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

ARM Holdings (NASDAQ:ARMH)

Q2 2012 Earnings Call

July 25, 2012 4:30 am ET

Executives

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

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

Analysts

Didier Scemama - BofA Merrill Lynch, Research Division

Kai Korschelt - Deutsche Bank AG, Research Division

Andrew Dunn - RBC Capital Markets, LLC, Research Division

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

Janardan Menon - Liberum Capital Limited, Research Division

Julian Robert James Yates - Investec Securities (UK), Research Division

Sumant Wahi - Redburn Partners LLP, Research Division

D. Warren A. East

Good morning, everybody. Olympic week, so it's a fairly select bunch, so thank you all very much for coming along, braving the London transport conditions. They were fine at 6:00 this morning, by the way. So as usual, I will step-through business update, and Tim will follow-up with some detail on the numbers. It's been a really good quarter. Not one that I would say, "Here's the standout one thing that we talk about." But actually if you look right across our business, whether you cut it up by applications sector, whether you cut it out by product sector, then it's been an excellent quarter with a -- with some good news.

But if we were to highlight some things at all, then on our highlights slides, it has been a continuation of big semiconductor companies continuing to invest in our technology, not just sort of Tier 2 types semiconductors, we've had some very serious semiconductor companies, who you'd call market leaders, who have incumbent architectures that they've been with for many years, adapting ARM in their next generation of their products, which is very good. We've signed another v8 architecture license, and that is -- that particular one will be announced in due course, as and when they want to announce it. But what we can say, is that it's in networking applications. And if there is a little bit of a theme, particularly behind my excitement in these results, then it is the fact that we're starting to see quite a lot more ARM activity in the networking space, and more on that as we go.

If you look at it from a volume shipments and a royalty point of view, again, we'll come onto some detail on that. But across all our target markets, we are continuing to outperform the industry at large, and I'll come back to the numbers on that. Just earlier this week, we had an announcement with TSMC about pushing forward on semiconductor process technology and involvement there in terms of optimizing our physical IP, optimizing their semiconductor process, and working with our leading edge 64 -- new 64-bit product, so a bit more on that later as well. But net-net, a very good quarter, which helped us generate increases, significant increases in levels of profitability. We're maintaining our dividend going forward. So that's the sort of summary picture.

Now if we sort of cut up and start looking at the business. And we look at the business to start with, from the outside in. So look at it by market sector to start with. Obviously, mobile and computing remains very, very important for ARM, and it's nice to see a flagship mobile product like the Galaxy SIII, which was launched during the quarter, containing so much ARM technology. In the ARM's processor, we've got ARM microprocessors, we've got ARM graphics, we've got ARM physical IP. And I've played with one of these products for the first time, only yesterday, actually, and it really does perform and it's an outstanding performer. So I can see why everybody is very excited about the Galaxy SIII, and for us of course having all that ARM technology is good. And by the way, it's also ARM in the touch screen, so that's encouraging to see, our processors getting into those more sophisticated touchscreens.

One thing we are seeing is the value coming through in mobile, generally, the increasing number of smartphones, and within the smartphones themselves, an increasing number of Cortex-A products. And you can see a little histogram halfway down the slide, the top bar there is the ARM11. So ARM11 is still accounting for 40%, roughly, of the apps processors. And the Cortex-A is accounting for, roughly, 60% of the apps processors. But within that Cortex-A, you can see dual-core Cortex-A increasing significantly if you compare the situation with a year ago. And that's good news from a value point of view for ARM as royalty, because typically these chips are more expensive. So single-core moving to dual-core and quad-core is a good trend for us. And note also, the underlying growth in sheer volume of our apps processors in smartphones. Don't forget, with all this gloom and doom around, smartphones continues to be an area of significant growth for the business, and we're looking forward to 30% thereabout growth in smartphones year-on-year so -- for the year as a whole.

A computer is really like a smartphone in a different form factor. And obviously, the big news in 2012, in the computing front for ARM will be the arrival of the Windows operating system on ARM, and this quarter saw the Computex show, we had an excellent Computex show. The ARM partners who are engaged in the Windows launch were showing of their products. They went down very well and we're looking forward to that launch, which is going to happen in the third -- fourth quarter rather, of this year. So that's yet to come but we've seen the products and they're looking good.

Just while we're on PCs, of course, it was a quarter in which AMD made an interesting announcement about adopting ARM technology for use in their computer chips. And this is an example of how ARM is actually sitting alongside an x86. So it isn't always a question of either/or, this is ARM adding significant value to AMD's x86 product line as security becomes more of an issue in these products.

Moving on to -- down the chain now, these smartphones, computers and everything, they have -- they communicate and that communication means that they're getting data from somewhere or they're sending data somewhere. They're sending over some data handling infrastructure. And the explosion in smartphones and more mobile computing and prevalence of the Internet is generating much more data. Some study suggests as much as 20x as much data over the sort of 10-year period from 2010 to 2020. And clearly, if that data is handled with the existing architecture, it's going to consume 20x as much power, which is not a very sustainable situation. If you look at all the electricity generated in the world, then IT equipment accounts for about 10% of it, and if that is going to increase by a factor of 20, then we'll going to have to build a lot more power stations. So that isn't going to happen. People are going to look for more power efficient ways of designing this stuff, and here is the opportunity for ARM in networking. And so you see, as I mentioned a moment ago, a new v8 architecture licensee engaged in ARM in networking.

Freescale, I wasn't there, Freescale technology forum a few weeks ago. Freescale busy announcing their extensive networking product range, switching to adopt the ARM architecture. We've seen similar indications from HiSilicon, LSI, TI, Xilinx and so on. Everybody is realizing that in order to get more power efficient products here, then ARM is a great solution. And it's the same power efficiency story, which is behind ARM's activity in servers. We talked about servers before, a great stunning news this quarter from ARM in servers, but just continuation of the 6-year journey that we're on that we're now getting towards the end of the 6-year journey from 2008 to when you can actually go out and buy commercially sensible ARM-based service. And it's actually been a good quarter in terms of data points on the way. So Calxeda, and we have a demonstration of some of the Calxeda equipment at our Analyst Day here earlier in the quarter, and you can see an example there in the histogram on the right of the slide, showing the energy saving for similar performance produced by an ARM-based Calxeda product.

It's not Calxeda alone, you saw Dell announcing products based on Marvell. And the hardware alone is of course not sufficient with one of the reasons why it's an 8-year journey is that the software ecosystem existing in the server world needs to become ARM-flavored. And so we've also had some announcements this quarter about that software ecosystem inching its way towards the ARM world as well. So with Canonical's announcement, that was very encouraging, continued proof points then of ARM in servers.

And next sort of high-volume wave that comes along after the wave of networking is going to be the Internet of Things. And we've talked about the Internet of Things, obviously, it's not our catchphrase. But certainly, ARM technology is sitting behind a lot of the products that comprise the Internet of Things. And we've seen a continuation of our Cortex-M series licensing. Now -- we've now over 100 companies using that product. Collectively, if you look at the line cards from the ARM partners, there are over 1,400 different ARM microcontroller products that you can go out and buy from ARM partners today. And that's going to be a much bigger number by the time we're all of that licensing that we've been doing gets into Silicon production.

Earlier this year, we launched the Cortex-M0 product, I think probably stood here, I've stood here in February, and said we've got a new product coming down. It's going through a -- one of them is going to be a small one and we're going to launch later in the quarter. We did -- that became the Cortex-M0 (sic) [Cortex-M0+] which is the most energy-efficient processor for microcontrollers that is out there. And again, at the Freescale technology forum, we saw an excellent demonstration of that power efficiency, where they literally had an ARM-powered charger, crank it up with a crank handle, charged a few capacitors up in the range of different microcontrollers and of course, the Cortex-M0 based 1 went on -- or M0+ went on and on and on. So that's a great product.

As far as the range of opportunities is concerned, it's huge, and we're starting to get design ins and as we start to get design ins, so more and more semiconductor companies are jumping onto the ARM-based microcontroller party. And they're making these decisions in order to position themselves for the Internet of Things way.

In terms of volume shipments, at the moment then we saw another great quarter, where if we look year-on-year on microcontroller shipments up about 20% compared with industry shipments, up about 8%.

Now looking ahead to a more leading edge technologies, as I said, we had an announcement earlier this week with TSMC, and this is ARM and the biggest independent semiconductor wafer fab or foundry company in the world getting together to actually continue work that's been ongoing together for quite a long time, in terms of optimizing their process technology, working with physical IP division to optimize our physical IP on their new FinFET process, and using our new 64-bit processor as a vehicle for that development. So it's world leading companies getting together to work from transistors right through its microprocessors to enable our joint partners to produce world leading products.

Now we'll look at the business and so I'll cut it the other way rather than by end products outside in. Let's look inside-out and let's look at processor licensing to start with. Solid quarter, up 15% and importantly, coming out of the quarter, our backlog, up again and now back at record levels, and I think we've got some data on that a bit later on.

We now have nearly 900 licenses, and so that continues to grow. The pool of licenses that are out there to generate royalties for the future. If I look at just quarter on its own, 23 licenses in total, collection of Cortex-A licenses, including our 12 big.LITTLE licensee. So we've now got 12 partners signed up for big.LITTLE. At the other end of this scale, the microcontroller end, I was just talking about the Internet of Things, yes, more licensing of our Cortex-M products. And our new architecture, the v8 architecture, the 64-bit stuff, we've now got 9 v8 licensees, including the latest architecture licensee. And we've got this rather, it's with -- rather ill-defined horizontal axis of time going along the slide here. We are at the stage where we've done a lot of lead licensing now. We are approaching the first Silicon, the product launch type phase and so the 64-bit program is on track. And the interesting thing about our 64-bit architecture, it is not just about high-end computing and servers, it's actually people talking about using it and the mobile as well, talking about using it in infrastructure applications, some of the networking applications that I talked about a moment or 2 ago.

Licensing is, of course, essential to drive royalties going forward and here's an update of the chart that we've shown several times. You can see the licensing on the bottom left of the slide, a continuation of growing our base of licenses, nearly 900 licenses out there. Interesting thing to note is, that if we look at the chart on the right-hand side, and the bullet halfway down the slide, only 5% of ARM's royalty in the last quarter came from the 350 licenses sold in the last few years. So 95% of ARM's current royalty is coming from legacy licensing. All that new licensing is royalty yet to be delivered. So that's a good picture for the future.

Now a look at royalties, actually, on how they sort of panned out during the year. Well, story here is consistent gain in market share from a volume point of view, up nearly 10% against an industry which is down, actually. So that's a continuation of the gaining market share story. If I translate that into value, however, value up 14% versus industry value, down 7%, it's a wider gap. And one of the things that's driving that increase in value is the increasing activity in the Cortex-A land, where increased adoption of Cortex-A in smartphones is helping us. But if you look at the waterfall chart, then you can see, yes, penetration in microcontrollers. We've always said, these are lower end, lower-price to devices and significant growth in microcontrollers, you can see is putting some downward pressure on the average amount that we earn per chip. And similarly, in the mobile world, some of the Bluetooth, some of the Wi-Fi-baseband modems, these sorts of things are having a similar sort of effect there. They're similar lower-priced chips.

If we look at the higher-priced chips, the networking, it's a small contributor at the moment. Hopefully, with all that licensing it's going to be a more significant contributor going forward. If we look at the Cortex-A, it's in consumer products and if we look at the Cortex-A in mobile apps, you can see a significant upward pressure there on the royalty, the ARM is earning per chip. So put all that together and that's why you get a 14% increase in value versus a 7% decline for the market when we look at ARM's royalty revenues.

Let's -- I should just highlight, we've got on the slide, of course, millions now of Mali devices as well, are going into those Cortex-A-based chips. And as far as Mali is concerned, then we are very much on track for the 100 million-plus units that we expect to deliver this year. If I look at physical IP, the story here is our physical IP is being used right across the different sectors that ARM's processors are used in. We're continuing with the processor optimization package activity. It was a record quarter for POPs. The best quarter we've had. So total of over 32 POPs sold now, still about a 50% attach rate with Cortex-A licensees, so that's good in terms of generating royalty for the future. And also good in terms of generating royalty for the future is that this quarter, we had 4 new fabless semiconductor companies adopting ARM physical IP for their 28nm designs and beyond. So that is good for royalty growth going forward.

If we look at, to sort of summarize, really, ARM is still getting design into a range of new products. And the exciting thing about this is, that when we look at the pictures, they're not all phones and tablets. We are seeing design ins in the automotive space, in the networking space, the infrastructures, the base stations and so on. We are seeing new designs in the embedded world, driving the Internet of Things. But of course, on top of that, if you look at the top of the slide, we're seeing ARM getting designed into a great range of new exciting products in the mobile and computing space, in that world of internet-connected screens.

So right across the different market sectors, we're getting more design ins, growing market share. We have strong licensing activity, sat behind that, which is building a continuation of this picture for the future. That's all generating enough revenue and profit for us to continue to invest in our roadmap back in ARM. So we've grown our headcount by 6% since the start of the year, and we are going to continue to grow our headcount into the back part of the year, so that we can actually put the resource behind the ARM activity where we're forming ever-richer partnerships with leading edge technology players, to develop more leading edge technology for the future. And with that, I will hand over to Tim, who will put some color on the numbers. Thank you.

Tim Score

Thanks, Warren. Good morning, everyone. Good news is we've only got 4 slides. Warren, I think, has given a pretty good overview coverage of the numbers in high-level than you see them in the details. So what I'll do is focus, as he says, a little bit of color and a couple of comments about the sort of forward-looking as we think about our models in the second half of the year, for the full year.

So licensing, $67 million. You will recall -- I mean, when we stood up Q3 '11 last year and we'd just done a sort of a $58 million and a $59 million, and we were sort of well up on the run rate before that, I gave guidance that said, looking out now it looks like a sort of $60 million plus or minus, a higher-level, but still potentially lumpy around the base. And since then, we've done a $67 million, a $65 million and a $67 million. So I think if I stand up here and say, $60 million-plus or minus, you're probably going to yawn ever so slightly. So what I'm going to say today is that I think, looking at the level of the backlog and looking at the pipeline, I think to move that base up a little, to think sort of $65 million, plus or minus as we look forward, I think it's the right way to think about it. And the reason I'm saying that is not just because the opportunity pipeline for the second half specifically, is as we say, they're healthy, and the order backlog at the end of June is, as Warren says, at a record level, having gone up sort of small single-digits in Q2 after a very slight fall in Q1. It's also about the picture on the bottom right, which shows the relationship between how license revenue has developed since the first half of 2007, and how the backlog has developed since the first half 2007. And that's PD licensing and PIPD licensing combined. And in a nutshell, what that's telling you is, in H1 2012, licensing is just under 1.5x higher indexed than it was H1 '07, whereas the backlog is broadly 3.5x higher. And obviously, what happens over time, and now on backlog, remember, is a contractual value of licensees signed. It's not some discretionary list of things that people may or may not choose to do in time. This is contract value, so this gets into license revenue in due course. And so what I'm telling you that gap there is obviously going to feed its way into license revenue over time.

So looking out now quite a long way, the underpin of future license revenue is very encouraging. And specifically, we do say in the release that prospects with backlog in the second half are promising, which is the language we've used before, suggesting that we think probably we exit the year with the backlog higher than it currently is. I mean, clearly, that's not guaranteed. This licensing is lumpy but that would be our expectation. So bottom line is, outlook for licensing is pretty healthy from here.

Looking at the royalty, Warren sort of touched on most of the numbers. I mean, clearly, it's another period of outperformance, plus 14% versus minus 7% in value terms, plus 9% versus minus 4% in unit terms, against the comparable periods, and gains in all markets, and increasing average royalty per chip. I mean, quite encouraging really, that the 4.8 average royalty per chip this quarter is at the same level as last quarter. Because last quarter, microcontroller growth was relatively muted compared to previous quarters, whereas this quarter, microcontroller growth is back strong again and yet the overall average has stayed up, notwithstanding that suppressing influence. So I think that's pretty encouraging.

As Warren says, we continue to invest. We're hiring people, both in the R&D capability, notably in our processor division and in our graphics division. We're also, obviously, scaling the sort of commercial and infrastructure party organization to support the growth, as those investment going on there.

I mean, OpEx overall, you've seen this morning, GBP 66 million against concensus, GBP 68 million and there's a reference in there to the mark-to-market FX impact, which every quarter, or in most quarters unless you have significant volatility, is in the sort of plus or minus GBP 2 million. This quarter because the dollar strengthened when we marking to market sort of contracts in the balance sheet that's sort of small credits. So basically underlying, in line with consensus and our guidance for next quarter, broadly similar exchange rates, GBP 68 million to GBP 70 million, again in line with GBP 69 million for Q3 and full year consensus for OpEx around the GBP 272 million, GBP 273 million mark looks to -- that will still be a good, best estimate, I think.

So notwithstanding this investment in our R&D capability and the growth of the company, margins, about 4 percentage points ahead of consensus and a couple of percentage points ahead of where we were this time last year, earnings up 20% in the quarter, 22% in the half, and interim dividend increased by 20%, consistent with where it's been for the last couple of years since we came of the downturn when we're -- reminder we increased it by 10% through the downturn when the world was falling off a cliff.

So outlook summary, putting a sort of bit of color behind our guidance. We're in good shape. We are entering the second half, I would say, with a record backlog, healthy pipeline, licensing looks robust. Underpinning this of course, is the dynamics that Warren was talking about in terms of more companies using more ARM technology in more markets as a long-term trend.

From a macro standpoint, we're all living in the real world. We're reading about the uncertainties that surround us. The industry in Q2 was up mid single-digit, 5% or 6%. That's obviously the context of our Q3 royalty. So you would expect to see a sequential increase in ARM's Q3 royalty. If you look back over the last 5 years at ARM's Q4 royalty, you would have seen numbers between a $10 million and a $16 million uptick on a quarterly basis, reflecting normal seasonality and ARM's growing faster than market. It looks from here as though we're going to see something overall, less than normal seasonality. I mean, a number of the semiconductor companies who have guided their Q3 to date, are guiding subseasonally, Core, Chromes, TIs, STs, these sort of people. Others are in a slightly different place. So as ever, it's a mixed picture. But I think as we look out over the second half and we look at the $875 million full-year revenue consensus coming into these results, we think -- with that uncertainty about the seasonality effect of Q4, we think that's a reasonable place to be thinking about ARM's revenue in the full year. I think if there is a risk in the Q4 royalty, we think it will be offset by licensing. So $875 million seems about the right full year number, which is why our conclusion is, we expect to be in line with market expectations.

So summary. Strong licensing, lots of design activity, ARM in an early stage of penetrating a lot of new markets, which is very encouraging. Expect to continue to outperform the industry. We're still investing, but we are increasing profitability and generating strong cash as we do that. So it's a good picture, a quick ad there at the bottom. Many of you would have gone to our Tech Con in the Valley last year. We're running a similar program this year. It's an industry event but there's an investor activity in there on the 31st of October. Our partners are involved so it's quite interesting to get their perspective of how ARM is helping them and how they work with ARM, focus on advance manufacturing mobile computing, networking, which Warren talked about, and securities. So anyone interested in going down to that, contact Jonathan. And with that, will move further into questions. Thank you. Didier first hand, first up. That's a long way from the mic.

Question-and-Answer Session

Didier Scemama - BofA Merrill Lynch, Research Division

It's Didier Scemama from Merrill Lynch. First question, just wanted to have your views on the ASML Intel transaction. What are your thoughts as to what ARM needs to do, can do in response to that and, in particular, I'm just wondering whether the ARM partners have talked to you about it and whether they would consider a similar transaction with ARM? A little bit of color.

D. Warren A. East

Yes. Well, I'll sort of take off. And it's not something we've spent a huge amount of time discussing and cogitating on in ARM, to be honest. We know that the world of equipment supply is small, the number of customers is small, and in order to move to 450mm wafers, then a significant investment is required. ASML have a business model where they get money from their customers, the products that they sell. And running that business model they reckoned that they were unprepared to invest in 450nm development. And Intel wanted them to invest in 450nm development and ASML presumed, we said, "Well if you want us to do it, you have to fund it." And that's how I would imagine it. Well we have a similar business model where we get money from our partners for selling ARM licenses, and they'd love us to do many more products. But we have to balance the books, and so we say, "No, and if you want us to invest some more, then you have to pay some more." And we generally manage to get into pay for the extra value of sort of higher-value products which involve more investing investment from ARM. So all the 64-bit products, for instance, we are selling these licenses at a higher level, and we have not had a reason to turn to our partners and say you need a different kind of commercial arrangement i.e. an investment in ARM to fund that sort of development. They invest in ARM through writing us purchase orders and they agree to pay us higher levels of money for a higher value license.

Didier Scemama - BofA Merrill Lynch, Research Division

So I think that you were just saying is that licensing could be sort of brought forward as a result of this transaction, as a retaliation from the ARM partners, something like...

D. Warren A. East

Well I don't anticipate a big sort of retaliation. I don't think it is about retaliation. It's about people wanting to build 450mm wafers instead of 300mm wafers. And whether Intel and ASML decide they need some different kind of commercial structure to make that happen is up to Intel and the ASML. As I say, you asked, did we have discussions with our partners about something similar, and no, we do it through the standard business model. And the standard business model in our case seems to work because people are prepared to pay more money for products that cost us more to develop, because we're able to show that those products deliver more value.

Tim Score

ASML are in business of supplying to the whole industry, and that's not going to change. The fact that their customers, Intel and/or others in the future, might be funding certain pieces of it isn't -- doesn't mean that, that technology is not really available to all, which in a way is the key thing from ARM's perspective and from the ARM partnership perspective.

Didier Scemama - BofA Merrill Lynch, Research Division

And then -- I mean, the counterargument to aggressive CapEx and process technology is CPU innovation, as you mentioned in the past. So I'm just wondering what you can say about the progress of big.LITTLE, you've announced to new customer also for the ARM v8. What sort of feedback you get from not just the semiconductor companies, but also the OEMs and the broader ecosystem about big.LITTLE, whether they think that's enough to sort of keep Intel at bay when it comes to power consumption.

D. Warren A. East

Well, a couple of things. I don't think it's all about keeping Intel at bay when it comes to power consumption. There is an underlying demand for making microprocessors more efficient. If we look over the next decade, then that's about a 30-fold increase in the amount of processing power that people expect to find in things like phones and tablets, and those sorts of things. And there's about a 2x improvement in battery capacity. So it's a massive gap to close by intelligent design of the products. You can't just rely on the batteries to get better. And that applies whether it's ARM, whether it's Intel, whatever. And that, I think, is driving our -- that's sort of motivating us to create microprocessors which are ever more efficient. big.LITTLE achieves -- we have yet to see the Silicon, but we anticipate that we can achieve multiples in terms of efficiency, rather than 10% improvement here, 20% improvement there. big.LITTLE, we expect to see about a 5-fold improvement in efficiency when you look at the whole system. And so our partners are buying into that. Their customers are buying into that because they want to close this massive gap that needs to be closed in terms of performance of the thing and amount of energy and get out of the battery.

Didier Scemama - BofA Merrill Lynch, Research Division

Final one, just maybe a quick one housekeeping question for Tim. If I remember correctly reading the press release, I just read about I think GBP 18 million for data center in Cambridge? Why do we need to build the data center? Is that what's behind it?

Tim Score

The data -- I mean, if you think about what the ARM R&D people actually do, is they're designing products using machines, and they need computing capacity. And the more engineers we have and the more complex the things they're designing, the more capacity you need. So yes, what this is, is a -- every so often you're going to get a step change in your sort of production requirements and that's what we're doing. In due course, over the next 3 or 4 years, there may be another data center built somewhere else in the world. So it looks like it's a fairly significant step-up, but it's kind of an investment for the next 10 years. So it's not something you're going to see keep repeating.

Unknown Analyst

Let's move along in the front row here. Warren will be out to the side. There you go.

Unknown Analyst

I'll try to be shorter. So on the FinFETs with TSMC, can you give us, maybe a bit more comments about this? How do you think it compares with Intel 3D, or whatever they call it? And how involved your PIPD team is involved trying [ph] to transistors characteristics, absorbs transistors? And also, I think the timing has been brought forward by 1 year, I think. So that's the first question. The second question is, you've been talking about 64-bits sort of v8 architecture taping out relatively soon. Maybe you could -- if you could give us a bit more details on what type of products would come on the market in the next 12 months for these 64-bit, if it's only servers and other things.

D. Warren A. East

Dealing with the FinFETs first. A year or so ago, when Intel took technology, we said yes. So this is something which has been around in the semiconductor industry for the last decade or more. It's one of the ways of making transistors more efficient, but it comes with a load of associated challenges that are actually making this stuff and making them yield and that sort holds back the semiconductor industry from taking that step. Intel took the step and announced that they've taken the step. They were the first ones over the gate, announcing that they were doing this. Of course, everybody else has been the same, researching it and playing with it for the best part of the last decade. And TSMC had their plans in place. They just were not choosing to go public on FinFET until they were choosing to go public. And we've been working with TSMC on their next-generation processes for some time. We always stood here and done presentations and talked about tape outs on 20nm, the first ARM tape out on 20nm was well over a year ago. We've taped out first 40nm designs already with some of these players and its R&D activity. As and when the foundry wants to make some of these things public, then they will, and that's what TSMC have chosen to do this week. And they chose to, I guess, communicate particularly with their customers who are ARM partners by saying, "Not only are we doing some process development in the back room, but we're also thinking about how you're going to take this technology to market, the sort of products you're going to built with it. You're probably going to build ARM-based products with it, and so we've been working with ARM and ARM's physical IP division to make sure that their physical IP, their microprocessors and our semiconductor process technology, works well together. And that's all there is to it." On the second question, about 64-bits, then as I said in the presentation, it's being used across a range of different applications, including mobile and computing. Servers is a very visible application area, where as we've said before, our penetration in the server market is limited until such time as we deploy 64-bit solutions. And I think it's well known that one of our early 64-bit architecture licensees is targeting server applications and so probably, you'll see that Silicon fairly early on. If we move along and move back.

Unknown Analyst

I guess, first is just a related question, I think, Calxeda provided some interesting milestones this quarter in terms of the server progress. I'm just wondering, whether you can talk to how you feel the progress is going there in terms of actual sort of processing. Secondly, I just wondered whether -- part of interesting slide just on the multi-core effect in the quarter, I just wondered, whether you have a sense of how much of your units shipped in mobile today is actually on quad-core based devices, versus dual-core, so the impact of quad-core presumably is still to come. And just secondly some housekeeping, maybe a couple for Tim. Sorry, for Tim, just in terms of the cash, it's creeping up, it's been creeping up for several years, and I know the historic argument that as percentage of your market cap, maybe it's not quite as high as some of the technology peers, but your business model is quite different. What's the intention for the cash part going forward?

D. Warren A. East

Okay. On Calxeda and the server activity, I really don't have anything else to say. We're very pleased with the progress. The data that's coming out suggests that all the experiments that we did before and all the simulation that we did before is being proven in Silicon. And bear in mind, this first Calxeda Silicon is actually Cortex-A9 based. And so I think I said Cortex-A9 was a core we developed very much with mobile in mind. Calxeda have added System-on-Chip infrastructure to turn into a server chip but it's still a microprocessor core that was designed for mobile. When you put that server infrastructure around the microprocessor core that's been a bit more designed with server applications in mind, like for instance, Cortex-A15, or moving onto v8, then you're going to see even better performance at these levels of power consumption. But we're very pleased with the data that's come out so far. We're also pleased to see other ARM Silicon partners starting to get a bit more public with their activity on the servers. The dual-core, quad-core, I don't know that I can talk specifically about numbers, but I'll just point you to shows like Mobile World Congress and CES, where what tends to happen is that you sort of have an announcement about products 1 year, and they turn into reality the next year. And we saw in the 2011 season, a load of dual-core devices being announced and they've now sort of materialized into phones. And it was about a year later at these shows that we saw the quad-core products announced and so we'd expect that sort of trajectory to continue. Over and above that, some people have gone a little bit further ahead with the quad-core and they're using it as a sort of marketing tool and saying that the quad is better than dual. It's a bit of a marketing thing. And it's up to us semiconductor partners to see what performance they can actually -- for what performance for a given level of power consumption they can actually achieve. We put it up on the slide as multi-core, and put the 2 together, because that's really how we view it.

Tim Score

Yes. I mean, on cash, I mean, nothing particularly new to say about that today. I mean, you're right. We managed cash down before the downturn to around GBP 50 million by the end of '07, and we bought back 16% of the stock in the period leading out to that, and into a little into '08 at about GBP 1.20. We have let the cash ride up through the downturn, and since we've come out of the downturn, we've now just under GBP 500 million, which as you say is sort of 7% or 8% of our market cap, although that is, in a sense, quite an academic point. But it doesn't -- it means -- I mean, certainly, if you benchmark the sector, it doesn't look an unsightly amount. But I mean, the bigger point is what are you doing with your cash, and why do you need it, and where is it going? I mean, the plan of record remains as the base case, a progressive dividend with a gradually growing payout ratio. Now at the moment, I mean, you look at half 1, I do interim dividend, it's up 20%, broadly the same as our earnings. And I think in a period of fairly considerable macro uncertainty, I think growing a dividend 20% in line with your earnings is not an unreasonable place to be especially at the interim. This is something that's being -- the trajectory of how this payout ratio increases is sort of constantly reviewed by the board. But at the moment, we are comfortable with the level. It may well be when we look out, that an increasing payout ratio depending on the trajectory is insufficient to stop the cash power from growing beyond the level that we feel comfortable we will need, and in which case, we could do other things. We could step up dividend, we could return buy special. There are other things that we consider. But the plan of record at the moment remains the gradual increase in payout ratio from here, i.e. dividend growing faster than earnings over time.

D. Warren A. East

I think if you could just sort of move it back in along over there.

Kai Korschelt - Deutsche Bank AG, Research Division

It's Kai Korschelt, with Deutsche. A couple of questions I had. The first one was just on the attach rates for GPU, or for Mali for that matter, and set-top box and Digital TV market, where do you think, say, at around this time, where we are in terms of percent, in terms of overall volumes and where do you think that goes maybe on a 5-year view? That would my first question be. The second one is, it looks like, particularly in the low-end of the smartphone market, there are sort of increasingly platform solutions, which rather than using an apps processor and GPU, use a beefed-up GPU as basically the only -- to drive the only processing function. I think Broadcom has one of these platforms out there. So I'm just wondering how, or whether you see a risk that may be particularly in the low end of the market, call them beefed-up GPUs, take over more of the historical or traditional application processor functions? The third one was, just on a like-for-like perspective, if you could remind us maybe of the potential royalty premium for a 64-bit versus 32-bit, please?

D. Warren A. East

Okay. On the Mali attached in Digital TVs, we expect to be in 70%-ish of the Digital TVs that we have processors in to have Mali. We expect to retain our #1 slot in TVs this year. Exactly where we are at the moment, I'm afraid I can't tell you. If you look at in -- do we have sort of a midyear view?

Unknown Executive

We can't say [indiscernible] we expect in 2012.

D. Warren A. East

Yes. So we don't really have an update on the full year view at the midyear on that, I'm afraid. As I've said in the presentation, we're very happy with the Mali shipments that our partners are reporting in the latest sort of quarter just gone. We think we're on track for the 100 million units-plus, and obviously, Digital TVs are part of that. On the low-end smartphones in the GPUs, that's an interesting question. I think people will -- you will see people experiment with this concept of GPUs being used for computing functions. I personally, I'm not seeing it as a serious threat to our applications business at the moment, our applications processor business in mobile phones. Probably, even less so in the low-end phones, where you want to produce something really cost-effectively. And we have Cortex-A, products like Cortex-A5, like Cortex-A7, which are really designed -- I mean, Cortex-A7 is a big.LITTLE, it's the little half of the big.LITTLE combo, but it can also be used on its own, and on its own it's the most efficient apps processor yet. And in terms of delivering into that low-end smartphone space, I'd say it's a lot less effort to use a Cortex-A7, efficient processor on its own, and coming with all the software ecosystem that already exists around the Cortex-A series product. That said, if the world does at some stage turn to GPU, then if we look at our Mali graphics family, then we do have 2 parts to our family: We have the pure graphics and we have the GPU series, as well. And so to an extent, we're sort of hedging our bets, but I don't think, see it as a serious threat. On 64-bit premium for -- or sort of royalty premium for 64-bit, I mean this is a continuation of the trend we've been on for a while, where, basically, if there's more value in the microprocessor, they royalty comes through with a higher rate. And we've talked about Cortex-A being sort of typically in the sort of 1.5% to 2% range, compared with preCortex-A being more in the sort of 1% to 1.5% range. And that trend will continue with our v8 architecture, so it's going to be at the higher-end of that range. Yes, I think we got one here. But yes, let's go in here first. And then we're coming over next one, son.

Andrew Dunn - RBC Capital Markets, LLC, Research Division

Just very quick. I'm Andrew Dunn from RBC. Just following up on royalties. Your Slide #5 on smartphone application processor times and multi-core, et cetera, could you just remind us on either the absolute or relative royalty rate you might get for each of those segments? So, multi-core, single-core, and ARM11, just a relative royalty rates for each of them.

D. Warren A. East

Yes. Well, typically, ARM11 is at the -- in the sort of 1% and 1.5%, and typically Cortex-A as I say, is in the sort of 1.5% to 2%. Cortex-A9 processors are less than Cortex-A15, so there will be more at the sort of 1.5% of that top range. And that's the percentage. You can multiply that by the chip price. And if it's a dual-core chip or a quad-core chip, typically, it's more expensive than a single-core chip. But it really is a matter for the semiconductor partners, and where they are sort of positioning their chips. So if you've got a single-core A9, with a very fancy video accelerators and graphics accelerators and some integrated Wi-Fi or something like that, it could be just as expensive as a dual-core chip with fewer fancy bits on the side. So I don't think we can clinically say, single-core is this price, dual-core is this price, and quad-core is a higher price. Clearly, there must be a sort of trend there, that otherwise, people wouldn't do it, but I can't tell you the data points. Finally, I think, we're over to you.

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

Simon Schafer, Goldman Sachs. I want to actually stick on this royalty debate. I guess, just in basic terms if I look at Slide 10, I think you talked about 95% of your royalty still being from licenses signed 4 years ago. So in rough terms, I mean, is it fair to say that 95%, collecting a 1% rates, and then the 5% are collecting a 2% rate, or how should we think about that?

D. Warren A. East

Yes and no. What I would do -- to refine that model slightly, I would make one refinement, and that is in your sort of 5%, I would split it into microcontrollers and the non-microcontrollers. And it might be fair to look at all -- or you could split it as Cortex-A and others. And the others, you'd still account the sort of 1% end and the Cortex-A, you could allow it to go a bit higher.

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

And when do you think that 5% will be 25%, how long will it take?

D. Warren A. East

That's why we published the LITTLE bit, the chart on the bottom. We would expect a similar sort of trajectory to what we've seen in the past.

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

Okay, great. And then just on the licensing side, Tim, you sort of alluded to that -- the $65 million number, yet another step up. In essence, is this just because people are paying a higher value per license? Or it's not necessarily more people. I mean, I appreciate there's a few more different verticals that are being added to the licensee based. But what's really the delta, is it just the higher price per license? How should we think about it?

Tim Score

Well, it's actually -- I mean it's multiple factors. I mean, clearly, there are more companies buying ARM licenses today than there were before. I mean, if you look back over the last couple of years, about 1/4 of the licenses we've signed are with the new companies. Okay, so that's not insignificant, albeit quite a lot of them at the Cortex-M end. I mean, I think in a way, the most interesting thing is that backlog line that we were looking at. Because a lot of the bigger deals that we've signed in the last couple of years have really found their way mostly into backlog, they're not yet into license revenue. And it's quite interesting looking at the -- if you look at the licensed growth in that bar chart, you can see that the growth is coming from backlog. But the turns business is staying reasonably consistent. Now you could argue with lots of big companies entering into things like more subscriptions. It's actually very encouraging that the turns business is staying at the same level on top of an increasing backlog. So I think it's multiple dynamics. But underpinning it is ARM's addressable market is much broader across the computing spectrum than it was viewed to be 2, 3, 4 years ago. And so now companies are licensing ARM, the traditional companies are using ARM more and more -- in more and more end product divisions because of the, in a sense, the typical outsourcing dynamics and the technology pressures. But then there are also new companies coming into the frame for the first time, both at the top end towards the servers, and to the lower end towards the Internet of Things, and all those factors are driving it.

D. Warren A. East

I think we will continue to move back to the area if we've got time for a second one. And I haven't forgotten, we've got one at the front here after this one.

Janardan Menon - Liberum Capital Limited, Research Division

It's Janardan from Liberum Capital. Two questions. One is on the FinFET agreement with the TSMC, it's on 64-bit. So I'm just wondering what plans you have on moving the 32-bit, Cortex-A15 kind of products to FinFET? DO you have another agreement with them which we don't know about and will the timing of the introduction of that be roughly the same as the 64-bit signed? Second question is on Windows on ARM, there have been not that many companies and devices being announced so far for Q4 and presumably, some of that is because of software compatibility issues and things like that. What is your estimate of how much time it will take for that software ecosystem to come up to comparable levels with x86 up? Are we talking about a couple of quarters, or is it going to be a year, or is it more than, what's your view on that?

D. Warren A. East

Okay. Well, let's answer the first one. The FinFETs, yes, the announcement is, with our 64-bit processor because just as we want to work with TSMC's most advanced process technology, they want to work with our most advanced microprocessor, making a 20nm FinFET and later, a 16nm FinFET implementation so that our 32-bit processors will form naturally out of that development activity. We're optimizing our physical IP to build microprocessors. We just happen to be using our new 64-bit processor as the vehicle for it. The same physical IP will be very easily used to implement our 32-bit processors.

Janardan Menon - Liberum Capital Limited, Research Division

And with your -- as part of the timescale of introductions, is that a 2014 introduction or is it '15?

D. Warren A. East

Well, we have to stick with the announcements for now. And I think as and when TSMC want to make more comments on when these things are available, then they'll make more comments. As I said, from a development point of view, we're taping out stuff all the time. Windows on ARM, not that many announced in our estimations, when things become widespread. We've said we're very excited to see the Windows on ARM products that they're going to be launched in the fourth quarter of this year. My expectation for volumes of those things in the fourth quarter of this year, incredibly modest. And frankly, I'd rather see fewer good quality products than many products that don't go down very well. So the fact that Microsoft, they're controlling the launch very tightly and working with a limited number of partners, we see as a good thing. We're not changing our estimates for an expectation that by about 2015, we expect that we'll have a share of the laptop market of maybe 15% to 20%. That hasn't changed. And I think that's a sort of measure of how we see the world out of how that it's going, because 2015 is still a few years away. Let's keep -- I haven't forgotten but let's keep going back because you've got a microphone there.

Julian Robert James Yates - Investec Securities (UK), Research Division

It's Julian Yates from Investec. Just a quick question on the licensees and backlog, Tim. If we look at the backlog, it seems as though you may be taking more from the backlog into the revenue line over a period of time. So I'm trying to understand, should we assume the backlog at some stage level which often starts declining as more of that backlog gets recognized since the P&L? Or do you think over the medium term, that backlog should continue to increase?

Tim Score

Well, I mean, backlog contribution to licensed revenues, typically in the 40% to 60% range per quarter, as it happens this quarter it's up at the 60% range. Therefore, in a sense, even more encouraging that the backlog is up quarter-on-quarter even with a reasonable -- yet a reasonable drawdown into the licensed revenues. And so therefore, in a sense whatever the reason dynamic has been, the fact is the backlog is 3.5x higher than it was at the first half of 2007. And frankly, that gap that I showed between license revenue growth and backlog growth, it takes a very long time to unwind because of licensed revenue recognition through periods, so no. I mean, obviously, that backlog is inevitably lumpy quarter-on-quarter, depending on which deals, which profile of deals assigned in a given quarter. But we're not just about to stare at a reduction in that backlog.

Julian Robert James Yates - Investec Securities (UK), Research Division

So we should worry about the increased in licensed revenues to $65 million being a reflection of your sales taking more from the -- on a -- of a bigger backlog?

Tim Score

And we've moved from a world of $30 million a quarter to $45 million a quarter to $60 million plus, and the backlog is still going up.

D. Warren A. East

Sorry, where do we want to go. Let's come over here to the front row.

Sumant Wahi - Redburn Partners LLP, Research Division

It's Sumant from Redburn Partners. Just 3 quick questions if I may. First is on your sort of market share. I mean, given that about 1/3 of your licenses are still sort of not generating much royalties yet, and majority of them are in the nonmobile sector, what do you see in the next 5 years, if you don't attain any further -- assuming you if don't attain anymore licensing, license in this space, what do you see your market share growing to just from these licenses which you've already sold out in terms of royalty market share? The second question has to do with the FinFET again. Am I doing -- most of the foundries are sort of offering different known transition and in between, I assume, a FinFET would be, an option in between 20nm and probably 16nm. So my question really was that, would you be licensing FinFET technologies separately as well, or is this an exclusive collaboration with TSMC? And then is there a royalty increase coming from products based on FinFET, PIPD, so to speak? And my final thing is on network opportunity, in networking equipment opportunity over there. I mean, I'm just trying to understand in the networking equipment, what -- how big as a percentage of your royalty revenue in about 5 years time do you see networking, so to speak? I mean, I'm talking separate from servers, you're talking about their being networking opportunity in terms of power saving. I'm just trying to understand what kind of chips are we talking about and what kind of cores are we talking about between them?

Tim Score

I mean, I think if I understand your question correctly you're talking about the overall market share, which currently -- in 2011, our estimation is we're about 30%, overall market share embedded processor market. And you can see from our market segments slides, which I think in this pack are in 21 or 22, if you look back over 5 years, that's growing from 17% to 30% and there are some years it's growing 3%, sometimes 4%, last year, 5%. We don't see any reason to suggest that the growth rate of our market share doesn't grow at, at least that rate, as when we look out over the next kind of 5 years ago. So a good number to have in your head might be about 50% in a 5-year view, which will obviously be around 4% per annum. But I mean, there are probably more reasons to think it's going to be at the high end of that than the low end, given microcontrollers and the volumes associated with it. And in a sense, if we were talking about this 9 months a year ago, we wouldn't been talking about networking in the same way. So there's a little bit of flicking of the switch going on. That's a bit of a pun, isn't it? But there's a bit of a flicking of the switch going on, I think in networking, which might drive it. So I'll say on balance, I mean, Ian and Jonathan update this every year. Most years, we update it. The actual market size grows a bit because the addressable market for ARM grows. But bottom line, around about 50% seems to us pretty reasonable in a 5-year view.

D. Warren A. East

Okay. Next question was about FinFET and whether it's essentially a different physical IP product from ARM. And the answer is, well, it's a different flavor. We have different flavors of our physical IP for each semiconductor process. And so a low-power version of a given note is a different physical IP bundle than a high-profile version. And the FinFET is another flavor again. So it would be an incremental licensing opportunity. But the fact that our physical IP is used, would generate the royalty opportunity. But it's not an incremental royalty opportunity. The fact that it's FinFET, it's just another flavor. So if we're going to have a 20nm low-power plainer flavor and the FinFET flavor, and the chips are going to be made out of one process technology, and so the royalty opportunity is the same. Networking equipment and what sort of share can we expect in that. I think to Tim's point, we update the numbers every year. We will be updating the chart in the sort of end of this year. Probably, when we look at the networking line, and you'll see on the slide, which was produced in the beginning of this year, we do have one of the green arrows as in key growth areas for ARM, beside networking on this slide, so we are excited and we have been about this area. Maybe, the absolute numbers there might be one of the areas where as he says, when we update we quite often revise the size of the market as we see bigger opportunity. I'm very encouraged by the reception that our customers' customers are providing to ARM technology in this space and I don't see why we can't have a very large share of these spaces. Current incumbents have a large share today. I think the power efficiency benefits of ARM and the ecosystem benefits of ARM and the business model benefits of ARM apply here just as well to this networking space as they do to mobile computing. I think we're on one more. Was there anybody at the back who didn't get the go yet? So Didier, bonus ball.

Tim Score

Final keynote question.

Didier Scemama - BofA Merrill Lynch, Research Division

I just wanted to do one on design in. You talked about the key different processors and so on. I was just trying to have your views as to whether we need higher performance GPUs in modem, e.g. does LTE require a higher performance modem? Does Wi-Fi AC require a higher performance modem? And in that, if that your answer is yes, what sort of upside in royalty rate broadly are we talking about? And the second bit is regarding, basically, the ARM v8. The best or, let's say, those who are skeptical about ARM penetrating the server market and the notebook market talk about lack of ecosystem support, they talk about the lack of EEC software, these sort of things. What's your response and more importantly, what's the feedback you get from the likes of HP and Dell that are doubling with the technology?

D. Warren A. East

Perceptive question on the modems. I mean, in fact, what we're trying to do with these modems is squeeze an awful lot more data down the same size pipe. And that means a much more complex coding system is required. And just to put in perspective some of sort of LTE-plus type modems, if we look at the complexity of that and compare it with, say, a 2G modem, you're talking about a factor of 500-or-so in the complexity. And so actually, they do need higher performance microprocessors. If we look at the modems which we're shipping today, sort of 3G-types modem, then it's not a linear relationship. It's not a sort of linear journey from 2G to LTE-plus. So actually, the 3G ones are just a little bit more complex than the 2G ones. And so today, most of those sorts of products will be ARM11 type products versus ARM7 or ARM9 type products, so a little bit more performance. But from a royalty point of view, no real sort of significant incremental royalty opportunity. We've had a lot of design ins for a Cortex, for all type products, and even some Cortex-A products in modems, but these aren't really shipping in volume today, and these are for sort of LTE, initial LTE-type modems. But as we look to the more sophisticated LTE type modems, then yes, they will certainly use more sophisticated processors because as I say, they are much, much more complex. And there will be a corresponding royalty upside opportunity there. It's just not really in the numbers yet, because I don't have the numbers of the top of my head, but the vast majority are ARM11 based today. And the last question was about?

Didier Scemama - BofA Merrill Lynch, Research Division

What's the feedback around [indiscernible]

D. Warren A. East

I mean, pretty positive so far. But I mean, they have to see the Silicon. And the other thing, as you pointed out, 64-bit, it's a new introduction, exactly. The software has to be written and so on. So it's early days. But they wouldn't be engaged in these programs with us if they weren't actually quite positive about it. Thank you. That is the last question and we've actually finished roughly on time. So thank you all very much. We'll look forward to seeing you again next time.

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

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

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

Source: ARM Holdings Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts