ARM announces its unaudited financial results to 31 December 2006

CAMBRIDGE, UK -- February 6, 2007-ARM Holdings plc [(LSE: ARM); (Nasdaq: ARMHY)] announces its unaudited financial results to 31 December 2006

Highlights (US GAAP unless otherwise stated)

• Q4 and H2 dollar revenues both up 20% year-on-year
• Physical IP Division (PIPD) Q4 revenues up 27%
• Processor Division (PD) Q4 revenues up 21%
• Record bookings quarter in Q4. Order backlog up c.20% sequentially
• Strong licensing of latest technology across the Group in Q4
• Five CortexT family licenses (including first license of next-generation Cortex processor)
• 45nm physical IP licensed to IBM, Samsung and Chartered
• First two licenses for new Graphics processor
• Good momentum in FY 06 royalty revenues
• PD up 25% to $164m on 2.45bn shipments
• PIPD up 26% to $35m
• Normalised* income before tax in Q4 of £21.3m (US GAAP £9.4m), after £1.3m of non-recurring net operating expenses
• Normalised* EPS in Q4 of 1.49p (US GAAP 0.87p), benefiting from net tax credit in the quarter
• FY 06 effective tax rate of 17%
• FY 06 normalised* EPS up 19% (US GAAP EPS up by 10%)
• Increasing cash returns to shareholders
• 4.6% of issued share capital purchased by Company in 2006 for £76.5m
• FY 2006 dividend up 19%

Commenting on the results, Warren East, Chief Executive Officer, said:

"2006 was another year of consistent execution and significant investment in our business, and we are encouraged to have grown revenues ahead of our targets. We go into 2007 in good shape, with a strong portfolio of products and a record level of order backlog. Last year the number of ARM® technology-based electronic products shipped grew by 47% to more than 2.4 billion."

2006 Revenue Analysis and Financial Summary (16Kb PDF)

Current trading and prospects

Based on a strong portfolio of products for licensing, an order backlog at record levels and the prospect of a full year's productivity from the investment in new employees in 2006, we are confident of achieving full-year dollar revenue growth in 2007 in line with expectations.

Given short-term industry conditions (including lower foundry utilization), which are generally anticipated to improve during the year, dollar revenues in Q1 2007 are expected to be at similar levels to Q4 2006.

Financial review

(US GAAP unless otherwise stated)

Total revenues

Total dollar revenues in Q4 were $130.3 million, up 20% versus Q4 2005 and up 8% sequentially.  Sterling revenues of £68.0 million were up 8% year-on-year after an 11% weakening of the dollar against sterling ($1.92 in Q4 2006 compared to $1.73 in Q4 2005). At the Q4 2005 effective rate, Q4 2006 sterling revenues would have been £75.2 million.

Full-year dollar revenues in 2006 amounted to $483.6m, up 16% on 2005.

License revenues

Total dollar license revenues in Q4 2006 grew by 26% to $55.5 million, representing 43% of group revenues, compared to $44.1 million in Q4 2005. License revenues comprised $37.4 million from PD and $18.1 million from PIPD, representing the highest ever quarterly licensing revenue for that division.

Full-year license revenues were up 8%, comprising 12% growth in PD and 2% growth in PIPD. Order backlog in both PD and PIPD was approximately 20% higher at the end of 2006 than at the end of 2005.

Royalty revenues

Total dollar royalty revenues in Q4 2006 grew by 19% to $52.4m, representing 40% of group revenues, compared to $44.2 million in Q4 2005. Royalty revenues comprised $42.8 million from PD and $9.6 million from PIPD.  Total PIPD royalties of $9.6 million included $0.7 million of catch-up royalties. PIPD underlying royalty revenues were up 39% in Q4 2006 compared to Q4 2005.

Full-year dollar PD royalty revenues grew by 25% to $164.1 million on unit shipments of 2.449 billion, up 47% on 2005. Full-year PIPD royalty revenues grew by 26% to $34.9 million. Excluding catch-up royalties in both years, underlying PIPD royalties also grew by 26%.

Development Systems and Service revenues

Sales of development systems in Q4 2006 were at a record level of $14.1 million, representing 11% of group revenue, compared to $13.5 million in Q4 2005. Service revenues in Q4 2006 were $8.3 million, representing 6% of group revenues, compared to $7.2 million in Q4 2005.

Full-year Development Systems revenues were $53.0 million, up 14% on 2005. Service revenues were up by 10% to $29.1 million.

Gross margins

Gross margins in Q4 2006, excluding the FAS123(R) charge of £0.4 million (see below), were 89.0% compared to 87.7% in Q3 2006 and 90.6% in Q4 2005.  The sequential increase in gross margin arises from a lower allocation of PIPD engineering time to cost of sales in Q4 compared to Q3, reflecting a higher proportion of engineering effort being allocated to research and development activities (treated as operating expenses) in Q4 as opposed to customization work carried out to convert order backlog into revenue (treated as cost of sales).

Gross margins for the year, excluding share-based remuneration charges of £1.1 million, were 88.7% compared to 89.1% in 2005.

Operating expenses and operating margin

Total operating expenses in Q4 2006 were £52.4 million  (£42.9 million in Q4 2005) and include amortisation of intangible assets and other acquisition-related charges of £4.7 million (Q4 2005: £4.8 million) and £5.8 million in relation to the fair value of share-based remuneration in accordance with FAS123(R) - "Share-Based Payment". The total FAS123(R) charge of £6.2 million in Q4 2006 is included within cost of revenues (£0.4 million), research and development (£3.6 million), sales and marketing (£1.2 million) and general and administrative (£1.0 million). As FAS123(R) was effective for the first time in Q1 2006 and as ARM is applying the standard on the "modified prospective" basis, there is no directly equivalent charge in Q4 2005. Total operating expenses of £42.9 million in Q4 2005 did, however, include a deferred stock-based compensation charge of £2.5 million as calculated under the previously applicable standard. Normalised income statements for Q4 2006, Q4 2005, FY 2006 and FY 2005 are set out in notes 7.24 through 7.27 below which reconcile US GAAP to the normalised non-GAAP measures referred to in this earnings release.

The commentary on operating expenses below excludes acquisition-related and share-based remuneration charges.

Operating expenses in Q4 2006 were £40.8 million compared to £37.4 million in Q3 2006 and £35.0 million in Q4 2005. Operating expenses in Q4 2006 include non-recurring expenses of £1.3 million. Excluding these, operating expenses in Q4 2006 were £39.5 million. In 2007, operating expenses will reflect a full year's cost for those employees who joined the Group during 2006.

Research and development expenses were £18.2 million in Q4 2006, representing 27% of revenues, compared to £15.5 million in Q3 2006 and £15.5 million in Q4 2005. Sales and marketing costs in Q4 2006 were £11.4 million, being 17% of revenues, compared to £10.0 million in Q3 2006 and £8.9 million in Q4 2005. General and administrative expenses in Q4 2006 were £11.2 million, representing 16% of revenues, compared to £11.9 million in Q3 2006 and £10.6 million in Q4 2005.

Normalised operating margin in Q4 2006 was 29.0% (7.1) compared to 30.1% (7.2) in Q3 2006 and 35.0% (7.3) in Q4 2005. Operating margins in Q4 2006 were lower than Q4 2005 due to the 11% weakening of the US dollar against sterling, the investment in headcount made in 2006 and the non-recurring expenses of £1.3 million. Excluding the non-recurring expenses, the operating margin would have been 30.9% at the Q4 2006 effective exchange rate (equivalent to 34.2% at the Q4 2005 effective rate of 1.73).

Total operating expenses in 2006 were £187.4 million, including acquisition-related and share-based remuneration charges of £20.1 million and £17.2 million respectively. Excluding these charges, operating expenses in 2006 were £150.1 million, compared to £131.1 million in 2005, reflecting the net addition of 335 people to the Group during the year.

Full-year research and development expenses were £63.8 million in 2006, representing 24% of revenues. Full year sales and marketing expenses were £40.5 million or 15% of revenues. Total general and administrative expenses were £45.7 million, representing 17% of revenues.

Normalised operating margin for 2006 was 31.7% (7.4) versus 32.7% (7.5) for 2005. At constant currencies (applying ARM's 2005 full-year effective rate of $1.80), the normalised operating margin for 2006 would have been 32.3%.

Earnings and taxation

Income before income tax in Q4 2006 was £9.4 million compared to £15.8 million in Q4 2005. After adjusting for acquisition-related and share-based remuneration charges, normalised income before income tax in Q4 2006 was £21.3 million (7.6) compared to £23.7 million (7.8) in Q4 2005.

The Group's effective tax rate in 2006 is 17%, primarily due to a non-recurring tax credit in Q4 arising from a tax-deductible foreign exchange loss. Given the expected distribution of the Group's profits, the Group's effective tax rate for 2007 is expected to be approximately 28%.

In Q4 2006, fully diluted earnings per share prepared under US GAAP were 0.9 pence (5.1 cents per ADS****) compared to earnings per share of 0.9 pence (4.7 cents per ADS****) in Q4 2005. Normalised fully diluted earnings per share in Q4 2006 were 1.49 pence (7.19, 7.24) per share (8.7 cents per ADS****) compared to 1.23 pence (7.21, 7.25) (6.3 cents per ADS****) in Q4 2005. 

Full-year 2006 fully diluted earnings per share prepared under US GAAP were 3.2 pence (18.9 cents per ADS****) compared to earnings per share of 2.9 pence (15.1 cents per ADS****) in 2005. Normalised earnings per fully diluted share for 2006 were 5.08 pence (7.22, 7.26) per share (29.9 cents per ADS****) compared to 4.28 pence (7.23, 7.27) (22.0 cents per ADS****) in 2005. 

Balance sheet

Intangible assets at 31 December 2006 were £405.3 million, comprising goodwill of £349.3 million and other intangible assets of £56.0 million, compared to £364.0 million and £58.6 million respectively at 30 September 2006. A regular review of the carrying value of assets arising on acquisition was performed at 31 December 2006 and it was concluded that no impairment charge was required.

Total accounts receivable decreased to £69.6 million at 31 December 2006, comprising £45.8 million of trade receivables and £23.8 million of amounts recoverable on contracts, from £73.1 million at 30 September 2006, comprising £46.6 million of trade receivables and £26.5 million of amounts recoverable on contracts. Days sales outstanding (DSOs) reduced to 43 at 31 December 2006 from 52 at 30 September 2006 and 54 at 31 December 2005.

Cash flow, share buyback program and 2006 final dividend

Net cash at 31 December 2006 was £128.5(7.11) million compared to £147.4(7.12) million at 30 September 2006. Normalised net cash generation in Q4 2006 was £13.3 million after taking into account £31.3 million returned to shareholders by way of share buyback (£25.8 million) and dividend (£5.5 million) and a net cash outflow of £3.3 million in relation to acquisitions.

Since introducing dividend payments in 2004 and commencing the Company's share buyback program in July 2005, £125 million has been returned to shareholders and 77.5 million shares, being 5.6% of issued share capital, have been bought back. This has contributed to a net reduction in the fully diluted shares in issue from 1,431 million in Q4 2005 to 1,381 million in Q4 2006. It is anticipated that the share buyback program will resume after these results.

The directors recommend payment of a final dividend in respect of 2006 of 0.60 pence per share, which taken together with the interim dividend of 0.40 pence per share paid in October 2006, gives a total dividend in respect of 2006 of 1.0 pence per share, an increase of 19% on the total dividend of 0.84 pence per share in 2005. Subject to shareholder approval, the final dividend will be paid on 21 May 2007 to shareholders on the register on 4 May 2007.

International Financial Reporting Standards (IFRS)

ARM reports results quarterly in accordance with US GAAP. At 30 June and 31 December each year, in addition to the US GAAP results, ARM is also required to publish results under IFRS. The operating and financial review commentary included in this release on the US GAAP numbers is for the most part applicable to the IFRS numbers and, in particular, revenues, dividends and share buybacks are recorded in the same way under both sets of accounting rules. A summary of the accounting differences between IFRS and US GAAP and reconciliations of IFRS and US GAAP profit and shareholders' equity are set out in note 6 to the financial tables below. 

The most significant difference between the two income statements arises on the accounting for share-based payments, including related tax effects. Total operating expenses under IFRS include compensation charges in respect of share-based payments of £17.4 million in 2006 compared to £20.9 million in 2005. The decrease is primarily due to reduced compensation charges relating to options assumed on the Artisan acquisition which are reducing over time as those options vest, offset by increased charges on new schemes.

Operating review

Backlog

Group order backlog at the end of Q4 was approximately 20% higher than at the end of Q3. Licensing in Q4 2006 was strong across the ARM business with the backlog increasing in PD, PIPD and Development Systems.

PD licensing

In 2006, ARM continued to see significant demand for the full range of its microprocessors with PD order backlog at the end of Q4 up approximately 30% sequentially. Having licensed Cortex family products to lead partners prior to 2006, the current portfolio of three Cortex family products became available for more general licensing as the year progressed. In 2007, all three products will be available for licensing for a full year for the first time. During 2006, 13 Cortex family licenses were signed, with five being signed in Q4. This brings the accumulated total of Cortex family licenses to 23, signed by 18 semiconductor companies. As well as being a year of gathering momentum for Cortex family licensing, 2006 also saw the first Cortex-A8 processor-based products being announced with the Texas Instruments' OMAP 3 line of products. ARM also received the first royalties for Cortex products following the rapid deployment of the Cortex-M3 product by Luminary Microelectronics. 

In addition, 2006 continued to be a year of strong licensing of the ARM11T family of products. In the year we signed 15 ARM11 family licenses bringing the total number to 52 from 36 semiconductor companies. This year signified a shift in ARM11 family licensing activity from the traditional first-mover mobile companies with the majority of the licenses being taken for applications outside of the mobile segment. Based on the opportunity pipeline, we expect ARM11 family licensing to continue to be a meaningful contributor to license revenues in 2007.

As part of the Cortex family licensing in Q4 2006, we signed our first lead partner for the next-generation Cortex microprocessor.  Although, as usual, we would expect to sign a small number of lead licensees for this product, we do not expect it to be available for mainstream licensing until 2008.   

Q4 2006 PD Licensing Analysis - 463 cumulative processor licenses

	Multi-use			Term			Per-use
	U	D	N	U	D	N	U	D	N	Total
ARM7						1			1	2
ARM9		1			1	1		1	1	5
ARM11	1	1	1							3
Cortex-A8	1	1								2
Cortex-R4	1			1						2
Next Gen	1									1
									Total	15

U:Upgrade     D:Derivative     N: New

PD royalties

In 2006, ARM achieved a significant milestone with more than 2 billion ARM technology-based products being shipped in the year. Total shipments were 2.45 billion, up 47% year-on-year. Total Q3 shipments of 700 million units (our partners report royalties one quarter in arrears) equate to 7.6 million units being shipped every day. ARM continued to benefit from significant growth in the mobile segment (which includes mobile handsets, Bluetooth devices and portable media players, such as the Apple iPod), with this segment accounting for 66% of the units shipped by the ARM partnership. We also saw significant growth across a myriad of applications outside of the mobile segment including smartcards, microcontrollers, automotive, connectivity devices, hard disk drives and many others. Total non-mobile shipments in 2006 were 838 million units, higher than total shipments into all applications as recently as 2003, illustrating ARM's increasing penetration across the full range of consumer electronics products. 

ARM's royalties are typically based on a percentage of the average selling price (ASP) of the chips which incorporate our technology. As the penetration of ARM technology-based chips grows across a wide range of end-market applications, the range of ASPs gets wider. The average royalty rate (ARR) earned by ARM in any one reporting period is dependent on the mix of the ASPs of the chips shipped in that period. In 2006, significant unit volume growth was driven by products which incorporate chips with lower ASPs including ultra low cost handsets, smartcards, microcontrollers and Bluetooth chips. As a result, the ARR in 2006 was 6.7 cents compared to 7.9 cents in 2005. For ARM, unit volume growth more than compensated for the reduction in ARR and royalty revenues grew by 25% year-on-year. Irrespective of the ARR, all royalty revenues earned are effectively at 100% margin and thus represent incremental return on the development cost of the ARM technology on which the royalty is earned.

In Q4, we continued to see an increase in the proportion of royalties earned from newer ARM technology. The ARM9T family of products accounted for 40% of unit shipments with the ARM926EJ-ST product accounting for 15% of total shipments. Although, ARM11 technology-based shipments continued to grow, they still comprise less than 1% of total shipments.  The continued strength of ARM7T family shipments demonstrates the long revenue-earning lifespan of ARM technology with approximately 70% of units shipped in 2006 being earned from licenses that were signed before 2001.

PIPD licensing

ARM continued to make progress in 2006 towards achieving the long term strategic goal of providing our physical IP to leading Integrated Device Manufacturer (IDM) and Fabless semiconductor companies. Licensing momentum for our 65nm physical IP products grew, with 12 new licenses signed in the year. By the end of 2006, we had signed a total of 22 65nm licenses to 10 companies, including TSMC, UMC, Fujitsu, IBM, Chartered and Samsung. Further, we also signed seven licenses for physical IP with four foundries (TSMC, IBM, Samsung, and Chartered) at the most advanced process of 45nm.

With acceleration of technology development progressing in PIPD, we continue regularly to sign synergistic licenses that we believe have been enabled by the combination of ARM and Artisan technologies. Synergistic licenses signed in 2006 included those for leading-edge technology with Fujitsu and Samsung, whereby the physical IP licensed can be used both as part of their foundry activities and in their internal chip development activities, and with UMC the license was taken to satisfy a physical IP design win with a large fabless semiconductor company.

Q4 PIPD Licensing Analysis - 287 cumulative physical IP licenses

	180nm	130nm	90nm	65nm	45nm	Total
Platform Licenses
ClassicT		1				1
MetroT	1	1			3	5
AdvantageT			1	1	3	5
Standard Cell Libraries
Classic		2				2
Metro	3					3
Advantage				3		3
Memory Compilers
Classic	2	2				4
Velocity PHYs			1			1
					Total	24

PIPD royalties

PIPD continued to see strong momentum in royalties with a 26% growth in both total and underlying royalties.  Sales at the 130nm and 90nm process nodes continued to be the fastest growing segments for PIPD, although more than half of royalties received in 2006 came from older geometries. 

Total catch-up royalties in 2006 were $3.1 million, 30% up on 2005.  Since establishing an enhanced process internally in mid 2005 to improve the timeliness and visibility of PIPD royalty revenues, we have seen catch-up royalties being reported on a regular basis. Whilst we expect this process to improve the quality of royalty reporting over time, there is still much work to do and we would expect catch-up royalties to continue to be reported in 2007. 

Development Systems

Q4 was a record quarter for Development Systems both in terms of revenue and bookings, with continued strong bookings reflecting the desire of a growing number of customers to enter into long-term commercial and technical relationships for Development Systems products. For example, during the year ARM saw a 65% increase in the bookings for Electronic System Level (ESL) tools that were derived from the acquisition of Axys in 2004, reflecting the increasing importance that our partners are attaching to the fast-growing ESL tools market. 

Emerging Business Units

Today, ARM generates most of its revenues from PD, PIPD, Development Systems and Services. We are, however, also investing in four emerging business units - Fabric, Graphics, Data Engines and Embedded Software - which we believe are complementary to our more developed businesses and in each case offer opportunity for profitable growth in the medium term. In 2006, these business units generated a small proportion of total group revenues but accounted in aggregate for some 10% of total group costs. By 2010, we anticipate that these businesses will generate more than 10% of total group revenues.

In 2006, a number of significant milestones were reached in these business units. In the Data Engines group, Toshiba announced that they had licensed our Optimode technology and Broadcom introduced a new line of Bluetooth products incorporating ARM AudioDE IP.  In the Fabric IP division, Broadcom and Toshiba licensed our Fabric IP solutions, reinforcing AMBA as the world's leading interconnect standard.  In the Embedded Software group, our TrustZone® technology was licensed by Texas Instruments and it was announced that Samsung had licensed and would incorporate Jazelle in their first commercially available Blue-Ray disc players. Further, in Q4 we signed the first two licenses for the graphics IP derived from the acquisition of Falanx Microsystems in May 2006. We understand that one of these licenses is intended for use in mobile applications, the other in non-mobile applications.

People

2006 has been a year of investment in headcount for ARM, with a net increase of 335 employees in the year. The focus of our investment has been in PIPD, where we have invested in engineering resources in order to accelerate the development of leading-edge physical IP products, and in our emerging business units (see above). We anticipate headcount growth will be lower in 2007 as our investment in people in 2006 yields productivity benefits. At the end of 2006 we had 1,659 full time employees compared to 1,324 at 31 December 2005. The group had 671 employees based in the UK, 582 in the US, 153 in Continental Europe, 203 in India and 50 in the Asia Pacific Region.

We were delighted that the efforts of our people have been recognised recently with the Company winning three prestigious awards available to businesses from all sectors. In November 2006, ARM was chosen as UK Business of the Year at the National Business Awards, an award taking account of market leadership, innovation, growth and financial return. In January 2007, ARM was recognised as European Business of the Year, competing against the other national award winners within the European Union. Further, at the Management Today awards in November 2006 for Britain's Most Admired Companies, ARM was recognised as the company with the "greatest capacity to innovate." Whilst these awards were for companies with headquarters in the UK or the European Union, they recognise the efforts of all ARM employees worldwide.

Legal matters

Nazomi

In May 2002, Nazomi Communications, Inc. ("Nazomi") filed suit against ARM alleging wilful infringement of Nazomi's US Patent No. 6,332,215 ("'215 Patent").  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.  In September 2004, the Court of Appeals for the Federal Circuit heard the appeal and issued its decision in April 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 in October 2005 to decide the construction of a fundamental term in the '215 Patent and a decision on claim construction was delivered on 6 September 2006. The decision emphatically supports ARM's construction of the relevant term and consequently strongly supports ARM's non-infringement arguments. In December 2006, ARM filed a renewed motion for summary judgement and a ruling that the accused technology does not infringe the '215 patent. On 17 January 2007 Nazomi filed a response to ARM's renewed motion for summary judgement in which they stipulated that, based on the claim construction delivered by the District Court, the ARM technology accused in the suit does not infringe the '215 patent but also objected to the claim construction delivered by the District Court and indicated their intention to appeal the claim construction to the Court of Appeals for the Federal Circuit.

TPL Group

In October 2005, Technology Properties Limited, Inc. ("TPL") filed suit, in the United States District Court for the Eastern District of Texas (Marshall Division), against certain companies in the Fujitsu, Matsushita, NEC and Toshiba groups of companies alleging infringement of TPL's US Patents Nos. 5,809,336; 5,784,584 and 6,598,148 (the "Litigation"). All of the defendants are licensees of various ARM technologies. It was revealed as part of the preliminary infringement contentions in the Litigation, filed in July 2006, that certain ARM technology is alleged to infringe a single claim in US Patent No. 5,784,584 (the "'584 Patent"). In September 2006 ARM filed a motion to intervene in the Litigation and that motion has been granted. ARM is now a defendant party in the Litigation. The claim construction (or "Markman") hearing is scheduled for May 2007 and the trial date is scheduled for November 2007. Based on legal advice and written opinions received from external counsel, ARM is confident that the accused ARM technology does not infringe any of the claims of the '584 Patent or that the patent is invalid. ARM has voluntarily joined as a party to the Litigation to proactively defend its technology against ill conceived and false infringement allegations and fully expects to prove the case for non-infringement or invalidity in the course of the Litigation.

Download ARM Holdings plc Q4 2006 & Annual Results Tables  (76Kb PDF)

About ARM

ARM designs the technology that lies at the heart of advanced digital products, from mobile, home and enterprise solutions to embedded and emerging applications. ARM's comprehensive product offering includes 16/32-bit RISC microprocessors, data engines, graphics 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.