hard to call right now.

Sumant Wahi – Redburn Partners

Thank you very much.

Operator

Your next question come from (inaudible). Please ask your question.

Unidentified Analyst

Hi guys, yes. On mobile royalties you mentioned in the press release and that mobile royalties were up 20% year-on-year, volumes were up 8%. That would imply that your royalty rate per unit within mobiles was up about 12%. Can you give us some sense obviously it’s being held by rising royalty rates but that’s been offset also by declining chipset ASPs. Can you give us some sense of how much that is actually being driven by the increase in royalty rates? And if that trend that we should actually expect going forward?

And then I have a link up, link to that – how do you actually see the adoption of both 64-bit and also big.LITTLE technology. Have you seen some traction, initial traction in the high-end but do you actually believe that these technologies will be needed in the mid-end of the smartphone market, three years, four years down the line?

Tim Score

Okay. Well, I’ll take the first part of that one. Yeah, so clearly stated in the release, look at Cortex-A processors and Mali graphic processors, both of those are about two fold year-on-year. Cortex-A advanced processors, when compared to sort of the ARM-11s and ARM-9s have a slightly higher royalty rate. And my graphic adds another sort of about 1% as well. So, the combination of those together does mean then that we are going to be seeing slightly higher royalty percentages from both platform as processor going into mobile phones.

And yeah, that’s going to be – has to be put into the overall mix with what’s going into invite some trouble in things where, we put – we have 10-class processor. So, in the end, what happens to the average going forward, we’re very much dependent, being dependent upon the mix. But certainly I think you can sort of separate your Cortex-A. Your application processor is going into smartphones, into tablet, into computers, into TVs, and also into things like enterprise networking and service.

And I think that those will probably have a growing royalty percentage over time. Whereas the idea of the markets where we have – we have a slightly higher royalty percentage but probably a slower growth trend going forward.

Simon Segars

So your follow-on question was that big level. So, we’ve seen a couple of announcements in the last quarter, one from MediaTek, one from Samsung about new devices using big.LITTLE. As you said, initially that’s been successful in the high end. I think over time we should expect to see that migrate into the mid-range. I think it’s most suitable where you have a broad range of processing performance requirement. Sometimes in an application where sometimes you need a lot of performance, sometimes you don’t need much performance, big.LITTLE is a great technology that’s helping a lot of power and smartphones exhibit those characteristics.

So, the reason why it’s not a suitable technology across the entire spectrum but in a low cost entry-level device, is probably initially at first anyway, we like you to go through the lowest cost implementation point which is probably a single or dual-core processor. But overtime, as devices continue to shrink, as silicon continues to get less expensive to manufacture, then there is no reason why big.LITTLE can’t spend the entire range of smart computers.

Unidentified Analyst

Great. Thanks a lot.

Operator

Your next question comes from Jerome Ramel. Please ask your question.

Jerome Ramel – Exane

Good morning. Just coming back to the royalty, achieved flat year-on-year. If I look at the mix between Cortex and the rest, Cortex was only a bit ahead of 50%, 53%, seemed it’s going to be higher than last year. And if I look between the Cortex-M, Cortex-A, whether one of 27% Cortex, ARM only 74%. So, I’m just wondering why, I understand the mix effect but if I look at Cortex-A grew significantly higher and quickly than the Cortex-M. So, I’m just wondering why we had only flat royalty per ship. So I’d just like to understand what was the end dollar in prior decline you saw per ship?

Tim Score

For us the price decline that’s there is potentially a large price difference in the cost of the application processor with multi-core Cortex-A in it. And the price of the microcontroller with a single Cortex eminent. I mean, one could be $5, $10, $15, maybe $20, the other could be $0.50 and below. So, in terms of the volumes, we’re seeing large volume growth in Cortex-M that has pretty rapid effect on pulling down the average when you just divide the royalty dollars by the royalty volume.

Jerome Ramel – Exane

I understand. And I know there are many inputs but what’s going to be your best guess for the royalty purpose you’re going forward?

Simon Segars

It depends on the mix.

Tim Score

I mean, Jerome this has obviously been a longstanding discussion. And now, our guidance you have heard before tends to be – we sort of think broadly flat. I mean, what we’ve seen over the last two or three years well, in many years before that – we saw a gradual decline as the weighted average of chip prices aren’t going designed into went down. And then we’ve seen in the last two or three years, sort of flat to slightly up.

And when we look out forward, we obviously see some trends that are taking in different directions, very strong growth Cortex-A, version 8, higher percentages, higher chip prices. But Simon has just painted a picture of what the internet of things opportunity looks like in massively high volumes. But obviously characterized by lower chip prices on average. So it really does depend on one’s assumptions about the growth rates of these markets and ARM’s penetration of these markets as to where you get to – on the average.

The good news is it’s all a 100% margin revenue.

Jerome Ramel – Exane

Thank you very much.

Operator

Your next question comes from Janardan Menon. Please ask your question.

Janardan Menon – Liberum Capital

Just to go on your guidance on royalties into the fourth quarter. You said it’s a similar level in dollar value. But obviously that would imply declining quarter on quarter growth rate, it’s taking sort of – which is taking sort of the mid-range of your guidance about $13 million, $14 million would imply about 10% versus to 14% that you’ve seen on previous years. So, I was just wondering, what wants you to read into that, is that – would you say that it’s a sort of a temporary kind of a deceleration that we’re seeing because of inventory, is that what you’re – or does that signal more structural slowdown in key markets like smartphone and tablets and until all the other applications start becoming bigger we could be in a slower growth phase for some time?

Simon Segars

Well, I think when you look at the end markets, I mean, consumer products go through cycles, what we’ve seen in Q3 is many devices kind of coming to the end of their life and consumers waiting for the next version to come out before upgrading. We’ve seen that in some smartphones, we’ve seen that in tablets, we’ve seen that in game platforms. A lot of that has happened at one.

We’re expecting something of an up-tick in Q4. We’re making a judgment on that based on the information that we have in front of us, which is obviously imperfect to most have the cool supplies out. In terms of long term structurally though I think when you look at the number of licenses that we’ve just done, when you look at the strength of licensing over the last couple of years that point is very strongly to an up-tick in design wins around technology which drives royalty, which royalty dollars.

So I think for the long term, and we are in the sort of long term, we should continue to see gains in market-share, royalty volumes and royalty dollars.

Janardan Menon – Liberum Capital

Got it. Thanks. Thanks a lot.

Operator

Your next question comes from Vijay Anand. Please ask your question.

Vijay Anand – Espirito Santos

Thanks guys. I had a question on the server market. Simon, could you maybe talk about the 64-bit ecosystem in terms of how far or how close we are for the ecosystem to be mature enough to support commercial deployment. And in that context, maybe could you also talk about the licensing traction you’re seeing in the server market, even in the third quarter both some quantitative as well as some qualitative color will be helpful. Thanks.

Simon Segars

So, in terms of the ecosystem, I mean, a lot of work has been going on for a long time to be ready for 64-bit commercial deployment of servers. And we’re starting to get to the point where that can happen. I mean, we are expecting this quarter for HP’s Moon Shop products to ship based on 64-bit ARM interim processor like AMCC.

So, at that time the required software and hardware will come together and we’ve seen much of that being developed by numerous partners in the army. So, it’s been a work in progress and I’d say at the moment it’s coming to fruition. We continue to see very strong interest in putting ARM in the datacenter.

Many people who build out datacenters for specific applications are very interested in doing trial deployments right now. And I would expect based on the number of trials that are going on to start seeing some meaningful commercial deployment probably starting in about what some time through next year. So I think we’re in pretty good shape. And it’s one of the things that’s helping drive licensing.

Operator

Your next question comes from Lee Simpson. Please ask your question.

Lee Simpson

Good morning. Thanks for letting me on. I just want to ask you a quick question about networking if I could. I mean, as far as looking at trends in that space, it looks as though there is an ongoing shift towards low cost while it’s base stations. And I just wanted to understand beyond help that it has for FTGA near term. And some of that obviously next phase roll outs infrastructure in China. I’m just trying to understand where ARM licensees are coming in to the mix here?

And maybe associated with that are you encouraged by the moves that some half towards a unified stack across macro and lower cost base stations as a positive for ARM architecture?

Simon Segars

I mean, I think in order to help lower cost, some form of standardization is required. And there are many ARM licensees now taking on technology and targeting this market. I think just to say there is a shift towards the combination of macro base stations and small cell base stations in order to achieve a number of things, delivering the bandwidth that 4G technologies are offered the capability of – you’re going to require an upgrade in the infrastructure. And upgrade the shift to the combination of large and small cells.

And also I believe people would do more and more communication from mobile devices indoors if something else is driving that. I mean, when regional mobile networks were deployed, they were deployed to enable people to make phone calls whilst they were out of the office and away from home. And now increasingly most calls are initiated inside buildings which the conventional infrastructure doesn’t well suit. So that is one of the things that’s driving the adoption there.

To make all of that reality these devices need to be low cost if you’re going to have high volume. And the ARM business model, the technology delivered through ARM’s licensees helps enable lower cost end devices and helps drive volume which is good for everybody and plays in the states and it’s certainly good for ARMs volumes and ARMs royalties.

Lee Simpson

Perfect. Thank you very much.

Operator

Your next question comes from Andrew Dunn. Please ask your question.

Andrew Dunn – RBC

Good morning. Most of my questions have been answered but I had one on actually on headcount. You’ve increased your headcount sequentially this quarter by around 8%. I think that’s the highest you’ve done for a number of years, particularly in Asia Pacific I noticed. Are there any specific areas that you’re investing in, I know you’ve spent a lot on Mali and getting that up to the competitive product. But are there any particular areas that you are investing in now going forward. Thanks.

Simon Segars

Well, there are number of areas. I mean, a lot of the engineers that we are hiring are going on to developing next generation of process of technology. We’re also increasing the number of people that we have kind of in the field working place with our customers to help with the integration of what we license to them. And help accelerate time to market for our customers and help support them.

But then we’re also investing in our internal infrastructure so that the company can scale and grow to deliver on the opportunity that we have.

Andre Dunn – RBC

Thanks.

Operator

Your next question comes from Brett Simpson. Please ask your question.

Brett Simpson – Arete Research

I just go back to the second quarter, looking at the smartphone market, some of the trends, quite a lot of changes with your Qualcomm and MediaTek spread among very strong selling in the June quarter. And Apple, you’re clearly working down inventory on the iPhone side ahead of the new product launches. And I think also had we got that numbers, so quite a big mix-shift in the second quarter to the low end. And I just wanted to ask can you just talk a little bit about Cortex-A royalty ASPs, with this mix-shift we saw in the June quarter, have you seen any major changes in your Cortex-A royalty ASPs?

Tim Score

Okay. Hi Brett, its Tim here. I mean, when we look back at the ASPs of the AR2 chips, then that being flattish, it’s kind of been flattish for the last few quarters. Also the royalty percentages that we get from those as you saw it and see, some of the Cortex-A16, some of the big.LITTLE ones start to come through like versatile. They actually had a little bit of an increment, sorry, high increment. And obviously with Mali graphics doubling units year-on-year, that also adds in an extra percent. So, there is a number of sort of drivers within that hopefully getting I would say a higher royalty percentage overtime.

Gareth Jenkins – UBS

All right, that’s helpful. And just maybe a follow-up here. Looking at the backlog on PD licensing. What portion would be 64-bit v8? And can you give us a sense what typical license ASPs – the bump in the ASP you’re getting for v8 versus v7 on a like-for-like basis?

Simon Segars

Well, we haven’t really yet provided guidance on ASPs of our licensees. Yes, that’s not something that’s particularly going to help us I don’t think in liaising with our customers. So we haven’t really broken that out.

Tim Score

The more sophisticated the process are in the more complicated to develop, the more – the higher the licensing brand, I mean, that normal trend continues. And we don’t – again, we don’t go down to the next level of detail around the backlog. Yes, as you know, I told you one time, the latest generation of technology that we are licensing forms a portion of the backlog and v8 is no different. And you’ve seen how many licenses we’ve done. And the revenue recognition on those is ahead of us, not just behind us though, yes.

Gareth Jenkins – UBS

And maybe just another way of asking that question Tim. I mean, when you look at v8 and the build you signed so far and compared to the same time with Cortex-A v7. Is the take rates from the industry for your latest architecture much faster than we saw in v7 Cortex-A?

Tim Score

I think there is distinct enthusiasm for the version 8 of the architecture. But there are other products that have licensed very rapidly like Cortex-M. So, yes, it’s, yes, you can tell generally if you look at what’s happened in licensing in the last year or so since the v8 has been introduced. It is benefiting everyone’s enthusiasm about technologies of our existing portfolio.

Simon Segars

And I would say probably numerically it’s the case that the up-sight has been faster. But compared to when we introduced v7, the business is bigger and the number of customers we have is bigger as well commensurately. So, yes.

Gareth Jenkins – UBS

Thanks very much.

Simon Segars

Okay. We’re going to make this the last question.

Operator

Your last question comes from Kai Korschelt. Please ask your question.

Tim Score

Hi Kai.

Kai Korschelt – Deutsche Bank

Yes, hello. Can you hear me?

Tim Score

Yes.

Simon Segars

Yes.

Kai Korschelt – Deutsche Bank

Yes. Sorry, yes, thanks for squeezing me in. I just had a couple on some of the incremental markets. So the first one was on networking, I know there are a couple of questions on this. But any color you can give on maybe the value and essentially unit opportunity shorter in the term here?

Then the second was really on the iPhone 5S, we saw further ARM content grow, if we had the m7, it’s obviously a lower ASP chip. But I mean, should we expect this sort of process of growth or content growth to continue in other high-end devices going forward? Thank you.

Simon Segars

So, I’ll take the last bit first. I mean, in terms of content in high-end smartphones, I think what you are seeing is an increase in the number of sensors that are embedded in the phones as well as just the role of application processor performance. You see that in a number of the high-end devices that have shipped over the last year. And I think that’s going to be a growing trend. So, that does represent a further opportunity for more ARM technology. Could you repeat the first part of your question?

Kai Korschelt – Deutsche Bank

Sorry, the first question was on networking. Just if you can maybe give any color on maybe the value of unit opportunity, maybe next year and then on a three-year view potentially? Thank you.

Tim Score

Kai, as you probably have seen before. Road checks, like we do intend to lay out quite a bit of detail. And here to that the brochure is like on slide 22, we do have a slide just on enterprise networking including value and size. And since there is a table there which will give you the details. But the headline basically is for the 2017 Charlene Marini, who runs that team there is excavating that 700 million chips is the size of the turn, and the value of that is about $17 billion, which when I get my calculator out that’s very similar sort of the application process is going into smartphones nearly $1 million. The key for Simon is amount in billion.

So, and I get my calculator that’s about the same for the size of application processors going into smartphones. And yet it’s a market where we have practically today – well, I wouldn’t say zero. We now actually do have one company that’s been shipping millions of units but even though it’s a very, very small market share. But hopefully as we’ve been discussing already about the licensing, yeah, it is a market where we hope to gain share rapidly with some of our most advanced processes which have the higher royalty percentages typically.

Kai Korschelt – Deutsche Bank

And based on the licenses, you’ve been signing recently what would be your sort of market share target maybe by 2017?

Tim Score

Well that is also on page 22 of the brochure slides. But I mean, like I guess, you’re looking at to the 20% to 30% by the time we get to 2017 on average.

Kai Korschelt – Deutsche Bank

Okay. Thank you very much.

Tim Score

Okay.

Simon Segars

Okay. Thank you very much for your questions and for your time this morning. And we’ll see you by the end of January.

Tim Score

End of January, like February.

Simon Segars

Thank you.

Operator

That concludes our conference for today. Thanks for participating. You may all disconnect.

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