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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 - MerrillLynch

Sandeep Deshpande - JP Morgan

Simon Schafer - Goldman Sachs

Robert Sanders - DresdnerKleinwort

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

Before I hand it over to them, Ijust have a few words to read out with respect to this conference call and whatwe're about to discuss. The contents of this conference call are being directedonly to those of you who have professional experience in matters relating toinvestments and the information communicated on this call is being madeavailable only to investment professionals. Any person present on this call whodoes not have professional experience in matters relating to investments shouldnot act or rely on the contents of this call.

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

On this note, I'll hand it overto Warren.

Warren East

Good morning everybody and thankyou for joining us on the call. I'll start with a summary to set the contextfor these results and then hand over to Tim to discuss the numbers in some moredetail.

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

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

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

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

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

However, encouragingly, thebacklog today sits at a higher level than it did at the end of Q2 in ourPhysical IP division. And some of the business that didn't close at the end ofQ3 has been signed early in Q4. So, despite the short term effect on ourrevenues in that business, with regards to the allocation of specificengineering resources, I believe it's absolutely the right approach. Andalthough not yet reportable as large scale bookings, the strategy of focusingon new technology development we know is beginning to yield results.

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

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

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

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

Just touching on developmentsystems, we did see some softness in development systems in Q3 at the latterstages of the semiconductor cycle combined with what is traditionally a slowerquarter in the third quarter. But the early signs are that we'll see the normalpick up in development systems revenue in Q4, which has happened over the lastseveral years.

So, switching now to ourProcessor 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 processorlicenses is now over 500.

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

Up at the high end of theProcessor spectrum, we launched the new Cortex-A9 a few weeks ago at ourDevelopers Conference. And at our ARM Partner Meeting, which is the internalevent that we have in Cambridge during the third quarter, the new Cortex-A9 andthe new Mali 200 Graphics processor took most of the attention. At that event,we had 350 semiconductor executives from around the world coming to Cambridgeand 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 threenew lead partners for the Cortex-A9. And we launched the A9 at our DevelopersConference at the beginning of this month, five companies stood alongside us aswe launched the product.

The A9 itself is a high endprocessor. It's a multi processor capable of approximately eight times theperformance of an ARM11. And yet, if you use it in a reduced configuration, itwill operate at only a quarter of a watt. And to put that into someperspective, if you just had the processor in your mobile phone and nothingelse, then a standard mobile phone battery in something like my Nokia phonewould last for six months.

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

The market conditions have heldback 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 timelast year.

But in addition to the progress Ihighlighted in microcontrollers, we're getting design wins in competitivesituations, in consumer and networking applications. And we're continuing toslowly increment what is our already large share in the mobile phone space.

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

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

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

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

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

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

Tim Score

Good morning, everybody. I'massuming that most of you have managed to see the earnings release. As Brucesaid, the full quarterly slide set is on our website. And also I'd just like todraw your attention to Note 6.24 of the earnings release, which sets out a line-by-linereconciliation of the normalized numbers that form the consensus with the USGAAP numbers. So, that I think is quite a useful reconciliation for you whenlooking at your models.

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

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

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

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

But in terms of those medium-termprospects, Q3 was another excellent quarter for processor licensing, as Warrensaid, now up 24% year-to-date. It was our most fruitful quarter for Cortexlicensing with seven licenses signed, including three lead partner licenses forthe A9 product.

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

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

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

In this third quarter, arelatively high 55% of PD license revenue came from backlog as a number ofengineering milestones on contract signed in previous quarters were achievedand quite a number of them in the context of the Cortex-A8. But the veryencouraging news from our perspective is that, by the quarter end, the backlogwas almost replenished as a result of the number of new deals in Q3 for ournewest technology.

And looking at the backlogprospects for the balance of the year and you've heard me in the past, I thinkbe really quite reluctant to forecast backlog on a quarterly stop basis. But Ithink 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 veryreal.

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

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

So looking forward to theprospects for the current quarter, we expect to see a Q3 to Q4 uplift inrevenues, at least as significant as that seen in 2005 and 2006. Just to remindyou in 2006, sequential revenue growth into Q4 was 10 million. And ourexpectation for an outcome in '07 at least as good as this is based on ahealthy and improving licensing pipeline, probably as rich a pipeline as we haveseen in the ARM business.

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

Seasonal strength in developmentsystems revenues, which given its nature as a predominantly terms businessinvariably suffers in the Q3 summer quarter. And sequential growth in PIPDlicensing revenues more in terms of what we expect our engineers to be doing inQ4 in terms of turning backlog into revenue than necessarily for wider industryfactors.

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

And secondly, that we'reundertaking a longer-term regional rebalancing of our resources. The headcountas 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 therest of the world.

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

So, the combination of thesefactors has meant that despite absorbing in 2007 the full year effect of theinvestment we made in heads in 2006, we've been able to continue to invest innew people this year, but still limit growth in normalized OpEx year-to-date to4%. And by the end of 2007, we expect year-on-year growth in OpEx to be lessthan 2%.

In 2008, we would expect toreturn 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 setout in May at the Analysts Day, where we said that our costs we would expect togrow at somewhere around half the rate of our revenues. And our medium-termrevenue growth expectation of being in the range of 10% to 20%, and perhaps asin the previous three years, focused in the middle of that range, we wouldexpect to continue into 2008, which is why we expect to costs to grow atbroadly half that rate.

Financial discipline is notlimited to control of costs. In Q3, we have achieved net cash flow generationin excess of 20 million pounds and that's a record by some margin for us forone quarter. Day sales outstanding and receivables are running at historicallylow levels. And therefore, Q3 has seen an acceleration in the ongoing sharebuyback program. At this level with 33 million pounds outlay in Q3, it isexpected to increase meaningfully in Q4, consistent with the year-end net cashtarget 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, whichyou will recall was itself a 100% increase in the 2006 dividend.

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

Question-and-Answer Session

Operator

Your first question comes fromNicolas 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 stilltargeting a cash balance, net cash of 50 million pounds. So, should we assumeconservatively 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 50million pounds in Q4?

Tim Score

Yeah. I think that's a fairassumption.

Nicolas Gaudois - UBS

Okay, great. And just coming backTim, on what you said in your expectations for backlog progression, I mean haveI 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 driversfor both PIPD and PD for us?

Tim Score

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

But certainly based on experiencenow over a number of quarters, the type of mix that we have in this pipelineand the sheer quantum of it and the value of the deals in it is indicative ofthe 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 perfectlyreasonable prospect. Yeah.

Nicolas Gaudois - UBS

Okay. Thank you very much.

Operator

Your next question comes fromWilliam 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 investmentsin kind of developing new products. And we've seen a couple of new deals intechnology. I guess the question again is at what point would you expect to seea step change in PIPD? When can we see a high profile IDM contracts for newtechnology? Is the timeframe here moving towards the end of next year?

Warren East

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

As I say, so far, we have nearly40 licenses based on technology that didn't exist when we acquired the business2.5 years ago. And all of that new technology has been developed in the last2.5 years. And particularly in the last quarter, we signed two licenses withsignificant semiconductor companies.

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

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

William Wyman - Cazenove

Okay. Thanks.

Operator

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

Jonathan Crossfield - Merrill Lynch

Yeah. Good morning. Just a followup on PIPD. I mean I guess we've seen sort of quite volatile revenues in thelicensing stream as you say because of deal flow and also because of how youallocate 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 theproducts at the rate you need to get ahead of your customers and drive thatfuture licensing?

Bruce Beckloff

Hello?

Operator

Excuse me Mr. Beckloff, just toinform you Mr. Crossfield has disconnected. And your next question comes fromSandeep 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 wasasking. On royalties, you had a couple of quarters of improving trends in theper unit royalty and there seems to have been some kind of tumble in the lastquarter. You can see the units much better than we can. Has there been a mixshift somewhere? Or is it that there are more low handsets? As you see it, whatis happening in this mix in royalties?

Tim Score

Hi, Sandeep. It's Tim. I don'tknow whether you're looking at the Sterling number. But the average royaltyrate per unit this quarter is $0.601. It's now been either $0.601 or $0.602 forlast 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 whatyou're seeing is, as you say, there's a sort of push-pull effect between theearly 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-wayprocess that's going on. But as I say, it's really been stable now for fourquarters.

Sandeep Deshpande - JP Morgan

Okay. And then secondly,regarding the revenues recognized in PIPD licensing. You have some quarters inwhich you have less recognition from the backlog, some quarters where there ismore. 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 thecompany. You know how much you are going to recognize from the backlog for PIPDin the current quarter.

And then, you would be at asimilar point at the beginning of the first quarter. Can you give someindications? Is that one of the reasons why you're much more bullish on revenuegrowth and licensing in Q4?

Warren East

Well, if you look at thevisibility 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 ofthe projects that we are working on for revenue in the current quarter stilldepend on inputs from customers, design rules and these sorts of things. Andthat can change the amount of work that we are able to turn in a period of timeor the number of people that we need to deploy to achieve a certain deliverableby a certain date.

And clearly, if we have afavorable 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 developingnew technology, we're not going to recognize any revenue in the currentquarter, but it's still as a result of an engagement with a customer. Theamount of effort that we have to deploy to achieve a deliverable in a certainperiod of time can change.

And if we have an unfavorablechange there, we think it's the right approach to concentrate on developingthose newer technologies in conjunction with the customers who are going totake this business forward and be a platform for future growth rather than toturn more revenue from old technology. Subject, of course, to satisfyingcustomers' delivery dates even for that older technology. So, that's what we'reseeing. And it is an operational balancing act.

Sandeep Deshpande - JP Morgan

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

Tim Score

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

Warren East

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

We've got seasonal factorsaffecting royalties and development systems working in our favor in the currentquarter. And we've got this issue that we've just been discussing aboutphysical IP, where we absolutely see the opportunity to deploy more engineeringresource 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 thenew technology. We see an opportunity for improvement there. So, in all four ofthose factors, we see positive pressure on the revenue for this quarter.

Sandeep Deshpande - JP Morgan

Thank you.

Operator

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

Simon Schafer - Goldman Sachs

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

Warren East

Well, unfortunately, we also saidit was partly due to lumpiness of some of the licensing. And indeed, if youtake 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 theconfidence partly to get to this 20% increase in Q4 backlog?

Warren East

Well, that's partly. I think thaton its own is not a very significant factor. In terms of the overall numbersbecause the 20% comment was in terms of the overall backlog for the business asa whole, not just the Physical IP division. And we are not getting into thebusiness of forecasting backlog. We don't really want to do that. We're simplysaying that the factors are in place for a situation rather like that whichoccurred 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 toboth the Physical IP division and the Processor division.

Simon Schafer - Goldman Sachs

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

Warren East

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

And as for M3, that's actually alittle bit behind in terms of where our partners licensed it compared withARM11. M3 products are shipping today, but they're shipping in relatively smallvolumes. And so, they don't really show up on the radar as far as you guys areconcerned. But by the end of 2008, well look, maybe we will be able to report anumber there. It's going to be very small single digit percentages comparedwith a total which by that time we're going to be talking about 3.6 billion to3.8 billion units on the year.

Simon Schafer - Goldman Sachs

But perhaps an absolute number ofunits 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 tothis call without having that one prepared, Simon. I'm sorry. The issue onthese percentages, certainly, we have still got ARM7 that's growing at a goodtick. So, all of our products are continuing to penetrate. Cortex-M3 as asignificant portion of the multiple billions of ARM processor is going out thedoor. I think it's going to be a bit challenged in its first year productionshipments to get to that. It took I think about six quarters starting fromARM11 shipments to get to the place it is today. So, it does take a while for thesethings to gather the momentum and get the design-ins. But you'll start to seesome of the shipments coming through.

Tim Score

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

Simon Schafer - Goldman Sachs

Yes. Thanks very much.

Operator

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

Robert Sanders - Dresdner Kleinwort

Yeah. Hi guys. Maybe just givenyour comments on the backlog, it seems to me that the consensus for next yearis a little bit off maybe what is going to turn out to be reality. If you lookat the licensing growth for PD, people are expecting 7%, and for PIPD, they're expecting31%. So clearly, would you expect the licensing growth next year to be sort ofmore similar for both divisions rather than the large disparity that thereseems to be currently in market expectations?

Tim Score

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

Robert Sanders - Dresdner Kleinwort

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

Tim Score

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

Robert Sanders - Dresdner Kleinwort

Okay. Second question, just onthe full year '07. I mean from my basic back of envelope sums from what you'resaying 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, youreversed engineering your OpEx back up to the top line, I assume?

Robert Sanders - Dresdner Kleinwort

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

Tim Score

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

Robert Sanders - Dresdner Kleinwort

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

Warren East

Yeah. Obviously, when we look atmicroprocessor architectures, there is only one other microprocessorarchitecture that really stacks up alongside ARM and that's Intel's. And thatis the main factor, in favor of that architecture is the company that sitsbehind it and the tremendous firepower they have in financial terms. However,the ARM architecture in terms of technology is outstanding, and still an orderof 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 powerconsumption. The ecosystem that has developed around the ARM architecture inthe Smartphone space is a very substantial ecosystem, even compared with theecosystem around the PC and the X86 architecture. Today, there are really morepeople accessing the internet via mobile phones than via PCs.

And then you've got the businessmodel as well where the likes of GI, Samsung, Freescale, QUALCOMM, et cetera,et cetera are standing behind the ARM architecture. And these are verysignificant semiconductor companies who have a vested interest in making surethat they remain dominant in the Smartphone space rather than allowing Intelin. 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 andcontinuing to grow.

Robert Sanders - Dresdner Kleinwort

Okay. Thanks a lot.

Operator

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

Didier Scemama - ABN Amro

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

Tim Score

What we said in the release isthat we are confident of achieving full year earnings expectations inline withconsensus, assuming about $2 to the pound.

Didier Scemama - ABN Amro

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

Tim Score

It says in the release, I'mexpecting 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 numberof shares went down by around only 11 million, I guess because of optiondilution. So, I understand you're going to step up your buybacks in Q4 which Ithink is pretty smart. Do you have any idea about option dilution andtherefore, the number of shares really share count at the end of Q4?

Tim Score

Interestingly, Didier, it's notquite 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 aweighted basis. So, we haven't yet seen the full benefit of the Q3 buybacks inthe share count. Also the fully diluted share calculation comprehends averageshare price because that in itself brings in diluted securities into thecalculations. So, it's an ongoing thing.

I mean, clearly, also we're goingto 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, Ican't forecast the share count but it's clearly going to be reduced on the 1363that we've ended in Q3. We'll have to see exactly where it ends up for theother reasons that I just said. I don't see necessarily a big dilution in Q4from options.

Didier Scemama - ABN Amro

Okay. Maybe just two quick followups, looking at your unit shipments for PD, it looks like, if I assume a prettysharp 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 andflat volumes in enterprise and obviously major growth coming from mobile andembedded segments. I'm just wondering if you could maybe explain why thevolumes in home and enterprise are flattish as you're talking about marketshare gains in those segments.

Warren East

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

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

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

Didier Scemama - ABN Amro

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

Warren East

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

Didier Scemama - ABN Amro

Okay. Thanks very much.

Operator

(Operator Instructions).

Warren East

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

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

So, I think that's the summaryand 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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