Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

ARM Holdings plc (NASDAQ:ARMH)

Q4 2011 Earnings Call

January 31, 2012 4:30 am ET

Executives

Warren East - Chief Executive Officer, Director and Member of Disclosure Committee

Tim Score - Chief Financial Officer, Director, Member of Compliance Committee, Member of Disclosure Committee and Member of Risk Review Committee

Analysts

Francois Meunier - Morgan Stanley, Research Division

Didier Scemama - RBS Research

Janardan Menon - Liberum Capital Limited, Research Division

Kai Korschelt - Deutsche Bank AG, Research Division

Andrew Dunn - RBC Capital Markets, LLC, Research Division

Sumant Wahi - Redburn Partners LLP, Research Division

Nick James - Numis Securities Ltd., Research Division

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Gunnar Plagge - Citigroup Inc, Research Division

Gareth Jenkins - UBS Investment Bank, Research Division

Andrew M. Gardiner - Barclays Capital, Research Division

Warren East

Okay, good morning, everybody, and thank you for coming to our results presentation. I have an obligatory slide to flash up in front of you. And in the usual manner, I'm going to do a business update, and Tim will summarize the effects, the financial effects of business, update for the last quarter before we do questions and answers.

I've been enjoying myself so far this morning with some of the broadcast media because we've been talking about another record quarter for ARM, which brings to close an excellent year. And I think the highlights are shown on this slide. Really that excellent year and record quarter and increase in backlog and so on, it’s been driven by continued activity from the major semiconductor companies investing in ARM technology. And in the last quarter, we're pleased to announce our lead partners signed for our version 8 architecture product that we announced in October. Actually, we haven't announced these products. What we announced in October was our version 8 architecture. We will, in due course, be announcing some products. And what you can see here is that some of the lead partners, our first lead partners, have signed up for those products. So this is indicative of the strength of the V8 architecture for the future, and so we're very pleased with that. There'll be a little bit more on that as we go through the presentation.

We have another subscription license in LSI, and I'm pleased with that, when we come to talk about that. LSI has been an ARM partner for a very long period of time. They use ARM in a handful of different products, and they have a product line around infrastructure and networking centered around the PowerPC architecture. And in their press release just a week or so ago, they talked about adopting ARM technology in those products as well. So it's very good to see LSI joining the subscription licensees and particularly for that application.

If you look at our business performance, we're continuing to grow our market share in all our target markets, and I really struggle to single out one area and talk enthusiastically about it at the expense of the other areas, because right across the piece we're very pleased with the progress there and overall increase in market share that we'll come to. In particular, microcontroller’s driving the volume and mobile is driving the value.

We've talked on, when we put up this slide, we talk about growing ARM and we talk about the different growth trajectories there in the graphic. And obviously, one of those is extending the outsourcing model to other IP and very pleased with our progress in our physical IP business, consistently building the processor optimization packages alongside the Cortex-A products, continuing to work at the leading edge in physical IP. And also, we're highlighting here our 5 Mali licenses in the quarter, bringing the total to nearly 60 Mali licenses now. And I'll talk in a little while about Mali's success, particularly in digital TV. So all in all, an excellent quarter, generating record revenues, generating record levels of profitability, and that's coming through into profit.

So there's been a lot of column inches during 2011 on ARM's progress in mobile computing. I was at CES a couple of weeks ago, and at CES, the interesting thing to note was that, well, ARM was everywhere. That was the really interesting thing to note when I had an interview really early on, having been there for about 2 hours, and somebody said, "What's the most exciting thing you've seen so far?" I hadn't really seen anything. But what I had already picked up on was that you could find ARM technology on just about everything you looked at, from home automation through to the biggest digital TVs. And we were also seeing ARM a lot in mobile computing. There's a huge range of form factors on show at CES, and certainly, most of the mobile computers on show at CES were ARM-powered, and those ARM-powered apps processors incorporating our Cortex-A processors. But the good news was that some of them were also incorporating ARM graphics and ARM physical IP.

And of course, the opening keynote at CES was from Microsoft, and Microsoft led off their keynote with their ARM-based mobile product. And then they went on to talk about Windows 8, and they went off -- on to kick off their demonstration of Windows 8 with an ARM-based product. So after 12 months since the initial announcement, we're now getting very close to Microsoft's beta launch, and at CES, they talked about beta being available in Q1. And so after 12 months, we're getting close, and we're looking forward to the Windows activity during 2012.

Obviously, it was a consumer electronics, a consumer products show, and I mentioned digital TVs. Digital TVs for us, it's an exciting area. These TVs are becoming smarter, and as they're becoming smarter, they're becoming connected. And as those 2 trends are happening, they're using more and more ARM technology. And over the last few years, we've been gradually increasing our share in digital TVs as they've been getting smarter and getting more connected, and we think our market share in 2011 was probably about 40%. And the good news is that in 2012, we expect that number to be over 50%, and it is driven by the need for these TVs to become connected to the Internet. Now these TVs are also including graphics processes, and they're starting to ship, and our Mali graphics processor is very well positioned in the TV space. We expect that of the TVs that ship in 2012, certainly more than 50 million of them will have embedded graphics, and we would expect to have about 70% of the market share in graphics in digital TVs in 2012. And a footnote on the bottom of the slide there, we're pleased to see our physical IP evident in some of these processors as well.

Computing is -- has been a topic, not just the mobile computing but computing in general, has been a topic of discussion around the ARM architecture during 2011, and it's not going to go away in 2012. We're looking forward to some great progress there. And the summary is that the mobile computers, still a lot of those products that will be launched this year, will be around Cortex-A9. There will be dual-core A9s, there will be quad-core A9s. And that's good for us from a business point of view, because, obviously, these chips are higher-priced chips and, therefore, translating into higher levels of royalty for ARM. But we're also expecting to see the first devices based on Cortex-A15 this year in the mobile computing arena, and you're going to see some Cortex-A15 products just in some of the initial server activity, too. Just before the end of last year, in the fourth quarter, we saw an announcement from Hewlett-Packard about their activity, which is based around, actually, Cortex-A9 in servers, and this is pointing the way for servers based on low-power architecture from ARM.

Now around the same time in October, we also had the version 8 architecture announcement, and the good thing about version 8 is that it includes 64-bit. It includes some other features which are applicable for computing and server applications, and it speaks a little to the need for increased levels of security with inbuilt hardware support for more cryptography. As with all ARM architectures, it's totally backward-compatible. So a code you wrote on ARM7 in 1994 will run, but of course, it does a lot more than that. And we're going to see these V8 products out in silicon. We have some announced architecture licensees, 2 of them are announced, but we have some other version 8 architecture licensees as well. And as I mentioned at the beginning, we've signed up our lead licensees for the ARM implementations, which will be announced later in the year. And V8 products, we expect to ramp into silicon in 2014, so a little while to wait before the silicon reaches significant volume.

So that's enough of an introduction. Switching to the business summary now, and looking at licensing to start with, the numbers in parentheses on the chart, which should by now be familiar to you. The numbers in parentheses are the numbers of licenses that we sold during the last quarter. So the 25 licenses that we sold brings to a conclusion an excellent year for licensing and a total of over 120 licenses sold, and it was a good mix of licensing across the Cortex product family in Q4. Interestingly, this is the first quarter where we hadn't actually sold any licenses for those older microprocessors on the far left-hand side of this slide. We just sold licenses to the newer products, but another 9 Cortex-A licenses during the quarter, another 8 Cortex-M licenses.

As we look forward for the last several years when presenting a slide that looks very like this, we've had the arrows and we've alluded to project names for some of the new products, which are coming out of ARM during this year. And at the top of the slide there, you will see our new graphics products aimed at higher performance and also energy-efficient graphics processing, and we're going to launch those later in the year. Atlas and Apollo are the codenames for the first ARM version 8 microprocessors that we'll be launching later in the year. And the aim there is to target the high end of the computing spectrum, servers and high-end smartphones.

And then at the bottom of this slide, we talk about Flycatcher. Flycatcher is the microcontroller end of the spectrum. This is going to be our smallest, most low-power product coming out of ARM yet, and this is really aimed at all those intelligent sensors that I stand here and talk about. Anyway, we're going to see some of those products later this year.

This is another chart which some of you are familiar with. And really, it's summarizing the effect of the last quarter's licensing and looking at over a longer time frame and seeing how the picture in terms of cumulative licenses is building up. So we did continue to sell, in Q4, licenses across this broad range of products. Good to see mobile, good to see TVs, set-top boxes and good to see a subscription license. The chart on the right-hand side of the slide shows the effect of our licenses on the royalties that we're earning and reminds people of the longevity of the ARM business model and the fact that royalty continues to be generated for many years. It also highlights the fact that it takes a long time for licenses to contribute significant portions of royalties. So we've now entered another 5-year period, and so we've now got sort of 4 levels of licensing when we split out according to time. And you can see that the 120 licenses that are sold during 2011, of course, not yielding any royalty yet. And in fact, the 350 licenses sold over the previous 5 years, now they are starting to ramp into volume, but you can see there’s tremendous potential for growth to come from those licenses. If you look at the progress for the whole year as well as adding 121 licenses into the cumulative pool of future royalty-generating licenses, the number of partners who are engaged has also grown during the year from 256 this time last year to 290 now. So good news is that we're exposed to more companies, more companies buying into the ARM technology.

Now switching to royalties. Again, a familiar chart here, and the pie chart on the bottom left is showing the split of where all the volume’s going. Mobile now accounting for just, well, 55%, just over half the overall volume. The pie that's growing really significantly at the moment is the embedded pile. This is part of the pie. This is microcontrollers primarily, microcontrollers and smartcards. And in spite of a huge volume there, over 500 million units during the quarter, that is still growing at a very, very significant rate, up 80% year-on-year now. We have seen very strong growth in this sector for the last several years. And we now have over 130 Cortex end licenses out there, ready to generate future microcontroller royalty, so you're going to continue to see this number grow. And as we look at what our microcontroller partners are doing, we're seeing, every quarter, launches of new ARM-based microcontrollers. These partners bring their products to market, and it isn't normally just 1 or 2, it's line cards of 50 microcontrollers at a time from ARM partners. So good news happening there.

One of the other things to bring out on this slide is the value of the mobile royalties. Obviously, we talk in fora like this and in investor one-on-one meetings, and we talk about the high value of application processors, the higher levels of royalty which the Cortex-A processors attract, adding extra ARM IP onto those application processors. And people say, "Well, where is that going to come through in terms of incremental royalty?" Well, it is coming through in terms of incremental royalty. We can see volumes up 10%, value up 20% in the Cortex-A and Mali area, and so we're bringing that out on the slide.

Apart from that, the other point on this slide is continued outperformance in each market sector, outperformance versus the market as a whole. And that's -- when we look at that over a longer period of time, that's what the chart on the right-hand side of this slide is showing us, that even as the industry cycles happen over multiple years, ARM royalty growth continues to outperform industry growth, and that's a trend which has been consistent. You can see in the 5-year CAGR at the bottom of the chart there, it's been consistent. And we expect by dint of the licensing and the designing activity that's happening, that trend is going to continue to happen as we look out into the future.

So where did all those products go? They didn't just go into smartphones. And I always ask Ian, "Can we have a slide that shows some pictures that aren't just gadgets and smartphones?" And so here, this is the broadest range of products that we've ever shown you, I think, on these slides. And you can look at the pictures and see where the ARM technology is going.

The other point to just highlight on this slide, in the bottom right-hand corner, you see we got miniature versions of slides that you will find in the back of your pack in the appendix.

And we have -- these slides should be familiar to many investors. They summarize how ARM's market share is earned across the different product categories. And for the last few years, we have been in a position where, after 12 months, the analysts like Gartner tend to go back and count a few extra microprocessors that the industry shipped. And so the total for the previous year sort of increases. And what we found this year is that the 2010 numbers, which last year we had a total of 22 billion units shipped in 2010, that's what we told you at the beginning of 2011. Now at the beginning of 2012 when we turn around and ask those analysts, they tell us, well, actually, it was more. And so the size of the market, backward-looking, increases. ARM's volume, of course, is exactly the same as it was. We told you the correct numbers in the first place. And so the net effect is that our apparent market share, when we look back, shrinks back. So instead of having 28% share in 2010, we think now, we had about a 25% share in 2010. Notwithstanding that, the numbers for 2011, the best-guess numbers for 2011 at the moment are shown in the appendix on the 2011 slide, and we had a 30% share in 2011. So if you look back over several years, those market shares have consistently grown from mid-teens to early 20s to mid-20s last year to 30% in 2012 -- in 2011.

So that's a little bit about royalty. Continuing with the theme of where does the ARM technology go and the fact that I do get a bit frustrated when people think that we supply the technology into gadgets and gizmos. The good news is that all those gadgets, all those smartphones, all those mobile computers, they do use incredible quantities of ARM technology. But we are getting our technology used in products that make the world a better place as well. That's what it says in the ARM vision. We want our technology to be invisibly making the world a better place, and it is. We're seeing ARM deployed, microcontrollers deployed in healthcare. We're seeing ARM in education. And the theme at the bottom of the slide is about energy. And as you know, energy is very important to ARM. Power efficiency is very important to ARM. And when you blow that up and look on a larger scale, the rate at which we all use energy is important to ARM. And the fact that we all are getting more concerned about how well we use energy is a great driver for ARM's business. So we're seeing ARM used increasingly in electric motors. We're seeing ARM used in smart meters, and you will see ARM increasingly used in servers, where energy efficiency is really very important, indeed.

Switching to physical IP, other parts of our business, physical IP. The news here is that over the last 2 years, state of the art has really moved from 40 nanometers to 20 nanometers. That's actually quicker than Moore's Law, but the good news is that ARM's activity at 20 nanometers is absolutely on track. We are engaged with all the major foundries at 20 nanometers. We're continuing to grow the number of platforms out in the field licensed on older technologies, and some of those older technologies are now starting to generate royalty. So we received in the last quarter our first 32-nanometer royalty. And of course, that was booked last quarter, so the first shipments were in calendar Q3. And as we look down the right-hand side of the slide, there you see that not only are we involved at 20 nanometers but leading edge to us is 14 nanometers. And so right now, we're engaged with the leading edge foundries on creating physical IP for 14-nanometer technology, which will obviously be several years in the works before it actually starts shipping in any appreciable volume. But it's good to see ARM physical IP there. And it's good to see that because when we deliver our physical IP to semiconductor partners in the form of things like processor optimization packages, it means that our processors can be implemented on the advanced silicon geometries. And the chart on the bottom right there shows the consistency of licensing of processor optimization packages, and we continued to do that in the last quarter of the year with further processor optimization packages.

So summary, really, is it's an exceptionally good quarter to an excellent year, very strong licensing and continued growth in the backlog. I'm not going to steal Tim's thunder on the numbers. He can cover that in a moment.

I think on the royalty side of the business, we're continuing to see ARM gain in market share as these new ARM-based chips come to market. In terms of additional ARM IP, physical IP and Mali graphics now generating royalty, we said 2011 was going to be the year of tens of millions of units of Mali graphics, it was indeed a year of tens of millions of units of Mali graphics. We're going to see that trend continue in 2012, particularly with the digital TVs. And all the while, we continue to invest in new technologies, so we can bring things like version 8 to market. Over the last year, we continued hiring. We hired an additional nearly 230 people last year. And it's a balancing act, because we're doing that at the same time as increasing margins and driving profitability to record levels as well.

A little bit of an advert on the bottom of the slide for Mobile World Congress coming up at the end of the month. I will be there as will Laurence Bryant, our mobile specialist, and we will be hosting a session for investors at Mobile World Congress in a couple of weeks' time. With that, I will hand over to Tim.

Tim Score

Thanks. Good morning, everyone. Warren is right. He hasn't stolen all of my thunder, but the good news is he's stolen most of it, so I only have 3 slides. And I think there's a lot of detail on the financials in the release. There's a lot of detail in the slide deck. So what I'm going to do is just try and share with you a little bit of color about how we should think of the numbers from here based on what we've read and talked about this morning.

So as I think you've all seen, a very strong licensing quarter, $68 million, and a backlog up 20% sequentially. What that, of course, means is that both from a revenue-bearing standpoint on licensing and from a backlog-building, very strong and leads us with a healthy pipeline into 2012. The backlog is up over 2x what it was this time 2 years ago. But that's good news because the license expectations for 2012 are running about twice the level that they were going into 2010. So in a sense, the relationship of backlog-to-target license revenue is actually consistent.

And from here, I would say that $68 million is a fairly exceptional quarter. That doesn't mean to say it's not repeatable in the medium term, but I think you should view it today as fairly exceptional. And the guidance that we're giving is that $60 million plus or minus per quarter is what we should expect going through 2012. So expect us to be over that in some quarters and potentially under it in others, but I think that's around about the level that you should think about when thinking about licenses going forward.

On the royalty front, clearly a much stronger outcome than I think we were all thinking about when we stood here or were on the phone, actually, at the end of October. The first -- certainly the first 2 months’ data for the third quarter, which is the context, of course, for our Q4 royalties, was fairly flat. There was a pretty appreciable uptick in September, which helped industry numbers, but of course, the industry was nowhere near up to the extent of 19%. And I think you're seeing there market share gains, which are consistent. You're seeing -- and I think we talked last time about ARM being impacted by Japan and a lot of that recovery to closer to fuller production. But I think we're also -- I think also, we're seeing about a quarter of the royalty reports for Q4 shipments, which of course are our Q1 royalties. And I think there are some signs of some fairly significant orders in the third quarter that I wouldn't expect to be repeated at the same level in the first quarter. So with the

[Audio Gap]

about 10%, it looks like. I would take somewhere plus or minus $90 million as the context for thinking about ARM's Q1 royalty, so broadly consistent with what happened in the overall industry. Yes, we would grow market share, but as I say, in the detail, we have seen some signs of some big orders in Q3, which look as though they won't be repeated in Q4, so around about $90 million is what we're expecting.

Margin expansion has 5% points in the full year, up from 40% to 45%, and we'll come on to that a little bit on the next slide. So for the full year and moving away from Q4

[Audio Gap]

year growth, up 24%. And so now, we've had ARM performing very resiliently in 2009 in the downturn, outgrowing the industry in the bounce back year of 2010 and outgrowing industry again in a steadier-state year of 2011, so that sort of consistent performance through the cycles.

As Warren said, a good year for licensing. We used to talk about 75 to 100 processor licenses a year as the run rate. We did 121 last year. And I think the key for that, of course, is it's the underpin. It's the install base for the royalty generation going forward.

Behind all this, of course, is investment in innovative and relevant technology for the markets that we are targeting. And you can see that in the last 2 years, we've been growing our headcount at around about a 10% growth, up from just over 1,700 at the beginning of 2010, 2009 to just over 2,100 at the end of last year. Our expectation going into 2012 is that we will continue to invest in our R&D capability. Most of our hiring is in the research and development area. You can see it there, 80%. So expect further investment through 2012.

And the margin expansion I talked about, 40% going to 45%, driving strong cash generation and consistent increase in the dividend, which again has grown through the cycles and up another 20% this time.

So going into 2012, as I say, we're well positioned. The backlog is twice as high as it was a couple of years ago. Warren touched on some of the new products that are going to be available for licensing and the new markets that we are developing technology to, to access. And of course, our traditional target markets, we're continuing to drive up our market share, and Warren showed we went from 25% to 30%. And Ian's restatement of the overall market size has left us with more room for growth than we thought we had under the old population. So that's good news, too.

Q1 specifically, as I say, thinking $60 million plus or minus for licensing, $90 million plus or minus for royalty, including the other revenue streams. That's consistent with about $200 million for Q1, which is where the market currently is. Our OpEx guidance, mid-60s. I think when you -- when we look at the models for 2012, we obviously need to take into account the full year effect of the hiring we've done in 2011. We need to take into account the wage inflation that kicked in on the 1st of January. And obviously, we need to take into account the 2012 impact of the hires that we intend to make through this year. So if the overall market holds up and we do invest in the way that I'm outlining, you would expect an ascending trajectory for our OpEx through the year from this base.

And looking for the full year, it's obviously very early days. And usually, at the end of January, you will hear us be fairly circumspect about how precise the crystal ball can be looking at the balance of the year. But we, on the assumption that the macroeconomic outlook stays about where it is now, i.e., some growth in the industry, not overly exciting but some growth in the industry and continued outperformance from ARM, we would expect to be, as I said there, at least in line with the current market expectation, which is just over $860 million.

And with that, I think we'll throw it open to the floor.

Question-and-Answer Session

Warren East

All right. We'll start at the front here. Oh, okay. You’ve got it.

Francois Meunier - Morgan Stanley, Research Division

[indiscernible] but the first question would be for Tim Score and the guidance for Q1, specifically. Looking at $90 million thereabout for royalties in Q1, as you just said, if we start from $100 million in Q4 and semiconductor revenues went down, say, something like 10% Q4 versus Q3, it looks like it's very conservative. You're not taking any market share. There is no positive impact from the new iPhone 4s, et cetera. So is your guidance for Q1 overly conservative? That's the first question. The second question would be for Warren. On the milestones for Windows on ARM, what is scheduled basically for this year? When shall we expect to see the first tablets? When shall we expect to see the first laptops? And have you seen any excitement on the software side, basically, to develop or to port more software to Windows on ARM in terms of software ecosystem outside of Office and Windows?

Tim Score

Thank you, François. I mean, obviously, I can understand where that question comes from because we've just beaten expectations for royalties in Q4 by about $10 million. But my answer to the question is precisely what I said up there, which is the industry looks down about 10%. That would obviously imply about $19 million without any market share gain. We expect to continue to make market share gain. But having seen about a quarter of our reports and looking at the detail of that, there are signs that there were, if you like, some overshooting in the third quarter shipments. And so the trajectory of Q3 and Q4 in the detail is not necessarily completely in line with what you would expect in the overall. Now, it's very early days. We've only seen about a quarter, and we may well do more than $90 million. But what I'm -- what we're guiding to you today, based on what we see in the industry and what we've so far seen in a small amount of the detail is that it feels as though it's somewhere in that area.

Warren East

And the second question was about milestones for Windows on ARM. I’m afraid we still have to re-refer you to Microsoft for the detailed answers on this. It is their product. They are in control of the rollout of their product. It's fair to say that, that project appears to be on track. They talked about beta release being available in Q1. I think it's going to be available certainly well before the end of Q1. As for Windows on ARM, in particular, in tablets and laptops, I don't think -- from where we sit, we don't see any difference between these 2 form factors. The laptop form factor or the tablet form factor, we're going to see both during this year, and when the beta is released, there will be -- we're led to believe there will be beta products. And it's really up to the OEMs as to which form factors they emphasize, whether they be tablets or whether they be laptops. As far as the software porting is concerned, then it's still a little early, and the whole point of the beta program is to start accelerating that application development. The application environment was demonstrated by Microsoft at CES. And I'm sure when they bring out their beta release, they’ll do more active promotion of that application environment. All right, move on to the second question.

Didier Scemama - RBS Research

It's Didier from RBS. Couple of questions. First of all, on your revenue growth -- not guidance but sort of your revenue growth expectation for 2012. When I look at capital spending by foundries, it feels as though the wafers out exposed to smartphone and tablets are going to be up well in excess of 50%, typically because the die size of application processors is increasing dramatically. So my first question is, do you think this year, we could see a firmer de-correlation of your revenues in smartphones from the underlying market because of ASP increases? And my second question's really out in competition. Obviously, there's been a major milestone from Intel recently with some major design wins. It remains, obviously, to be seen whether those phones are going to sell. But how do you see Intel competition, in particular, the comments they made about the potential work-around on supporting Android applications on x86?

Warren East

Okay. First question on the ASP. So I think we're already seeing, as we tried to pull out on the slide, we're already seeing some effect of pricing on higher-value chips in the mobile space. It seems to be a fairly well-recognized phenomenon that these chips are getting larger. I mentioned we'll see dual cores. We'll see quad cores. We're seeing embedded graphics and that does blow up the size. No doubt about that. It pushes up the underlying cost. However, it continues to be a very competitive marketplace, and it's really not for ARM. It's for those ARM licensees who are competing in that space to determine the pricing that they're going to deploy for those apps processors. Undoubtedly, the chip areas are going to be bigger. You're absolutely correct. We can't really comment on the pricing. Intel phones and Android. Well, we've been talking for some time about Intel being able to announce some smartphone design wins. They've announced a couple at CES. I'm sure they're going to announce a couple more at Mobile World Congress, probably. That seems to be a pretty good forum to announce them. But our answer hasn't really changed. We have a lot of respect for Intel technology, which is excellent; Intel's investment capability, which is very strong. And they're making great progress to take their devices and make them more power efficient and get them into the sort of zone which makes them suitable for smartphone designs, and they’ll inevitably get some. One of the factors that -- one of the hurdles that they have to overcome is the fact that every day, there's 700 million -- 700,000, sorry, Android phones activated around the ARM architecture, and the application developers are working on creating applications that run on ARM. So Intel are going to have some products that are in the zone, and they're going to have to compete with the 20 or so ARM licensees who are very actively supplying apps processors into that zone, into the ecosystem, which is ARM flavored. This is really a question for Intel as to how well they think they're going to be able to overcome those hurdles.

Janardan Menon - Liberum Capital Limited, Research Division

It's Janardan from Liberum. I have 2 questions. One is your licensing backlog and your licensing outlook into the current year and for the next couple of years. You've doubled your backlog over the last 2 years. Is there anything which you see on the horizon which prevents you from, say, doubling it in the next 2 years? And why would the backlog not continue to rise? Have you -- do you see less potential in terms of your negotiations to keep rising that and, therefore, for your licensing revenues to keep rising over the medium term, even if there are 1 or 2 quarters here and there? The second question is back to Intel again, to be honest. They have achieved quite a big breakthrough in terms of power consumption with their latest Medfield processor, and power consumption has been the key platform for ARM over the years. So from an R&D perspective, what can you do or what are you doing to try and ensure that you stay well ahead of the game going forward, so that you can try and keep up a significant gap with them on power consumption terms?

Tim Score

I mean, in relation to the first question, I mean, let's remind ourselves of the context of ARM's licensing. We have said consistently over the last 5, 6, 7 years that we see license revenue as a sort of mid- to high-single digit growth stream, with royalties growing at a faster rate over time and, therefore, that operating leverage driving increasing margins and increasing earnings. We've seen a, obviously, a much stronger 2-year period of growth for licensing, 30% and 40%, respectively. And as that's been happening, the main questions we've been getting is that's so far above your mid- to high-single digit guidance, is there a lot of -- is this a one-off peak? Or is there stuff being brought forward? Is this pent-up demand out of the recession? And the answer to all those things is no. This is a function of ARM's addressable market broadening from mobile phones further up, further down and that introducing lots of new technology and lots of new customers able to use ARM for the first time. So what we're saying going forward is still think about licensing as a mid- to high-single digit growth stream, but on top of a much higher platform that has been created in 2010 and 2011. And exactly how the backlog develops in that context, I think we'll have to wait and see. I mean, backlog's obviously quite a lumpy concept. But in general, we would see it growing consistent with that type of guidance, so that's kind of how we see it.

Warren East

And your second question was about Intel and their progress in smartphones and what ARM is doing about that. And the answer is that, of course, as Intel are making great progress here, ARM is not standing still. One of the key drivers of Intel's progress is their ability to ramp new semiconductor processes fast and to be able to move to later generations of semiconductor technology. And so you see ARM working, as I was describing, with all the leading foundries at leading edge. And in fact, even as Intel are bringing their 32-nanometer Medfield product to market, we're seeing ARM's 32-nanometer products starting to ship. We're seeing ARM 28-nanometer products starting to ship. We're seeing ARM engaged at 20 nanometers, and we're seeing ARM engaged at 14 nanometers. And in addition to that, of course, there's another whole dimension to this, which is delivering real solutions in a phone environment. And that's what the ARM partnership has been doing for the last 15 years or so, and that's what Intel is getting to grips with right now. And ARM's building on that lead, taking that system expertise that we've built up over the last 15 years or so and turning it into things like big.LITTLE, which we announced back in October, where we have the benefits of high performance with a big processor married in a seamless way to the power efficiency of a small processor. And that sort of system-level solution is moving the goalposts significantly, so you end up with something that has the performance of a Cortex-A8, a smartphone of 2 or 3 years ago, delivered in a power envelope that uses about 20% of the power. And so we're continually moving those competitive goalposts. I don't know. We've probably still got -- there's so many.

Kai Korschelt - Deutsche Bank AG, Research Division

It's Kai, Kai Korschelt at Deutsche Bank. The first one was just on the Windows 8 tablets. Just wondering from your perspective what do you think will drive consumer interest in those sort of devices, given the probably at the end of the day disappointing Android tablet sales, which, from a OS user experience perspective, probably weren't too shabby. So that's my first question. Why would that change with Windows 8 from Q4 onwards versus Apple? And then my other one is just on share buybacks. Clearly, dividend’s a main mechanism to distribute cash to shareholders, but you keep piling on cash on the balance sheet. Is there any level from an absolute or relative perspective in cash terms, which would trigger you potentially thinking about buyback or anything similar?

Warren East

Okay. Starting with the first one, on Windows 8 and Android. A few factors to consider I think. Android tablet shipping in 2011 has been described by some as you described it. However, I'd say actually, when Android phones were introduced, they took off -- there was a lot of hype and then actually, they didn't take off in the sort of way that reflected that hype. And then a few years later, 2 years later, we're seeing Android phones shipping 0.5 million units a day, 700,000 units a day and continuing to ramp and really be a very successful product. So I think we should give the Android tablets a little bit more time. And the second point to note is of course that consumers are very familiar with Microsoft and very familiar with Windows and they're less familiar with an Android environment. So I think Microsoft have an awareness advantage with consumers that the Android folks didn't have. Now it's up to Microsoft exactly how well they're going to exploit that advantage, but I think that's a fundamental difference. Second question.

Tim Score

Yes, I mean, generally, on the sort of management of the balance sheet and the capital structure, we've got GBP 424 million of net cash at the end of 2011. We think that is a reasonable amount of net cash to hold in the context of our investment opportunity. We, I think, demonstrated between 2005 and 2008, when we bought back 16% of the shares of the company, that buyback is a mechanism for returning cash that we are quite happy to deploy if we think the time is right. We don't plan to build a cash pile. We do plan to grow our dividend. And I think in the medium and longer term, we plan to grow our dividend progressively, by which we mean expect a gradually increasing payout ratio. And depending on our investment needs and opportunities as that develops, we’ll define whether we need to deploy some other supplementary mechanism to avoid building a cash pile, and buyback could well be one of those mechanisms.

Andrew Dunn - RBC Capital Markets, LLC, Research Division

It's Andrew Dunn from RBC. You've mentioned Mali today I think more times than I've heard you mention Mali for a long time. Can you just talk about -- and you're obviously gaining market share there against your major competitor. Can you just talk about what's driving that, how you're able to gain that market share? You've also talked a lot about digital TV today. How should we think about royalty rates in digital TV? Obviously, the chip price is probably higher than any you'd see in handsets. How should we think about royalty rate there? And then if I could finally ask a question. You signed a license with MStar, announced just over the weekend. MStar, obviously, is a MIPS licensee. I understand that will sit alongside the MIPS processor, the MALI will sit alongside MIPS. Is there an opportunity there to get the full ARM CPU into MIPS -- into MStar?

Warren East

Yes. With the way you introduced the question, I think, yes, that's an interesting observation, perhaps we did mention Mali quite a lot. I don't think you should read anything into the fact that we're mentioning Mali a lot other than we're at a slightly different stage now in terms of Mali penetration than we were at 12 months ago. 12 months ago, we were still quite early. We are coming from behind. We're undoubtedly the #2 player in outsourced graphics IP. And so it's sort of almost inevitable that if somebody has very, very high share and you have a #2 player that's coming after them with a competitive solution, that that #2 player is going to gain some market share. And we have sold more Mali licenses during 2011. The total is now nearly 60 Mali licenses. And inevitably, over time -- this Mali license is exactly the same as our standard microprocessors. It takes about 4 years to go from licensing to royalty. That licensing has been happening. It's not surprising that the chips will start to ship. And the fact that we're continuing to sell more licenses, if you look at the licensing trajectory over the last few years, that's also been growing, so that the number of licenses per annum has been growing. You're going to see the volumes continue to ramp. I highlighted digital TVs because that is an area where we're particularly pleased to see Mali's success. And we've got 2 factors. We've got digital TVs adopting graphics processing and the proportion of digital TVs that includes a graphics processor is increasing. And at the same time, the licensing that we've done suggests to us that we're well positioned to be the majority -- have the majority of the market share there, probably as much as 70%. So that's the reason we're mentioning it. Because it's a significant milestone in the progress of Mali. As far as MStar is concerned, yes, they had an announcement at the beginning of the week or at the weekend for the U.K., anyway. And we'd love to see ARM processors deployed more widely in MStar. And obviously, we're in the business of selling microprocessors, they're in the business of using them, so I think you'd expect us to be talking. Shall we work sort of from the front back?

Sumant Wahi - Redburn Partners LLP, Research Division

It's Sumant from Redburn. Just a very quick question on your PIP division. You have been very kind to give out the breakdown on the profit side. Given that the catch-up phase of the PIP division is now somewhat over but we still see somewhat of a profit loss in this particular division in the last half as well, when do you see this vertical division become profit-making? Or is it still going to remain somewhat of a drag to the sort of the higher bigger brother processor division valuation? And secondly, what percentage of licenses in 2011 were on the nonmobile side? And where do you see the nonmobile royalty value to grow in the medium term?

Warren East

Do you want to take this?

Tim Score

Yes. I think on the physical IP division, if you sort of track the segmental analysis that we do on a twice-a-year basis, you’ll see that the fully allocated loss or the loss after all of the sort of central ARM costs have been allocated to each of the divisions is reducing. And I think having established the leading position in, technology-wise, in the advanced processors, I think the physical IP division is well positioned to grow. Having said that, the division is going to continue to invest in securing the leadership position in the advanced processes. And I think, also, when you think about the physical IP division, don't just think about what the divisional P&L looks like. Think also about the value the physical IP is bringing to the processor division, which is significant because these processor optimization packs and the like are making our processors much more attractive. So really, you have to look at -- you called it, I think, a drag or a lag or something. We absolutely do not view it like that. We view physical IP as a very significant enabler and enhancer of the processor division as well as a steadily growing revenue stream in its own right.

Warren East

And your question about licensing, I think in the road show slides, we’ll have a pie chart.

Tim Score

About 75% of the processor licenses signed were non-mobile.

Warren East

And that's a trend which has been sort of -- certainly, 2/3 or thereabouts has been in place for the last 2.5, 3 years. And bearing in mind the time lag that I mentioned between licensing and royalty, we would expect that licensing to come through. And indeed, we are seeing nonmobile continue to grow and slightly outpace mobile in terms of growth, which is why this year, we're now at sort of 45% of the total volume being nonmobile. I think that trend is going to continue. But meanwhile, don't forget, mobile has a huge potential as well. So as we look at the market for 2016 and if you look at your appendix, you will see that Ian’s broken it out for 2016, 40 billion units, somewhere just under -- just over, rather, 3/4 of those would be in what we would call non-mobile. Now obviously, we have a very high share in the mobile area, in the 25% area, and we have a much lower share in the much bigger market, which is about ¾, we have been doing that licensing, so we're going to continue to see upward trend in nonmobile.

Sumant Wahi - Redburn Partners LLP, Research Division

And value growth?

Warren East

Well in value, I think in the mobile space, you have high-value devices, apps processors. You have lower-priced chips, modems, connectivity devices and so on. And similarly, in nonmobile, you have vast volumes of lower-priced chips, microcontrollers and so on. But similarly, you have high-value devices in networking and servers and in some of the higher end consumer products as well. So I think the nonmobile-mobile split won't really have much of an effect on the average chip price. Let's keep working backwards. Sorry.

Nick James - Numis Securities Ltd., Research Division

It's Nick James from Numis. Just a couple of follow-ups on licensing. Just in terms of what you describe as abnormal strength in Q4. I wondered if you could give us any more detail. Is that centered around specific customers or any more granularity there? And then the other thing was on the subscription license with LSI for, kind of, higher-end wireless infrastructure or network infrastructure-type applications. That would seem to be a new segment for ARM, and is there scope for further types of licensing in that area over the following year?

Tim Score

I think on licensing it is just a question of -- if you look at the detail, the -- if you look at the aggregate of revenue-bearing deals that were signed in the quarter and we project forward as to the likely run rate, it looks higher. But it's really just a function of the specific deals that happened to be signed in that quarter. And so abnormal in the context of I'm here telling you, you shouldn't think of that as the base. It's not abnormal in the sense if it's unrepeatable.

Warren East

And with regard to the networking infrastructure and the mobile networking infrastructure, the LSI agreement is a very significant one for us. We're very pleased to see that, as I said. It is one of several pieces in the jigsaw for ARM to gain share in that space. That space is dominated by different architectures, particularly, PowerPC is strong. A couple of years ago, we had some activity with Xilinx, and they've been deploying PowerPC. Those sorts of devices get deployed in those sorts of products. They've moved to have some ARM-based products as well, LSI moving to have some ARM-based products. You will, hopefully, see some others. It's a multiyear journey, but we do expect to gain share in that space. And Ian’s telling us we must move on, so we’ll try and pick up the pace. There's quite a few towards the back.

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Sandeep Deshpande from JPMorgan Caz. Just a couple of quick questions. Firstly, on the ARM processor itself, I mean, with Windows having been seen in the mobile market here in Europe, I mean, not great success at the moment, at least. What kind of applications are we going to be running on ARM on Windows when it comes later this year or early next year? I mean, are you working with developers in developing ARM-based -- or porting current Intel applications onto ARM? Or is ARM only going to appear in the metro version of Windows? Secondly, on the Mali processor, I mean, another follow-on question. I mean, you've clearly gained -- done quite well in the digital TV part of the graphics market but, actually, possibly have lost some share within the mobile part of the graphics market. I mean, what do you see the dynamics there in the mobile part of the graphics market? And then finally, regarding -- actually, I'll leave it at that.

Warren East

Okay. Quick answers then. Windows, I'd refer you to Steve Ballmer and his keynote at CES. When asked what's the future, he said, "Metro, Metro, Metro." And I think Microsoft are launching their product, not us, and you'll have to talk to them about which applications are going to appear and what the way to get at those applications is going to be. But they were very positive about Metro when they were doing their keynote. I don't think we've lost share in mobile in graphics because as I pointed out, we're coming from behind and we don't have share to lose in mobile. And so what are the dynamics there? It's going to be the same as the dynamics across the market. ARM technology is not more or less applicable in mobile than in digital TVs, but we are #2 in that market space.

Gunnar Plagge - Citigroup Inc, Research Division

It's Gunnar from Citi. Just on the average royalty rates. I know that you're not guiding for this, but last couple of quarters were stabilizing. We had a sequential pickup this quarter. So how should we think conceptually about royalty rates going into 2012? And secondly, on development systems, you're rebuilding your system. You are guiding to flat revenues. How much visibility do you have along this process?

Tim Score

I mean, you're right, we don't guide on average royalty rates because, clearly, it is a mathematical output of blended growth rates across a variety of sectors. I think it's worth noting that if you look back over the last 2 years, 8 quarters, it's been between sort of 4.4 and 4.8. And some quarters, it's notched up, in some quarters it's notched down. So the current level is not a bad way to think about it. But ultimately, it will depend on the relative growth rates of the top-end processors and the microcontrollers. And as we've said many times before, the best outcome for our total royalty revenue and our margins and our earnings may well be a lower average royalty rate because faster penetration into microcontrollers. But certainly, looking into 2012, 4-point-something looks sensible.

Warren East

And with regard to our development systems business, we are doing a bit of restructuring there. You are seeing the world changing in that space for nonmicrocontroller applications, increasing use of open-source tools, and ARM is not open-source tools. Our tools are higher-value tools. And undoubtedly, some of the market where we would normally have expected to sell tools, people are using fully open-source tools. And so we need to adjust our product line to cope with that. At the other end of the spectrum, we have growth in microcontrollers. Microcontroller tools are much lower priced, but obviously, we're selling into a much higher volume market. And so we are seeing growth in terms of number of products sold, but they're at a lower value, and that's why you see this flattening of the revenue in that business. But I point at the 130-odd Cortex-M licenses and the vast growth that we are seeing in microcontrollers and that whole space around ARM growing significantly, so we're playing into a much larger market.

Tim Score

I think we should have 2 more questions, unfortunately.

Gareth Jenkins - UBS Investment Bank, Research Division

Gareth Jenkins from UBS. Two very quick ones if I could, one for Tim. Just on the gross margins. Given what you've just said on development systems, is 96% the kind of new baseline that we should assume going forwards through this year? And then just secondly, Warren, on big.LITTLE, I just wondered whether you can give us some initial sort of industry feedback and the kind of timetable for implementation.

Tim Score

I'm not too good on baselines because they're sort of hostages to fortune. I think if you look at Q4 and you look at the -- what we've told you is some very strong licensing, very strong royalty, yielding a 96% gross margin. I think if -- given the guidance I'm saying of $60 million plus or minus on licensing, if the licensing is around the $60 million area and the royalties are lower because of, well, the market's down in Q4, then all other things being equal, the gross margin will be a bit lower. But I mean, the main point is the gradual increase over multiple periods that we've seen in gross margin, which is essentially a reflection of royalty revenue increasing as a proportion of total is going to continue over time. Are there going to be quarters when it's lower than 96%? Yes, but it's always going to be in the mid-90s on a medium-term rising trajectory.

Warren East

And with regard to big.LITTLE, it is a little early to see anything coming out there. We have sold licenses for Cortex, what's become Cortex-A7, which is the product that we announced, the LITTLE core that we announced at the time. But I think you should probably ask that question again in July when we're back at the half year. Because at that stage, we will be a little bit -- or we'll have better visibility of our partners' plans to bring big.LITTLE products to market. However, it's been very enthusiastically sort of received by our semiconductor partners. Yes? One -- I think we've got...

Andrew M. Gardiner - Barclays Capital, Research Division

Andrew Gardiner from Barclays Capital. Just on the licensing side. Warren, you said that the number of partners that you're now working with, something like 290, I think up from 220-something the year ago, so a fairly significant, almost a 30 percent-ish increase year-on-year.

Warren East

Up from 256, actually, a year ago.

Andrew M. Gardiner - Barclays Capital, Research Division

So in terms of the increase then, year-on-year, how much of that is from either, say, sort of new start-up semiconductor companies versus more established ones who are perhaps changing their architecture choices?

Warren East

Yes. It is almost exclusively new ones, and it’s almost exclusively in the microcontroller area. What we're seeing is ARM gaining share in microcontrollers where hitherto, people would use an 8-bit architecture, and they're now adopting a 32-bit architecture and ARM is the architecture of choice.

Andrew M. Gardiner - Barclays Capital, Research Division

And just given the structure of that market, how do you -- do you see similar opportunities in 2012, 2013 for…

Warren East

Yes, that is going to continue. There are many companies there, and that's why we're continuing with our microcontroller product lines, introducing things like the Flycatcher product, because we can see scope for more product licensing into that marketplace.

I don't know. If anybody has any other questions, then we're probably around for just a few minutes. But at this point, we ought to thank you very much for your questions and say thank you for coming and we'll see you in July.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: ARM Holdings plc's CEO Discusses Q4 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts