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Executives

Bruce Beckloff - VP of IR

Warren East - CEO

Tim Score - CFO

Analysts

Nicolas Gaudois - UBS

William Wyman - Cazenove

Jonathan Crossfield - Merrill Lynch

Sandeep Deshpande - JP Morgan

Simon Schafer - Goldman Sachs

Robert Sanders - Dresdner Kleinwort

Didier Scemama of ABN Amro

ARM Holdings plc (ARMHY) Q3 2007 Conference Call October 25, 2007 3:30 AM ET

Bruce Beckloff

Good morning everyone and thank you for joining us this morning. This is Bruce Beckloff, VP of IR at ARM. On today's Q3 and nine months results conference call, we have Warren East, the Chief Executive Officer and Tim Score, the Chief Financial Officer. On today's call, Tim and Warren will take us through the highlights and comments from the quarter results and then we'll open it up to Q&A. Just to remind you guys that on the IR part of the ARM website, there is a set of presentation slides that sort of summarize the results as well.

Before I hand it over to them, I just have a few words to read out 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 person present on this call who does not have professional experience in matters relating to investments should not act or rely on the contents of this call.

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

On this note, I'll hand it over to Warren.

Warren East

Good morning everybody and thank you for joining us on the call. I'll start with a summary to set the context for these results and then hand over to Tim to discuss the numbers in some more detail.

So today, I am pleased to say that we are reiterating our confidence in achieving the full year's earnings in line with expectations despite Q3 revenues being somewhat lower than our expectations back in July. Throughout the year in 2007, we have faced challenging conditions as the semiconductor market has improved but only gradually. But during this time, we've managed costs and operations tightly and we've continued to invest in innovation and future technology development.

Putting these together, this has enabled us to firstly come through the current cycle with growth and operating margins ahead of consensus in spite of currency effects. And secondly, develop a cost base which will enable meaningful operating leverage and any expected improvements in market conditions continues into 2008. And into the medium term give us a platform that we laid out at our Analysts Day in May.

So in summary, in Q3, we've continued to push ahead with positioning the business for the future. We've been launching new products, moving forward with our leading edge physical IP, addressing the global balance of resources. And today, we're reporting some very encouraging pointers actually to future growth inline with that scenario that we painted at our Analysts Day back in May.

In the near term, we see the opportunity for a meaningful uptick in Q4 revenues driven by several factors. Firstly, cyclical and seasonal factors combining favorably to drive our royalties. Secondly, new products are continuing to push our licensing. And thirdly, scope for deployment of more engineering time to be focused on conversion of backlog into revenue in our Physical IP division.

And now I will go into a little detail and I'll start with physical IP. For the second quarter in succession, license revenue fell short of our expectations. This was partly due to lumpiness of license deal closure. But mainly due to Q3 being another quarter during which in terms of engineering resource priority, we simply had to choose the future over the present. That is developing new technology.

However, encouragingly, the backlog today sits at a higher level than it did at the end of Q2 in our Physical IP division. And some of the business that didn't close at the end of Q3 has been signed early in Q4. So, despite the short term effect on our revenues in that business, with regards to the allocation of specific engineering resources, I believe it's absolutely the right approach. And although not yet reportable as large scale bookings, the strategy of focusing on new technology development we know is beginning to yield results.

And just to think about some of that, since the time of the acquisition, we've now signed 38 licenses for technology that wasn't in existence at the time we began on physical IP. And more near term in Q3, we actually achieved several milestones including two licenses to IDM companies amongst the top-20 semiconductor companies. We signed our second SOI license, again leading edge technology. And in addition, early in this quarter in the first couple of weeks of October, we signed yet another SOI agreement, this time at 45 nanometers. That's just one year after entering the SOI Physical IP business with the acquisition of Soisic. So, progress in that business with that technology is now running ahead of our expectations.

And still on the subject of Physical IP technology development, looking further ahead, some of you might have noticed the EE Times article coming out of our Developers Conference, which was headlined "ARM gets serious about 32 nanometers." And whilst at our Developers Conference, we made no specific product announcements, it is very clear that the industry is heading in that direction. And at the conference, we reminded our customers that having accelerated our technology development to 45 nanometers, we are now developing the product portfolio which will secure our leadership position going forward.

Before I leave the Physical IP, I'll just switch to Physical IP royalties. Underlying royalties in the Physical IP business were actually up 15% ahead of the gradually improving semiconductor market, indicating a continued market share gain into the ASICs and ASSPs at which our technology is targeted. And it's not a number that I want to get into reporting on a regular basis. But anecdotally, I'll say the number of new tape outs based on our Physical IP is continuing to increase.

So, whilst we're investing very heavily in our Physical IP business for the long term, of course the majority of the ARM business continues to thrive in the short term.

Just touching on development systems, we did see some softness in development systems in Q3 at the latter stages of the semiconductor cycle combined with what is traditionally a slower quarter in the third quarter. But the early signs are that we'll see the normal pick up in development systems revenue in Q4, which has happened over the last several years.

So, switching now to our Processor division, our licensing revenue is up 24% in US dollars year-to-date. And it's pretty obvious that we're designing products that our customers need, in order for them to be successful. And following a very successful first half, we signed a further 17 licenses in Q3. So, the total number of processor licenses is now over 500.

And the Cortex strategy seems to be right for our customers. They've now purchased 34 Cortex licenses in total, seven in the last quarter. The M3 Microcontroller variant is proving very popular. And the growth of ARM based microcontrollers is really exploding at the moment and is now 2.5 times last year's level in volume terms. And it promises to continue for us as a key volume driver.

Up at the high end of the Processor spectrum, we launched the new Cortex-A9 a few weeks ago at our Developers Conference. And at our ARM Partner Meeting, which is the internal event that we have in Cambridge during the third quarter, the new Cortex-A9 and the new Mali 200 Graphics processor took most of the attention. At that event, we had 350 semiconductor executives from around the world coming to Cambridge and spending the week with us in spite of some fairly unseasonal weather.

Anyway, by the end of the quarter, we'd achieved a further sale of our graphics processor and we'd signed three new lead partners for the Cortex-A9. And we launched the A9 at our Developers Conference at the beginning of this month, five companies stood alongside us as we launched the product.

The A9 itself is a high end processor. It's a multi processor capable of approximately eight times the performance of an ARM11. And yet, if you use it in a reduced configuration, it will operate at only a quarter of a watt. And to put that into some perspective, if you just had the processor in your mobile phone and nothing else, then a standard mobile phone battery in something like my Nokia phone would last for six months.

So, ARM processors now span a huge range of applications and performance points. And this together with our improving pipeline is one of the things that's driving our confidence in strong licensing activity through Q4 and into 2008.

The market conditions have held back some of our customers and as a result in royalty terms looking at volumes, volume is up only 7% over the previous quarter and 12% versus the same time last year.

But in addition to the progress I highlighted in microcontrollers, we're getting design wins in competitive situations, in consumer and networking applications. And we're continuing to slowly increment what is our already large share in the mobile phone space.

In the summer of 2007, we've seen a step change in smart phone momentum with the launch of the iPhone at the end of June. And very meaningful shipments of these types of high-end products are helping to drive up significantly the royalty earned when a consumer like you or I purchases an ARM-based product.

And that does help address some of the mix issues associated with the microcontrollers also driving volume at the low end and so affecting the average selling prices of baskets of ARM chips. So if we look, our partners are positioned at the start of this Christmas and New Year season with ARM technology throughout their portfolios and that's really continuing to drive confidence in a strengthening royalty position as well.

Now, alongside all this commercial activity, we've had a year of much tighter financial discipline and a record 33 million pounds has been used to buyback shares in Q3. And that takes the total return to shareholders since the beginning of 2005 to 200 million pounds. And we've managed to apply this financial discipline internally to our operation as well striving for operational excellence through 2007, a focus on simplification, productivity and the bottom line. But that hasn't come at the expense of development for the future.

Over the last seven quarters, we have added over 400 people. And this year in 2007, we've absorbed the full year effect of heavy recruitment during 2006. We've grown our headcount a little this year as well. We continue to build a workforce which is balanced globally for the future.

And as a result of all this activity, we've got a robust operating margin. And together with bottom line earnings, this will benefit strongly from expected growth in revenue in the fourth quarter and as we go into 2008.

And on that, I'll hand over to Tim.

Tim Score

Good morning, everybody. I'm assuming that most of you have managed to see the earnings release. As Bruce said, the full quarterly slide set is on our website. And also I'd just like to draw your attention to Note 6.24 of the earnings release, which sets out a line-by-line reconciliation of the normalized numbers that form the consensus with the US GAAP numbers. So, that I think is quite a useful reconciliation for you when looking at your models.

So moving on to a bit more detail then and just a reminder of what we said in July, when we did our half year results. We said that we were entering the second half with a strong order backlog and a healthy licensing pipeline. We expected royalty revenues to benefit from the generally anticipated improvement in industry conditions, increased foundry utilization rates and the momentum behind smart phones in the second half.

And as a result, we said that although the pace of improvement in industry conditions was uncertain, we were confident of achieving full year earnings inline with expectations.

And today we are, as Warren said, reiterating our confidence in achieving full year 2007 earnings in line with expectations. And we're looking forward to 2008 with confidence.

So although, Q3 revenues were lower than consensus estimates, the results contain many features that bode well for our medium-term prospects. And I will return to our short-term prospects for Q4 shortly.

But in terms of those medium-term prospects, Q3 was another excellent quarter for processor licensing, as Warren said, now up 24% year-to-date. It was our most fruitful quarter for Cortex licensing with seven licenses signed, including three lead partner licenses for the A9 product.

And whilst the continued focus on the development of leading edge technologies again suppressed short-term license revenue in PIPD, the outlook for the next few quarters is set for return to the sequential revenue growth that we saw in the five quarters between Q4 '05 and Q4 '06 as we move through some of these leading edge technology developments.

And being based on Q2 shipments, both PD and PIPD royalty revenues reflected the early benefits of the unwinding of the inventory correction and the higher foundry utilization.

Looking at the order backlog, the backlog at the end of Q3 '07 was slightly lower than at the half year, but remains at historically high levels. And if you look back in history, a flat or slightly down revenue is actually the norm for ARM at the end of the third quarter.

In this third quarter, a relatively high 55% of PD license revenue came from backlog as a number of engineering milestones on contract signed in previous quarters were achieved and quite a number of them in the context of the Cortex-A8. But the very encouraging news from our perspective is that, by the quarter end, the backlog was almost replenished as a result of the number of new deals in Q3 for our newest technology.

And looking at the backlog prospects for the balance of the year and you've heard me in the past, I think be really quite reluctant to forecast backlog on a quarterly stop basis. But I think I can say that sort of based on the quality of the licensing pipeline, the prospect of ending 2007 with a backlog higher than today, I think is very real.

I mean, in 2006, backlog at the end of Q4 was some 20% higher than it was at the end of Q3. And I think a similar outcome is not impossible this year.

We include the usual analysis of backlog maturity and composition in the slides. But the headline is that over the next two quarters, we would expect 45% of total backlog to be recognized within revenue over the next six months. That's similar to the position as at July.

So looking forward to the prospects for the current quarter, we expect to see a Q3 to Q4 uplift in revenues, at least as significant as that seen in 2005 and 2006. Just to remind you in 2006, sequential revenue growth into Q4 was 10 million. And our expectation for an outcome in '07 at least as good as this is based on a healthy and improving licensing pipeline, probably as rich a pipeline as we have seen in the ARM business.

The continuing improvement in industry conditions, as seen in Q3 feeding into royalties, which we will also expect to benefit from the normal pre-Xmas seasonal strength.

Seasonal strength in development systems revenues, which given its nature as a predominantly terms business invariably suffers in the Q3 summer quarter. And sequential growth in PIPD licensing revenues more in terms of what we expect our engineers to be doing in Q4 in terms of turning backlog into revenue than necessarily for wider industry factors.

And so moving on to costs, there are really two factors at play here. I think firstly, anticipating the slower industry environment that we saw in the early part of the year, we have managed costs carefully in the short term. And after a year of high investment in headcount in 2006, we said in February of this year and again in April and again in July, that 2007 would be a year of lower investment in headcount and that we would focus on productivity and consolidation.

And secondly, that we're undertaking a longer-term regional rebalancing of our resources. The headcount as Warren said at the end of Q3 was 76 higher than at the start of the year, with headcount increasing by 100 in India and China and decreasing by 24 in the rest of the world.

And again, just to confirm what Warren said our headcount has actually increased by over 30% in the seven quarters since the beginning of 2006 as we brought 411 new heads into the business.

So, the combination of these factors has meant that despite absorbing in 2007 the full year effect of the investment we made in heads in 2006, we've been able to continue to invest in new people this year, but still limit growth in normalized OpEx year-to-date to 4%. And by the end of 2007, we expect year-on-year growth in OpEx to be less than 2%.

In 2008, we would expect to return to OpEx growth in the more normal range of somewhere between 5% or 10%, which is consistent with the sort of medium-term financial profile that we set out in May at the Analysts Day, where we said that our costs we would expect to grow at somewhere around half the rate of our revenues. And our medium-term revenue growth expectation of being in the range of 10% to 20%, and perhaps as in the previous three years, focused in the middle of that range, we would expect to continue into 2008, which is why we expect to costs to grow at broadly half that rate.

Financial discipline is not limited to control of costs. In Q3, we have achieved net cash flow generation in excess of 20 million pounds and that's a record by some margin for us for one quarter. Day sales outstanding and receivables are running at historically low levels. And therefore, Q3 has seen an acceleration in the ongoing share buyback program. At this level with 33 million pounds outlay in Q3, it is expected to increase meaningfully in Q4, consistent with the year-end net cash target of 50 million pounds that we announced in April of this year.

And just a reminder, early in Q4, we have paid 10.5 million pounds in respect to the '07 interim dividend, which you will recall was itself a 100% increase in the 2006 dividend.

And so now, with that I think we'll open the call to questions from the line. Thank you.

Question-and-Answer Session

Operator

Your first question comes from Nicolas Gaudois from UBS. Please ask your question.

Nicolas Gaudois - UBS

Yes. Hi. I've got two questions. Firstly, you confirmed basically in your presentation that you are still targeting a cash balance, net cash of 50 million pounds. So, should we assume conservatively that if the dividend payout in Q4 offset part of the cash flow, you would at least do buybacks of basically the delta, which is nearly 50 million pounds in Q4?

Tim Score

Yeah. I think that's a fair assumption.

Nicolas Gaudois - UBS

Okay, great. And just coming back Tim, on what you said in your expectations for backlog progression, I mean have I heard right? You expect 20% growth or you said 20% growth sequentially is in [programs] possible in Q4. And could you evaluate the case applying the drivers for both PIPD and PD for us?

Tim Score

Yeah. What I said was, if you look into the actual licensing pipeline of opportunities, it's as rich as it's been. And if you look at the mix of opportunities in terms of deal type and the sort of technology that is under discussion, a kind of normal closure rate and a normal mix from that pipeline in Q4 would suggest that a meaningful uptick in the backlog at the end of the year is reasonably likely. I say on these calls every quarter, it's very hard to call the quarterly closure date of individual licenses.

But certainly based on experience now over a number of quarters, the type of mix that we have in this pipeline and the sheer quantum of it and the value of the deals in it is indicative of the backlog being more likely to be up than not.

Nicolas Gaudois - UBS

Okay. And on the back of that, would you expect as a consequence, double-digit revenue growth for licensing in '08, despite the fact that PD had effectively a good year so far?

Tim Score

I think that's a perfectly reasonable prospect. Yeah.

Nicolas Gaudois - UBS

Okay. Thank you very much.

Operator

Your next question comes from William Wyman of Cazenove. Please ask your question.

William Wyman - Cazenove

Hello. Just a question on PIPD. You mentioned that the division has fallen short again because of investments in kind of developing new products. And we've seen a couple of new deals in technology. I guess the question again is at what point would you expect to see a step change in PIPD? When can we see a high profile IDM contracts for new technology? Is the timeframe here moving towards the end of next year?

Warren East

No. I don't think there's going to be a sudden overnight explosion and I have already suggested that. But what we are seeing and we're going to increasingly see is take up of newer technology by ever more significant semiconductor companies.

As I say, so far, we have nearly 40 licenses based on technology that didn't exist when we acquired the business 2.5 years ago. And all of that new technology has been developed in the last 2.5 years. And particularly in the last quarter, we signed two licenses with significant semiconductor companies.

We say in the release top-20 semiconductor companies. That's because, we couldn't say top-five semiconductor companies. And be assured as soon as we do sign the license there, then we will be talking about it.

We said that it was going to take four to seven years to position the business and get it running. And the first stage of that is developing the leading edge technology. The licenses that we've signed with the top-20 semiconductor companies this quarter, the SOI licenses that we've signed over the last several quarters including the one that's actually signed just in the last couple of weeks, are indicative that this focus on new technology developments is the right approach for developing a business for growth in the future. So, it is painful in the short term. I acknowledge that in terms of revenue. But it's absolutely the right strategy.

William Wyman - Cazenove

Okay. Thanks.

Operator

Your next question comes from Jonathan Crossfield of Merrill Lynch. Please ask your question.

Jonathan Crossfield - Merrill Lynch

Yeah. Good morning. Just a follow up on PIPD. I mean I guess we've seen sort of quite volatile revenues in the licensing stream as you say because of deal flow and also because of how you allocate resources. And at the same time, we're seeing very good cost control. Are you happy that the resource is at the right level in PIPD to develop the products at the rate you need to get ahead of your customers and drive that future licensing?

Bruce Beckloff

Hello?

Operator

Excuse me Mr. Beckloff, just to inform you Mr. Crossfield has disconnected. And your next question comes from Sandeep Deshpande of JP Morgan. Please ask your question.

Sandeep Deshpande - JP Morgan

Yeah. Hi.

Bruce Beckloff

Hi, Sandeep.

Sandeep Deshpande - JP Morgan

Can you hear me?

Bruce Beckloff

Yeah.

Sandeep Deshpande - JP Morgan

Yeah. Hi. Couple of things. Firstly on royalties, and then I'll go back to this question which Jonathan was asking. On royalties, you had a couple of quarters of improving trends in the per unit royalty and there seems to have been some kind of tumble in the last quarter. You can see the units much better than we can. Has there been a mix shift somewhere? Or is it that there are more low handsets? As you see it, what is happening in this mix in royalties?

Tim Score

Hi, Sandeep. It's Tim. I don't know whether you're looking at the Sterling number. But the average royalty rate per unit this quarter is $0.601. It's now been either $0.601 or $0.602 for last four quarters. So, it's actually been remarkably stable actually. Pardon?

Sandeep Deshpande - JP Morgan

Wasn't it $0.603 last quarter?

Tim Score

$0.602 I think last quarter, and $0.601 the one before that and $0.602 the one before that. So and I think what you're seeing is, as you say, there's a sort of push-pull effect between the early stages of the Smartphone benefit being offset by, as Warren described, some fairly explosive volume growth in MCUs. So, I think that's a two-way process that's going on. But as I say, it's really been stable now for four quarters.

Sandeep Deshpande - JP Morgan

Okay. And then secondly, regarding the revenues recognized in PIPD licensing. You have some quarters in which you have less recognition from the backlog, some quarters where there is more. How do we look at it going forward? I would assume that at this point, you know how much you can recognize given what projects are ongoing within the company. You know how much you are going to recognize from the backlog for PIPD in the current quarter.

And then, you would be at a similar point at the beginning of the first quarter. Can you give some indications? Is that one of the reasons why you're much more bullish on revenue growth and licensing in Q4?

Warren East

Well, if you look at the visibility that we do have, you're right we have some level of visibility. However, it's not perfect even at this stage in the quarter, because some of the projects that we are working on for revenue in the current quarter still depend on inputs from customers, design rules and these sorts of things. And that can change the amount of work that we are able to turn in a period of time or the number of people that we need to deploy to achieve a certain deliverable by a certain date.

And clearly, if we have a favorable shift in those factors, we'll recognize more revenue in the quarter. And if we have an unfavorable shift, we recognize less.

Similarly, when we're developing new technology, we're not going to recognize any revenue in the current quarter, but it's still as a result of an engagement with a customer. The amount of effort that we have to deploy to achieve a deliverable in a certain period of time can change.

And if we have an unfavorable change there, we think it's the right approach to concentrate on developing those newer technologies in conjunction with the customers who are going to take this business forward and be a platform for future growth rather than to turn more revenue from old technology. Subject, of course, to satisfying customers' delivery dates even for that older technology. So, that's what we're seeing. And it is an operational balancing act.

Sandeep Deshpande - JP Morgan

Okay. And one more thing, I probably missed something you said to a response to an earlier question. Are you saying that the revenue growth is what is going to be substantial in the fourth quarter, which will allow you maintain consensus for the full year? Or is it that you see some changes in the margin structure?

Tim Score

It's both, Sandeep. And as you've seen I think from today's results, normalized OpEx is round about 3 million pounds lower than consensus in Q3. And I would expect, although the OpEx is likely to increase a little bit in Q4, it's likely to be well under consensus again in Q4. So, you've got two things going on. We are on a different cost trajectory and also we are looking at a meaningful uplift in Q4 revenues at least as good as that which we saw last year.

Warren East

But that meaningful increase in revenue, it's been said, when we said on this conference call 12 months ago, we were forecasting a meaningful increase in revenue in Q4. And I recall, we needed to explain that at the time and there were some very solid factors behind it. Once again, there are some very solid factors behind this. We have a very healthy licensing pipeline supported by some new products in our processor division. The pipeline probably as strong as it has ever been. We can see an improving situation in the industry which is underpinning royalty growth.

We've got seasonal factors affecting royalties and development systems working in our favor in the current quarter. And we've got this issue that we've just been discussing about physical IP, where we absolutely see the opportunity to deploy more engineering resource over the next -- well, the duration of the quarter that we are in now, on turning backlog into current revenue rather than developing so much on the new technology. We see an opportunity for improvement there. So, in all four of those factors, we see positive pressure on the revenue for this quarter.

Sandeep Deshpande - JP Morgan

Thank you.

Operator

Your next question comes from Simon Schafer of Goldman Sachs. Please ask your question.

Simon Schafer - Goldman Sachs

Hi, good morning. Thanks very much. Sorry to ask on this again, but I wanted to ask a clarification on Artisan. I can see the revenue missed, but clearly you're saying that that's just a function of somewhat lower backlog conversion. But your overall backlog was down and the percentage for Artisan hasn't changed. So, in other words, the backlog for Artisan hasn't grown either. So, why is it that the missed revenue isn't necessarily showing up in backlog?

Warren East

Well, unfortunately, we also said it was partly due to lumpiness of some of the licensing. And indeed, if you take into account the little bit of licensing that fell over from Q3 into Q4, then the backlog in that division would indeed be up quarter-on-quarter.

Simon Schafer - Goldman Sachs

So, is that what's giving you the confidence partly to get to this 20% increase in Q4 backlog?

Warren East

Well, that's partly. I think that on its own is not a very significant factor. In terms of the overall numbers because the 20% comment was in terms of the overall backlog for the business as a whole, not just the Physical IP division. And we are not getting into the business of forecasting backlog. We don't really want to do that. We're simply saying that the factors are in place for a situation rather like that which occurred 12 months ago, to occur again.

Tim Score

But I think it's worth adding, Simon that the healthy improving licensing pipeline that we see does apply to both the Physical IP division and the Processor division.

Simon Schafer - Goldman Sachs

Okay, got it. Thanks. And then on the royalty side, ARM11 now close to 2%. What type of percentage could that be in 2008 based on what you know? And then the same question I guess on Cortex-M3. Does that actually become shippable some time in '08 or is that still too early?

Warren East

Yeah. Well, I think ARM11 is going to follow a very similar trajectory to ARM926. The initial applications are all the same. We're just looking at exactly the same thing happening two to three years later. So, I'd expect by the end of 2008, the 2% to have drifted up into the 5% region on ARM11.

And as for M3, that's actually a little bit behind in terms of where our partners licensed it compared with ARM11. M3 products are shipping today, but they're shipping in relatively small volumes. And so, they don't really show up on the radar as far as you guys are concerned. But by the end of 2008, well look, maybe we will be able to report a number there. It's going to be very small single digit percentages compared with a total which by that time we're going to be talking about 3.6 billion to 3.8 billion units on the year.

Simon Schafer - Goldman Sachs

But perhaps an absolute number of units shipped it can be similar to what ARM11 is now by the end of next year?

Warren East

On M3? To be honest, I came to this call without having that one prepared, Simon. I'm sorry. The issue on these percentages, certainly, we have still got ARM7 that's growing at a good tick. So, all of our products are continuing to penetrate. Cortex-M3 as a significant portion of the multiple billions of ARM processor is going out the door. I think it's going to be a bit challenged in its first year production shipments to get to that. It took I think about six quarters starting from ARM11 shipments to get to the place it is today. So, it does take a while for these things to gather the momentum and get the design-ins. But you'll start to see some of the shipments coming through.

Tim Score

And you've seen, Simon, ARM926 to Warren's point, sort of really picking up the momentum now at 20%. But it has taken multiple years to get from standing start to 20%.

Simon Schafer - Goldman Sachs

Yes. Thanks very much.

Operator

Your next question comes from Robert Sanders of Dresdner Kleinwort. Please ask your question.

Robert Sanders - Dresdner Kleinwort

Yeah. Hi guys. Maybe just given your comments on the backlog, it seems to me that the consensus for next year is a little bit off maybe what is going to turn out to be reality. If you look at the licensing growth for PD, people are expecting 7%, and for PIPD, they're expecting 31%. So clearly, would you expect the licensing growth next year to be sort of more similar for both divisions rather than the large disparity that there seems to be currently in market expectations?

Tim Score

Rob, I think it's a little bit too early for us to start guiding on individual revenue streams for 2008. I mean -- as we've said, we fully expect to go into 2008 with a very healthy backlog and a healthy pipeline. And so, I said in my comments that we would expect to return to the normal growth range that you've seen for ARM in recent years. And the growth range that we set out in the Analysts Day in May, sort of somewhere in that 10% to 20% probably somewhere in the mid-range. But I think it is a bit early to start getting into the individual line items.

Robert Sanders - Dresdner Kleinwort

But the trend of licensing is growing faster than royalties. You would expect to be a sort of short term rather than a medium term trend effectively?

Tim Score

Yeah. I think we've been fairly clear that if you look at the financial profile of this business and you look at our long term comments on growth in May, we would expect royalties to grow faster than licensing. In a sense for the obvious reasons, that royalties are a function of all the cumulative licensing that we've done. So, we're very, very encouraged that processor licensing is growing 24% this year.

Robert Sanders - Dresdner Kleinwort

Okay. Second question, just on the full year '07. I mean from my basic back of envelope sums from what you're saying about OpEx, is it around $525 million to $530 million for the full year '07? Is that roughly the range that you're expecting?

Tim Score

Okay. So leaping ahead, you reversed engineering your OpEx back up to the top line, I assume?

Robert Sanders - Dresdner Kleinwort

Given the consensus is 0.409 pound for this year normalized, given what you said about the OpEx being cut low next quarter as well. Would it be $525 million to $530 million for the full year? I mean just to give a ballpark.

Tim Score

I mean what we've said on OpEx is that it's going to grow less than 2% full year. So, your number obviously, the back of your envelope seems to make sense.

Robert Sanders - Dresdner Kleinwort

Okay. And then finally could you just give us some more, maybe a question for Warren, just the recent announcements from Intel’s mobile phone platform seems to be targeting the Smartphone segment. If you could just sort of give us a feeling as to how you think that's going to play out. Maybe it's more of a three to five year question I suppose.

Warren East

Yeah. Obviously, when we look at microprocessor architectures, there is only one other microprocessor architecture that really stacks up alongside ARM and that's Intel's. And that is the main factor, in favor of that architecture is the company that sits behind it and the tremendous firepower they have in financial terms. However, the ARM architecture in terms of technology is outstanding, and still an order of magnitude ahead in terms of performance and power consumption.

The new Cortex-A9, for instance, that we just announced takes this to new levels of performance and power consumption. The ecosystem that has developed around the ARM architecture in the Smartphone space is a very substantial ecosystem, even compared with the ecosystem around the PC and the X86 architecture. Today, there are really more people accessing the internet via mobile phones than via PCs.

And then you've got the business model as well where the likes of GI, Samsung, Freescale, QUALCOMM, et cetera, et cetera are standing behind the ARM architecture. And these are very significant semiconductor companies who have a vested interest in making sure that they remain dominant in the Smartphone space rather than allowing Intel in. Having said all that, Intel's a big company. They remain an ARM licensee. They pay us a royalty every quarter and we look forward to that continuing and continuing to grow.

Robert Sanders - Dresdner Kleinwort

Okay. Thanks a lot.

Operator

(Operator Instructions). Your next question comes from Didier Scemama of ABN Amro. Please ask your question.

Didier Scemama - ABN Amro

Yes. Good morning, gentlemen and thanks for taking my question. I just would like to make sure I understand everything here, when you say you've got a mid consensus expectation, if I look at the consensus I have got in front of me, it is about 490 and 273. But we are talking here at I guess constant currency, aren't we?

Tim Score

What we said in the release is that we are confident of achieving full year earnings expectations inline with consensus, assuming about $2 to the pound.

Didier Scemama - ABN Amro

Right. Okay. Perfect. Do you have any sort of idea on the tax rate for Q4?

Tim Score

It says in the release, I'm expecting a full year rate in the 26% to 27% range.

Didier Scemama - ABN Amro

Okay. In terms of share count, you returned 33 million pounds in the third quarter. Nevertheless, the number of shares went down by around only 11 million, I guess because of option dilution. So, I understand you're going to step up your buybacks in Q4 which I think is pretty smart. Do you have any idea about option dilution and therefore, the number of shares really share count at the end of Q4?

Tim Score

Interestingly, Didier, it's not quite as straightforward as buybacks versus option dilution. And don't forget, as you do buybacks through the quarter, you only get the benefit of them on a weighted basis. So, we haven't yet seen the full benefit of the Q3 buybacks in the share count. Also the fully diluted share calculation comprehends average share price because that in itself brings in diluted securities into the calculations. So, it's an ongoing thing.

I mean, clearly, also we're going to pick up the benefit of that. And obviously with the Q4 buyback program, we're going to start getting some of that into the share count as well. So, I can't forecast the share count but it's clearly going to be reduced on the 1363 that we've ended in Q3. We'll have to see exactly where it ends up for the other reasons that I just said. I don't see necessarily a big dilution in Q4 from options.

Didier Scemama - ABN Amro

Okay. Maybe just two quick follow ups, looking at your unit shipments for PD, it looks like, if I assume a pretty sharp uptake in volume shipments for home and enterprise in the fourth quarter, it looks like we're going to end up '07 with basically flat volumes in home and flat volumes in enterprise and obviously major growth coming from mobile and embedded segments. I'm just wondering if you could maybe explain why the volumes in home and enterprise are flattish as you're talking about market share gains in those segments.

Warren East

Yeah. Particularly in enterprise, I think we have the challenges all of year, well, certainly in the first half of PC-related type applications, printers, hard disk drives, those sorts of things that have actually been holding us back. And I think most people would say that off the back of everybody thinking that the World Cup was all of a sudden going to generate a lot of DTV sales, those things have not actually been growing as quickly as most people really expect.

I think going into the holiday season, I think most comments out there in the market are PC-related shipments are going well. So, we can see some upticks in things like printers and hard disk drives and that. And then we'll typically get the Christmas rush as well for the other kind of consumer related devices. So, but all in all, I think during this kind of inventory challenge that we've been seeing over the past 12 months, certainly the more consumer-related non-mobile phone, non kind of iPod stuff has been challenged more than our mobile or our MCU shipments.

So, I think that's across the board. I don't think that -- we aren't seeing that the market share gains relate to those devices as well. But the overall shipments of volumes across the board of those types of devices have been down during this inventory correction.

Didier Scemama - ABN Amro

Okay. And my final question, I'm sorry to dwell on that because I think Rob just asked the question. But I'm not sure I really got the answer. You've got about 31% consensus growth next year for PIPD items. And I was wondering given what Warren said earlier about not an explosion but more of a gradual shift towards the outsourcing model for PIPD. I mean I was wondering why that business would grow 31% in '08?

Warren East

Well, I think that it's too early to be too granular about the revenue growth for licensing. I mean we said at the Analysts Day the range that we expect overall licensing to grow. The PIPD division itself, yes, there is scope for superior licensing growth in 2008 due to the fact that we are grinding through some of these operational issues that we talked about at the beginning of the call. And once we have got through that phase of this technology development, then we should be able to translate some of that into revenue. Because we are still taking orders as seen by the licensing that's been done.

Didier Scemama - ABN Amro

Okay. Thanks very much.

Operator

(Operator Instructions).

Warren East

So, there don't appear to be any further questions. At this stage, we'll just wrap up with a quick summary. We're pleased to be reiterating our confidence in year-end earnings expectations. We are sitting in a position of very strong licensing with new products gaining traction. Things like the A9 new Cortex products and the Mali product earning accolades from the technical people around the world, coming off the quarter with record Cortex licensing. And we look forward to that continuing in Q4 and into 2008 with an improving pipeline.

In our Physical IP division, we are confident that our focus on developing new technology is absolutely right. Some of that's coming through with licenses to top-20 semiconductor companies and SOI licenses. The operating leverage is inherent in our business and it’s working, allowing us to have significant investments in new technology, even in the last quarter, but certainly over the last several quarters. And still build ourselves a cost base which is a platform for the margin growth that we outlined at our Analysts Day. And that's enabling us to have outstanding cash generation, record quarter that we're just reporting for cash generation. And scope for acceleration of cash return going forward.

So, I think that's the summary and thank you very much for listening, and we'll be back in February. Goodbye.

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Source: ARM Holdings Q3 2007 Earnings Call Transcript
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