ARM Holdings plc – Results For The Fourth Quarter and Year Ended 31 December 2005

CAMBRIDGE, UK, 31 January 2006—ARM Holdings plc [(LSE: ARM); (Nasdaq: ARMHY)] announces its unaudited financial results for the fourth quarter and for the year ended 31 December 2005 showing full Q4 dollar revenues up 8% sequentially and strong profitability with a normalised operating margin of 35%

Financial Highlights – FY 2005

• FY total dollar revenues* up 14% to $418.7m comprising Processor Division (“PD” – formerly expressed as “Original ARM”) licensing $124.0m (up 19% year-on-year), PD royalties $131.1m (up 22%), Development Systems $46.5m (up 29%), Service revenues $26.5m (up 6%), Physical IP division (“PIPD”) $90.6m (licensing $63.0m, royalties $27.6m) (up 9% on actual PIPD 2004 revenues of $83.1m; down 4% on pro forma PIPD 2004 revenues of $94.6m(see note 7.23))

• FY 2005 PIPD revenues 15% up on actual PIPD 2004 revenues excluding “catch-up” royalties from both years ($88.2m in 2005 compared to $76.5m in 2004)

• FY normalised operating margin increased to 32.7%

• FY normalised earnings per share up 24% year-on-year and full year dividend of 0.84p per share, up 20% on 2004

• £26.6m returned to shareholders in 2005 through dividends (£10.4m) and the rolling share buyback program initiated in July 2005 (£16.2m)

Financial Highlights – Q4 2005

• Q4 total dollar revenues* up 8% sequentially to $109.0m comprising Processor Division (“PD”) licensing $30.3m (£17.7m), PD royalties $36.2m (£20.7m), Development Systems $13.5m (£7.8m), Service revenues $7.2m (£4.1m), PIPD $21.8m (licensing $13.8m, royalties $8.0m including “catch-up” royalties of $1.6m) (£12.6m)

• Total Group order backlog flat at end Q4 with PIPD component of backlog up more than 20% sequentially 

• Q4 normalised operating margin increased to 35.0% 

Operating Highlights

• Strong processor licensing momentum continues in 2005, up 19% year-on-year

• 71 processor licenses signed in 2005 bringing cumulative total to 398

• Record 499 million ARM Powered® products shipped

• Rapid growth in non-mobile unit shipments, up 46% year-on-year

• Seven synergistic deals signed in 2005 demonstrating early benefits from Artisan acquisition

• 19 new physical IP licenses signed in 2005 bringing cumulative total to 176

Commenting on the fourth quarter and full year, Warren East, Chief Executive Officer, said:

“2005 has been another successful year for ARM and we enter 2006 well placed to build on our market-leading position. Q4 was an excellent quarter for our processor division with our new flagship Cortex®-A8 product winning four high-profile industry awards and initial deliveries of the next two Cortex products being made to lead partners. These innovative products underpin license revenues in 2006. We have also made substantial progress in positioning the combination of physical IP and processor IP in order to realise the anticipated financial and technological benefits in 2006 and beyond.”

Tim Score, Chief Financial Officer, added:

“We have grown revenues at twice the rate of the semiconductor industry, achieved operating margins healthily in excess of 30% and seen volumes of ARM Powered products grow by more than 30% year-on-year to 1.66 billion units. Notwithstanding the 20% increase in R&D expenditure to drive expected strong revenue growth, a 24% increase in earnings per share has enabled us to return more cash to shareholders via our progressive dividend policy and the ongoing share buyback program that we introduced during the year.”

Full year 2005 – financial summary

Q4 2005 – financial summary

* Dollar revenues are based on the group’s actual dollar invoicing, where applicable, and using the rate of exchange applicable on the date of the transaction for invoicing in currencies other than dollars. Approximately 95% of invoicing is in dollars.

** Each American Depositary Share (ADS) represents three shares.

*** Normalised figures are before acquisition-related charges and other deferred stock-based compensation charges and related payroll taxes. For reconciliation of GAAP measures to normalised non-GAAP measures detailed in this document, see notes 7.1 to 7.23.

**** Before dividends, share buybacks and acquisition consideration - see notes 7.14 to 7.16.

Current trading and prospects

During 2005, we integrated Artisan into ARM and began to accelerate new product development in physical IP. We also brought three new processor designs to market, completed the acquisition of a microcontroller tools company and further invested in research and development. As a result, ARM enters 2006 well placed to build on its market leadership position.

A broad technology portfolio for licensing, increasing royalty momentum, growth in development systems sales and the prospect of more synergistic revenues arising from the combination of processor IP and physical IP underpin confidence in another strong performance in 2006 in line with current market expectations.

Financial review

(US GAAP unless otherwise stated)

Fourth quarter ended 31 December 2005

Total revenues

Total revenues for the fourth quarter of 2005 amounted to £62.9 million. In US dollar terms*, fourth quarter revenues of $109.0 million were 8% up sequentially. The effective US dollar to sterling exchange rate for ARM in Q4 2005 was $1.73 compared to $1.78 in Q3 2005 and $1.80 in Q4 2004.

License revenues

Total license revenues in the fourth quarter were £25.7 million, representing 41% of group revenues. License revenues comprised £17.7 million from PD and £8.0 million from PIPD. In US dollar terms*, PD license revenues of $30.3 million in Q4 2005 were 5% up on Q4 2004.

Royalty revenues

Total royalty revenues in the fourth quarter were £25.3 million, representing 40% of total group revenues. Royalty revenues comprised £20.7 million from PD and £4.6 million from PIPD. In US dollar terms*, PD royalty revenues of $36.2 million in Q4 2005 were up 13% sequentially on Q3 2005 and were 23% up on Q4 2004.

ARM partners shipped 499 million units in Q3 2005 (we report royalty revenues one quarter in arrears) at an average royalty rate (“ARR”) of 7.3 cents. The ARR was down from 7.9 cents in Q3 due primarily to the strong growth in shipments of low-cost handsets, hard disk drives and Wi-Fi chipsets. Of the 499 million unit shipments in Q4, 34% related to units based on ARM9™ family technology. Shipments of ARM926 processor-based product accounted for 8% of total shipments. The mobile and non-mobile segments accounted for 62% and 38% of total shipments respectively in Q4, compared to 64% and 36% in Q3. A further six partners began paying royalties in Q4, bringing the total to 68 out of our 172 partners.

Total PIPD royalties of $8.0 million included $1.6 million of catch-up royalties. Underlying royalties of $6.4 million were up 7% sequentially. 19 companies are paying royalties at the end of 2005.

Development Systems and Service revenues

Sales of development systems in Q4 2005 were £7.8 million, representing 12% of total group revenues, compared to £5.8 million in Q3 2005. In US dollar terms, Development Systems revenues were $13.5 million compared to $10.3 million in Q3 2005. The good momentum behind Development Systems revenues seen in the first half of 2005 resumed in the quarter after a seasonally slow third quarter. Q4 revenues also included the first contribution from Keil®, our new microcontroller tools business acquired at the end of October 2005. Service revenues in Q4 2005 were £4.1 million, representing 7% of total group revenues. Dollar revenues of $7.2 million were up 11% sequentially and 21% ahead of last year.

Gross margins

Group gross margins for the fourth quarter were 90.6% compared to 87.7% in Q3. The increase arises primarily due to the increased proportion of royalty revenues earned in Q4 relative to Q3.

Operating expenses and operating margins

Total group operating expenses in Q4 2005 were £42.9 million, including acquisition-related charges of £5.3 million and other deferred stock-based compensation and related payroll taxes of £2.6 million. Excluding these charges, operating expenses in the quarter were £35.0 million, comprising £29.3 million for the group excluding PIPD and £5.7 million for PIPD, compared to £32.0 million in Q3 2005.

Total research and development expenses were £15.6 million in Q4 2005, representing 25% of revenues, compared to £13.9 million or 25% of revenues in Q3 2005. Total sales and marketing costs in Q4 2005 were £9.1 million or 14% of revenues compared to £8.5 million or 15% of revenues in Q3 2005. Total general and administrative expenses in Q4 2005 were £11.0 million representing 17% of revenues compared to £9.6 million or 17% of revenues in Q3 2005.

Operating margin in Q4 2005 was 22.4% compared to 18.8% in Q3 2005. Normalised operating margin was 35.0%(7.1) in Q4 2005 compared to 31.3%(7.2) in Q3 2005. Normalised operating margin of 35.0% in Q4 2005 comprises 36.9% for the group excluding PIPD and 27.4% for PIPD.

Interest receivable

Interest receivable increased to £1.7 million in Q4 2005 compared to £1.4 million in Q3 2005, due to higher average cash balances offsetting slightly lower interest rates.

Earnings and taxation

Income before income tax in Q4 2005 was £15.8 million compared to £12.0 million in Q3 2005. Normalised income before income tax was £23.7 million(7.6). The group’s effective tax rate under US GAAP in Q4 2005 was 17.8% bringing the effective rate for the year to 21.3%, reflecting the availability of research and development tax credits and taking into account the benefits arising from the structuring of the Artisan acquisition.

Fourth quarter fully diluted earnings per share prepared under US GAAP were 0.9 pence (4.7 cents per ADS**) compared to earnings per share of 0.7 pence (3.6 cents per ADS**) in Q3 2005. Normalised earnings per fully diluted share in Q4 2005 were 1.23 pence(7.17) per share (6.3 cents per ADS**) compared to 1.05 pence(7.18) (5.5 cents per ADS**) in Q3 2005.

Year ended 31 December 2005

Revenues

Total revenues for the year ended 31 December 2005 amounted to £232.4 million. In US dollar terms*, revenues of $418.7 million were 14% up on the aggregate pro forma ARM and Artisan revenues of $367 million in 2004 and 18% up on the aggregate actual revenues of $355 million. The effective average dollar to sterling exchange rate in 2005 was $1.80 compared to $1.78 in 2004 for ARM standalone.

Total license revenues in 2005 were £104.2 million, being 45% of total revenues. Total royalty revenues were £87.8 million, representing 38% of total revenue. Sales of development systems were £25.7 million, being 11% of total revenues. Service revenues were £14.7 million, representing 6% of total revenues.

Operating expenses and operating margins

Total group operating expenses in 2005 were £159.2 million, including acquisition-related charges of £23.2 million and other deferred stock-based compensation and related payroll taxes of £4.9 million. Excluding these charges, operating expenses in 2005 were £131.1 million, comprising £110.0 million for the group excluding PIPD and £21.1 million for PIPD.

Total research and development expenses were £60.1 million in 2005, representing 26% of revenues. Total sales and marketing were £34.1 million or 15% of revenues. Total general and administrative expenses were £37.6 million, representing 16% of revenues.

Operating margin in 2005 was 20.6% compared to 20.6% in the ARM standalone business in 2004. Normalised operating margin was 32.7%(7.4) in 2005 compared to 26.9%(7.5) in 2004. The 2005 normalised operating margin of 32.7% comprises 33.2% for the group excluding PIPD and 30.9% in PIPD.

Interest receivable

Interest receivable was £5.3 million in 2005.

Earnings

Income before income tax in 2005 was £53.2 million. Normalised income before income tax was £81.3 million(7.9).

Fully diluted earnings per share under US GAAP in 2005 were 2.9 pence (15.1 cents per ADS**). Normalised earnings per fully diluted share were 4.28 pence(7.20) per share (22.0 cents per ADS**).

Balance sheet and cash flow

Intangible assets at 31 December 2005 were £457.9 million, comprising goodwill of £385.6 million and other intangible assets of £72.3 million, compared to £340.4 million and £74.6 million respectively at 31 December 2004. The increase in goodwill in 2005 is due primarily to foreign exchange movements, given the strengthening of the US dollar against sterling from $1.92 at 31 December 2004 to $1.72 at the end of 2005. Goodwill is no longer amortised under US GAAP but is subject to impairment review on at least an annual basis. A regular review of the carrying value of the assets arising on the acquisition of Artisan was performed as at 31 December 2005 and it was concluded that no impairment charge was required. The movement in other intangible assets reflects the amortisation in the year of the intangible assets arising on the acquisitions of Artisan and Axys of £16.9 million and the addition of £8.7 million arising on the acquisition of Keil in October 2005. The other intangible assets are being amortised through the profit and loss account over a weighted average period of five years.

Accounts receivable increased to £55.5 million at 31 December 2005 from £52.2 million at 30 September 2005. The allowance against receivables was £2.2 million at the end of the year compared to £1.8 million at 30 September 2005. Deferred revenues were £20.4 million at the end of the year compared to £23.2 million at 30 September 2005.

After net cash generation of £15.9 million(7.14) in Q4 2005, total net cash generation in 2005 amounted to £65.0 million(7.16) giving total cash, cash equivalents, short-term investments and marketable securities of £160.9 million(7.11) at 31 December 2005.

Share buyback program and 2005 final dividend

Since the share buyback program was initiated in July 2005, the Company has purchased a total of 13.9 million shares at a total cost of £16.2 million. It is anticipated that the buyback program will resume after the announcement of these results.

The directors recommend payment of a final dividend in respect of 2005 of 0.5 pence per share, which taken together with the interim dividend of 0.34 pence per share paid in October 2005, gives a total dividend in respect of 2005 of 0.84 pence per share, an increase of 20% on 0.7 pence per share in 2004. Subject to shareholder approval, the final dividend will be paid on 5 May 2006 to shareholders on the register on 31 March 2006.

Operating review

Processor Division (“PD”) licensing and product development

11 licenses for microprocessors were signed in Q4 2005. Four new partners took a total of five licenses, of which two were per-use licenses and two were term licenses. The two per-use licenses comprised one license for the ARM7TDMI® processor and one license for the ARM922T™ processor. The two term licenses were for the ARM926EJ-S processor and the ARM946E-S™ processor. The remaining license was for the ARM926EJ-S processor.

A further six licenses were signed with five of our existing partners, comprising three derivative licenses and three upgrades. The derivative licenses consisted of one term license for the ARM7TDMI-S™ processor, one term license for the ARM946E-S processor and one license for the ARM11™MPCore™ processor. The upgrades consisted of one term license for the ARM926EJ-S processor and two licenses to the ARM1176JZ-S™ processor, one of which was a term license.

Overall, group order backlog at the end of Q4 was similar to the level as at the end of Q3, with the PIPD component of backlog being up more than 20% sequentially. The PD component of the backlog, which was down sequentially, is expected to build during 2006 as the Cortex portfolio of products become available for general licensing.

Having grown license revenues by 27% and 19% in 2004 and 2005 respectively, ARM enters 2006 well placed to maintain momentum in processor licensing. The portfolio of licensable products comprises a rich mix of well-proven ARM technology, such as the ARM7™ and ARM9 families of products, products introduced in recent years which are still in the early stages of their licensing life cycle, such as the ARM11 family of products, and the first three Cortex family products which have already been licensed by lead partners and which will be available for general licensing in 2006.

In October 2005, we formally launched the Cortex-A8 processor, the industry’s fastest embedded processor to date and the first complete processing solution comprising a broad portfolio of ARM technology to reduce time-to-market. The award-winning Cortex-A8 processor is expected to revolutionise consumer and low-power mobile devices, enabling the delivery of higher levels of entertainment and innovation to end users. Its performance and power utilisation characteristics make it ideal for demanding consumer products running multi-channel video, audio and gaming applications. The exceptional speed and power efficiency of the Cortex-A8 processor is enabled by new ARM Artisan libraries supporting technologies such as Intelligent Energy Manager (IEM). Additionally, the new processor features ARM TrustZone® technology for secure transactions. The ARM TrustZone Software Application Program Interface (API) is gaining wide industry endorsement and quickly becoming a standard foundation for the implementation of security functions such as digital rights management, device protection and payment.

The attributes of the Cortex-A8 processor were recognised by the winning of four high-profile industry awards: Electronic Products magazine’s “Product of the Year”; Portable Design magazine’s “Editor’s Choice”; Electronic Design magazine’s “Best of Embedded 2005” and Microprocessor Report’s “Analysts’ Choice Award for the Best Processor-IP Core of 2005”.

The Cortex-M3 processor has been licensed to four lead partners to date. Initial product deliveries were successfully made to the lead partners in Q4 2005 and the product is now available for mainstream licensing. Test silicon for the Cortex-M3 processor has been received and is exhibiting higher performance and smaller size characteristics than initially expected. The Cortex-M3 processor is specifically designed to meet the requirement for high system performance in microcontrollers and other very cost-sensitive embedded applications such as automotive products and white goods. The microcontroller market has traditionally been serviced by 8- and 16-bit devices, but it has seen a substantial increase in performance requirements as users demand greater flexibility based in software, and as cost pressures drive the consolidation of applications on to a single device. The Cortex-M3 processor, with multiple technologies to reduce memory use whilst delivering industry-leading power and performance, provides an ideal platform both to accelerate the migration of thousands of applications from legacy components to 32-bit microcontrollers and for use in such products as ultra low-cost mobile handsets.

The third Cortex family product available for mainstream licensing in 2006, currently code-named “ServalE”, has been licensed by two lead partners to date. ARM’s ServalE next-generation processor for deeply-embedded applications is expected to be available for mainstream licensing in the first half of 2006.

Taking into account the 11 licenses for microprocessor cores that were signed in Q4 2005, a total of 71 licenses were signed in 2005 compared to 65 licenses in 2004 and 51 licenses in 2003. Of the 71 licenses signed in 2005, 12 were for products in the ARM11 family, 30 were for products in the ARM9 family, 23 were for products in the ARM7 family, and six were for products in the Cortex group of processors. 32 companies became new ARM partners in the year, bringing the total number of semiconductor partners at the end of 2005 to 172.

PD royalty revenues and unit shipments

Total unit shipments in 2005 of 1.662 billion were 31% up on 2004. Unit shipments in the mobile segment grew by 23% year-on-year with unit shipments in the non-mobile segments growing by 46%. Growth in the non-mobile segments was achieved across a broad range of product applications including hard disk drives, games consoles, smart cards, printers, DVD players, flash memory products, digital still cameras, Wi-Fi chipsets and automotive products.

Total PD royalty revenues in 2005 were $131.1 million, 22% up on the $107.1 million reported in 2004. The average royalty rate (“ARR”) of 7.9 cents in 2005 compares to 8.4 cents in 2004. The ARR in a given period is based on a number of variables, including the ASPs of the chips shipped, the applicable royalty rate payable to ARM and the mix of unit shipments by ARM product family. When evaluating the ARR trend in 2006, the key positive variables are likely to be the increased proportion of ARM9 family-based products, particularly in smarter mobile phones, and the ramp-up of ARM11 family-based products. However, there is likely to be continued strong growth in microcontroller shipments which typically have lower ASPs. In 2005, 31% of shipments were based on ARM9 technology. By the end of Q3 four partners were shipping products based on ARM11 technology with the first ARM11 family-based handsets now being shipped in Japan. The proportion of ARM11 family-based shipments is expected to grow meaningfully in 2006.

Physical IP Division (“PIPD”) licensing and product development

PIPD achieved its second highest bookings quarter ever in Q4 2005, giving rise to an order backlog up more than 20% sequentially and at a record level at the end of the year. PIPD reported license revenues of $13.8 million in Q4 compared to $15.2 million last quarter.

In Q4, PIPD licensed five physical IP platforms to two further foundries and one integrated device manufacturer (“IDM”). One foundry licensed both the Metro and Advantage platforms for their 90nm process and the other licensed both the Metro and Advantage platforms for their 65nm process. The IDM licensed the Advantage platform for their 65nm process. This follows other physical IP platform announcements made earlier in the year including IBM licensing the Metro platform for their 65nm ASIC process, IBM-Chartered licensing the Metro platform for their common 65nm process, UMC licensing the Metro platform for their 130nm process and most recently Grace Semiconductor licensing the Classic platform for both their 180nm and 130nm processes. This brings the total number of physical IP platforms licensed to foundries and IDM’s to 67. In addition to platform licenses, PIPD licensed its cell libraries, memory compilers and high speed PHYs to a further 15 end user licensees. This brings the total number of end user licensees for these technologies to 143. In Q4, PIPD made the first product deliveries of the Metro, Advantage and Velocity™ products for 65nm to both foundry licensees and design partners.

2005 has also seen the first synergistic benefits from the combination of ARM and Artisan, both in terms of revenue and technology collaboration. One further synergistic revenue deal was signed in Q4, bringing the total in 2005 to seven. Synergistic deals include both instances of physical IP being licensed to ARM partners and instances of contracts being won against the competition due to both processor and physical IP being available from ARM.

As well as the Cortex-A8 processor, we are already developing other products which benefit from the integration of processor and physical IP. In January 2006, we unveiled a ground-breaking high performance implementation of the ARM1176JZF-S processor, enhanced with the ARM Artisan Advantage cell library and memories, which achieves a frequency of more than 750 MHz in a high-performance 90nm foundry process while occupying less than 2.4 mm2 of silicon area. This represents a significant performance increase through a combination of collaborative design, advanced physical IP and process technology. The optimised implementation delivers an industry-leading performance for existing applications and operating systems without the need for expensive software re-design or re-compilation. Further, the ongoing collaboration between PIPD and ARM’s Fabric IP business unit yielded fruit in Q4 with the first 130nm test chip with combined DDR and PrimeCell® peripherals being received back from the fab and working first time.

PIPD royalty revenues

As with PD royalties, PIPD receives and reports royalty data one quarter in arrears. Total royalties of $8.0 million in Q4 2005 included “catch-up” royalties of $1.6 million. These catch-up royalties represent the initial yield from an enhanced process of internal analysis and external audit to ensure that ARM receives all royalties when due. Underlying royalties of $6.4 million compared to $6.0 million in Q3 2005 and $5.7 million in Q2 2005. Underlying royalties (excluding catch-up) are up 1% year-on-year compared to an overall decline in foundry revenue of some 3% over the same period.

Development Systems

Development Systems revenues have grown 29% in 2005 to $46.5m. This growth has been generated by working with customers on longer term relationships for the supply of RealView® Developer tools for software development, continued momentum behind the RealView Create tools for Electronic System Level design tools (“ESL”) customers and a buoyant market place for tools to support the broad portfolio of ARM microprocessors. Development Systems has entered into more multi-year contracts for larger product volumes which improves the visibility of business going forward and builds a good customer base from which to drive new innovation. Keil, a supplier of microcontroller tools, was acquired in October 2005. This acquisition enables ARM to benefit even further from the accelerating growth in the 32-bit microcontroller market and provides Development Systems access to a well-developed channel through which to sell microcontroller toolkits in order to address the much larger customer base associated with this market.

In 2006, growth is expected to be generated from new products launched into the microcontroller tools market that bring together technology from ARM and Keil, the launch of RealView Developer Suite 3.0 and RealView ICE 3.0 and the increase in the number of customers adopting ESL as a design methodology. Development Systems will also continue to increase the value provided to key customers with the RealView product line by strengthening the link between hardware and software development in order to provide a complete solution to the challenges of hardware and software co-design and by putting in place more long term agreements for the supply of RealView tools.

People

At 31 December 2005 we had 1,324 full time employees compared to 1,272 at the end of Q3 2005 and 1,171 at the end of 2004. At 31 December 2005, the Group had 576 employees based in the UK, 486 in the US, 101 in Continental Europe, 116 in India and 45 in the Asia Pacific region.

Legal matters

In May 2002, Nazomi Communications, Inc. (“Nazomi”) filed suit against ARM alleging willful infringement of Nazomi’s US Patent No. 6,332,215. ARM answered Nazomi’s complaint in July 2002 denying infringement. ARM moved for summary judgment and a ruling that the technology does not infringe Nazomi’s patent. The United States District Court for the Northern District of California granted ARM’s motion, and Nazomi appealed the District Court’s ruling. On September 7, 2004, the Court of Appeals for the Federal Circuit heard the appeal and issued its decision on April 11, 2005. Because, in the opinion of the Court of Appeals for the Federal Circuit, the District Court did not construe the disputed claim term in sufficient detail for appellate review, the Court of Appeals for the Federal Circuit remanded the dispute back to the District Court for further analysis. A supplementary “Markman” hearing was held on 11 October 2005 and we are presently awaiting the ruling of the District Court. Based on legal advice received to date, ARM has no cause to believe that the effect of the original ruling by the District Court will not be upheld.

ARM Holdings plc Fourth Quarter and Annual Results Tables (74K PDF)

About ARM

ARM designs the technology that lies at the heart of advanced digital products, from wireless, networking and consumer entertainment solutions to imaging, automotive, security and storage devices. ARM's comprehensive product offering includes 16/32-bit RISC microprocessors, data engines, 3D processors, digital libraries, embedded memories, peripherals, software and development tools, as well as analog functions and high-speed connectivity products. Combined with the company's broad Partner community, they provide a total system solution that offers a fast, reliable path to market for leading electronics companies. More information on ARM is available at http://www.arm.com/

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