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ARM Holdings (NASDAQ:ARMH)

Q1 2012 Earnings Call

April 24, 2012 3:30 am ET

Executives

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

Ian Thornton - Vice President of Investor Relations

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

Analysts

Vivek Arya - BofA Merrill Lynch, Research Division

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Gunnar Plagge - Citigroup Inc, Research Division

Francois Meunier - Morgan Stanley, Research Division

Gareth Jenkins - UBS Investment Bank, Research Division

Andrew M. Gardiner - Barclays Capital, Research Division

Simon F. Schafer - Goldman Sachs Group Inc., Research Division

Nick James - Numis Securities Ltd., Research Division

Janardan Menon - Liberum Capital Limited, Research Division

Paul Gilmer Morland - Peel Hunt LLP, Research Division

Johannes Schaller - Deutsche Bank AG, Research Division

Lee J. Simpson - Jefferies & Company, Inc., Research Division

Martin O'Sullivan - Cenkos Securities plc., Research Division

D. Warren A. East

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 Analyst Conference Call. [Operator Instructions] I must advise you the conference is recorded today, on Tuesday, the 24th of April 2012. And I would now like to hand over to your first speaker today, Mr. Ian Thorton. Please go ahead, sir.

Ian Thornton

Thank you very much indeed. Good morning, everybody. This is Ian Thornton, the Head of Investor Relation at ARM. On today's Q1 Results Conference Call, we have, with me, Warren East, Chief Executive Officer and Tim Score, our Chief Financial Officer. On today's call, Tim and Warren will take us through the highlights and comments from the quarter's results, and then we'll open up the call to a Q&A session. As a reminder, the presentation and release can be found on the ARM Investor Relations' website at www.arm.com/ir.

Before I hand over to them, I just have to read a few words with respect to this conference call and what we are 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 been made available only to investment professionals. Any persons present on this call who do not have professional experience in matters related to investment should not act or rely on the contents of this call. The following conference call will contain forward-looking statements, other than statements of historical facts The company's actual results in future bids may materially from these statements, as they are based on current expectations and are subject to a number risks and uncertainties.

And on this note, I'll hand over to Warren.

D. Warren A. East

Thank you, Ian. Good morning everybody, and thank you for joining our call. I will start with some context, then go into business highlights and hand over to Tim, and as usual, I hope we'll cover most of the content in Q&A.

So to some context. 2011 was an excellent year for ARM, and we're pleased that this morning, we can report that the first quarter of 2012 has shown our momentum continuing and indeed, we have some further healthy indicators that are underpinning the long-term growth opportunity for our business. We came into the year with a record backlog with several innovative new products in development, which will enable our customers to enter new markets and a strong competitive position in our target market. And we're continuing to see an increase in the demand for our smarter low -- lower-powered technology, in particularly, all aspects of people's lives become enhanced with the digital products that results from that. And that's driving both our licensing and our royalty revenues. And in the first quarter of the year, we saw demand for our technology driven by a huge variety of end market, from highly efficient servers and high-performance mobile computers right through to very low power energy sipping sensors and low-cost microcontrollers. If we look at the volumes actually shipped, our royalty revenues, again, outperformed the overall semiconductor industry as our customers launched products into new markets and gained market share within existing target markets. And this revenue growth has enabled them to continue to invest further in R&D, enhancing our ability to innovate and continue to develop new products. And at the same time, we've grown earnings by 23% and delivered strong cash generation.

So looking forward to the rest of the year, despite Q1 industry shipment declining, sequentially, most analysts expect the industry to recover in the second half. And it is in that context that we expect the group dollar revenues for the full year will be in line with current market expectations.

Now we'll look at some of the business highlights and discuss the revenue drivers in the different parts of the business, starting with the Processor division, where all our licenses were assigned for, either, Cortex or Mali processors. And we signed 22 licenses in the quarter with a broad range of end markets. I've already mentioned servers and centers but we also signed licenses for product developments in security, security modules; the game consoles; mobile phone power controllers, which of course adds an extra royalty opportunity for mobile devices; deeply embedded chips in electric motor controllers and smart meters; and of course, the high-end apps processors for mobile computers and digital TVs and for those low- and high-end smartphones.

If we look at where these licenses were sold, just over half the licenses were for customers based in Asia. This included Cortex-A and Mali processors for consumer electronics, Cortex-R processors for base-band modems and Cortex-M processors for microcontrollers and smartcards. Over the years, we've increased our focus on the major economies in Asia. Last November, for instance, we announced we'd opened a design center in Hsinchu in Taiwan to deepen our collaboration with the major companies in that region.

We licensed 8 Cortex-A processors mainly to consumer electronics companies and people building chips for servers, and that -- these included another lead partner for our new Atlas product which is based on the next-generation ARM architecture, which includes 64-bit support. We also sold licenses for Cortex-A5, Cortex-A7 and Cortex-A15. We sold 10 licenses for Cortex-M processors, mainly for microcontrollers and smartcards. And in the M processor family, during the quarter, we announced the Cortex-M0+, which is our smallest and lowest power processor so far. I'm particularly excited at the prospects for that processor going forward. This new technology will enable our customers to have software compatibility across their entire product range but now, including chips that were previously 8-bit microcontroller parts. And the lead partners for that were NXP and Freescale. Two of the processor licenses sold for Mali graphics processors into digital TVs and mobile computing. And both of those design wins are alongside Cortex-A family processor, and so putting those together further increases our royalty percentage per chip.

Talking of royalty, we'll now talk about that. Remember, our royalty revenues are reported a quarter in arrears, so the numbers we're talking about, our royalty in Q1, was generated from chips sold during Q4 last year. Processor royalty revenue was up 6% year-on-year compared with the relevant industry revenues declining by about 2%, so continued outperforming of the industry. 1.9 billion ARM processor-based chips were reported in the quarter, and that's a 5% year-on-year increase. And it was mainly driven by growth in non-mobile markets. In Q4 last year, we reported 2.2 billion chips, and so there was a sequential decrease and that was primarily due to an 11% decrease in industry shipments overall. ARM is very exposed or particularly exposed to markets like disk drives and microcontrollers, and these sectors saw the largest falls.

So with fewer low-cost microcontrollers, the change in the mix of our ARM-based chips has contributed to a sequential increase in the average royalty revenue per chip from $0.045 in the previous quarter to $0.048 in Q1 reporting today. Common to the sequential increase was also due to an increase in the number of Cortex-A and Mali processor-based chips, especially into things like smartphones and digital TVs, typically received the higher royalty percentage per chip -- per chips containing Cortex-A processors and for chips with multiple processors, including Mali graphics. And over the last year, we've seen a near doubling of Cortex-A family shipments and a 30-fold increase in Mali graphics shipments, and that's against the backdrop of the continuing growth of chips with 2 or more ARM processors. So the benefit arising from the combination of all this more ARM technology per chip is illustrated by the average royalty revenue per chip in mobile devices increasing by 5% over the past year, while the average royalty revenue per chip in home electronics has increased by 15% over the last year.

Switching now to our physical IP division. Total physical IP revenue was up 6% overall, $24.7 million. And during the quarter, we signed licenses for a new 130-nanometer royalty-bearing platform, several updates, extensions to existing platforms spanning technology all the way from 130 nanometers to 28 nanometers. We're continuing to see demand for our processor optimization packs. These comprise physical IP optimized for use with Cortex-A family processors. During the quarter, we signed another 3 POP licenses, including the first POP license for a Cortex-A7 for use in mobile and mobile computing apps processes and the other POPs were for Cortex-A9 and Cortex-A5 processors, demonstrating demand for physical IP across the full range of ARM's apps processors.

We also announced the availability of the Cortex-A15 platform TSMC's 28-nanometer process and a Cortex-A9 POP on GLOBALFOUNDRIES' 28-nanometer process. Underlying physical IP royalties in Q1 were $11 million, which was up 9% year-on-year compared to foundry revenues which declined 3% in the relevant period. Royalty revenue from physical IP has advanced nodes, that's 45 nanometers and newer, continues to increase. And now that's accounting for approximately 1/3 of our total physical IP royalty revenues.

Development systems. Development systems had a great quarter, and we won a large one-off deal with a major semiconductor company, but that is a one-off deal. ARM is continuing to transition the business to focus -- the tools business to focus on microcontroller tools and premium toolkits for multi-core systems. This is against an industry context of increasing adoption of open-source tools. And as we stated last quarter, due to this transition, we expect that full year revenues for our development systems business will be broadly flat year-on-year.

What we've been doing from an operational point of view. We've continued our investments in R&D, grown our engineering teams working on advanced processors and graphics. That was an addition of 60 people during Q1, and we expect to continue that investment, in new people, during Q2. The result of that investment can be seen with some of the new technology announcements, I've already referred to, things like the Cortex-M0 and the new processor optimization packs. And in addition, we recently announced a joint venture with Gemalto and Giesecke & Devrient to deliver improved security for applications and services running on top of our connected devices. And this joint venture will create and deliver a secure operating system, creating a so-called trusted execution environment, and that utilizes ARM's TrustZone technology, which can be found in all the Cortex-A family of processors.

So that's a quick run through of highlights in the business. I'll now hand over to Tim, who will provide some further detail on the numbers.

Tim Score

Thanks, Warren. Good morning, everybody. Hopefully, most of you have had a chance to have a quick look at our Q1 earnings release out this morning. And in addition to the financial information included in that release, the quarterly slide set is available on our website, as usual, to help with models, et cetera.

So the headlines, overall, Q1 dollar revenues, $209.4 million. Up 13%, year-on-year, particularly strong growth in processor license revenues, which are up 27% at $65.2 million. And that's now for sequential quarters with licensing around $60 million, plus or minus, which is consistent with our guidance. And we expect license revenues to continue to be around $60 million in the second quarter. Although it's too early in the quarter to tell, it's going to be 60-plus or 60-minus.

Going into Q1. Backlog, order backlog was at record levels, and we exited the quarter with backlog marginally lower sequentially and up some 15% higher than a year ago. In the first quarter, approximately 60% of PD license revenue was generated from backlog, and that's at the upper end of the typical 40% to 60% range. The usual analysis of backlog maturity and composition is included in the slide set on the website, and that shows that 26% of total backlog is expected to be recognizable as revenue over the next 2 quarters. As Warren said, processor royalties were up 6% year-on-year to just under $93 million on the positive side of the $90 million, plus or minus, that I referred to at our Q4 results at the end of January. The royalty revenues were impacted to some extent in Q1 by the slowdown of -- in Q4 of the sales of disk drive components, as a result of the Thai floods and by the general slowdown in semiconductor sales in Q4 that Warren referred to.

In previous years, normal seasonality has resulted in a modest sequential decline in royalty revenues from Q1 to Q2. Industry data indicates that semiconductor sales were likely to be down about 5%, in the period that's relevant for our Q2 royalties, i.e., Q1. But most analysts are forecasting that Q1 is the bottom of the current cycle, which would benefit our royalty revenues in the second half of the year.

Normalized OpEx in Q1 was GBP 66.1 million compared to the guidance given in January of GBP 64 million to GBP 66 million. And as noted in the earnings release, the increase in OpEx over the last 12 months is due to increased investment in our research and development teams. Normalized OpEx for Q2 is expected to be in the range of GBP 67 million to GBP 69 million, assuming current exchange rates. Sequential increase is expected as we continue to invest in the development and deployment of new technology. Normalized operating margins were over 44% in Q1 this year compared to 43% a year ago, and cash generation continued to be strong, demonstrating that we're managing to increase profitability and generate good levels of cash, whilst increasing investment in future product development and organizational capability.

Now on to the outlook. Both the order backlog and the licensing pipeline are robust, pointing to continued strength in processor licensing revenue. ARM Q2 royalty revenues are generated, as I say, from Q1 chip shipments. And as mentioned earlier, relevant data for the first quarter indicates that industry-wide revenue is down about 5%. But with most analysts expecting recovery in the second half, in that context, ARM expects group dollar revenues for the full year, 2012, to be in line with current market expectations, which are $879 million. And that is just under $20 million higher than the full year consensus revenues that were in place at the end of January, when we did our full year results.

So now over to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Vivek Arya from Merrill Lynch.

Vivek Arya - BofA Merrill Lynch, Research Division

I'm curious what are you seeing in the industry regarding the supply issues that some of these advanced nodes, 28 nanometers, specifically. Do you think that will have an impact on your second half results?

D. Warren A. East

It's Warren. We're not anticipating an impact. I think you're probably referring to the comments made by Qualcomm. And from what we can see/know, Qualcomm are experiencing very strong demand for some particular designs. And they highlighted that it would be a supply-constrained situation rather than a demand-constrained situation as far as those particular products are concerned. But don't forget, Qualcomm is just one of ARM's customers, and many of our semiconductor partners are seeing demand for ARM-based technology. So we don't think that, that will be a material impact on our business.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And just on a separate subject, when is the earliest, Warren, that we should start thinking about impact from Windows 8? I know it's probably very small this year, but how should we think about the impact on your revenues? Is it more a second half 2013 impact? Or how should we think about it?

D. Warren A. East

I think a few things to take into account. I mean first of all, the timescales are very heavily controlled by Microsoft and not by ARM or ARM's partners. Secondly, you're right not to get any serious expectations for the current year, because, certainly, all indications are that product launches are right towards the back end of this year. Thirdly, these types of products, we're talking about things like mobile computers and tablets and the like, there is a little bit of a bias towards consumer, and that does tend to be a little bit seasonal and so that would point towards later in the following year as being time for more demand. I mean the story, as far as we're concerned, is that this is a long-term thing. I know it's very exciting as far as when is the impact actually going to hit, but we see this as a continuous opportunity over several years and exactly when it starts, it's going to be only really noticeable after it's happened.

Operator

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

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Firstly, I mean, Tim, could you talk about this increase in OpEx? I mean what -- why is this OpEx increasing more than that we were expecting? I mean you talked about R&D, but exactly what is changing in your R&D spending trends? And secondly, if you could talk about the increase in your Cortex-M shipments, I mean Cortex-M seems to be increasing quite substantially as a percentage of your shipments, but, at the same time, I mean your royalty per device also seem to have increased, which seems to be a factor from Cortex-A. So maybe we can talk -- if you can just talk about these dynamics within your royalty mix?

Tim Score

Sandeep, yes. I mean on the OpEx runs, and as I said in the comments, I mean guidance for Q1 was GBP 64 million to GBP 66 million, and it came out at GBP 66 million. I mean consensus was GBP 65 million. GBP 1 million, I don't think is particularly significant on a quarterly basis. I mean what we are doing, as we've said, is investing in our R&D capability and our technology roadmap, that's in processors, it's in graphics, it's in physical IP and it's also in our -- this sort of organizational capability as we grow. So I don't think there's any particular surprise there in OpEx. And yes, we do see that we will continue to invest subject to the market staying or improving in the second half.

D. Warren A. East

Okay and I'll now talk to the Cortex-M question, Sandeep. I mean Cortex-M is obviously our processors aimed at microcontroller products. We are seeing very strong growth there. Year-on-year, we saw microcontrollers grow 35% this quarter with the industry shipments actually down 10%. And so that is Cortex-M-based product, taking market share. If you look at it on just quarter-on-quarter basis, than microcontroller units, ARM-based microcontroller units, were down 20% compared with mobile devices down 10%. And the Cortex-A products are typically commanding a higher royalty rates and they're going into higher-priced chips. And so we saw the increase in average royalty per chip driven by the relative higher shipments of Cortex-A compared with Cortex-M. And that's what drove the average royalty up. But Cortex-M-based products, we expect, as you look sort of on a longer-term basis, I would say year-on-year, it is significant industry outperformance. We expect that to continue. At the end of 2011, our market share was approximately 10% in microcontrollers. We do see that continuing to grow over the years and Cortex-M is a serious driver. And as I mentioned in the introduction, Cortex-M0+ will help accelerate that by really opening up the opportunity to replace very small, very low power 8-bit microcontrollers.

Sandeep Deshpande - JP Morgan Chase & Co, Research Division

Just a follow-on, Warren. I mean you talked about 10% in the microcontroller market in 2011. I mean do you have any metric to help us understand -- I mean whether there are about 50 microcontroller companies that you've targeted to license your IP to and well, you've succeeded in licensing it out to 40 or anything like that?

D. Warren A. East

That's a good point, and there are hundreds of these, of course. A few years ago, we produced a slide in our earnings pack where we were looking at semiconductor companies producing microcontrollers, those of whom who had licensed Cortex-M and those of whom who were using ARM in their microcontrollers. We haven't updated that slide in this set. Perhaps we should, looking forward, maybe include some information on that over the coming weeks. But the opportunity is very large because some of these companies are shipping products based on an 8-bit processor, and it just into very niche applications. There are literally hundreds of them. We've sold well over 120 Cortex-M licenses so far, and we expect that to continue to grow.

Tim Score

Yes, and I think it's worth saying -- I mean -- this is Tim. The royalties that we earned from microcontroller today are earned from a relatively modest number of semiconductor partners, roundabout 10, 10 to 20. And as Warren said, in the last 3 or 4 years, we've signed just about 140 Cortex-M licenses to sort of over 100 companies. So you can see that the vast majority of those have not yet come to market with ARM-based products but are all planning to do so.

Operator

Your next question comes from the line of Gunnar Plagge from Citi.

Gunnar Plagge - Citigroup Inc, Research Division

Mobile unit growth in the first quarter seems to be down by about 4%. And I was just sort wondering whether you could give us a bit of as to what you expect next quarters and where we should probably end up for the full year?

D. Warren A. East

Well, obviously, as we look at our royalties that we're going to report next quarter, there's going to be a very strong correlation with industry shipments in Q1. And as we have a very, very high share in the mobile space, then ARMs shipments there will reflect the industry. And to that extent, when we look at the prospects for the mobile phone space overall, and in particular, smartphones, analysts are across the board, generally were looking at about a 35% increase in smartphones volume year-on-year. And that should be reflected in ARM's numbers. We are seeing trends for sort of integration of functions, combination of sort of WiFi and Bluetooth and that sort of thing, which will, when you look at it in volume terms, I mean the numbers deviate slightly from that, that I just outlined. But generally, our mobile shipments will be driven by that strong 35% growth in smartphones that people still expect this year.

Gunnar Plagge - Citigroup Inc, Research Division

Okay. And as a follow up, you launched the A15 hard macro for TSMC. And I remember, about 3 years ago, we talked about the Osprey. And with regard to that hard macro, you said once in a while, we do that but I don't see a substantial industry trend. Now on the back of substantial competitives pressures vis-à-vis Intel, I mean do you think there's an overall trend for maybe a diversification of System-on-Chip design and strategies away from RTL and more to maybe potentially hard macros?

D. Warren A. East

It's certainly a possibility, and we keep in very close touch with the trends and the desires of our semiconductor partners and those people who use foundries like TSMC. I think occasionally, you will see the hard macro, like we did, Osprey. But more exciting trend for us is the processor optimization packs, where we can optimize our physical IP and give people the flexibility of RTL-based design combined with the performance power characteristics and the server optimization characteristics that you get from designing for the transistor level. And that's what our processor optimization packs are all about. And Q1 this year, we saw a continued to demand for those. The reason that we launched the ones that I mentioned, the new ones, that's based on dialogue with our partners and their foundry partners. And so that's based on future demand that we can see.

Operator

Your next question comes from the line of Hans Francois Meunier form Morgan Stanley.

Francois Meunier - Morgan Stanley, Research Division

Just a quick question on the tax rate, maybe longer term. We've seen in the U.K. budget that there was a Patents Box and potentially, the tax rate could decrease significantly for ARM in the coming year. If you have a bit on that. The 2 other questions I have, first is on servers. You've seen -- you've signed a 64-bit license with ELITE partner. Could you confirm this is a relatively large customer? And do you feel more a bit about server following signing this license? My third question, if I may, is about the royalty rate you got. I know you don't disclose exactly this number, but was it up year-on-year to compare to Q1 2011?

Tim Score

Yes, I'll deal with the tracks. As you say, François, the Patent Box is moving towards its introduction. It's going to be introduced in April next year, 2013. And there will be, if you like, a transitional implementation, where a significant proportion of the benefit will be introduced in year 1 and then the remainder will introduced gradually over the next few years. Overall, I mean, obviously, the devil is in the detail of what constitutes a qualifying patent, et cetera. But certainly, by the time we're through the implementation period, you can expect a significant reduction in ARM's effective tax rate. I mean this year, this quarter, you've seen us looking at 25% normalized rate for this year, and the expectation would be, post the introduction of Patent Box, that the rate would be potentially sub-20.

Francois Meunier - Morgan Stanley, Research Division

Sub-20?

Tim Score

Yes.

Francois Meunier - Morgan Stanley, Research Division

Okay, very good.

Tim Score

The other thing to bear in mind, which is also not yet definitive but is likely to occur, is the reclassification of the R&D tax credits from the tax lines, who above the line is an offset against operating expenses. That is neutral to earnings. But when considering impact on tax rates, bear in mind that if it is introduced, and if it is introduced, that's expected to come in around the same time as Patent Box, then that would increase operating margins but also increase tax rates with neutral on earnings. So that's just also worth bearing in mind should that be introduced, I mean, in more detail to follow as and when.

D. Warren A. East

And your other questions, François. The question about the server opportunities. You have 2 licenses there, and we put in the earnings release, one is driving a new lead partner for Atlas and one is a Cortex-A15. I mean, obviously, these are high-end processors, they're high-value products from ARM and therefore, more likely to be sold to larger semiconductor companies with more resource to take on those sorts of very large-scale development. We're certainly very enthusiastic about them. But the -- as for the customers involved, then they will be sort of revealing themselves as and when they want to make announcements about their products, and we can't really comment any further on those customers now/. But we're quite pleased with those design wins, and I think it will be very helpful for ARM's activity in service. Your question about royalties. Typically, we don't really get involved much in talking about trends year-on-year on this particular parameter. As you know, it's a combination of upward pressure on the royalty rates caused by multi-core and higher value -- higher-value ARM processors, and there's a downward pressure caused by increasing success in the microcontroller space, which tend to be lower-priced chips. And the result is a combination of those 2 factors. As I said earlier, for this quarter, it happens to have resulted in an uptick in our royalties. We absolutely expect the upward pressure from more higher-value chips to continue. But we welcome market success in the microcontroller space as well. So that's why we don't really forecast what the number is going to be for the whole year.

Operator

Your next question comes from the line of Gareth Jenkins from UBS.

Gareth Jenkins - UBS Investment Bank, Research Division

It's Gareth Jenkins. Just a couple of follow-ons, one from François. Just I wondered if you could give a sense of whether die size increases have been a driver in the last couple of quarters. Obviously, you've seen some fairly sizable increases on the apps processing side. Secondly, I just wondered now we're a bit of a way into the year, whether you feel comfortable giving us more of a steer in terms of Mali units and the run rate at the end of this year that you're expecting. I think last year, you gave a very helpful steer on that. And then finally, Warren, just on big.LITTLE, what the development is in terms of licensing and progress with the big.LITTLE development.

D. Warren A. East

Okay. First of all, let's do -- let's do die size. Obviously, for processor royalty, it's really driven by chip prices and whether that happens to be a big chip or a little chip, it's the price that the chip is sold for, that really matters. And clearly, semiconductor companies are going to try to sell the chips that cost them a lot more at higher prices. And to that extent, big applications, processors with multiple processors, lots of memory, graphics processors and other hardware accelerated pushes the die size up, pushes that chip price up and with our percentage-based royalty, it's one of the contributors for driving up the price per chip. In terms of die size specifically and where it might make a difference to ARM, is probably in our physical IP royalties. And you'll note that we said 1/3 of our physical IP royalties are now derived from 45 nanometers and newer. And as that trend continues, we will see more of our physical IP royalties driven by apps processors. And to that extent, the -- we should see upward pressure from the increasing die sizes because the royalty in our physical IP business is on a per-wafer basis. So fewer chips per weight, that means more wafers and means more royalty. On Mali, we expect to see ourselves growing through this year. We said that last year was going to be a year of tens of millions of units in 2011. Indeed, it was. We're hoping that this year we'll be -- we'll be breaking the 100-barrier for the full year as a whole. So that's where we expect on Mali. And your third question, Gareth, was on big.LITTLE. We have 11 partners committed to going down the big.LITTLE route at the moment. We are in the phase where the first chips are, sort of, being manufactured at the moment, and so we're looking forward to silicon later in the year, and that will be the next milestone for the big.LITTLE story. So it's going pretty well. And as we have said before, we think big.LITTLE is going to be a serious step forward in terms of power efficiency for the ARMs story as a whole.

Operator

The next question comes from the line of Andrew Gardiner from Barclays.

Andrew M. Gardiner - Barclays Capital, Research Division

Firstly, I was interested if you could shed a little bit more light on Windows and ARM. I know the last time the questions came up after fourth quarter results. Microsoft hadn't given a whole lot of detail around the project. But now they're steadily giving more detail about the pending launch, how their viewing Windows on ARM or rather what they're calling Windows RT now. How are you seeing your semiconductor partners react to this or plan for the pending launch and in particular, on the software porting side of things, do you have anything you can share on that? Also, just a quick 2 follow-ups on the server side. Can you tell us, obviously, without naming the company, can you tell us whether they're existing or new customers? And then finally, on PIPD, when do you expect to see the POP royalty revenue to start in more significant volume?

D. Warren A. East

Okay. Let's look at Windows on ARM to start with. I mean this is a -- both an engineering program and a product launch. Microsoft are managing the product launch, and they are obviously a key player in the engineering program. But our semiconductor partners, who are involved, are also key players in the engineering program. As far as we can see, that program is on track and aligned with Microsoft's marketing launch. There isn't really any new news on Windows on ARM. Obviously, all the blogs which came out during Q1, the blogs which have emerged over recent weeks, are milestones on the journey towards both the engineering program getting to fruition and the marketing launch. I mean there is no other sensible thing that I can add to it. You'll need to talk to Microsoft if you want to talk any further detail about that. Software porting for the chips involved is part of the engineering program, and that is underway. And the OEM customers who are being supported are being supported. As far servers are concerned and the server announcements, then know they're existing partners, and the facts, there will be some individual product launches as and when those partners want to talk about them. We actually have already seen our first royalties for the POPs. We saw that in the fourth quarter of 2011. However, we would expect, given the trajectory of licensing in POPs over the last 18 months or so, we'd expect to see that gradually increase, and it's a component of our physical IP royalties. But bear in mind that the time-to-market here is similar to the time-to-market from when we license a microprocessor tool. And typically, to get into appreciable volume, we have said that's a 4-year exercise. So, although we've seen the leading edge of that, it's really a very minor contributor at the moment, and that should grow significantly over the next several years.

Operator

Your next question comes from the line of Simon Schafer from Goldman Sachs.

Simon F. Schafer - Goldman Sachs Group Inc., Research Division

Actually, Tim, I want to ask a question on OpEx growth. I think, historically, you've always sort of hinted towards the expectation, perhaps, that sales growth should be outpacing OpEx growth by a factor of 2 to 1 or something to that effect. This year, I think it sounds like, perhaps, your OpEx growth is significantly higher than that ratio. So I guess, post this year, which is still a big investment year in a couple of the peripheral technologies and so on and so forth, do you expect that OpEx growth to perhaps have a lower run rate than your revenue -- in comparison to your revenue growth opportunity?

Tim Score

Simon, yes, and I think there's no change to the overall messaging that we give here around the shape of the ARM business model and what it -- how we expected it to develop financially over time. The operating leverage is there. We expect, over time, royalties to grow faster than licensing. And we expect costs to grow more in line with licensing than with royalties. And therefore, you're going to get margin expansion. I think looking at it quarter-to-quarter and even year-to-year doesn't really give you the full picture. I mean, if you look at last year, obviously, revenue grew well ahead of costs. We'll see exactly how that develops this year. But yes, the basic position, there is no fundamental change to how we are seeing the development of operating expenses. There's no change in what we feel we need to do to achieve the growth. And therefore, the margin expansion that we've seen in the last 2 to 3 years, from 30% into the mid-40s, we continue to see the margin expanding. And as I said before, if you look forward 4, 5 years time, is the margin 50%, is it 55%, is it 60%, that will depend on what we're investing in, at the time, for future technology development and license revenue opportunity. And of course, it will also depend on precisely how our market penetration grows in target markets. But the basic message is no change to the relationship between OpEx development and revenue growth in this business.

Operator

Your next question comes from the line of Nick James from Numis.

Nick James - Numis Securities Ltd., Research Division

I just had a question, a follow-up on PIPD, in terms of licensing revenue. Obviously, there's a lot of kind of qualitive (sic) [qualitative] signs of momentum with the POPs and new nodes. But the licensing revenue seems to be kind of stuck around this kind of $11 million to $12 million a quarter. So are we expecting it to kind of grow from this level, at some point? And if so, when?

D. Warren A. East

Well, we do expect it to grow. It's going to grow modestly. Part of that growth is because of an increasing shift towards newer technology, leading-edge processors and that's other things. You'll notice I talked about a whole range of licensing done during the quarter ranging from 130 nanometers to 28 nanometers. A couple of quarters ago on a call like this though, we had been talking about a range from 250 nanometers to 28 nanometers, so the bias is shifting more towards the newer technologies. And those newer technologies takes more effort, they're higher value licenses, and so we'd expect to see that revenue come through. But because there is a lot of new technology in there, then a lot of the orders that we take for physical IP licensing actually go into the backlog, and license revenue that's actually recognized is -- takes longer for these -- for these newer technologies, simply because the development takes longer.

Operator

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

Janardan Menon - Liberum Capital Limited, Research Division

I was just wondering, Tim, maybe if you could give us a feel for how you expect licensing, especially BD (sic) [PD] licensing, to move over the next few quarters. You've guided down licensing again to around the $60 million level. One, would that be feeding off the backlog again or would you expect to replenish the backlog? And two, by around what quarter, based on your visibility right now, would you expect licensing revenues to start inflecting back up again on a growth trajectory?

Tim Score

Well, I think it's worth putting that question in context. I mean our long-term process to licensed growth, revenue growth guidance is mid- to high-single digits. And I think we've seen in the last 2 full years, 2010, 2011, growth well in excess of that 2011, bouncing out -- of 2010 bouncing out of the downturn, 2011 strong, both 30% -- plus years. And in Q1, as you've seen, growth of 27%, we're actually not guiding down license revenue. I mean we're actually maintaining consistent guidance of EUR 60 million, plus or minus. And in some quarters, it will be plus, as it has been in the last 2 quarters, and some, potentially, will be minus. But in terms of an order backlog, that is, although marginally down this quarter, still at record levels and more than 2x where it was 2 years ago. That's a very strong underpin for future license growth. And as I said, in the opening remarks, the opportunity pipeline is significant. So we do see continued strength in licensing. And if you look out over multiple periods, even off this much higher base that has been created over the last couple of years with significantly above-trend growth, we are pointing to licensed revenue growth continuing to grow in the sort of mid- to high-single digits as we go forward from this higher base. And that guidance remains unchanged. The quarterly fluctuations are -- obviously, there's still potentially some lumpiness there, which is why we say 60 million, plus or minus, rather than a more definitive number.

Janardan Menon - Liberum Capital Limited, Research Division

Okay, got it. And I was just a bit curious on a small comment in the press release saying that the average royalty revenue from mobile devices increased by 5%, while for home electronics, it increased by 15%. I was just wondering what are the dynamics in home electronics which is driving it up? Is it just a shift towards Cortex-A-plus processors, which is behind that strength?

D. Warren A. East

Well, the shift to Cortex-A processors applies to our growth in the home electronics, as well as in mobiles. I think a key difference is penetration there in Mali graphics, where in things like digital TVs, we have a very strong share in Mali graphics and that's certainly helpful. And the other thing to note, of course, is that mobile is much bigger than just the application processor fees and that comprises things like baseband modems, Bluetooths, WiFis, GPSs and all those sorts of things, other things, which go into mobile in a much bigger way than we're talking about with home electronics.

Operator

Your next question comes from the line of Paul Morland from Peel Hunt.

Paul Gilmer Morland - Peel Hunt LLP, Research Division

A couple of things. First of all, I just wanted to clarify that comment Tim made on tax. I thought the consensus for next year on the tax rate was about 25% to 26%. Are we now saying we should be using 20% based on the patent release?

Tim Score

When you say next year, you mean -- are you referring to 2013?

Paul Gilmer Morland - Peel Hunt LLP, Research Division

2013. Yes.

Tim Score

Yes, well, what I'm saying -- what I said was that my expectation for this year is around about 25% and what I'm saying is that when the Patent Box is introduced in April '13, there are going to be some transitional implementation rules. And as I said, the devil will be in the detail of about what precisely is a qualifying patent for this tax. But our expectation is that when it is fully implemented, the rate will be sub-20. Now between now and when it's fully implemented, the rate is going to be on a decreasing trend, partly because of the transitional implementation rules and partly, of course, because of the already-legislated reductions in the U.K. corporate tax rates. Now the exact line of the descending rate will be a detail, but it's going from 25 to sub-20 over the next 5 years.

Paul Gilmer Morland - Peel Hunt LLP, Research Division

So for the C-F models, et cetera, we should be using sort of 20% or below?

Tim Score

I think a gradual step down between now and 5 year's time with sub-20 in 5 year's time. Exactly how you step down from 25% to 20% will be tied up with other assumptions and the implementation detail.

Paul Gilmer Morland - Peel Hunt LLP, Research Division

Okay. The other question was just on the cash generation in the quarter, it was bit lower than I expected. Normalized cash generation GBP 58 million down on Q1. I had expected that to be a bit stronger based on the high debtors at the end of last year. And I just wondered what other factors where in there. Because I know debt has gone down, and it was reflected in much better DSOs at the end of this quarter compared to the end of December, but what else was in there that stopped the cash generation being better than that GBP 58 million?

Tim Score

Well, I think the problem is, Paul, when you looking at quarterly cash generation, it's a -- that's a pretty short period. I mean, GBP 58 million is one of the higher cash generation quarters we've had a history. It happens not to necessarily be the absolutely highest but there's nothing specific that I would want to point to. That's a higher-than-average quarter and consistent with where we'd expect it to go.

D. Warren A. East

And higher than last quarter as well.

Tim Score

And higher the last quarter, yes, for Q1.

Paul Gilmer Morland - Peel Hunt LLP, Research Division

Well, I know, but the last quarter was particular low because you signed those deals at the end of December, didn't you, where you didn't get the cash? So I thought with the cash coming in for those, that would help this quarter. But you say -- I mean there's nothing unexpected in there then, than that sign?

Tim Score

No, no. I think it's the detailed flows of receivables and payables and the timing of cash payments, and I think to look at it on a quarterly basis is probably slightly overanalyzing it. As I say, if you look at the trend line, the GBP 58 million is the highest quarter for a year. And yes, well in the range of what I would expect as a sort of an average quarterly cash flow, as the cash generation grows over time.

Operator

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

Johannes Schaller - Deutsche Bank AG, Research Division

I just really wanted to get a bit of detail on that JV announcement with Gemalto and G&D. If you could just generally share a bit of your expectations for this JV over the next years and also what it does potentially do to your ASPs per chip or kind of what the revenue opportunity is from those TrustZone and TEE add-ons to the chips? And also maybe how the revenue recognition exactly works, you said like an option that ships automatically, it can then be activated, I think, that's how I understand it at the moment.

D. Warren A. East

Right, well, you probably need to have a detailed discussion, a more detailed discussion with us about that than what we have time for on the call this morning. But I mean, the JV is a 3-way JV because when we looked at the software environment around our TrustZone, then both Gemalto and Giesecke & Devrient are sort of leaders in the secure operating system and the Trusted Execution Environment that sits around that. Both of them are working towards developing services, secure services that sits on top of that. And the situation was a little bit diverse because we have, sort of, people developing slightly different approaches to the same thing. And what we needed to do was come up with something -- we unified these approaches to enable both to thrive and to develop the business further. And in fact, when we did calls with journalists, on announcement of the JV, we were drawing an analogy to a few years ago when people were developing different approaches to high-definition video storage and a group of people got together and said, "The answer is Blu-ray." And at that point, that enabled Blu-ray to develop as a standard because it was a critical map around one thing, and that's what we're aiming to create with the joint venture. From a revenue opportunity, the main revenue will be for services provided on top, and the joint venture itself will be -- will be securing revenue as and when services are activated on top of the Trusted Execution Environment. There are a number of different approaches to business model, which have yet to be developed by the JV. And that's another reason why it's a JV because, again, we needed to create a single unified revenue model in this space. As far as expertise is concerned, all 3 companies have a different, slightly different pieces of the jigsaw puzzle, and we felt the best way of taking those contributions to market was to get together and form a single entity, which would develop their section of the market.

Johannes Schaller - Deutsche Bank AG, Research Division

That's very helpful. Just in terms of revenue split, I mean whenever there are any revenues occurring would that be split 40-30-30 for all the revenues occurring in that JV?

D. Warren A. East

Well, everything to do with the JV goes into the JV. And the JV owners have to account for the contributions from the JV as per their individual accounting standards.

Operator

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

Lee J. Simpson - Jefferies & Company, Inc., Research Division

Just want to ask another question on Mali, if I could. I wonder if you could categorize for us really what the Mali graphics growth profile would be if we exclude some Samsung, LSI or perhaps Mstar and Digital TVs. An adjunct to that really, how do we actually see ARM optimize their GPU to sit next to their CPU cores? I mean how does that manifest? If we look at this possibility, I can't see this change unless you overhaul the fabric and maybe make some changes in the memory interface. Is that the ideas at hand?

D. Warren A. East

Well, I mean certainly, there are commonalities or there are technical synergies to exploit in sort of having the processor and the graphics processor working together, which indeed, we intend to exploit in the product roadmap and we are exploiting in the product roadmap going forward. The companies to which you referred to, of course, our existing licensees, they've licensed stuff which is, essentially, designs that are historic from a point of view of realizing technical synergy. And actually, they don't realize a lot of technical synergy. So the technical synergy piece is something for those customers and others going forward. But those customers that you mentioned, they're, of course, significant players in target markets that chip volume, and that's what driving volume today and the volume growth that I referred to for 2012. I mean we sold 60-odd licenses, and so I mean there are other customers as well as the ones that you mentioned. And but certainly, those are in themselves, customers driving significant volume and representative of others driving volume in those types of target applications. And then there are some others that are slightly sort of smaller applications.

Lee J. Simpson - Jefferies & Company, Inc., Research Division

Okay. I mean maybe just a follow-up question, if I could. I mean if you look at the back half of the year, one of the main events happening, as far as we see, is the release of Jelly Bean. It looks like the first main line release on Android, that sees concurrent ARM and Intel readiness. I wonder if you could characterize for us what sort of impacts from this could there be for Cortex-A volumes in the back half and possibly in the 2013, just really given that potential Intel presence that we could see?

D. Warren A. East

Well, of course, the next release of Android is just one of the components that's driving the 35-or-so percent increase in smartphones expected this year. And to that extent, it's hard to single out one release of Android. And it's been well documented that Intel have intent to capture a share of the smartphone space. They have a couple of customers announced so far and obviously having day 1 support on a new Android release is very helpful for that. But I don't think it's, on its own, going to be something that we can quantify -- where we can quantify an impact on Intel's market share, which, in this time period, is, of course, likely to be pretty small any way.

Ian Thornton

I think we'll have time for one more question, please.

Operator

Okay. We do have one more question in the queue for you, sir. And that's the last question from Martin O'Sullivan from Cenkos.

Martin O'Sullivan - Cenkos Securities plc., Research Division

Just a follow-on on Mali, the 100 million target. I gather Digital TVs are a key porter for Mali, at the moment. But can you indicate approximately sort of mix shift you'd expect, during the remainder of the year as you move towards that 100 million target?

D. Warren A. East

Well, I mean, not.

Tim Score

I mean the vast majority of that 100 million would still be expected to come from smartphones because we're only expecting a relatively, probably, 200 million Digital TVs sold next year, probably only about a quarter of those to have any sort of 3D graphics acceleration at all. And although we do expect to have the large, majority share of those, of the 3D graphics, in things like digital TV. So, therefore, that still remains that the majority would be, of the Mali shipments, this year, would be in smartphones.

Operator

That was your final question, sir. Back to you.

D. Warren A. East

Good. Well, thank you very much everybody for joining the call. We will be back at the end of July with our half-year results, and we look forward to talking to you then and individually in the meantime.

Operator

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you all for participating, and you may not disconnect.

Tim Score

Thank you.

Operator

Thank you.

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