ARC International plc Fourth Quarter and Full Year results for the year ended 31 December 2003

February 4, 2004 - ARC International plc (LSE: ARK), a world leader in user-customizable processors for embedded system design, announces its unaudited financial results for the fourth quarter and full year ended 31 December 2003.

Highlights:

Fourth Quarter ended 31 December 2003:

• Turnover £3 million: up 18% sequentially (Q3 2003: £2.5 million); down 8% over Q4’02 (Q4 2002: £3.2million) due to currency impact. At constant exchange rates, turnover up 26% sequentially and flat year on year.
• Operating costs before exceptionals, amortisation and depreciation £6.4 million: reduced by 4% sequentially (Q3 2003: £6.7 million) and 10% over Q4’02 (Q4 2002: £7.2million)
• Pre-exceptional net loss £4.9million: improved 16% sequentially (Q3 2003: £5.8million) and flat over Q4’02 (Q4 2002: £4.9million)
• Record royalty income, up 39% sequentially to £0.7 million (Q3 2003: £0.5 million) and 300% year on year (Q4 2002: £0.2million)
• Net cash ouflow £3.2 million: reduced 27% sequentially (Q3 2003: £4.4 million); year end cash at £37 million
• 11 new design licenses including 10 USB peripheral IP licensees and 1 ARCtangentTM processor license booked in Q4
• Introduced ARC600, the industry’s smallest and lowest power 32-bit RISC/DSP processor
• New Board launched operational and strategic restructuring review
  

• Turnover £10.7 million (2002: £11.7 million): down 8% due to currency fluctuations; flat in US Dollars.
• Operating costs before exceptionals, amortisation and depreciation £27.1 million: reduced 8% sequentially (2002: £29.3 million)
• Pre-exceptional net loss £20.7 million: 1% up on prior year (2002: £20.5 million)
• Net cash outflow(excluding buyback) £15.7 million: reduced 25% (2002: £21 million)
• Won 44 new design, 32 new processor and USB customers

Commenting on the results, Peter van Cuylenburg, Chairman and interim CEO, said:

“We were encouraged by several significant improvements in ARC’s business in Q4, notably in software and peripheral revenues and in royalty income. However, our processor license revenue continued at a low level, pending the release of new products. Initial market reaction to the new ARC600 processor, launched in Q4, gives us confidence that we will see a return to a healthy rate of processor design wins across 2004.

The structural and strategic changes announced today will decrease ARC’s quarterly cost structure by 40% to the £3.8 million range by the end of 2004. With 20% overall semiconductor growth forecasted by industry analysts for 2004, we are confident that ARC will benefit from these improvements.”

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Overview

2003 has been a challenging year for ARC with a mixed performance across the business. Revenues year on year were flat although the fourth quarter revenue performance showed a significant improvement of 26% over the third quarter in US dollars, and 18% in sterling. Royalties and software also showed steady improvement and we reported record levels for both in the fourth quarter.

Year on year, pre-exceptional net loss was £20.7 million and was unfavourably impacted by lower interest income. The steps taken to reduce operating expenses within the business delivered an 8% reduction over the year. In addition, net cash outflow was down 25% year on year to £15.7 million.

Across our product areas of processors and peripherals, we won 44 new designs during the year, including 32 new processor and peripheral customers. Given our focus on new processor products, we have been encouraged by the reaction from our customers to the launch of the ARC600 processor in October 2003, and by pre-launch reaction to the ARC700. Through the introduction of new products and certification of our IP, we have maintained our leadership position in USB. In the software business, new releases and a further strengthening of our relationship with Metrowerks, a division of Motorola®, led to record software revenue in the fourth quarter.

Strategic Redirection

Since the appointment of ARC’s Chairman Peter van Cuylenburg as interim Chief Executive Officer and Mike Morrissey as Chief Operating Officer in December 2003, management has conducted a thorough evaluation of the business to address how best to build value from the core product areas and align the cost structure more closely to the requirements of the business.

The new strategic direction announced today recognizes that ARC has two distinct areas of technology: first, a set of hardware circuit designs and programming tools for designers of complex System-on-chip integrated circuits (SoC ICs); and second, embedded system software products used to provide the application platform in embedded systems.

ARC’s overall strategy previously offered a one-stop-shop for technology required by embedded system designers. In practice, however, embedded system designers typically choose their hardware and software independently, so few customers have purchased from more than one area of ARC’s products. As a result, most of ARC’s embedded system software has been sold to customers who are not using ARC’s underlying SoC hardware designs.

ARC’s new strategy will build on a better understanding of its customers’ needs by establishing two distinct businesses: the SoC solutions business and the embedded system software business. A new General Manager has been appointed to run the embedded system software business, while the SoC solutions business will be managed as a functional organization .

The USB product line has been a growing business for ARC. USB research and development work is scheduled to be completed at the end of Q2. At that time all hardware IP research and development will consolidate into our Elstree, UK location where we will continue our support of that product family.

Once these changes have been implemented, ARC’s quarterly cost structure (excluding depreciation and amortisation) is planned to decrease by 40% to the £3.8 million range by the end of 2004. At this level of cost, modest revenue growth should allow the company to reach breakeven and require significantly less cash usage than previously projected.

As a result, the company has taken an exceptional charge of £4.3 million in the fourth quarter related to the impairment of assets no longer in use and goodwill related to the acquisitions made in 2000. Upon implementation of the transition plan, the company expects to take a further charge in Q1 2004 in the range of £2.5 million.

SoC Solutions Business

This business will comprise some 75% of ARC’s revenues, and will combine its hardware circuit designs, principally processor cores and peripheral circuits, with the programming tools required to produce code for those circuits. Tighter coupling between these related components will ensure that customers see a better integrated, easier-to-use offering. Furthermore, this business will focus specifically on market segments where ARC’s offering is highly competitive, already well-established, and where we see the greatest opportunities for growth: digital media devices, and wireless and networking connectivity.

A significant strategic shift for this business will be its emphasis on partnering with external companies who provide other components for SoC designs in those same market segments. We will use our market focus as a means of combining other companies’ offerings with our own, thus further enhancing the combined solution offering.

Going forward, ARC will offer its customers a more complete solution while performing a smaller percentage of the underlying development itself, thereby growing revenues while reducing operating expenses.

Embedded System Software Business

ARC’s real-time operating system (RTOS), called MQX, is well-accepted by embedded system designers using Motorola and other processors, along with its protocol and security software stacks. As a result, this business has begun to migrate from its direct-sales model to a more effective channel partnering model, working with suppliers targeting the same areas. By focusing tightly on this particular market and continuing the channel transition, we expect to continue to grow revenues while reducing operating expenses.

Share Buyback

In May 2003, ARC completed a share buyback as a result of a full strategic review undertaken in association with its financial advisers, West LB Panmure Ltd. The Company purchased 162,413,705 shares at a strike price of 29 pence, amounting to a total consideration of £48.3 million (including expenses) that was returned directly to shareholders. Following the buyback, the company maintained a healthy cash balance and at the year-end reported £37 million on the balance sheet.

Product update

ARC Processors

ARC processors are synthesizable, configurable and extendible, enabling users to fully optimize the architecture for their specific applications. The newest processor, the ARC 600, is the industry’s smallest area and lowest power 32-bit RISC/DSP processor in its class and has been nominated for a 2004 Analyst’s Choice Award. ARC has secured more than 140 design wins since the processor family was introduced in 1998.

The next generation of ARC’s processor family will be announced in Nuremberg, Germany on February 17th at Embedded World.

USB portfolio

ARC is the recognized leader in the USB IP market. Several new versions of our USB product line were released in the course of the year; with further releases scheduled for the first half of 2004 to complete coverage of the full range of USB standards.

USB is now a popular input/output device used across most classes of consumer-oriented digital products.

Software

ARC’s real-time operating system, MQX, continues to be highly regarded by embedded systems designers using not only ARC processors but also several other prominent processor architectures including the Motorola ColdFire. As a result of the popularity of ARC’s software with Motorola processors, ARC has recently formed a close channel partnership with the Metrowerks division of Motorola, propelling ARC’s software revenue growth to record levels in recent months. Additional channel partnerships of this nature are planned and are expected to be the catalyst for accelerating ARC’s software revenue growth.

Customers

ARC won numerous new customers during the course of 2003. The company’s top 20 SoC customers include many of the world’s leading providers of integrated circuits or finished products in its target markets of digital media devices, and wireless and networking connectivity. Approximately half of ARC’s 2003 System-on-Chip revenue was achieved through customers in these high growth markets.

Royalties

Consistent with the success of ARC’s customers in these fast-growing markets, and the move into production of many ARC-based designs, the company has seen its royalty income increase rapidly throughout the year, culminating in a record 4th quarter.

Management

There were several management changes during the last few months of 2003, beginning with the appointment of three new members of ARC’s Board of Directors in September, and the concurrent resignation of three former directors.

The newly appointed directors are: Peter van Cuylenburg, who also serves as Chairman of the Board; Geoff Bristow, who also serves as Chairman of the Remuneration Committee; and Richard Barfield, who also serves as Chairman of the Audit Committee.

The three non-executive directors who stepped down are: Mike Risman, Dennis Millard, and Gregorio Reyes.

In December, ARC’s Chief Executive Officer, Mike Gulett resigned, to be replaced by Peter van Cuylenburg as interim Chief Executive. At the same time, Mike Morrissey was appointed Chief Operating Officer until the search for a new Chief Executive is complete. The search is well underway and the Board has identified and interviewed several candidates for the position of Chief Executive Officer, and expects to name the successful candidate before the end of the first quarter of 2004.

Group Headcount

At December 2002, Group headcount totalled 198 employees. During 2003, this was reduced to 174 as a result of changes to more closely align the cost structure with ARC’s business objectives. Changes announced today to the business model will result in a further reduction in headcount of approximately 20% by the end of 2004.

On behalf of the Board, I would like to thank the staff for their continued loyalty to the company and hard work this past year.

Outlook

ARC has achieved a strong position with customers in its three most important System-on-chip markets: digital media devices, and wireless and networking connectivity. These markets are forecasted by industry analysts to grow in excess of 20% per year from 2002 to 2006, and by 2006 over 80% of the SoC integrated circuits that use 32-bit processors are expected to be found in these three segments.

The semiconductor industry is showing signs of recovering from its worst-ever downturn, and total semiconductor growth is forecasted in the 20% range for 2004.

The structural and strategic changes announced today will decrease ARC’s quarterly cost structure by 40% to the £3.8 million range by the end of 2004. We are confident that ARC will benefit both from these operational improvements and from market conditions.

As part of the overall move to reduce costs and focus resources, the company is moving to half-yearly reporting in 2004, although we will update the market on our restructuring progress during the second quarter of the year. Following this change, the company will formally report the next set of results in July 2004.

Financial Review

Fourth Quarter ended 31 December 2003

Turnover

Total turnover for the fourth quarter was £3.0 million, up 18% from the third quarter turnover of £2.5 million and down 8% year over year (Q4 2002: £3.2 million). Prior to currency translation, with virtually all sales in US$, underlying turnover was up 26% sequentially and flat to Q4 2002. License income was 21% higher than the previous quarter at £1.8 million (Q3 2003: £1.5 million). Maintenance and service income was 11% lower than the previous quarter at £0.4 million (Q3 2003: £0.5 million). The number of designs being shipped by our customers and contributing to royalties increased significantly resulting in a 39% increase in royalties to £0.7 million (Q3 2003: £0.5 million). Within the turnover base, 20% of sales were in Europe, 74% in North America and the remaining 6% in Asia. From a product perspective, 34% were processor shipments, software sales represented 36% of turnover and the remaining 30% was peripheral products.

Costs

Cost of sales of £0.4 million increased 33% sequentially and increased 19% year over year (Q3 2003: £0.3 million, Q4 2002: £0.3 million) resulting in a gross margin of 86% (Q3 2003: 88%, Q4 2002: 89%). Total operating costs (excluding exceptional costs, amortisation of goodwill and depreciation) decreased by 4% sequentially and 10% year over year to £6.4 million (Q3 2003: £6.7 million, Q4 2002: £7.2 million).

The Company had 174 employees at 31 December 2003 compared with 201 at 30 September 2003. Research and development costs have decreased 10% sequentially and decreased 15% year over year at £2.8 million (Q3 2003: £3.1 million, Q4 2002: £3.3 million). Sales and marketing costs decreased 27% sequentially and 37% year over year to £1.6 million (Q3 2003: £2.2 million, Q4 2002: £2.6 million). General and administration costs at £1.6 million were up 45% sequentially and 60% year over year (Q3 2003: £1.1 million, Q3 2002: £1.0 million) due to currency translation expenses and other one-time charges.

Interest

Interest income decreased 11% sequentially and 68% year over year to £0.3 million (Q3 2003: £0.4 million, Q4 2002: £1.0 million) due to lower cash balances resulting from the share buyback.

Net Loss

The net loss prior to exceptional items was £4.9 million representing a sequential decrease of 16% and flat year over year (Q3 2003: £5.8 million, Q4 2002: £4.9 million). Loss per share prior to exceptional items increased to (3.54) p (Q3 2003: (4.20) p, Q4 2002: (1.63) p) as a result of the significant reduction in the number of shares in issue following the share buyback. Net loss including exceptional items was £9.0 million (Q3 2003: £5.8 million, Q4 2002: £4.3 million).

Cash flow and balance sheet

The net cash outflow from operations was £3.1 million (Q3 2003: £4.9 million, Q4 2002: £4.3 million). Capital expenditure was £0.5 million. . The movement in net funds during the quarter was an outflow of £3.2 million. Net assets at 31 December 2003 were £40.4 million, including net cash of £37.2 million.

Twelve months ended 31 December 2003

Turnover

Total turnover at £10.7 million was flat year over year prior to currency translation and down 8% from the previous year with currency impact (2002: £11.7 million). License income was £7.0 million (2002: £9.2 million). Maintenance and service income was £1.9 million (2002: £2.0 million). Royalties were £1.8 million (2002: £0.5 million). Within the turnover base, 24% of sales were in Europe, 66% in North America and 10% in Asia. From a product perspective, 37% were processor shipments, software sales represented 33% of turnover and the remaining 30% was peripheral products.

Costs

Cost of sales was £1.5 million (2002: £1.3 million), resulting in a gross margin of 86% (2002: 89%). Total operating costs (excluding exceptional costs, amortisation of goodwill and depreciation) decreased 8% to £27.1 million (2002: £29.3 million).

Total headcount in the business at 31 December 2003 was 174 employees compared with 198 at 31 December 2002. Research and development costs were down 5% to £12.4 million (2002: £13.1 million), sales and marketing costs were down 16% to £8.5 million (2002: £10.1 million) and general and administration costs were down 4% to £4.7 million (2002: £4.9 million).

Interest

Interest income was £2.4 million (2002: £4.4 million).

Net loss

The net loss prior to exceptional costs was £20.7 million (2002: £20.5 million). Net loss including the exceptional items was £24.6 million (2002: £22 million). Following a review of assets the company had an asset write down of £1.3 million and a goodwill impairment of £2.9 million.

Cash flow and balance sheet

The net cash outflow from operations was £17.5 million (2002: £19.6 million). Capital expenditure was £2.7 million (2002: £3.3 million). The movement in net funds was a £64.0 million outflow of which £48.3 million was related to the share buyback. On 2 April 2003 the court approved the reduction in share capital resulting in the cancellation of the share premium account, write-off of the accumulated deficit on the profit and loss account, creation of a distributable reserve of £73.5 million and the balance credited to a special reserve.

Shares in ARC International plc held through an ESOP trust are deducted in arriving at shareholders’ funds in accordance with UITF 38, which the company has adopted early. This is a change in accounting policy in 2003 and as such the comparatives for 2002 have been restated as if this policy was followed for that year.

Net assets at 31 December 2003 were £40.4 million (31 December 2002: £113.1 million), including net cash of £37.2 million.

Dividend

No interim dividend payment will be made in respect of the twelve months ended 31 December 2003.

Financial tables

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About ARC

ARC International is a provider of uniquely optimized SoC solutions for exceptionally competitive markets. ARC's IP solutions consist of user-customizable 32-bit RISC/DSP processor cores with integrated development tools, peripherals and software. ARC solutions help companies develop application-specific SoCs that are differentiated and highly competitve for the wireless, multimedia and networking/storage markets.

ARC introduced the industry’s first user-customizable 32-bit RISC/DSP processor core and the industry's first USB Hi-Speed On-The-Go IP. ARC’s turnkey embedded solutions, combining the processor core with a real-time operating system, development tools and peripheral hardware and software IP, enable developers to optimise the design and performance of their applications. ARC also supplies embedded system software, consisting of MQX RTOS and various protocol stacks for a variety of embedded processors. By providing designers with a single source for all major embedded silicon and software IP building blocks, ARC dramatically reduces their number of suppliers, thereby reducing cost, reducing risk and reducing time-to-market.

ARC International employs approximately 174 people in research and development, sales and marketing offices across North America, Europe and Asia. Full details of the company’s locations and other information are available on the company’s website, http://www.arc.com. ARC International is listed on the London Stock Exchange as ARC International plc (LSE: ARK).

Statements made in this press release that are not historical facts include forward-looking statements that involve risks and uncertainties. Important factors that could cause actual results to differ from those indicated by such forward-looking statements include, among others, market acceptance of the ARC technology; fluctuations in and unpredictability of the Company’s quarterly results; general economic and business conditions; regulatory policies adopted by governmental authorities; assumptions regarding the Company’s future business strategy; changes in technology; competition; ability to attract and retain qualified personnel; risks associated with the Company’s international operations; and other uncertainties that are discussed in the “Investment Considerations” section of the Company’s listing particulars dated 28 September 2000 filed with the United Kingdom Listing Authority and the Registrar of Companies in England and Wales. The Company disclaims any intention or obligation to update any forward-looking statements as a result of developments occurring after the date such statement was first made. In view of the many applications in which its Licensees may use the ARC products, ARC cannot warrant that those applications do not infringe the patents of others. ARC strongly encourages its Licensees to become familiar with the policies governing the use and licensing of intellectual property established by any organization whose standards the Licensee wishes to follow, and to review the list most standards-promulgating organizations publish, of entities that claim to have patents relating to the relevant standards or underlying technology.

ARC, the ARC logo, ARCtangent, ARCangel, ARCompact, ARChitect, ARCform, CASSEIA, High C, High C/C++, SeeCode, MetaDeveloper, MetaWare, Precise Solution, Precise/BlazeNet, Precise/EDS, Precise/MFS, Precise/MQX, Precise/MQXsim, Precise/RTCS, Precise/RTCSsim are trademarks of ARC International. All other brands or product names are the property of their respective holders.

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