ARM Holdings' CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.23.14 | About: ARM Holdings, (ARMH)

ARM Holdings, Plc (NASDAQ:ARMH)

Q1 2014 Earnings Conference Call

April 23, 2014 04:30 ET

Executives

Ian Thornton – IR

Simon Segars – CEO

Tim Score – CFO

Analysts

Gareth Jenkins – UBS

Matt Ramsay – Canaccord Genuity

Sandeep Deshpande – JPMorgan

Andrew Gardiner – Barclays

Adithya Metuku – Bank of America Merrill Lynch

Francois Meunier – Morgan Stanley

Achal Sultania – Credit Suisse

Sumant Wahi – Redburn Partners

Andrew Dunn – RBC Capital Market

Johannes Schaller – Deutsche Bank

Amit Harchandani – Citigroup

Lee Simpson – Jefferies

Vijay Anand – Espirito Santos

Alex Gauna – JMP securities

Dan Gardiner – Arete

Jerome Ramel – Exane BNP Paribas

Janardan Menon – Liberum Capital

Operator

Welcome to the ARM Q1 Results Analyst Call. (Operator Instructions). I must advise you this conference is being recorded today, Wednesday, 23rd of April, 2014. I would now like to hand the conference over to your speaker today, Mr. Ian Thornton. Please go ahead, sir.

Ian Thornton

Thank you Helen. Good morning everybody welcome to this call. This is Ian Thornton, I’m the Head of Investor Relations at ARM. On today’s Q1 results conference call we have Simon Segars, Chief Financial 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 will open up the call to a Q&A session.

As a reminder the presentation and press release can be found on the ARM Investor Relations website at www.arm.com/ir. Before I hand over to the team I just have to read out a few words with respect to this conference call and what we’re 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 that does not have professional experience in matters relating to investment should not act nor 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 of 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 will hand over to Simon’s.

Simon Segars

Thanks Ian. Good morning everyone. After an excellent year to ARM in 2013 we are pleased to announce this morning that we have built on that progress in the first quarter with strong demand from technology leading to revenues, profits and earnings in-line with market expectations. Continuing demand for ARM products underpins our confidence in the long term growth of the business. The first quarter of 2014 saw particularly strong uptake of ARM’s most advanced ARMv8 processor technology with five licenses signed by four semiconductor companies.

These customers are planning to develop chips for automotive infotainment systems, carrier networks and high performance computing. During the quarter we saw announcements from Marvell, Mediatek and Qualcomm on how they are developing multicore ARMv8 based processors for use in mid-range and premium smartphones and tablets. There were also announcements from Broadcom and Freescale, they plan to deploy ARMv8 based chips into data centers and enterprise networking equipment. ARMv8 is now the computing platform of choice for future chip designs not just in mobile computing but increasingly in consumer electronics, the data center and networking infrastructure. As we have seen in previous years Q4 and Q1 can be susceptible to take inventory ebbs and flows, especially in chip sales into mobile devices where ARM has a very high market share.

For example our Q1, 2012 was impacted by an inventory correction in late 2011. Q1, 2014 looks very similar with many semiconductor companies having reported sequential declines in Q4, 2013 and this is reflected in our Q1, 2014 royalty revenues.

In addition the reported process of royalty revenue includes a one off deduction of $5 million from one of our customers due to over reported royalty revenues from prior years. Now Q2 royalty revenues will result in the sale of chips in Q1. It is common for the semiconductor industry to decline sequentially in the first quarter of the year, market commentators generally regard the decline this year similar to that to prior years. However, recent indications from the semiconductor industry announced customers suggest that ARM will benefit from an improving industry environment in the second half.

ARM’s pipeline of licensing opportunities remain healthy for both Q2 and the rest of the year. Assuming the outlook for the semiconductor industry in the second half improves is generally anticipated. We expect group dollar revenues for the full year 2014 to be in line with market expectations.

Now I will discuss the revenue drivers in the different parts of the business in more detail starting with technology licensing. We signed 26 processor licenses in the quarter. These licenses were signed for a broad range of end applications, from smartphones to enterprise infrastructure to wearable technology.

Six of the licenses signed with the ARM’s Cortex A series technology. This included five licenses for ARM’s latest Cortex-A53 and Cortex-A57 processors, once licensee being a brand new customer to ARM.

ARM has also continued to see strong demand for our Cortex M class processors which are used extensively in microcontrollers and embedded connectivity chips and smartphones and can be found in most of the internet of things and wearable devices that’s been announced to-date.

Eleven Cortex M class processors were licensed in the quarter including four companies taking their first ARM processor license. Finally ARM signed four more Mali graphics licenses and five more POP's during Q1. POP IP is physical IP that has been optimized to enhance the performance of ARM processors including Cortex A, Cortex M and Mali graphics processors.

And now I will switch to the royalty side of the business. ARM’s royalty revenues are reported one quarter in arrears. So royalty for Q1 was generated from chip sold in Q4, 2013. Underlying processor royalty revenue was up 8% year-on-year compared to relevant industry revenues increasing about 6%. Our customers reported that they had shipped 2.9 billion ARM processor based chips. This 11% year-on-year increase represents an additional 300 million chips. Many of these additional chips went into enterprise networking and infrastructure equipment and into microcontrollers that are embedded into everyday objects that are becoming smarter such as watches, washing machines, touchscreen controllers and alike.

We saw the sale of ARM based chips into enterprise networking more than doubled year-on-year and ARM based microcontrollers grow by more than 40% year-on-year. ARM continues to benefit from the sale of smart consumer devices such as smartphones, tablets and digital TV. Most of these products have an application process that are based on Cortex A class processor which typically has a higher royalty percentage per chip and we saw a 30% year-on-year increase in Cortex A shipments. Many of these chips are replacing chips that were based on the ARM11 processor which declined 40% year-on-year.

And now I will talk about the uptake of ARM technology into the market. Q1 is typically a very exciting time for companies within the ARM ecosystem. Events such as the Consumer Electronics Show, Mobile World Congress, Embedded World and the Open Compute Summit give our customers the opportunity to demonstrate the new technologies that will going into the products and services that we will be enjoying as consumers in the years to come.

Having attended some of these shows personally I have met with many of our customers and ecosystem partners in person I came away with was that the adoption of ARM technologies broader than ever and that it's helping to accelerate innovation everywhere.

As examples as carrier infrastructure moves to heterogeneous networks ARM is being used in new designs from small cells to base stations to virtualize networks and service. As data centers and cloud computing companies look to optimize their services so opportunities for ARM based service are being created.

We are now seeing the second generation of wearable and internet of things devices. They are well taught through in terms of design, have good feel quality of hardware and provide easy to use software services. This is still a very fragmented end market but with many of the chips going into these devices being based on ARM the benefits of our ecosystem make it easier for developers to create new products. And we’re seeing more innovation within mobile devices too. Entry level smartphones are now available unsubsidized for less than $50 making them affordable for the largely untapped consumer markets in India, Africa and South America.

Premium mobile devices are becoming increasingly used in enterprise applications and with productivity software such as Microsoft Office are being available for ARM based computers, we anticipate further penetration of the enterprise.

Finally we have continued our investment in R&D and have grown the engineering teams working on advance processors and graphics products. We hired 120 people in Q1 and we expect investment to continue in Q2.

We were pleased to be named as one of the UK’s top employers in 2014 by the Top Employers Institute based on independent research conducted by the Corporate Research Foundation. ARM’s technology roadmap is developed and deployed by about 3000 highly skilled and experienced engineers and sales and marketers and professionals in the areas of legal, HR, IT and finance.

It's vitally important that we recruit and retain the best people and this award reflects our dedication to make ARM a great place to work. I will now hand over to Tim who will provide further details on the numbers.

Tim Score

Thank you Simon. Good morning everybody. Simon has obviously given an overview of the key financials so I will provide a little bit more color on the numbers there is obviously a lot more detail both in the release and in the normal quarterly slide sets which as Ian said at the beginning it's on our website now.

So as we have seen overall Q1 dollar revenues just over 305 million up 16% year-on-year with strong growth in both processor and physical IP license revenues which were up 38% and 30% respectively and 16% dollar revenue growth translated into 10% year-on-year sterling revenue growth as the dollar was weaker in Q1, ’14 at 163 that year ago when it was 155.

Processor license revenue of a 112 million driven by both a large contributions from backlog and by strong turns business as we licensed six high value Cortex A class processors and four Mali graphics processors. Backlog, all the backlog is down about 5% sequentially with approximately 65% of Q1 license revenues coming from the backlog, as those who follow on closely will know the typical contribution from backlog in most quarters is in the range of 40% to 60% so slightly above the top end this quarter as contract milestones were achieved on some of our advance processors thereby releasing revenue from backlog on a percentage of completion basis.

Looking at the expected conversion of backlog to revenue over the rest of this year and the pipeline of licensing opportunities that are in view we would expect order backlog at the end of 2014, at the end of this year to be at a similar level as the backlog at the end of Q1. So backlog is expected to remain broadly flat from here over the balance of the year.

As Simon touched underlying processor, royalty revenue grew 8% year-on-year slightly ahead of relevant industries which grew around 6%, this degree of outperformance is lower than we have seen in previous quarters mainly due to the unwinding of inventory correction is being widely reported and as Simon said impacted many of our customers in fourth quarter of 2013 and in addition the reported processor royalty revenue includes a one-off deduction of $5 million from one of our major customers due to over reported royalty revenue from prior years.

Looking at the cost side normalized OpEx Q1 was 84.3 million so we continue to invest in the development of more advanced processors, of computing service and enterprise infrastructure given its ongoing investment in our R&D teams had in our business infrastructure, we would expect normalized operating expenses in the second quarter assuming effective exchange rates are broadly similar to be in the range of £86 million to £88 million.

A quick note on interest income, you would have noted that in Q1 that was £3 million and given the lower interest rates that are available on new deposits, I would expect the quarterly interest for the rest of quarterly interest income for the rest of 2014 to be around the £3 million mark or ever so slightly lower and despite increasing net cash.

On the tax front the normalized rate in Q1 was 18% and we’re reiterating our guidance for the full year effective tax rate of around 18% that level as we continue to benefit from the reduction in UK corporation tax rates and the introduction of the Patent Box, tax regime that we have talked about before.

Normalized PBT in Q1 up 9% year-on-year and earnings up 5% which reflects the unusually low tax rate in Q1, 2013 which is 16.5% and you may recall that Q1, 2013 benefited from if you like two tranches of U.S. R&D tax credit. U.S. government was late in legislating the 2012 tax credit and we got the first year of the 2013. In this particular quarter Q1, ’14 the U.S. government has not yet legislated the 2014 R&D tax credit so our Q1 tax rate includes no U.S. R&D tax credit compared to last year were included two tranches hence the Q1 rate being a little bit higher. But as I say full year tax rate expected to be around 18%.

Looking forward to the rest of the year and really reiterating what Simon said earlier, given the strength of the order backlog which remains at very close to historically high levels and the licensing opportunity pipeline together with the indications from the industry that the prospects of the second half looked brighter than the first half. We would expect group all our revenues for the full year to be in line with market expectations and with that we will open to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Gareth Jenkins from UBS. Please ask your question.

Gareth Jenkins – UBS

I guess a couple if I could, firstly I just wondered if you could talk about progress on 64 bit and some of the design activities that you’re seeing and when you expect that really to have a meaningful impact on your business? We have obviously seen the first launches and it's come to market and the smartphones, I just wanted if you can talk about the progress there and secondly I just wanted whether I think you historically talked about 19% growth or the higher end of your prior royalty PD royalty revenue growth rates the target for this year. Should we still expect that for the full year? Thanks.

Simon Segars

So I will talk about first part of your question about 64 bit and if I could just generally ask you to ask one question at a time and then we will be able to get around to everyone. So, overall progress in deploying ARM version of the architecture is going very well. We have had very strong licensing as you’ve seen in the numbers here and we have seen a number of exciting products announcements from some of our licensees. At Mobile World Congress recently we saw three key announcements from Qualcomm, from Marvell, from Mediatek talking about ARMv8 based chips for mid-range and high-end smartphones and tablets.

Now those devices will take time to conclude, they will take time to get into products, take time to ship. But I think we’re in good track in generally in terms of the deployment of those version 8 of the architecture.

Tim Score

Yes and on the royalty front, Gareth you’re right, I mean at the beginning of the year we said that we expected full year royalty revenues to be similar to now we have seen in the last three years which have been sort of a 18.5% last year and 17.5% and 22% which people averaged out concluding it was about 19%. We remain confident in full year royalty revenues and as you’ve seen we have reiterated guidance for the full year and I think probably there are more industry data points that is supportive of the strong second half now than we had in early February. So yes we remain confident about full year royalty revenue growth.

Operator

Your next question comes from the line of Matt Ramsay from Canaccord Genuity. Please ask your question.

Matt Ramsay – Canaccord Genuity

I guess on the printed quarter [ph] either for Simon or Tim I think many of us were expecting slower year-over-year growth in royalties due to inventory correction. I was a bit surprised in the narrowing out of outperformance band versus the industry growth rate and can you talk a little bit about the narrowing of that band I guess maybe naively I expected the sort of market data from Q4 actuals for the industry to sort of mimic what your performance was and it seems that magnitude of outperformance narrowed a bit. So any help there would be appreciated. Thanks.

Simon Segars

Well these things do ebb and flow based on how the market is performing, based on mix, based on a variety of factors and it's something hard for us to call exactly what’s going to happen. I mean overall we have seen an increase in volume, 300 million more chips in Q1 than a year before and it's still ahead of where the market is. The outperformance comes as we gain market share as more on processors per device are putting to end products. We have seen very strong growth in the microcontroller end of versus which is sort of one for one kind of relationship because of the more simplistic nature of those devices but we are continuing to grow market share there.

So the outperformance is going to change from quarter-to-quarter. We’re going through this period of inventory correction at the moment and we would expect in the longer term to get back to more sort of normal levels.

Tim Score

I think as Simon referred earlier to the inventory correction in the first half of 2012 where I think our outperformance actually was very similar, the ones we have been experiencing. So looking at the sort of medium term outlook. We see no reason to change, the sort of our guidance and looking at history and about our overall outperformance we continue to see a similar going forward.

Matt Ramsay – Canaccord Genuity

And just sort of maybe unrelated follow-up on the licensing side, I noticed in the slide deck the long term CAGR guidance was taken from high singles to 10% maybe it's sort of a tiny move but a nit pick in the positive direction. Maybe you could talk a little bit about the reasons for that longer term guidance change and if you still expect the 2014 licensing to outperform that longer term ratings even with the backlog change being down in the quarter for the first time a bit. Thanks.

Simon Segars

Yes I think we have been very consistent in saying that we don’t see 30% license revenue, CAGR is as being the norm and we have consistently painted the picture of sort of medium term license revenue growth around the 10% number and there is no real change there. I mean high single digits, 10% I think it's sort of little bit in the noise. I mean I think the question is what does the transition look like from the 13% growth that we have seen to the let’s say broadly 10% and certainly as part of that transition, we would expect license revenue growth in 2013 to be quite well ahead of that medium term guidance but as the business model develops further we do believe that we sort of revert to a situation where royalty revenues are going faster than license revenues which is obviously not a position we have seen in recent quarters.

Operator

Your next question comes from the line of Sandeep Deshpande from JPMorgan. Please ask your question.

Sandeep Deshpande – JPMorgan

I just want to understand within your business in smartphones and tablets I mean from what we know in terms of the inventory correction is that there has been a slowdown in the high end handset market but the low end and mid-end handset market is continuing to do very, very strong, be very strong and we can see that for instance in Mediatek’s number’s. So can I try to understand from you as you understand it, why that low end, mid-end strength is not being seen in your royalty revenues?

Simon Segars

I think it is, I mean the volume growth year-on-year is quite high. We’re seeing a mix of devices and when we talk about inventory correction we’re talking about that going across a range of markets not just being about handsets. As you say the entry level end of the market is performing well and we think that is a market that is very valuable to ARM and additive to what we’re doing and it's going to create a whole load of opportunities for more technology overtime as that trend really takes off when people start using those phones and using them to interact with other devices.

So you know I think to your question we are seeing the positive benefits of that, it's just offset by the trends in many other markets.

Operator

Your next question comes from the line of Andrew Gardiner from Barclays. Please ask your question.

Andrew Gardiner – Barclays

My question is related to the last one as well, if we look at you’re the mobile units within your mix. So flattish year-on-year, your overall royalty revenue is up 8% year-on-year and you’ve highlighted that a lot of this is sort of can be or some of this can be attributed to non-mobile growth but given that again you pointed out microcontrollers it's sort of one for one, it's a lower royalty generator. Can you help us a little bit in terms of the pricing that you’re seeing within mobile? I know it's a sensitive topic but just in terms of the impact from steady increases in Cortex A class and in particular 64 bit in the metric. Is this sort of pricing trend something that we can expect to see continue later in the year?

Simon Segars

Well broadly in mobile I mean we have seen pricing being fairly flat over the last level period in terms of the roll out of the v8, it was still at the very early stages of that. I mean it is very key devices that actually contain that right now. So this is about mix. We’re seeing lots of integration of devices at the low end of the mid-range. We’re seeing single core devices, we have multi-ARM processors and integrated modems and connectivity in a single device. So there are lots of parameters moving around here.

Andrew Gardiner – Barclays

Also just two quickly, on one of the slides that is sort of a regular feature in the deck and you’re talking about, on page 11, the licensing driving market share. Just looking at the sort of number of companies we’re equipping in terms of licenses in the quarter. You’re highlighting five there for 1Q in total whereas for the full year last year it was only about 12. So looks like this trend continues or is even accelerating if we look at 1Q. Can you help us with any color around those trends?

Simon Segars

Yes I mean you look at the number of licenses we signed in the quarter 26, that’s quite high. We’re seeing continued uptake of the technology across a wide range of end markets. So to us that’s sort of business as usual.

Operator

Your next question comes from the line of Adithya Metuku from Bank of America Merrill Lynch. Please ask your questions.

Adithya Metuku – Bank of America Merrill Lynch

My first question is on the backlog, I would have expected your backlog to have gone down as you go through 2014, actually recognize on v8 licenses but you’re seeing it tend to remain flat basically implying that your licensing pipeline is very strong. I was just wondering if you could provide some color on your licensing pipeline and on the puts and takes on the backlog as we go through the rest of the year.

Simon Segars

I think it's worth pointing out that the v8 licensing cycle is in its relatively early stages. We have done sort of 30 licenses plus compared with well over a 100 in v7. So you’re still going to, we’re still going to be -- we are still going to be signing licenses through the backend of this year for processes that are already and if like announced that are going drive some level of backlog as well as a turns business and of course generally as you know we have I mean our technology roadmap is a continuum whereby we’re regularly bringing out new processors in the appropriate times. We will be announcing new processors that as they start to get license we will also be driving backlog. So our commentary obviously comes from insight into the planned engineering work that will achieve contract milestones and release revenue and also from insight into the discussions that we’re having and expect to be having during this year that generates both turns and backlog revenue. So it's a kind of a bottoms up analysis but again there are many moving parts to the relationship between backlog and license revenue but our overall view of that is that we end this year with a backlog very similar to where it is now.

Operator

Your next question comes from the line of Francois Meunier from Morgan Stanley. Please ask your question.

Francois Meunier – Morgan Stanley

I’m afraid I have to question again about the backlog Tim this is probably the first time in a very long time that you’ve been so specific about guiding for backlog to go down I mean 5% is nothing. So how should we read this? Is it your actual cautiousness about this number as we have seen in the past two years. Growth has always been much stronger than what you’re applying to lead us. So is it extra-cautiousness or are you really reading something different this year and shall we really, really forecast for like 8% – 10% growth in revenues and maybe less next year?

Tim Score

As you know the order of backlog has gone up significantly and consistently over the last couple of years and I explained earlier that we did a transition from 30% licensed revenue growth to somewhere closer to 10% and as part of that process the backlog sort of levels out and doesn’t keep growing significantly. I mean I think the reason we are drawing this out today that obviously with a 5% sequential drop and it being relatively flat last quarter you could take away from that we could expect a series of quarters where the backlog would be on a downward trend, we don’t see that and so the point we’re making today is that we actually see the backlog being similar to the end of the year to where it is now which is at historically high levels and supportive of continued license strength but not at the 30% last CAGR.

Francois Meunier – Morgan Stanley

So basically if I conclude if you’ve licensing growth slowing to say 10% which is still extremely good and royalty grew around 15% to 20% then the average growth of the company is more in the tune of 15% then long term.

Tim Score

That would be an analysis and as I said earlier I mean I expect to revert to an environment where royalties as you say are growing in sort of mid-teens and above and licensing’s growing at broadly 10 and that’s driving earnings growth in the future similar to that which we have seen in the past.

Operator

Your next question comes from the line of Achal Sultania from Credit Suisse. Please ask your question.

Achal Sultania – Credit Suisse

So on the chipset pricing trends especially in the smartphone market in the last couple of years we have seen very aggressive pricing in the lower end of the smartphone market. So guys like Mediatek and Spreadtrum, how should we see that trend evolving as we see actually more and more higher end processors being used even in lower end devices. So use of like Octacore and Quadcore processors in lower end devices. Are you seeing some level of moderation in chipset pricing from your customers?

Simon Segars

As I said earlier we have seen chip pricing stabilize across the spectrum of entry level to high end over the last little while. Generally the trend is that existing chips get cheaper and customers introduce new products with greater functionality to help reset the pricing and provide more value. I see no reason why that trend wouldn’t play out here in smartphones no matter where they are in the spectrum of performance.

Achal Sultania – Credit Suisse

And then just an update on Mali, obviously I think you gave a number of 400 million units last year. Have you given any color around what the number is for Q1 or what the target is for full year ’14?

Tim Score

Well in the Q4 results we said we expect between 500 million and 600 million units of Mali in 2014. We haven't given a breakout of the numbers in Q1 but we believe we’re on track to achieve those kind of levels.

Operator

Your next question comes from the line of Sumant Wahi from Redburn Partners. Please ask your question.

Sumant Wahi – Redburn Partners

I have two quick questions, one is essentially on the royalty you guys should achieve on licensing in the internet things and the server market essentially. So there are two other buckets outside of smartphones. Essentially your licensing has been fairly strong in the past and you still guide to about 10% but my understanding is that probably a bigger proportion of the licensing demand will now be coming from the non-mobile traditional sector. So my question is that do you still believe that your royalty revenue per license should remain at the similar levels to what we saw in the smartphone side or should we be assuming a lot more licensing for a similar level of royalty. I just want to kind of probably my own enthusiasm on how I should extra play the strong licensing into royalties over the next 3 to 5 years that’s my first question.

Simon Segars

Okay I mean I think in terms of the financial structure of our contracts, there has been no significant changes in that. So the kind of rates that we have established in the market over last 20 odd years at ARM kind of pertain for the future. What we have seen historically is as we sign license bills [ph], customers typically have a first end product in mind but then often use the same license to multiple different designs. So you get a kind of fan out of one license driving multiple products hence multiple royalty streams into ARM and again I see no reason why that wouldn’t continue at any moment in time. We’re licensing big companies with multiple product lines who overtime will find uses for the technology that nobody anticipated when they signed the contract and then we’re licensing small companies who are starting up and just up a single product line and trying to establish themselves in the market. Again I don’t think that mix has fundamentally changed over the last little while and so I would expect to see a sort of future in terms of licensing translates into royalties to be very similar to how it's been in the past.

Sumant Wahi – Redburn Partners

I guess the reason I was asking that is because in the smartphone industry at least chip suppliers are quite consolidated whereas in the rest of the market there is lot more fragmentation I guess but I see you still believe it should remain as similar it was right?

Simon Segars

Yes I think it's all about the point in the life cycle of a market. Once upon a time there were lots and lots of companies licensing ARM7 to build GSM based bands and that consolidated down into a smaller number. We have seen a number of people who are developing chips for smartphones increase and then consolidate down. We will see other ways of that I’m sure, we’re at a wave of that in IoT right now, clearly where there are lots of companies looking to develop products that market. Now it's a very broad market so it probably does support lots of people doing it and you will see similar trends in other markets such as servers. So I think again that’s all about the cycle where we are in the lifetime any particular class of product.

Sumant Wahi – Redburn Partners

Okay and just very quickly my second question is I mean listening to the recent conference call comments from TSMC some of the sector, it suggests that your ecosystem player, the foundries are spending a bit longer time at 20 nanometer versus transitioning into 14 nanometer, 16 nanometer. So just wondering whether in your view is this more of a reflection on the demand environment in essence the stay on internet of things and just lower medium phone demand or do you think, are you at all worried whether your ecosystem has currently the capability of moving to 16 – 14 [ph] nanometer in time to complete with Intel?

Simon Segars

Well last part of the question is no, I think there is a lot of activity going around the development of FinFET technology; the proving out of the technology, the creating of design environments so people can build chips and you know to me that all seems to be progressing very well. I think what you will see is some of the older technologies particularly 28 nanometer stay around for long time and maintain applicability as the cost goes down in a wide range of markets. So again this is in some ways nothing new, FinFET introduced a whole new load of technology challenges but the industry, they are new to the industry but the industry is very well set to address -- bring these new technologies to the market, so I guess it's about timing.

Sumant Wahi – Redburn Partners

But I guess if Intel is already there I’m just wondering whether you still believe it on performance power ratio you would be competitive for them -- with them in the next two year or so?

Simon Segars

Well they are building highly integrated SoCs and that is what the foundry industry does well in terms of bringing technologies to market and I’m confident that our foundry partners will do that for FinFET’s and beyond.

Operator

Your next question comes from the line of Andrew Dunn from RBC Capital Market. Please ask your question.

Andrew Dunn – RBC Capital Market

If I can ask something just around enterprise networking, you’re obviously seeing very strong growth there from a lowest base and you indicate number around 150% growth rate for this period. Could you just perhaps give us a little bit more detail into what’s driving that growth? What sort of IP or selling into that market and perhaps which segments you’re seeing particularly good growth in that new market for you? Thanks.

Simon Segars

Yes the uptake of ARM into enterprise networking has been very strong, the units in Q1 are more than twice that of the year before. It's in a range of a market but what we’re seeing is with the increase generally with the increase bandwidth requirements as 4G smartphones and tablets are deployed that is driving generally an upgrade in the network and as we see more and more smartphones that’s going to drive a further upgrade.

So people are looking at the long term. They are looking at what processor or architecture to base the future on and given the strength of the ARM ecosystem for lot of those companies they are concluding that ARM is the right choice to make. So there will be early stages of deployment into this market but progress is very good and growth is good. Where we’re seeing the technology, there is lot of in mobile infrastructure, both small cell and large cell base stations in wireline and corporate networks and also in conventional access point technology. So it's across a broad range, we have seen a couple of recent announcements, we have seen Freescale in terms of what technology they are using. The products that they announced recently are based on Cortex-A57 one of their products using eight cores. We have seen similarly very high core count devices from LSI, we have seen announcements from Broadcom recently in terms of using the ARM architecture for very high performance devices. So many companies in fact most of the suppliers into this market are using ARM technology and we’re very pleased with the progress.

Operator

Your next question comes from the line of Johannes Schaller from Deutsche Bank. Please ask your question.

Johannes Schaller – Deutsche Bank

If I look at your outperformance over TSMC which is obviously quite important data point, Q4 now for your Q1 royalties you have actually nicely outperformed here and if I take TSMC’s Q2 guidance and also what they said for the second half of the year, to me it looks like that your royalty guidance actually looks relatively achievable from that cyclical semiconductor recovery perspective. I was just wondering if you could give us maybe a bit more color on what you’re assuming in your guidance kind of 19%-20% in terms of structural drivers like higher royalty rates from v8 or big. LITTLE and share gains and networking and if you think you’re more conservative here or what is kind of baked in from the structural side into that guidance and I’ve a quick follow-up if I could.

Tim Score

No in guiding royalty revenue growth for ARM over any period, we’re obviously factoring in a number of things. One of them is the industry environment and we are seeing the same data points but you’re seeing in terms of the expected improvement in the second half. I mean recent TSMC guidance would be a very specific but supportive data point. Clearly we’re looking at the trajectory of percentage per chip that we will be earning on these devices and again in the sort of smartphone mobile and most markets in fact that is on an upward trajectory but it's a continuum and as Simon said earlier in v8 we’re at the very early stages and that’s a story that's going to unfold over a number of years. So you know we’re obviously taking into account all of the factors that you would imagine we need to in terms of trying to forecast wherever all this is going to end up and that’s what brings us to the conclusions that we discussed earlier about the likely four year royalty growth.

Johannes Schaller – Deutsche Bank

Then a follow-up quickly on, just on the gross margins were actually quite good in terms of year-on-year improvement in Q1. I think last year they were on average flat, if you could maybe give us a bit more color on what drove the improvement and how we should be thinking about gross margins for the rest of the year?

Tim Score

I mean gross margin is a very difficult number to, I mean it basically moves within a very tight band of sort of 94.5 to high 95s and on the quarterly basis to assess where it fits within that sort of 1% band is quite tough. I mean suffice to say that on a medium to long term basis as royalty revenues grow and drop through to the bottom line then we would expect gross margins to stay in the sort of mid-90s and if anything edging emphasis slightly up.

Operator

Your next question comes from the line of Amit Harchandani from Citigroup. Please ask your question.

Amit Harchandani – Citigroup

My first question is really in terms of competitive dynamics, we have heard one of your major competitors talk about making strong progress and even using sort of a contra-revenue philosophy to make in-roads. So I’m wondering what you’re hearing from your customers or what your sales guys are picking up from your customers in terms of how they are thinking about evolving competitive dynamics in the mobile space? That would be my first question.

Simon Segars

Okay well in terms of what our customers are seeing is in a lot of ways unchanged. Our customers are focusing on competing with each other and competing with anybody else who is targeting the space which of course is large and has a lot of potential for profit in it. Everybody wants to build the most highest performance, most power efficient processor they possibly can. So we maintain big conversations and relationships with our customers about how our roadmap develops, how their roadmap develops and making sure that the features in our products and the specifications of our products are best suited for the end markets that our customers are targeting.

That hasn’t changed in the length of time I’ve been at ARM. Everybody wants to produce the best thing, everyone is driving very hard for the best technology and in that competition is always good. It keeps everybody innovating, it keeps everybody focused on differentiation and that’s a good thing for ARM, it's a good thing for our customers as well. So I think the fact that some of our competitors are using mechanisms other than straight technology to compete in the market just means everybody has to work hard to have the best products out there and ultimately through our business model it creates a lot of choice and creates a lot of differentiated devices and ultimately consumers can choose which ones are the best and which ones are the most successful.

Amit Harchandani – Citigroup

And maybe as a quick follow-up in terms of architecture licensing just philosophically when you look at v7 versus v8, do you see any change in the way customers are embracing architecture licenses. Do you think it's been viewed much more favorably as a means or maybe greater differentiation? Just you’ve seen any difference in the trend for adoption of architecture licenses, v8 versus v7?

Simon Segars

I think, I don’t have the exact numbers on the top of my head but certainly there were more architecture licenses earlier in the lifetime of v8 than there were in v7, that was driven more about the addressing different markets. So most of the early architecture licensees for v8 in fact all the architecture licensees for v8 have been looking at markets that hasn’t traditionally served with our own base products and when it gets to market very early as some of the early guys took an architecture license, companies like Cavium, companies like Applied Micro, who really wanted to target the enterprise space, the data center, high end networking which wasn’t where ARM had traditionally played and that was a vehicle to enable them to get into that market using ARM technology. So that’s been a great vehicle for us because it has allowed us to broaden the penetration of the ARM architecture into new markets and we see that as part of our strategy for long term growth.

So we never sort of sit back and look at the numbers and worry about that at all. It's part of our business model that allows for a very broad adoption of our technology and that’s a good thing.

Operator

Your next question comes from the line of Lee Simpson from Jefferies. Please ask your question.

Lee Simpson – Jefferies

Just two from me. First of all, I wonder if you could update for us the adoption of ARM's SBSA spec for v8-based server SoCs. Especially as it relates to names like AMD and AMCC for -- does this present a real design accelerator for fiscal year 2015 and 2016 for these early adopters? Or is this more a means to see other typical ARM SoC makers coming in for late 2016 and beyond? And maybe as a follow up, we know that I think last week that ARM and Samsung have joined the Board of the FIDO Alliance and just wanted to understand if this is an accelerator for trust zone adoption and what sort of roadmap plans you might have for trust zone vis-a-vis mobile payments and maybe the FIDO Alliance use of non-pass -- user passwords.

Simon Segars

Okay so in terms of SBSA the main purpose of that work was to accelerate the deployment of SoCs into the data center. The great beauty of our model is that every customer of ours can design a chip that’s different from any other customer and when it comes to enterprise software though there is great benefit in having some of the system architecture that is actually not differentiating, standardized, so it's easier for software developers to write code that’s going to run on these chips. So SBSA was all about standardizing the right points of the chip to accelerate software development and hence accelerate deployment of real systems. So it's less so about SoC development as it was about software development. We have seen the uptake of SBSA in the SoC architecture by a number of our licensees. Those chips are coming to market now and with a more clearly defined target architecture for software developers the work to we should see more on deployments in ARM based service sooner. But that’s what that’s all about.

FIDO, as you say it's about again it's an industry body that’s about standardizing in the right way so that people don’t reinvent the wheel the whole time and burn their effort on things which are ultimately non-differentiating. Very much it came to the ARM business model, it's enabling people to spend their R&D differentiating in the right areas.

We have a long time seen that security in embedded devices is really important. We started work on trust zone more than 10 years ago and are now starting to see that as a technology it's really, really important. So FIDO as an industry body is one of the many industry bodies that we work with to drive acceleration and standardization in the right places and as a growing area of mobile payments it's important and that’s why we are contributing to it.

Operator

Your next question comes from the line of Vijay Anand from Espirito Santos. Please ask your question.

Vijay Anand – Espirito Santos

I just wanted to go back to the backlog discussion and I was basically hoping you could talk a bit more about your product roadmap. It has been roughly 18 months since you launched the A53 and A57. So my question is based on your current thought process and customer discussions at what point would you be looking to launch sort of next generation of v8 processors?

Simon Segars

Well we have with Cortex-A53 and Cortex-A57 a lots of designs in flight right now with our customers. We have a healthy set of sales opportunities ahead of us those products and I think we’re going to see that very broadly deployed. We’re of course always talking to our customers about the next generation, about what learning we can take from the deployment of the current products. What new design opportunities there are out there and how we can further optimize our products to take best advantage of these new opportunities. And at the right point in time we will go public on those and talk more broadly about what we’re doing but for now they are NDA discussions with our customers.

Vijay Anand – Espirito Santos

All right and as a quick follow-up I understand you said that pricing in mobile was relatively flat but I was wondering if you can talk about the royalty revenue per unit in mobile, how did that trend in Q1?

Tim Score

So overall it's moving up. We’re seeing more and more chips, we’re using multi-core devices, we’re seeing the volumes of Mali’s we have talked about earlier going up and the tax rate of Mali in mobile devices is increasing. So overall there is an upward trend on the royalties per mobile device that we’re receiving.

Vijay Anand – Espirito Santos

Are you able to give us a figure?

Simon Segars

Not today.

Operator

Your next question comes from the line of Alex Gauna from JMP securities. Please ask your questions.

Alex Gauna – JMP securities

I was wondering you’ve given a lot of helpful information around ARMv8 and you just touched on royalty revenues now but I’m wondering seeing us how you have seen a faster than typical uptake of ARMv8 does that also imply in the latter part of this year perhaps a faster than good typical pull in to the royalty impact from ARMv8 and for the full year in terms of getting to normal type of average of royalty growth, are you more optimistic about unit volumes or about royalty rates continuing to improve sequentially as they have here in the first quarter.

Tim Score

I mean I think based on what we see going on in the industry, what we’re seeing being reported. I think we’re certainly more optimistic about units. In terms of the uptake of ARMv8 that has certainly being strong, being more rapid that it was at the early stages of v7 and ultimately with higher royalty rates there that will start to go through but there is a trend I think we will see play outs relatively slowly given the volumes of ARM chips, given the large numbers of microcontrollers based on single core v7 devices.

You need to v7 devices, you need to ship an awful lot of something else to really see a noticeable effect come through. So we always view our royalty stream as built up with multiple layers, the v8 layer will start to grow as probably into next year before we start to see that in a real meaningful way but the trend is definitely in the right direction.

Alex Gauna – JMP securities

And GlobalFoundries and Samsung have announced collaboration on 14 nanometer, their timeline seems relatively aggressive. I’m wondering how involved you’re in that, how optimistic you’re about them hitting their targets? And then similarly when that really starts to work its way into benefiting you.

Simon Segars

So we have worked very closely with both Samsung and GlobalFoundries for a long time in working on physical IP to support their foundry businesses and we have a range of IP that is targeted for both companies’ technologies. I think the collaboration between Samsung and GlobalFoundries is a very thing for the industry. It's going to provide more manufacturing choices especially with leading edge technologies and I would hope that a lot of our physical IP is used by the foundry customers who adopt those processors. So this represents a further opportunity for us.

Operator

Your next question comes from the line of Dan Gardiner from Arete. Please ask your question.

Dan Gardiner – Arete

In terms of licensing what are the next generation technologies that you think ARM still needs to develop and license beyond what’s available in today in v8 and can you give us a sense of what specifically you’re focused on whether employee hiring is currently taking place?

Simon Segars

Well as we said in report a lot of the employee hiring is going into developing next generation products, a lot of it is going into our processor developments generally CPUs, GPUs but then also we’re hiring into all the other teams, we create all the other supporting technologies. The software compilers, the physical libraries to allow optimized implementations and so on and then support our customers. We’re recruiting across the board to allow us to successfully deliver our roadmap and support our customers in the adoption of that technology.

In terms of what’s coming next can’t really talk about much about that today but suffice to say as we look at the adoption of ARM in the data center, into networking, into the continued opportunities that come from mobile. There are new technologies coming, new ways in which we can see for making these products more and more efficient in terms of their power efficiency, the way they use resources, the way they connect to networks and so we see a lot of opportunities, had to develop new products which will help drive further licensing and ultimately help make better products that consumers enjoy.

Dan Gardiner – Arete

And as a follow-up on Mali, one of your competitors here talking about benchmarks which demonstrates significantly better power efficiency particularly in gaming applications. I mean clearly you’re still expecting to gain share in Mali this year but do you acknowledge that this further work to do here in terms of the technology to make Mali sort of competitive again?

Simon Segars

I think there will always be work to do to make these products better. I think Mali is very competitive, we’re seeing very strong uptake of Mali into many mobile devices and that’s because the technology is very good. The graphics processors can be -- can occupy quite a significant area in an SoC so there is always work to do to try and make them more efficient as the demands for GPU compute performance goes up and up. So again this is an area where I think we have the industry has many generations ahead of it to provide scope for further optimizations and make products better.

Operator

Your next question comes from the line of Jerome Ramel from Exane BNP Paribas. Please ask your question.

Jerome Ramel – Exane BNP Paribas

A question, how far do you think the spec of the application processor in a smartphone will go? Beyond Octacore 64 bit, what kind of performance do you think eventually we need in a smartphone for, I would say, 50% [ph] of the usage?

Simon Segars

Well it's a very hard question to answer because one of the uses of smartphones is that the software development environment is so open and so as new features are brought into the hardware devices, software programmers all over the world, big company, small companies, individuals working out of their basements can write code, write applications that exploit the technology and that helps create pull for more devices. So we have seen applications come up that rely on smartphones that nobody would have thought about 5 or 10 years ago and I don’t see that that trend is going to change anytime soon.

So I wouldn’t want to call when enough is enough in terms of performance. I think the way that application is developed and the way people use technology has a lot of innovation left in it and I think there will be many, many generations where we are looking to provide more performance in different ways to make these devices more efficient because software developers will keep thinking of new ways to use them and as more and more sense is getting embedded into these smart devices that further creates an opportunity for new applications.

So I don’t see kind of the ingenuity there running out of steam anytime soon.

Operator

Your next question comes from the line of Janardan Menon from Liberum Capital. Please ask your question.

Janardan Menon – Liberum Capital

Just two small questions, if I may. One is, can you give us an update on the server market? Where are you in terms of the ecosystem? And roughly by when do you think we can see commercial shipments of ARM-based servers? Is that something we can see before the end of this year, or is that likely to be more a 2015 phenomenon? And a second question is on enterprise networking, just going back to your answer to a previous question where you saw 150% growth. I was just wondering, since that's quite a wide market, which goes from low-end stuff, like network interface cards, all the way up to base stations, routers, et cetera., the growth that you're seeing, where is it coming from? And, more specifically, in the current quarter, in the reported quarter, was that a positive to your $0.047 of average royalty per unit? Is it already adding to that? Or is the big additions going to come as you see more and more shipments to the switch and base station markets going forward?

Simon Segars

Okay. So let me just briefly talk about service, I think progress there is good. We’re starting to see silicon devices, we’re seeing a lot of effort go into software development for ARM based servers. I mean recently as an example we just saw Oracle introduce Java SE, which brings Java to many ARM-based devices and that’s very important technology for servers but again SBSA as a vehicle for accelerating software development, it is also very important and I think we will start to see commercial deployments later this year. I have been saying that sometime I still think that’s on track to happen and we will start to see volume start to take off I think probably next year but I do expect to see commercial deployment this year.

On enterprise networking you mentioned there is a whole wide range of end markets that could be targeted and where are we seeing success. It really is across the range, I mean we have been in routers for a long time, more kind of commercial grade. We’re starting to see use of ARM is switches, in base stations, big base stations, small base stations. It really is across the board and in that enterprise space that is something that’s very positive for our blended average royalty rate and we’re seeing effects of that. I mean a lot of the bigger chips that I was saying are using multiple-cores. There are large numbers of Cortex-A15 is being used for example in some of the bigger chips today and that obviously has a positive impact on the royalty rate per chip on average but again given the volumes this is one of those things where every little helps and makes a small change.

As volumes grow we’re starting from a low base, we will see that become more of a factor but that’s probably for years to come.

Janardan Menon – Liberum Capital

All right. Thank you very much.

Simon Segars

Okay well with that thank you very much for joining us this morning and we will see you all on the road and at the Analyst Day on the 20th of May. Thanks very much.

Operator

Thank you. Ladies and gentlemen that does conclude our conference for today. Thank you for participating. You may now disconnect.

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