ARM Holdings plc (NASDAQ:ARMH)
Q4 2013 Earnings Call
February 4, 2014 4:30 AM ET
Simon Segars – CEO
Tim Score – CFO
Sumant Wahi – Redburn Partners
Didier Scemama – Merrill Lynch
Gareth Jenkins – UBS
Nick James – Numis
Achal Sultania – Credit Suisse
Andrew Dunn – RBC
Andrew Gardiner – Barclays Capital
Simon Schafer – Goldman Sachs
Vijay Anand – Espirito Santos
Adam Bowler – Deutsche Bank
Dan Gardiner – Arete
Okay. Good morning, everyone. Welcome to ARM’s Full-Year 2013 and Q4, 2013 results. What we’re going to do this morning? I am going to talk about the business, the progress we’ve made, so with our strategic objectives. Then I am going to hand over to Tim. He is going to talk through some of the numbers, and then we’ll go to Q&A. I’ll take as read the usual cautionary statements and we’ll start talking about the business.
So I think it was a very exciting year for ARM in 2013. We achieved some great milestones in our business with our technology. I think one of the most significant being that our licensees sold over 10 billion chips containing ARM processors. And that was a key milestone for us, that takes the cumulative total now to over 50 billion chips containing ARM processors since the company was founded just over 23 years ago.
And that’s a huge number and it represents a massive diversity in the end markets in which ARM is designed. You see ARM technology being used in big high compute performance applications such as servers, in networking equipment, in phones and smartphones and tablets obviously, and also growing a proportion of ARM processors in very small, very low power deeply-embedded microcontrollers that are in a vast range of new and exciting markets.
Mobility, smartphones, tablets remains a very important market for ARM. And a year ago we were forecasting there would be about a billion smartphones sold in 2013, and that indeed seems to being the case. Our estimates show about 1.1 billion smartphones were sold, taking the total now in use around the world to about two billion. Now the growth of smartphones, the growth of tablets has been very strong, we’ve seen tablets out-shipping PC notebooks in 2013 as well, because these devices are the way in which people want to interact with the internet, want to interact with each other and I think there is going to be a continued growth of these markets but we’ll come back to it.
In 2013, we also saw some key milestones in terms of our technology and the growth of new markets. As far as our technology goes, we saw the first ARMv8 architecture product shipped. These are our processors that add to 64-bit processing capability and we received our first royalty from those. We started our first royalties from 20 nanometer physical IP as our partners moved to advanced processors.
We’ve also seen growth in new markets for ARM. There is a lot of buzz and hype at the moment around the category of wearable devices. And recently at CES, you just saw a plethora of new devices, all based around ARM processors which are exploring this product category, and I think we’re going to see a lot of growth there in the years to come.
That is a sub-category of the internet of things, which again is in its infancy, but I think set to grow very, very strongly. And right now what people are using are ARM-based processors. They are using the chips that have been designed by our licensees. They are embedding them in devices, and they are very quickly getting to market with new and exciting products. And as these markets mature, we’re expecting that as the internet of things runs on ARM today, a vast, vast majority of that is going to run on ARM in the future.
At the other end of the computing spectrum, we’ve seen progress in enterprise networking and servers, all of this data that smartphones and tablets and IoT devices are producing, needs moving around. It needs storing and processing. And we’re seeing traction for ARM technology into these markets as well.
So with this success to this business, that’s led to record revenues, record profits and we’ve been continuing to invest in our technology. We added over 400 people into the business in 2013 to help us capitalize on the new opportunities in front of us. So it was a very exciting year, very busy year.
Q4 rounded off that year with great progress, a very strong quarter again in terms of licensing. We sold 26 processor licenses and that helped create 121 licenses for the full-year. Within that, there were four Mali licenses. And in the quarter our licensees shipped 2.9 billion chips. That’s the most ever shipped in one quarter.
Now there is a lot made at the moment about the slowing of growth in the high-end of smartphones, and indeed that appears to be the case, but despite that, still we have record unit shipments, because of the vast number of end markets in which ARM technology is used.
The performance of the licensing and the royalty growth led to 15% year-on-year revenue growth and through that performance of the business, we’re able to keep investing in the business, while we increase returns to our shareholders. We’ve just announced we would increase our dividend by 27%.
So if we look into what’s behind royalty at the moment. Typically you are used to hearing us talk about how ARM has outperformed the industry, and indeed through 2013, that was the case, the semiconductor industry only grew by about 1% in 2013, the ARM’s royalty revenues grew 19%. So we continue to strongly outperform the industry.
In Q4, that outperformance was lower. ARM’s royalties grew about 7% year-on-year, the industry grew about 2% to 3% in that time, but overall for full-year, another very strong performance for royalty growth.
Again you are used to hearing us talk about progress within mobile and progress outside of mobile. And now over half the chips that are shipped by our customers are used in applications that aren’t mobile devices, they aren’t smartphones or basic cell phones or tablets. They are in things such as consumer electronics. And it was about two billion chips shipped into products like digital cameras, digital TVs, DVD players, vast range of consumer electronics, and about 3.5 billion shipped into enterprise networking applications and embedded computing is very small microcontrollers I was talking about.
Smartphones though, remained a very important and a very valuable market to ARM, and one we’re expecting to continue to grow. Growth in 2013 was strong. We’re expecting 15%, maybe as much as 20% growth in 2014, and in long-term, a compound annual growth rate of about 10%. So this market is going to continue to grow and continue to be profitable for ARM, despite the slowing of growth in the high-end, what we’re expecting overtime is a rapid growth of entry level, mid-range phones, priced such that literally billions more people can get access to these devices and that creates a very valuable opportunity for ARM.
If we look into that, you can see the graph on the right there showing our expectation of growth rates of these different market segments of smartphones. At the top of the premium end, we’re predicting about 4% CAGR out to 2018 with much higher growth rates at the entry-level and at the mid-range.
Now, right now if you go out to buy a smartphone, about 95% of them have an ARM processor in the application processor, almost all of those now are Cortex-A processors. You’d find it really difficult to buy any sort of phone that doesn’t have an ARM processor in its modem. So in combination, you’re going to struggle to buy a phone that does not have at least one ARM processor in it and usually many more.
And as these markets grow, we’re seeing a greater opportunity. About 70% of the chips inside smartphones integrate, both the modem and the apps processors, and that helps reach a lower price point that is helping enable growth at the entry-level and the mid-range.
Now the common complaint we get is that, well those devices are cheaper, you’re going to take less money than you would at the high-end. And while it will be a glorious thing if everybody on the planet spends $700 on smartphone, it just isn’t going to happen. And the growth of the entry-level, the growth of the mid-range is a great thing because they represent big opportunity for additional ARM content in these devices. And what they are replacing? A very simple voice-only and feature phones which have a single ARM processor, but they are going to be replaced overtime by smartphones, some of them maybe more basic than the high-end than we know today, but there is more ARM content in there.
Cortex-A processors, graphic scores, the chips are built on advanced processors which often use our physical IP, as we go forward we’ll see big.LITTLE configurations of processors, again increasing ARM’s royalty, the adoption of 64-bit processors across the entire product range at some point in the future.
So this growth represents very valuable revenue potential for ARM, and we believe mathematically supports our estimated growth of revenues from smartphones out to 2018.
Now the other side of mobile computing right now is tablets. And tablets had a very strong year in 2013, as we can see there out-shipping laptops and ultra-mobiles – sorry, tablets and ultra-mobiles between them out-shipping laptops. And again the growth rates expected in this category are very strong. We’re expecting a solid growth in 2014 and out to 2018, again this five year window that we look at, a 20% compound annual growth rate of tablets. And you can see how the growth just starts to swamp conventional legacy laptops overtime.
When you look at desktop PCs, again you see the growth there very slow, minus 5% CAGR. Desktop PCs aren’t going to disappear. There is always going to be a need for those, but the way in which most people are using computers most of the time is via smartphones, via tablets and that’s why the growth rate is so strong. Again virtually all of those are using ARM processors today and we expect that to continue.
As again the market splits into different categories. There will be premium tablets. There will be low cost tablets. The low cost tablets today are all using ARM, and that is enabling billions of more people to get access to this technology.
Now one area I’ve been particularly pleased with progress on in 2013 is the adoption of ARM technology into enterprise networking. This is a big market today and will grow to about a $20 billion Silicon TAM in 2018 and that’s about the same size as smartphone application processors. So this is a big semiconductor market. And it saw products that form the infrastructure of the cloud and the high-performance switches that are required to move all the data around the internet.
This is a market that’s served by a relatively small number of semiconductor companies and all of them, or almost all of them have already announced products based on ARM technology, and in fact four of them are shipping and paying royalty.
What’s that led to in 2013, is about a 5% market share for ARM in enterprise networking and that might not seem like much but that’s 70 million chips, and that’s about twice what it was in 2012. So the growth rate is strong. We’ve been working with our partners. Our partners has been working very hard on designing the right technology, winning the sockets in the enterprise networking equipment companies, and we’re starting to see growth, and we expect to see more products brought to market based on Cortex-A15, based on ARMv8 architecture in 2014. So this is a market, we’ve had good success in 2013 and one we expect to continue to growth.
Similarly in servers, I think 2013 and very recently there has been a good sign for progress for ARM technology in servers. This was a strategy that was always going to take a long time to play out. There is a discontinuity that comes from the changing workloads of servers and that creates some opportunity to change the way in which servers are built, to move to much more customized chips that are specific to the tasks that the server is trying to process. And that is what the ARM partnership does very well. Taking high performance processing technology from ARM, integrating it with IP, and know-how in our customers to produce a tailored solution that’s optimized for the workload.
If we look back over the last couple of years, prior to 2013, we were in a very early pioneering phase were some of our partners were looking at this discontinuity and looking at how to take advantage of the opportunity that came from that discontinuity. Through last year, there were about 15 different companies building chips and looking at designs based on ARM technology. And what we’re expecting this year is that growth to accelerate, units start to ship and based on all the software work that we’re doing, servers actually deployed.
Now I think of course one of the most exciting developments very recently was last week, we announced a partnership with about 12 or 14 other companies and that really demonstrates the ARM ecosystem in action. What we’ve been looking at for a long time now – this activity has been going for about a year, is how to ensure some degree of standardization to make it much easier to pull software to an ARM-based server.
And so in conjunction with some big companies that play in this space, people who build servers, people who buy servers, people who write software for servers, a collaboration has formed to create a standardization effort called the Server Base System Architecture, that many ARM-based server designs will confirm to and therefore make it easier to support and run software.
And of couple of announcements recently, AMD just announced their Opteron A1100 Series, which is compatible with this new standard. Applied Micro, similarly they designed compatible with this standard, and that’s going to make it easier for the industry to adopt ARM-based servers and get software running more quickly.
So this is a great demonstration of the kind of thing ARM can uniquely do, help work with people who compete with each other to solve common problems and make it more efficient to deploy new technology.
Now the other end of the computing spectrum, are these very small microcontrollers. And through last year in this embedded space, there were over three billion chips sold containing ARM embedded processors. A lot of those are based around the Cortex-M Series. This is a series of products with designed specifically with this market in mind and is now about 160 companies with licenses to Cortex-M technology.
What many of them are doing are building devices that integrate a sensor which is largely an analog device, that’s sensing something from the environment, be it temperature or humidity or the road shaking, integrating those sensors with the processor that can make sense of all the data that’s coming from the sensor, and then with the radio that’s performing some form of connectivity up to the cloud.
ARM’s share in MCUs is about 20%, over 20% now. And what we’ve seen over the last few years is a migration from very, very simple what’s called 8-bit processors to much more sophisticated 32-bit processors, i.e., ARM and that gives more compute power and makes it easier to write software and makes it easier to maintain software.
Because we’re able to deliver 32-bit performance and all those benefits at very, very low cost, the fastest growing segment of MCUs is 32-bit and we are very well placed to take advantage of that.
Similarly with the radios from a heritage in mobile, many of ARM’s partners are using ARM processors in their radio devices and processing the protocol stack, processing the data that comes in and forming the connectivity of the sensor-MCU combo up into the cloud.
Now there are many examples of how these devices are being used on display at CES couple of weeks ago, everything from basketballs to watches and wearable devices, just a whole plethora of end-devices that are being made. And this category I think is going to grow very, very strongly. We’re seeing lots of experimentation in wearables. Which ones take off, which ones fail is hard to say, but I think what’s really interesting right now is just how much experimentation is happening and is enabled because the access to the technology is very low cost, the access to cloud-based storage and processing is very low cost, and all of this is coming together to create an environment where many product experiments can be run simultaneously and we’ll find out which ones are the most successful more quickly.
So this is a really interesting space. Wearables is going to grow to a very large market, more than 200 million units, is our expectation in 2018, and we expect that ARM will have a very large market share of that.
So as we look generally at the expanding opportunity for ARM, we see within smartphones, application processors, that’s a large Silicon market today, about $13 billion, growing to about $20 billion in 2018. And there are multiple opportunities for ARM royalties within that segment. We have a very large market share today, but as the market grows, there are more opportunities for ARM royalty bearing units, as these devices move to 64-bit and as they become more sophisticated.
Enterprise networking, as I mentioned earlier, grows to a market that’s about $20 billion in 2018 as well, from about $13 billion today. We have a very low market share there right now, but as I explained earlier that’s grown from about 2.5% year before. And as those devices are built out, again there is more opportunities for ARM royalty. Cortex-A15 moving to v8 architecture, multiple processors in these very sophisticated devices.
And then within embedded, this is a market where we have pretty respectable market share today about 22%. The size of that market today is about $14 billion of silicon. Now these devices are very, very low cost that adds billions literally – tens of billions of different devices.
The semiconductor TAM grows again to about $20 billion out in 2018 and we expect to see ARM’s market share grow again generating very profitable royalty stream from that market as it grows.
So these are the three ways that we look at the expanding opportunity for ARM. Though the ARM content in all of these devices is different, but represents a big opportunity for ARM’s royalty streams to continue to grow.
So in summary, I think 2013 was a very exciting year for ARM. We made great progress on a number of fronts in delivering our technology, in working into these new and exciting growing markets, and that has led to a very strong performance of our business.
Right now, the smartphone market may be slowing at the high-end, but it’s still a very large and very valuable market and I’ve explained how, as the entry-level, as the mid-range grows, that represents valuable royalty stream to us, despite that growth in slowdown of the premium end in the second half of the year.
The design wins that we’ve been working towards in enterprise networking, particularly in servers starting now, are a great opportunity for future royalty growth and that embedded market is growing very, very fast. The uptake of Cortex-M, that end of the market has been really, really strong and we’re seeing just lots of devices start to ship.
So all of this explains together I think to a great opportunity. ARM’s fundamental business model is intact. We’re able to respond quickly to new opportunities as they emerge, and I think that creates a great potential for future, very strong business as we had in the past.
So with that, I’ll hand over to Tim.
Thank you, Simon. Good morning, everybody. If I look a bit miserable, I’ve been feeling a little bit of lurgy over the last 12 or 18 hours. So if you see me sprinting from that platform out of doors not because I don’t like you or I’m not enjoying myself but I think we’re okay for the next hour or so.
As usual, I will be fairly brief. I mean there is a lot of financial information in the release, there is a lot of financial information in the slide deck for you to help you with your models. So I’m just going to focus on the brief highlights of Q4, talk a little bit about the exceptional items that most of you might have noticed going through the Q4 results, look at the full-year and then focusing on the outlook.
So for Q4, you’ve read the headlines. Revenue growth of 15%. Again, very strong licensing, well ahead of expectation. Royalty, slower growth, little bit behind expectations. So a combination about 10 [ph] ahead in dollar terms on the market, and despite the normalized OpEx in Q4 being a little bit higher than we and you were expecting. That’s driving PBT growth of 19%.
In that £88 million, you’ve got some mark-to-market impact to the normal reevaluation of the mandatory items in the four contracts etcetera, and a little bit of a bad debt provision, some truing up of sort of bonuses and commission payments. So it’s a little bit higher, but most of that is not run rate, so that when we look into Q1, despite the fact that obviously there is some wage inflation coming in from January 1, which is when most of that folks get their pay increases, the guidance for next quarter’s OpEx is obviously somewhat lower than the Q4 outturn in the sort of £84 million to £86 million range.
And the combination of those two factors has driven earnings growth of 30%, benefiting to some extent – I mean the difference between the 19% and 30% is to a large extent made up by tax, because we are now getting, if you like, the first 60% of the benefit of the Patent Box regime that was introduced last year. So our tax rate is down from late 20s to around about 20. And we’ll talk about the full-year a bit later on that.
So you may have seen in the release in the IFRS numbers, there was an impairment charge, exceptional item, non-cash. And I just wanted to sort of give you the context, briefly cast your mind back to this time a year ago, many of you will recall that MIPS Technologies patent act of a shareholder on their register and it was very clear that that business was going to change its shape. And really the headline value in MIPS was the patent portfolio.
That is a patent portfolio that had been developed over the last 20 years very close to our Heartland 32-bit processors. And we along with other companies were not very keen about the notion of that portfolio getting into the hands of, for example the patent troll, because over the long-term that could have caused quite a lot of disruption to the ARM ecosystem.
So we felt it was very important to neutralize the potential impact of that, and we clubbed up with a couple of handfuls of other major technology companies, and acquired rights of that portfolio for $350 million. Our share, you may recall was a $167.5 million. And we view that – and how we told you about it last year was effectively that was a lifetime insurance policy as far as we were concerned against costs that would have been incurred down the road had that patent portfolio got into the wrong hands.
The way that was accounted for is in the balance sheet split between $67 million intangible asset, as it says there, which is being written off over eight years which is the average life of the patents, and an available for sale financial asset which represented the fact that typically these Trusts that hold these patents often embark on licensing programs that yield cash and the cash is returned to the participants. And obviously given all the contribution, we were well placed to receive that cash, so rather than it being written off at that point or a larger intangible asset, it wasn’t available for sale.
During this year, for a number of reasons around the participants in the consortium and around discussions that what the parameters of a licensing program might look like and the type and size and competitor who might take licenses, it was decided by the Trust to not license the program, to not do a license program but to put it up for sale.
And for us, we see incremental long-term strategic benefit in owning those patents outright than having the rights to license them. So for a fairly nominal incremental cash outflow of $4 million, we have now brought that patent portfolio inside of ARM and it’s adding broadly 500 patents to an existing portfolio, that was about 3,000. So it has the effect of, in accounting terms of impairing that financial asset, but in cash terms, what’s actually happened is the lifetime insurance policy we brought for $167 million for an extra four, we’ve now improved, and because there are lots of things you can do when you own patents in terms of defending your position out in the future, that you can’t do it if you have rights to them. So that’s the detail on the exceptional item, non-cash and non-recurring.
So for the full-year, briefly 22% revenue growth overall, 32% licensing. Licensing as we all know in here, is a revenue stream that in the history of ARM has grown closer to 10% than 30%, but for the last four years it’s grown to 30%, which I think represents the fairly dramatic increase in ARM’s addressable market and the fact that a very wide range of semiconductor companies now feels that they have the opportunity to deploy our technology in multiple markets. And that’s been driving very strong licensing growth. And we have been fairly serially beating licensing expectations, but it remains a lumpy concept.
We only do 20 or 30 licenses a quarter, but it looks strong and we’ll cover that in the – when we look at the outlook.
Overall for the full-year, as Simon said, another strong year for royalties overall. Clearly as Simon said, we’ve seen some slowdown in the backend. And again we’ll look at that when we come to outlook. So 22% revenue growth, 32% growth in normalized PBT, in spite of the fact that this is probably the singular biggest year of investment that we have made in the business. And we have increased our overall headcount by over 400 people this year, and we’ve invested in, sort of business infrastructure that is absolutely crucial to supporting this rapid growth that we’re enjoying.
So it’s been a big year of investment, but the operating margin has gone up from about 46% to 49%, notwithstanding that investment. And again because of the tax, the 32% increase in PBT becomes a 40% increase in earnings. Effective tax rate on normalized basis in 2013, about 20%, expectations for 2014 about 18%, because we get – well the Patent Box regime is being implemented over five years, you’ve got 60% of the benefit in year one and another 10% in each of the next few years. So you can expect that tax rate as I’ve said before to gradually edge down overtime.
Strong year for cash. Net cash generation, over £344 million. We ended the year with £700 million net, no debt. As Simon said, we’ve increased the dividend by 27%. And we’ve also said in the statement that we intent to – we are confirming that we intent to maintain a flat share count overtime. In reality, if you look back on a nine-year view which is – I know there are some faces in here who have being throughout that journey but on a nine-year view, we actually have a flat share count.
It just came in one particular period in ‘05 to ‘08 when we bought back 16% of the stock. And usually the share capital is now just coming back to the level at where we started that program.
So the share count has been flat over nine years, we intent to keep it flat. And in reality what that will mean is a limited share buyback program to achieve that, which would be sort of an ongoing item.
So quickly looking forward then, before we get into Q&A. The release had the order backlog which as we know has been growing very strong was marginally down Q4 versus Q3, but up about 17% end of 2013 compared to the end of 2012. So a combination of that high order backlog and looking forward into our opportunity pipeline of licensing looks encouraging. We see another positive year for licensing in 2014.
And of course what this means is, licensing is the key leading indicator for ARM’s growth and for ARM’s value. There are no royalties without licensing. So licensing is completely clear, and the fact that we’ve grown licensing broadly 30% per annum over last four years I think bodes very well for royalties in the medium and longer term.
And so what we’re saying in this particular year, despite some of the slowness at the high-end that we’ve been seeing, because of the some of the penetration we’re making into the new markets, because we still see mid and low-end phones growing nicely next year, we see the full-year growing at a similar rates that we’ve seen over the last three years, which for those who have added numbers and divided by three as one way of assessing that, it’s about 19.3 or 19.5, but what we’re actually saying is similar rate to that normal growth in royalties what we expect.
And therefore overall, we expect the full-year dollar revenues to be in line with market expectations, which are currently in the sort of 12.80s, high 12.80s, $1.28 billion. And that’s assuming semiconductor industry improves as generally anticipated. I think most of us around here are expecting a stronger second half than a first half, and we see no reason why that isn’t going to materialize for us, but again we’ll also have to see certainly on in the year.
So with that, I will throw it open to the floor.
Let me just say before we get into the Q&A. I’ll respect to everybody in the room, if you could a question as supposed to 17 [indiscernible] then we could – might move around and then come back for another guy. So [indiscernible].
So we’ll have 16 questions instead. Right. So I would like to understand what’s going on with ASP going from 4.8 or 4.9 to 4.5, so it’s going 10% down. I understand it’s a mix effect, but at the same time I think Cortex-A shipments have doubled and the embedded microprocessor – microcontrollers have gone up by only 35%. So if you could help me reconcile those numbers that would be really helpful.
Yes. As you say, it is about mix. That Cortex-M growth is in chips which are much less expensive than typically what Cortex-A goes into. And as we’ve seen – there is slowing of growth in the premium end of smartphones. So one would expect that the ASPs will come down a bit.
So as well in Cortex-A [ph]?
Well, as we know, some of the devices are being built for the low-cost handsets, sell at lower costs that some of the chips for the higher-end. They are physically smaller. They integrate less technology. They sell for a lower ASP. That’s purely to be expected.
Sumant Wahi – Redburn Partners
Sorry, thanks. It’s Sumant from Redburn. I guess if you don’t mind, could you give us, how many number of your licenses, both in number as well as in value are coming out of China and Taiwan? And the related question I actually have is that if I look at your licenses growth for the past three years and/or the three years before then and compare it to the royalty growth, and then I look at the licensing surprise this time around, I am just wondering whether the royalties you make with the incremental licenses that you are getting in the last two or three years is lower than the average royalties you got from licenses previously?
That’s an interesting question. I think that’s not necessarily the case. The licensing that we’ve done over the last couple of years has been version 8 of the architecture, both the architecture itself and the processors that we’ve built around that. And they are typically going into higher ASP devices. So I think one would expect the royalties from that to be at the higher end.
In terms of the split of licenses into China, I don’t know if that’s on my head but roughly half of our total business comes out of Asia. China is a growing area for that. We’re seeing increased design activity in China. We’re seeing the sophistication of the chips designed in China going up and up overtime and I think that’s partly overall trend of the technology industry.
Sumant Wahi – Redburn Partners
Could I assume more than a quarter?
Sumant Wahi – Redburn Partners
Could I assume more than a quarter then from China and Taiwan?
In terms of number.
Yes, maybe. I think if the general line of inquiry is, has your licensing growth really been fueled by China, and is that likely to leave to a lower conversion into royalty overtime? I think the answer is not – we don’t see that. I mean we’ve been licensing in China for really many years. And in the last two or three years, material royalties are now being earned from Chinese licensees, that at least were licensed four, five or six years ago. This is not a new phenomenon.
And I think if you look into this, what underpins this 30% licensing growth, it is very broad in territory, and is very broad in anticipated product that the market is being aimed at. So I don’t think there is a particular China focus to it, but it’s helpful.
Didier Scemama – Merrill Lynch
Yes, thanks. Didier Scemama from Merrill Lynch. Shall I ask two questions? First one, can you just maybe just talk about your PBT royalty guidance 19%, 20%. Maybe just give us the puts and takes in that. How much of that’s driven by share gains in non-mobile, how much of that is driven by royalty rate expansion, how much of that is driven by specific share gains in graphics or other elements, because I think given your recent performance in revenue growth probably some people will look at that number and thinking it’s a bit of a stretch. The second part is on licensing. I was just curious to have a bit of color from you on the comments you made on the press release regarding licensing that has been done with telcos and software companies. How meaningful is that going forward? Thanks.
Sorry, I’ve actually forgotten the first part of your question.
I think it’s probably the royalty.
I should do it. I think as you know our ARM growth is about layers. You heard, Simon say that, it is our expectation that smartphones generally continue to drive very meaningful growth in ARM’s royalties, which is broadly consistent with the overall royalty growth we see.
In a five year view, you’ve heard us talk about driving a 15% to 25% overall royalty growth from smartphones, and we do see strong growth in 2014 in the medium and low end. So I think you’ve got – smartphones are still contributing well. I think Simon touched on a lot of things like enterprise networking, are now starting to be meaningful in 2014.
We’ve signed 200 Cortex-M licenses in the last few years, a relatively small proportion of those are shipping to-date. There is a lot of them just about come to market, I know it’s low-end, it’s high volume, low value but it all adds up nicely. And I think towards the backend, we’re going to start seeing some contributions from the v8 higher priced – higher chip priced. So again it’s a combination of those factors that support our confidence in that.
And in terms of the growth of type of licensee, I mean that’s something that’s been going on for sometimes, we’ve – ARM’s history is obviously about licensing semiconductor companies, but overtime our commercial relationships with other people in the supply chain have grown, and you are seeing really just an extension of that, us developing relationships with other people who are either buying silicon or contemplating doing designs themselves or wanting to engage differently with the overall semiconductor supply chain as they look to optimize their products and maximize their differentiation. We are a partner in that. Gareth?
Gareth Jenkins – UBS
One question to each of you if I could. It’s Gareth Jenkins from UBS. Simon, I just wondered if you could talk about Calxeda’s exit from the market. And I guess whether you see more of an opportunity in micro servers and the data center opportunity rather than necessary enterprise class servers in the kind of medium-term? And one for Tim. Just on the OpEx progression through the year. Should we expect to kind of steady progress in OpEx through 2014 upwards and related to that headcount forecast for the year? Thanks.
So in terms of the opportunity around servers. As I’ve talked about in the presentation, I do see a big opportunity for us there. And I think when I look at the amount of activity that’s going on in that space, I’m confident the products are going to come out and they are going to start to ship and that they are going to grow. Calxeda was a pioneer in that field. They entered this market very quickly, and like many start-up companies, they didn’t get there, but I don’t think that means that that’s the end of the foray into servers with ARM licensees. Quite the opposite, you’ve seen from the press release about the system architecture that’s just come out, big players are looking at this space.
We talked to lots of people about the adoption of ARM in a datacenter, because people want a different approach. They want to take advantage of this discontinuity about workload and they want a different approach to solving a problem. So I think the opportunity is very real, and I think the ARM partnership in totality has made great progress on that in 2013.
Yes. And generally on OpEx, we are still investing in the business and therefore from the Q1 base, you would expect OpEx to sort of gradually go up quarterly all other being equal. To what extent we invest in the business in this 12 months, it will depend to some extent on our view of the market and the speed of the appetite and how the overall market is playing out. And we obviously have got a lot of control, or almost total control over the timing of our investment in people. But certainly there are a lot of opportunities here that we need to see, so we would expect it to be an ongoing investment period in 2014.
Nick James – Numis
Good morning. It’s Nick James from Numis. Just on the smartphone thing. I guess we’re having two changes in the market. One is the growth in the low and the mid-end, process of change in the supply base of the Asian chipmakers from the Western chipmakers. Asians tend to accept lower gross margins, lower ASPs. So I just wanted to understand how you are thinking about this impacting on chip prices and royalty rates?
Yes, primarily the way we think about it is an overall expansion of the end markets. I think it’s a great thing that you can today buy a smartphone out the door zero subsidies for $50 in China. That is going to put smartphones in the hands of many, many more people driving overall long-term upgrade in both the handset devices themselves in the network infrastructure that’s going to process and move around this increased amount of data.
So we look at the long-term trend of an increased number of units on the field and see that as the good thing. There will be pricing pressure. It’s a maturing market overall, so you would expect that, but we think low-end devices, there is just more opportunity for ARM content. So the volume is good. The sophistication of the product is going up consistently overtime is a good thing for us.
Nick James – Numis
Achal Sultania – Credit Suisse
Thanks. It’s Achal Sultania from Credit Suisse. Just a clarification on the smartphone question earlier. So you are basically saying about – talking about 10% CAGR growth in smartphone volumes, and you expect your smartphone royalties to grow at about 15% to 25% CAGR over the next four, five years. Now given that what we know about the volume growth and obviously bulk of the growth is going to actually come from the lower end of smartphone market, would it be fair to say that all this growth in smartphone royalties is actually going to come from increase in royalty rates as opposed to increase in the application processor market – size of the application processor market. Would it be fair statement to say that?
Well, I think it’s mainly a growth in the ARM content. So as I said in the presentation, right now we’re looking at very low cost smartphones replacing basic voice-only phones which have a single ARM processor in them doing not very much. As the smartphones get more sophisticated, there is opportunity for a new Cortex-A processor replacing probably an ARM7TDMI that was designed 20 years ago.
There is opportunity for graphics processors. Overtime, I think the whole smartphone markets moves to 64-bit. So it’s a blend of more opportunities for ARM royalty bearing processors within a smartphones that today doesn’t even exist. And then overtime the royalty rate going up, as say 64-bit comes in.
Andrew Dunn – RBC
Andrew Dunn from RBC. If I can just ask the smartphone question perhaps in a different way. I mean your outlook for smartphone royalties hasn’t changed in the last two, three quarters as far as I can tell, but you did single out high-end slowing in the second half of last year. So were there any perhaps customer or industry specific issues in the second half of last year that you perhaps wouldn’t expect to repeat going forward? Thanks.
Well, I think what we’ve seen is for now anyway a maturing of that high-end. Now, I wouldn’t write-off the possibility of innovation in the high-end at all. In fact I’ll be surprised if there isn’t continued innovation on the high-end, which creates demand for those products. But for now we’re in a period where constant replacement seems to have slowed down and therefore people are living with their device for longer isn’t necessarily is going to be the case, so that won’t be like that forever, but that’s the period that we’re in at the moment. And that’s being anticipated through last year and we saw it really happening in the second half.
Andrew Gardiner – Barclays Capital
Thank you. Andrew Gardiner from Barclays. A question around licensing. Clearly you have a very strong year in 2013. You’re guiding for another one in ‘14. Can you just give us a bit of color about sort of levels coming out of backlog with sort of off the record level in the fourth quarter, but as we look into 2014, can we continue to expect on the order of 20 to 30 per quarter and similar kind of bookings levels to be coming through from that? I am just sort of putting it in the – can you put it in the context of – obviously a very good couple of years for v8, big.LITTLE, Mali coming on stream, that kind of thing. Is there enough activity going forward to continue to support that backlog? Thank you.
I mean typically when we look forward 12 months, we would expect about 50% of target license revenue to be in opening backlog. Some quarters, it’s 40%, some quarters it’s 60%, but I think 50% is a good – and although the backlog is a little bit off marginally Q4 versus Q3, if you actually look at how the backlog has developed over last three or four years, it’s actually grown faster than the license revenue and obviously in a sense that gaps needs to be the changed.
So now in combination of that and in combination of how you would expect just to look at this is, which is, by product, by customer, by value, what does that pipeline look like in 2014. That’s what gives us the confidence. I think v8 is relatively early in its licensing cycle. We have done many, many more v7 licenses than we have v8. So although it’s grabbing a few headlines, it’s still very early its licensing cycle. That will be a continued grow and Cortex-M is by no means for example – and there will new processors coming out all the time as you know.
So no, I think – but having said that – and I think we’ve ever tried to positioned license revenues as the 30% growth forever. It will revert closer to the historic growth rate before 2009, which you’ve often heard me talk about as mid high single-digit. But I think there is going to be a journey from what we’ve seen there over the next two or three years.
Simon Schafer – Goldman Sachs
Thanks. Simon Schafer, Goldman Sachs. I just have a follow-up question for Tim. And I think you said backlog has been grown significantly faster than even licensing, which of course has been a stronger amount of momentum as a lot of the non-mobile people that have been signing up your architecture, but why does the register backlog actually starts to decelerate a lot in an environment that you alluded that licensing only grows mid-single digits and backlog actually starts to go down? I am just wondering just because when you look at a 15-year trend line licensing, the run rate of $100 million is a standard deviation above what we used to. So again just any consensus that backlog actually may start to fall?
Well, I think what we’ll move into is a world where backlog is kind of a bit more lumpy and goes up some quarters and goes down. We’ve seen a fairly relentless period of backlog growing really very, very fast. And some of which has come into the license revenue, but obviously a lot hasn’t, but I think the part of the move from growing license revenue 30% to growing license revenue at, let’s say 10% in the out years, part of that will be a kind of flattening out of the backlog. And in the end – ultimately of course backlog kind of has to grow in sync with license revenue will be removed in time.
Simon Schafer – Goldman Sachs
Just from the gentlemen in front.
Vijay Anand – Espirito Santos
Thanks. It’s Vijay Anand from Espirito Santos. A question on the networking market. You have a 5% share today. On the Analyst Day, you talked about a target of 25% to 30% share by 2017. I guess sparring Intel, pretty much all the major networking semis have licensed ARM. So the question is, are there any major roadblocks or major uncertainties which can, I guess, prohibit you from hitting that target or is it just about steady share gains from here? And related to that, the vast majority of the networking market is based on 64-bit. So would it be fair to say that the average royalty rate in the networking market is going to be higher than what we’ve seen in the smartphone market? Thanks.
Yes. So to your question, right now our market share is small, the chips that we expect, ARM-based chips to replace are using a variety of other architectures, PowerPC, MIPS, some Intel. As you saw in the slope there, most of the people who are playing in this space are using ARM technology and we would expect to share gains overtime. As you also point out, a lot of those applications run 64-bit code. It’s only very recently that ARM 64-bit products are out there, so again that’s going to take some time to come through into Silicon and to broaden out the number of sockets that be addressed.
As that happens obviously with the higher royalty rate for 64-bit technology, that benefits us. And in the meantime, there were a number of designs out there with multiple Cortex-A15s in them, that generates a good royalty per chips, and those chips are physically large and obviously have a higher ASP. So it helps to push the average up. To the extent, that’s important.
So those chips whilst they are much lower in volume and slightly embedded space, have quite a lot of ARM content in them, and I think represents a good profit stream for us in terms of royalty.
Adam Bowler – Deutsche Bank
It’s Adam Bowler from Deutsche Bank. You’ve previously talked about 15% to 20% PBT royalty rate outperformance versus the wider semi industry. You obviously came in at the higher end of that this year. When we look at 2014 based on the outlook that you’ve given us today, is that still the case or should we think 15% and slightly lower if anything now?
Well, I think if you take the 19% that I talked about and add your forecast for the semiconductor industry, you will get the answer. And probably that implies around 15%. But I think these are sort of medium term measures and trends we are seeing. ARM does not grow its royalties at that rate every quarter. And I think I remember in the first half of 2012, it was growing at 5% or something. But certainly we don’t see any reason why our long-term relationship to the industry growth should change or in fact I could probably build a case for why it would improve given our penetration across these multiple markets, notwithstanding the fact that high-end smartphones and smartphones in total have slowed down over the last two or three years, but don’t forget in a period where smartphone growth overall is already been slowing from three or four years ago, ARM’s royalty revenues have been growing at a similar rate. So we’ve already been more than making up for the slowdown in smartphone growth in penetration in other markets.
Dan Gardiner – Arete
Thanks. Dan Gardiner, Arete. Given how fast Cortex-A has ramped over the last three years, 100% penetration of smartphones, 18% units and 500 million units per quarter. How quick do you think v8 will ramp, based on your understanding if when Android will adopt it? If you can kind of frame that for 2014 and ‘15, that would be very helpful. Thanks.
So I think the growth of v8 and the growth of Cortex-A aren’t necessarily – growth rates aren’t necessarily going to look the same. Cortex-A is used in a very wide range of end products, where most of them may move to 64-bit overtime, but there is no kind of burning need to do that. I think where we will see v8 adopted is strongly in networking in the server space, and overtime across pretty much I think the whole market of smartphones. Once all the software starts to move or once software starts to move over the 64-bit, then it’s just easy to be compatible or easier if every device is compatible running the same version of the software, but I think that’s a long-term trend.
So I think given the general very broad applicability of Cortex and our 32-bit architecture, I still expect very strong performance there, and with a more gradual shift to 64-bit.
I’d just like to go back to royalties for Q4, maybe a feel for Q1 if you’ve got any. I am just looking at the thesis for ARM for the last – I think in the Analyst Day 2011, you were talking about the expansion of royalty rate, more recently v8, yet your very recent royalty revenue growth has not been totally correlated really from unit growth and the deceleration we saw in the end markets. So I am just wondering, have you seen any meaningful impact from 64-bit in Q4 or is that really something that’s going to kick in Q1 going forward, or is there anything sort of slightly different underlying that we should be aware of that would justify the deceleration in your PBT [ph] royalty revenue growth?
I think the total number of units containing v8 in Q4 was small – compared to 2.9 billion, it was a small amount. So to start seeing that come through appreciably is going to take some time. I expect v8 shipments will increase through 2014, because probably beyond then, that you will really start to see meaningful volumes and kind of be at a spot that, given the vast number of ARM-based chips they are selling to other markets, 2.9 billion is a lot to make an impact on. So I think you’re going to see overtime exactly when is a [indiscernible] it’s based on product shipments that are being made by companies a long way further up the supply chain than we are, but when it happens obviously we stand a benefit from it.
I think we’ve got time for one more. Gareth, are you keen [ph]? Let’s take of together, a gentlemen there and then Gareth. Two more questions. There we go.
Sumant Wahi – Redburn Partners
Sorry, trying to squeeze in here.
These are repeat question, isn’t it?
Sumant Wahi – Redburn Partners
No, it’s not a repeat question. So you gave already a very, very useful I think baskets of three end markets essentially where you see your royalty revenue potential being the application processor mobile computing, enterprise networking and then the IoT and MCUs. In fact that kind of highlights how the traditional non-mobile has almost double in revenue potential versus the old mobile going forward. But if I look at your royalty revenue guidance in the medium term, you talk about 15% to 20% performance versus semis. If you take a 3% semiconductor growth, that means a roughly about 18% to 20% royalty revenue growth. Now if I look at these particular baskets and I look at the mobile growth potential, that’s about 10% CAGR unless you get a lot more content growth over there. So I would bet that a lot of your growth essentially going to be coming in the future from the non-mobile potential essentially. So I was wondering when you look at that guidance which you have given on enterprise networking or MCUs, would it be fair to assume that you are expecting sort of a quadruple in market share or something of that sort in this particular space? What would be the underlying market share growth potential in here or what are you seeing from your licensing which gives you this confidence of growth?
Well, if you take the two non-mobile buckets, we showed a 5% market share for enterprise networking, the servers. As one of the other gentlemen pointed out, the numbers we put in the Analyst Day last May were more in the kind of 17-ish percent in 2018. So that’s quite a significant growth there. In embedded, we had a 22% for 2013. That was up from I think about 18% in 2012. So we’re seeing steady gains there.
We’ve done a lot of Cortex-M licensing over the last couple of years. Designs, as we always say take three, maybe five years to come into mass productions. We’ve been on a licensing program with Cortex-M for longer than that. So you would expect to see increased share gains there in the mobile – sorry, in the embedded segment. So I think hopefully that answers your questions in terms of – of where we see that going. We do expect an expansion of our market share in those two areas, and I think we’re well planned for it.
Sumant Wahi – Redburn Partners
I guess given in the internet of things and MCUs, you don’t have much of a competition so to speak versus just the internal customers within that. Would it be fair to say that you could double your market share within the next three years in that?
I’d be very happy if we did, but still to say that there isn’t competition there. It is a large market. It’s a new market. There are internal architectures competing for it. There are other third-party IP vendors out there trying to take the share as well. I think we’ve got a strong story that sets us up well to take a significant share.
Gareth Jenkins – UBS
Thanks. This is Gareth Jenkins again from UBS. Last year, you gave some very useful metrics around graphics and your units in terms of graphics development. I just wondered whether you could give us a sense of your graphics market share this year, the growth that’s expected in that market. I guess you’ve got very high attach rates with Chinese mobile players, so you benefit from the low-end. You’ve got higher attach rates from DTV. I just wondered if you could give us a sense of what you think your graphics market share will be through the course of this year. Thank you.
I mean the growth has been strong. I am not sure we’ve put a number indeed.
Yes, 150 going to go on [indiscernible].
Right, there you go. He was in there after all [ph]. So 150 million units in 2013 going to up about 400…
Sorry 2012, it’s 2013. Sorry, [indiscernible]. Right, so the total for the year was about 400 million in 2013, up from about 150 million in 2012 – it’s 2013.
Strong trajectory. I mean if you think of where it’s come from. If you look at the Mali licensing in the last few years, and you look at where the unit shipments, to get back to ‘12 and ‘11 and ‘10, there is virtually nothing. So it is a pretty strong trajectory.
So I’ll just say that again. So total for 2013, about 400 million, up from 150 in 2012.
Gareth Jenkins – UBS
Do you have the guidance for this year for growth [ph]?
We haven’t guided the number, but I would expect solid growth.
Gareth Jenkins – UBS
All right. Well, thank you everyone.
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