Thank you for standing by. Welcome to the Arm Q1 Results Analyst Call. At this time, all participants are in a listen-only mode. There'll be a presentation followed by a question answer session, at which time, if you wish to ask a question, you will need to press Star and One on your telephone keypad. I must advise you this conference is being recorded today, Wednesday, the 23rd of April, 2014. I would now like to hand the conference over to your speaker today, Mr. Ian Thornton. Please go ahead, sir.
Thank you, Helen. Good morning, everybody. Welcome to this call. This is Ian Thornton. I'm the head of investor relations at Arm. On today's Q1 results conference call, we have Simon Segars, Chief Executive Officer, and Tim Score, Chief Financial Officer. On today's call, Simon and Tim will take us through the highlights and comments from the quarter's results, and then we'll open up the call to a Q&A session. As a reminder, the presentation and press release can be found on the Arm investor relations website at www.arm.com/ir. Before I hand over to the team, I just have to read out a few words with respect to this conference call and what we're about to discuss.
The content of this conference call are being directed only to those of you who have professional experience in matters relating to investment, and the information communicated on this call is being made available only to investment professionals. Any persons present on this call that does not have professional experience in matters relating to investments should not act nor rely on the contents of this call. The following conference call will contain forward-looking statements which are other than statements of historical fact. The company's actual results for future periods may differ materially from these statements as they are based on current expectations and are subject to a number of risks and uncertainties. On this note, I'll hand over to Simon.
Thanks, Ian. Good morning, everyone. After an excellent year for Arm in 2013, we're pleased to announce this morning that we've built on that progress in the first quarter with strong demand for Arm technology, leading to revenues, profits, and earnings in line with market expectations. Continuing demand for Arm products underpins our confidence in the long-term growth of the business. The first quarter of 2014 saw particularly strong uptake of Arm's most advanced ARMv8 processor technology with five licenses signed by four semiconductor companies. These customers are planning to develop chips for automotive infotainment systems, carrier networks, and high-performance computing. During the quarter, we saw announcements from Marvell, MediaTek, and Qualcomm on how they are developing multi-core ARMv8-based processors for use in mid-range and premium smartphones and tablets.
There were also announcements from Broadcom and Freescale, who plan to deploy ARMv8-based chips into data centers and enterprise networking equipment. ARMv8 is now the computing platform of choice for future chip designs, not just in mobile computing, but increasingly in consumer electronics, the data center, and networking infrastructure. As we've seen in previous years, Q4 and Q1 can be susceptible to inventory ebbs and flows, especially in chip sales into mobile devices where Arm has a very high market share. For example, our Q1 2012 was impacted by an inventory correction in late 2011. Q1 2014 looks very similar, with many semiconductor companies having reported sequential declines in Q4 2013, and this is reflected in our Q1 2014 royalty revenues.
In addition, the reported processor royalty revenue includes a one-off deduction of $5 million from one of our customers due to over-reported royalty revenues from prior years. Our Q2 royalty revenues will result from the sale of chips in Q1. It is common for the semiconductor industry to decline sequentially in the first quarter of the year, and market commentators generally regard the decline this year to have been similar to that of prior years. However, recent indications from the semiconductor industry and Arm's customers suggest that Arm will benefit from an improving industry environment in the second half. Arm's pipeline of licensing opportunities remains healthy for both Q2 and the rest of the year. Assuming the outlook for the semiconductor industry in the second half improves as generally anticipated, we expect group dollar revenues for the full year 2014 to be in line with market expectations.
Now I'll discuss the revenue drivers in the different parts of the business in more detail, starting with technology licensing. We signed 26 processor licenses in the quarter. These licenses were signed for a broad range of end applications from smartphones to enterprise infrastructure to wearable technology. Six of the licenses signed were for Arm's Cortex-A technology. This included five licenses for Arm's latest Cortex-A53 and Cortex-A57 processors, one licensee being a brand-new customer to Arm. Arm has also continued to see strong demand for our Cortex-M processors, which are used extensively in microcontrollers and embedded connectivity chips and smart sensors and can be found in most of the Internet of Things and wearable devices that have been announced to date. Eleven Cortex-M processors were licensed in the quarter, including four companies taking their first Arm processor license.
Finally, Arm signed four more Mali licenses and five more POPs during Q1. POP IP is physical IP that has been optimized to enhance the performance of Arm processors, including Cortex-A, Cortex-M, and Mali processors. Now I'll switch to the royalty side of the business. Arm's royalty revenues are reported one quarter in arrears, so our royalty for Q1 was generated from chips sold in Q4 2013. Underlying processor royalty revenue was up 8% year-on-year compared to relevant industry revenues increasing about 6%. Our customers reported that they had shipped 2.9 billion Arm processor-based chips. This 11% year-on-year increase represents an additional 300 million chips. Many of these additional chips went into enterprise networking and infrastructure equipment, and into microcontrollers that are embedded into everyday objects that are becoming smarter, such as watches, washing machines, touchscreen controllers, and the like.
We saw the sale of Arm-based chips into enterprise networking more than double year-on-year, Arm-based microcontrollers grow by more than 40% year-on-year. Arm continues to benefit from the sale of smart consumer devices such as smartphones, tablets, and digital TVs. Most of these products have an application processor based on a Cortex-A class processor, which typically has a higher royalty % per chip. We saw a 30% year-on-year increase in Cortex-A shipments. Many of these chips are replacing chips that were based on the ARM11 processor, which declined 40% year-on-year. Now I'll talk about the uptake of Arm technology into the market. Q1 is typically a very exciting time for companies within the Arm ecosystem.
Events such as the Consumer Electronics Show, Mobile World Congress, embedded world, and the Open Compute Summit give our customers the opportunity to demonstrate their new technologies that will be going into the products and services that we will be enjoying as consumers in the years to come. Having attended some of these shows personally, met with many of our customers and ecosystem partners, the impression I came away with was that the adoption of Arm technology is broader than ever, it is helping to accelerate innovation everywhere. As examples, as carrier infrastructure moves to heterogeneous networks, Arm is being used in new designs from small cells, to base stations, to virtualized networks and servers. As data centers and cloud computing companies look to optimize their services, opportunities for Arm-based servers are being created. We're now seeing the second generation of wearable and Internet of Things devices.
They are well thought through in terms of design, have good build quality of hardware, provide easy-to-use software services. This is still a very fragmented end market, but with many of the chips going into these devices being based on Arm, the benefits of our ecosystem make it easier for developers to create new products. We are seeing more innovation within mobile devices, too. Entry-level smartphones are now available unsubsidized for less than GBP 50, making them affordable for the largely untapped consumer markets in India, Africa, and South America. Premium mobile devices are becoming increasingly used in enterprise applications. With productivity software such as Microsoft Office being available for Arm-based computers, we anticipate further penetration of the enterprise. Finally, we have continued our investment in R&D and have grown the engineering teams working on advanced processors and graphics products.
We hired 120 people in Q1, we expect investment to continue in Q2. We were pleased to be named as one of the U.K.'s top employers in 2014 by the Top Employers Institute, based on independent research conducted by the Corporate Research Foundation. Arm's technology roadmap is developed and deployed by about 3,000 highly skilled and experienced engineers, and sales and marketeers, and professionals in the areas of legal, HR, IT, and finance. It's vitally important that we recruit and retain the best people, this award reflects our dedication to make Arm a great place to work. I now hand over to Tim, who'll provide further details on the numbers.
Thank you, Simon. Good morning, everybody. Simon's obviously given an overview of the key financials. I will provide a little bit more color on the numbers. There's obviously a lot more detail both in the release and in the normal quarterly slide set, which as Ian said at the beginning, is on our website now. As we've seen overall Q1 dollar revenues at just over $305 million, up 16% year-over-year, with strong growth in both processor and physical IP license revenues, which were up 38% and 30%, respectively. 16% dollar revenue growth translated into 10% year-over-year sterling revenue growth, as the dollar was weaker in Q1 2014 at $1.63 than a year ago when it was $1.55.
Processor license revenue of GBP 112 million, driven by both a large contribution from backlog and by strong terms business as we licensed 6 high-value Cortex-A class processors and 4 Mali graphics processors. Order backlog is down about 5% sequentially, with approximately 65% of Q1 license revenues coming from the backlog. As those who follow Arm closely will know, the typical contribution from backlog in most quarters is in the range of 40%-60%. Slightly above the top end this quarter as contract milestones were achieved on some of our advanced processors, thereby releasing revenue from backlog on a percentage of completion basis.
Looking at the expected conversion of backlog to revenue over the rest of this year, and the pipeline of licensing opportunities that are in view, we would expect order backlog at the end of 2014, at the end of this year, to be at a similar level as the backlog at the end of Q1. Backlog expected to remain broadly flat from here over the balance of the year. As Simon touched on, underlying processor royalty revenue grew 8% year-over-year. Slightly ahead of relevant industry, which grew around 6%. This degree of outperformance is lower than we have seen in previous quarters, mainly due to the unwinding of the inter correction that has been widely reported, and as Simon said, impacted many of our customers in the fourth quarter of 2013.
In addition, the reported processor royalty revenue includes a one-off deduction of $5 million from one of our major customers due to over-reported royalty revenue from prior years. Looking at the cost side, normalized OPEX Q1 was GBP 84.3 million, we continue to invest in the development of more advanced processors for computing servers and enterprise infrastructure. Given this ongoing investment in our R&D teams and in our business infrastructure, we would expect normalized operating expenses in the second quarter, assuming effective exchange rates are broadly similar, to be in the range of GBP 86 million-GBP 88 million. A quick note on interest income. You would have noted that in Q1, that was GBP 3 million.
Given the lower interest rates that are available on new deposits, I would expect the quarterly interest income for the rest of 2014 to be around the GBP 3 million mark or ever so slightly lower, despite increasing net cash. On the tax front, the normalized rate in Q1 was 18%, we are reiterating our guidance for the full year effective tax rate of around 18%, that level, as we continue to benefit from the reduction in U.K. corporation tax rates and the introduction of the Patent Box tax regime that we've talked about before. Normalized PBT in Q1 up 9% year-on-year. Earnings up 5%, which reflects the unusually low tax rate in Q1 2013, which was 16.5%. You may recall that Q1 2013 benefited from, if you like, two tranches of U.S. R&D tax credit.
U.S. government was late in legislating the 2012 tax credit, we got the first year of the 2013. In this particular quarter, Q1 2014, the U.S. government has not yet legislated the 2014 R&D tax credit. Our Q1 tax rate includes no U.S. R&D tax credit compared to last year, where it included two tranches, hence the Q1 rate being a little bit higher. As I say, full-year tax rate expected to be around 18%. Looking forward to the rest of the year really reiterating what Simon said earlier. Given the strength of the order backlog which remains at very close to historically high levels, and the licensing opportunity pipeline, together with the indications from the industry that the prospects for the second half look brighter than the first half, we would expect group USD revenues for the full year to be in line with market expectations.
With that, we'll throw open to questions.
As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Your first question comes from the line of Gareth Jenkins from UBS. Please ask your question.
Yeah. Hi. Thanks for taking the question. I guess a couple if I could. Firstly, I just wondered if you could talk about progress on 64-bit and some of the design activities that you're seeing and when you expect that really to have a meaningful impact on your business. We've obviously seen the first launches, and it's come to market in smartphones. I just wondered if you can talk about the progress there. Secondly, I just wondered whether, I think historically you talked about 19% growth or the higher end of your prior PD royalty revenue growth rates as a target for this year. Should we still expect that for the full year? Thanks.
Okay. Thanks, Gareth. I'll talk about your first part of your question there about 64-bit. If I could just generally ask people to ask one question at a time, then we'll be able to get around to everyone. Overall progress in deploying Arm version 8 of the architecture is going very well. We've had very strong licensing, as you've seen in the numbers here. We've seen a number of exciting product announcements from some of our licensees. At Mobile World Congress recently, we saw three key announcements from Qualcomm, from Marvell, from MediaTek, talking about Arm version 8 based chips for mid-range and high-end smartphones and tablets. Now, those devices will take time to conclude. They'll take time to get into product, take time to ship. I think we're in good track generally in terms of the deployment of version 8 of the architecture.
Yeah. On the royalty front, Gareth, you're right. At the beginning of the year, we said that we expected full year royalty revenues to be similar to we've seen in the last three years, which have been 18.5% last year, then 17.5% and 22%, which people averaged out and concluded was about 19. We remain confident
In full year royalty revenues. As you've seen, we've reiterated guidance for the full year. I think probably there are more industry data points that are supportive of the strong second half now than we had in early February. Yeah, we remain confident about full year royalty revenue growth.
Thanks.
Your next question comes from the line of Matt Ramsay from Canaccord Genuity. Please ask your question.
Yes, thank you very much. I guess on the printed quarter, either for Simon or Tim, I think many of us were expecting slower year-over-year growth in royalties due to the inventory correction. I guess I was a bit surprised in the narrowing out of the outperformance band versus the industry growth rate. Maybe talk a little bit about the narrowing of that band. I guess maybe naively, I expected the sort of market data from Q4 actuals for the industry to sort of mimic what your performance was, and it seems that magnitude of outperformance narrowed a bit. Any help there would be appreciated. Thanks.
Well, these things do ebb and flow based on how the market's performing based on mix, based on a variety of factors, and it is something hard for us to call exactly what's going to happen. I mean, overall, we've seen an increase in volume, 300 million more chips in Q1 than a year before, and that is still ahead of where the market is. The outperformance comes as we gain market share, as more Arm processors per device are put into end products. We've seen very strong growth in the microcontroller end, of course, which is a sort of one for one kind of relationship because of the more simplistic nature of those devices. We're continuing to grow market share there. That outperformance is going to change from quarter-to-quarter.
We're going through this period of inventory correction at the moment, we would expect in the longer term to get back to more sort of normal levels.
I think Simon referred earlier to the inventory correction in the first half of 2012, where I think our outperformance actually was very similar to ones we've been experiencing. Looking at the sort of medium-term outlook, we see no reason to change our guidance, and looking at history of our overall outperformance, we continue to see a similar picture going forward.
Great. Just as a maybe unrelated follow-up. On the licensing side, I noticed in the slide deck the long-term CAGR guidance was taken from high singles to 10%. Maybe it's sort of a tiny move, but a nitpick in a positive direction. Maybe you could talk a little bit about the reasons for that longer-term guidance change and if you still expect the 2014 licensing to outperform that longer-term range, even with the backlog change and being down in the quarter for the first time in a bit. Thanks.
Yeah. I think we've been very consistent in saying that we don't see 30% license revenue CAGR as being the norm. We have consistently painted a picture of sort of medium-term license revenue growth around the 10% number. There's no real change there. I mean, high single digits, 10%, I think it's sort of a little bit in the noise. I think the question is, what does the transition look like from the 30% growth that we've seen to the, let's say, broadly 10%? Certainly as part of that transition, we would expect license revenue growth in 2014 to be quite well ahead of that medium-term guidance.
I think as the business model develops further, we do believe that we almost sort of revert to a situation where royalty revenues are growing faster than license revenues, which is obviously not a position we've seen in recent quarters.
Thanks very much.
Your next question comes from the line of Sandeep Deshpande from J.P. Morgan. Please ask your question.
Yeah. Hi. Thanks for letting me on. I'm trying to understand within your business in smartphones and tablets, I mean, from what we know in terms of the inventory correction is that there has been a slowdown in the high-end handset market, but the low-end and mid-end handset market is continuing to do very, very strong, be very strong, and we can see that, for instance, in MediaTek's numbers. Can I try to understand from you, as you understand it, why that low-end, mid-end strength is not being seen in your royalty revenues?
Well, I think it is. I mean, the volume growth year-over-year is quite high. We're seeing a mix of devices. When we talk about inventory correction, we're talking about that going across a range of markets, not just being about handsets. As you say, the entry level end of the market is performing well. We think that is a market that is very valuable to Arm and additive to what we're doing. It's going to create a whole load of opportunities for more technology over time as that trend really takes off and people start using those phones and using them to interact with other devices. I think to your question, we are seeing the positive benefits of that. It's just offset by the trends in many other markets.
Okay. Thank you.
Our next question comes from the line of Andrew Gardiner from Barclays. Please ask your question.
Good morning. Thank you. Actually, my question is related to the last one as well. If we look at the mobile units within your mix, they were flattish year-over-year. Your overall royalty revenue's up 8% year-over-year, and you've highlighted that a lot of this, or some of this can be attributed to non-mobile growth. Given that, again, you pointed out microcontrollers, it's one for one, it's a lower royalty generator. Can you help us a little bit in terms of the pricing that you're seeing within mobile? I know it's a sensitive topic, but just in terms of the impact from steady increases in Cortex-A class and in particular 64-bit in the metrics. Is this pricing trend something that we can expect to see continue later in the year?
Well, broadly in mobile, we've seen pricing being fairly flat over the last little period. In terms of the rollout of the A, we're still at the very early stages of that. There's very few devices that actually contain that right now. This is about mix. We're seeing lots of integration of devices at the low end, at the mid-range. We're seeing single core devices with multi-Arm processors and integrated modems and connectivity in a single device. There are lots of parameters moving around here.
Thank you. Just quickly, on one of the slides that is a regular feature in the deck. You're talking about page 11, the licensing driving market share. Just looking at the number of companies re-equipping in terms of licenses in the quarter. You're highlighting five there for one Q in total, whereas for the full year last year, it was only about 12. It looks like this trend continues or is even accelerating if we look at one Q. Can you help us with any color around those trends?
They don't continue in that. You look at the number of licenses we signed in the quarter, 26. That's quite high. We're seeing continued uptake of the technology across a wide range of end markets. To us, that's business as usual.
Okay. Thank you very much.
Our next question comes from the line of Adithya Metto from Bank of America. Please ask your question.
Morning, guys. Thanks for taking my question. My first question is on the backlog. I would have expected your backlog to have gone down as you go through 2014, as you recognize the ARMv8 licenses. You're saying it's going to remain flat, basically implying that your licensing pipeline is very strong. I was just wondering if you could provide some color on your licensing pipeline and on the puts and takes on the backlog as we go through the rest of the year.
Yeah. I think it's worth pointing out that the ARMv8 licensing cycle is in its relatively early stages. We've done sort of 30 licenses plus compared with well over 100 in ARMv7. We're still going to be signing licenses through the back end of this year for processors that are already in, if you like, announced, that are going to drive some level of backlog as well as turns business. Of course, generally, as you know, our technology roadmap is a continuum whereby we are regularly bringing out new processors. At the appropriate time, we'll be announcing new processors that as they start to get licensed, will also be driving backlog. Our commentary obviously comes from insight into the planned engineering work that will achieve contract milestones and release revenue.
Also from insight into the discussions that we are having and expect to be having during this year that generates both turns and backlog revenue. It's a kind of a bottoms-up analysis. Again, there are many moving parts to the relationship between backlog and license revenue. Our overall view of that is that we end this year with a backlog very similar to where it is now.
Okay. Thanks very much.
Your next question comes from the line of François Meunier from Morgan Stanley. Please ask your question.
Yes. Hello, guys. I'm afraid I have to ask a question again about the backlog, Tim, because this is probably the first time in a very long time that you've been so specific about guiding for backlog to go down year-on-year. I mean, 5% is nothing. How should we read this? Is it your cautiousness about this number? As we've seen in the past 2 years, growth has always been much stronger than what you are trying to lead us. Is it extra cautiousness, or are you really reading something different this year? Shall we really forecast for 8%-10% growth in licensing revenues and maybe less next year?
Well, as you know, the order backlog has gone up significantly and consistently over the last couple of years. I explained earlier that we envisage a transition from 30% license revenue growth to somewhere closer to 10%. As part of that process, I think the backlog sort of levels out and doesn't keep growing significantly. I think the reason we've drawn this out today, that obviously with a 5% sequential drop and it being relatively flat last quarter, you could take away from that we could expect a series of quarters where the backlog will be on a downward trend. We don't see that. The point we're making today is that we actually see the backlog being similar at the end of the year to where it is now.
Which is at historically high levels and supportive of continued license strength, but not at the 30% plus CAGR.
Basically, if I conclude, if you have licensing growth slowing to, say, 10%, which is still extremely good, and royalty growth around 15%-20%, then the average growth for the company is more in the tune of 15% then, long term.
That would be an analysis. As I said earlier, I expect us to revert to an environment where royalties, as you say, are growing in mid-teens and above, and licensing is growing at broadly 10%. That's driving earnings growth in the future, similar to that which we've seen in the past.
Okay. Thank you, guys, see you another day.
Thanks.
Thank you.
Your next question comes from the line of Achal Sultania from Credit Suisse. Please ask your question.
Thanks, guys. On the chipset pricing trends, especially in the smartphone market, in the last couple of years, we've seen very aggressive pricing in the lower end of the smartphone market. Guys like MediaTek and Spreadtrum. How should we see that trend evolving as we see actually more and more higher-end processors being used even in lower-end devices? The use of octa-core and quad-core processors in lower-end devices. Are you seeing some level of moderation in chipset pricing from your customers?
Well, as I said earlier, we've seen chip pricing stabilize across the spectrum of entry-level to high-end over the last little while. Generally, the trend is that existing chips get cheaper and customers introduce new products with greater functionality to help reset the pricing and provide more value. I see no reason why that trend wouldn't play out here in smartphones, no matter where they are in the spectrum of performance.
Just an update on Mali. Obviously, I think you gave a number of 400 million units last year. Have you given any color around what the number is for Q1 or what the target is for full year 2014?
Well, in the Q4 results, we said we expect between 500 and 600 million units of Mali in 2014. We haven't given a breakout of the numbers in Q1, but we believe we're on track to achieve those kind of levels.
Thank you.
Your next question comes from the line of Sumant Wahi from Redburn Partners. Please ask your question. Mr. Wahi, your line is now open. Please ask your question.
Hello, can you hear me?
Can indeed.
Hi. Sorry, I don't know what happened there, but thanks for taking my question. I have two quick questions. One's essentially on the royalty you guys should achieve on licensing in the Internet of Things and the server market, essentially. The two other buckets outside of smartphones. Essentially, your licensing has been fairly strong in the past, and you still guide to about 10%, but my understanding is that probably a bigger proportion of the licensing demand will now be coming from the non-mobile traditional sector. My question is that do you still believe that your royalty revenue per license should remain at the similar levels to what we saw in the smartphone side? Or should we be assuming a lot more licensing for a similar level of royalty?
I just want to kind of temper probably my own enthusiasm on how I should extrapolate the strong licensing into royalties over the next three to five years. That's my first question.
Okay. I think in terms of the financial structure of our contracts, there's been no significant changes in that. The kind of rates that we've established in the market over the last 20 odd years at Arm kind of pertain for the future. What we've seen historically is as we sign license deals, customers typically have a first end product in mind, but then often use the same license for multiple different designs. You get a kind of fan out of one license driving multiple products and hence multiple royalty streams into Arm. Again, I see no reason why that wouldn't continue. At any moment in time, we're licensing big companies with multiple product lines who over time will find uses for the technology that nobody anticipated when they signed a contract.
We're licensing small companies who are starting up and just have a single product line and are trying to establish themselves in the market. I don't think that mix has fundamentally changed over the last little while. I would expect to see a sort of future in terms of how licensing translates into royalty to be very similar to how it's been in the past.
I guess the reason I was asking that is because in the smartphone industry, at least the chip suppliers are quite consolidated, whereas in the rest of the market, there is a lot more fragmentation, I guess. I see you still believe it should remain at similar levels, right?
Yeah, I think that's all about the point in the life cycle of a market. Once upon a time, there were lots and lots of companies licensing ARM7 to build GSM basebands, and that consolidated down into a smaller number. We've seen the number of people who are developing chips for smartphones increase and then consolidate down. We'll see other waves of that, I'm sure. We're at a wave of that in IoT right now, clearly, where there are lots of companies looking to develop products for that market. Now it's a very broad market, so it probably does support lots of people doing it. You'll see similar trends in other markets, such as servers. I think, again, that's all about the cycle where we are in the lifetime of any particular class of product.
Okay. Just very quickly, my second question is, listening to the recent conference call comments from TSMC, ASML, et cetera, it suggests that your ecosystem players, the foundries are spending a bit longer time at 20 nanometer versus transitioning into 14, 16 nanometers. I'm just wondering, in your view, is this more of a reflection on the demand environment, in essence, the stay on Internet of Things and just low and medium phone demand? Or are you at all worried whether your ecosystem has currently the capability of moving to 16/14 nanometer in time to compete with Intel?
The short answer to that last part of the question is no. I think there's a lot of activity going on around the development of FinFET technology, the proving out of the technology, the creating of design environments so people can build chips. To me, that all seems to be progressing very well. I think what you'll see is some of the older technologies, particularly 28 nanometer, stay around for a long time and maintain applicability as the cost goes down in a wide range of markets. Again, this is in some ways nothing new. FinFETs introduce a whole new load of technology challenges. They're new to the industry, but the industry is very well set to address these and bring these new technologies to market. Again, that's about timing.
I guess if Intel is already there, I'm just wondering whether you still believe that on a performance power ratio, you would be competitive with them in the next two years as well.
They're there for building highly integrated SOCs, and that is what the foundry industry does well in terms of bringing technologies to market. I am confident that our foundry partners will do that for FinFETs and beyond.
Thank you very much.
Thanks.
Your next question comes from the line of Andrew Dunn from RBC Capital Markets. Please ask your question.
Thank you very much. Good morning. If I could ask something just around enterprise networking. You're obviously seeing very strong growth there from a low-ish base, and you indicate a number around 150% growth rate for this period. Could you just perhaps give us a little bit more detail into what's driving that growth, what sort of IP you're selling into that market, and perhaps which segments you're seeing particularly good growth in in that new market for you? Thanks.
Yeah, as you say, the uptake of Arm into enterprise networking has been very strong. The units in Q1 are more than twice that of the year before. It's in a range of end markets. What we're seeing is generally with the increased bandwidth requirements as 4G smartphones and tablets are deployed, that is driving generally an upgrade in the network. As we see more and more smartphones deployed, that's going to drive a further upgrade. People are looking at the long term. They're looking at what processor architecture to base the future on. Given the strength of the Arm ecosystem for a lot of those companies, they're concluding that Arm is the right choice to make. We're at the early stages of deployment into this market, but progress is very good and growth is good.
Where we are seeing the technology, there's a lot in mobile infrastructure. Both small cells and large cell base stations in wireline, in corporate networks, and in the more sort of conventional access point technology. It's across a broad range. We've seen a couple of recent announcements. We've seen Freescale, in terms of what technology they're using. The products that they announced recently are based on Cortex-A57, one of their products using eight cores. We've seen similarly very high core count devices from LSI. We've seen announcements from Broadcom recently in terms of using the Arm architecture for very high-performance devices. Many companies, in fact most of the suppliers into this market are using Arm technology, and we're very pleased with the progress.
Brilliant. Thank you.
Your next question comes from the line of Johannes Schaller from Deutsche Bank. Please ask your question.
Hello, thanks for taking my question. If I look at your outperformance over TSMC, which is obviously quite important data point. Q4 now for your Q1 royalties, you've actually nicely outperformed here. If I take TSMC's Q2 guidance and also what they said on the second half of the year, to me, it looks like that your royalty guidance actually looks relatively achievable from that cyclical semiconductor recovery perspective. I was just wondering if you could give us maybe a bit more color on what you're assuming in your guidance, the kind of 19%-20% in terms of structural drivers like higher royalty rates from v8 or big.LITTLE and share gains in networking. If you think you're more conservative here or what is kind of baked in from the structural side into that guidance. I have a quick follow-up if I could.
Well, it's good it's a quick follow-up. No, I think in guiding royalty revenue growth for Arm over any period, we're obviously factoring in a number of things. One of them is the industry environment. We're seeing the same data points that you're seeing in terms of the expected improvement in the second half. Recent TSMC guidance would be a very specific but supportive data point. Clearly, we're looking at the trajectory of percentage per chip that we will be earning on these devices. Again, in the sort of smartphone, mobile, and most markets, in fact, that is on an upward trajectory. It's a continuum. Simon said earlier in v8 we're at the very early stages. That's a story that's going to unfold over a number of years.
We're obviously taking into account all of the factors that you would imagine we need to, in terms of trying to forecast where our royalty is going to end up. That's what brings us to the conclusions that we discussed earlier about the likely full year royalty growth.
Understood. Then a follow-up quickly. Just some gross margins were actually quite good in terms of year-on-year improvement in Q1. I think last year they were on average flat. If you could maybe give us a bit more color on what drove the improvement and how we should be thinking about gross margins for the rest of the year.
Gross margin is a very difficult number. It basically moves within a very tight band of 94.5% to high 95s. On a quarterly basis to assess where it fits within that sort of 1% band is quite tough. Suffice to say that on a medium to long-term basis, as royalty revenues grow and drop through to the bottom line, then we would expect gross margins to stay in the mid 90s and if anything, edging ever so slightly up.
Got it. Thanks very much.
Your next question comes from the line of Amit Harchandani from Citigroup. Please ask your question.
Good morning. Amit Harchandani from Citigroup, thanks for taking my question. My first question is really in terms of competitive dynamics. We have heard one of your major competitors talk about making strong progress and even using sort of a contra revenue philosophy to make inroads. I'm wondering what you're hearing from your customers or what your sales guys are picking up from your customers in terms of how they are thinking about evolving competitive dynamics in the mobile space. That would be my first question.
Well, in terms of what our customers are seeing is, in a lot of ways, unchanged. Our customers are focusing on competing with each other and competing with anybody else who's targeting the space, which of course is large and has a lot of potential for profit in it. Everybody wants to build the most highest performance, most power efficient processor they possibly can. We maintain deep conversations and relationships with our customers about how our roadmap develops, how their roadmap develops, and making sure that the features in our products and the specifications of our products are best suited for the end markets that our customers are targeting. That hasn't changed in the length of time I've been at Arm. Everybody wants to produce the best thing. Everyone's driving very hard for the best technology. In that competition is always good. It keeps everybody innovating.
It keeps everybody focused on differentiation. That's a good thing for Arm, and it's a good thing for our customers as well. I think the fact that some of our competitors are using mechanisms other than just straight technology to compete in the market, just means that everybody has to work hard to have the best product out there. Ultimately, through our business model, it creates a lot of choice, and it creates a lot of differentiated devices. Ultimately, consumers can choose which ones are the best and which ones are the most successful.
Thanks, Simon. Maybe as a quick follow-up. In terms of architecture licensing, just philosophically, when you look at v7 versus v8, do you see any change in the way customers are embracing architecture licenses? Do you think it's being viewed much more favorably as a means for maybe greater differentiation? Just if you have seen any difference in the trend for adoption of architecture licenses, v8 versus v7.
Well, I don't have the exact numbers off the top of my head, but certainly there were more architecture licenses earlier in the lifetime of v8 than there were in v7. That was driven more about addressing different markets. Most of the early architecture licensees for v8, in fact, most of all the architecture licensees for v8 have been looking at markets that Arm hasn't traditionally served with our own base products. They wanted to get to market very early. Some of the early guys took an architecture license. Companies like Cavium, companies like Applied Micro, who really wanted to target the enterprise space, the data center, high-end networking, which wasn't where Arm had traditionally played. That was a vehicle to enable them to get into that market using Arm technology.
That's been a great vehicle for us because it's allowed us to broaden the penetration of the Arm architecture into new markets. We see that as part of our strategy for long-term growth. We never sort of sit back and look at the numbers and worry about that at all. It's part of our business model that allows for very broad adoption of our technology, and that's only a good thing.
Great. Thank you, Simon.
Thanks.
Your next question comes from the line of Lee Simpson. Please ask it from Jefferies. Sorry. Please ask your question.
Thanks. Good morning, gentlemen. Just two from me. First of all, I wonder if you could update for us the adoption of Arm's SBSA spec for v8-based server SoCs, especially as it relates to names like AMD and AMCC. Does this present a real design accelerator for FY 2015 and 2016 for these early adopters? Or is this more a means to see other typical Arm SoC makers coming in for late 2016 and beyond. Maybe as follow-up, we noted, I think last week, that Arm and Samsung have joined the board of the FIDO Alliance. Just wanted to understand if this is an accelerator for TrustZone adoption, and what sort of roadmap plans you might have for TrustZone vis-à-vis mobile payments and maybe the FIDO Alliance use of passwords.
Okay. In terms of SBSA, the main purpose of that work was to accelerate the deployment of SoCs into the data center. The great beauty of the Arm model is that every customer of ours can design a chip that's different from any other customer. When it comes to enterprise software, though, there's great benefit in having some of the system architecture that is actually not differentiating standardized, so it's easier for software developers to write code that's going to run on these chips. SBSA was all about standardizing the right points of the chip to accelerate software development and hence accelerate deployment of real systems. It's less so about SoC development as it was about software development. We've seen the uptake of SBSA in the SoC architecture by a number of our licensees. Those chips are coming to market now.
With a more clearly defined target architecture for software developers to work to, we should see more Arm deployments in Arm-based servers sooner. That's what that was all about. FIDO, as you say, again, it's an industry body that's about standardizing in the right way so that people don't reinvent the wheel the whole time, and burn their effort on things which are ultimately non-differentiating. Very much akin to the Arm business model. It's enabling people to spend their R&D differentiating in the right areas. We've, for a long time, seen that security in embedded devices is really important. We started work on TrustZone more than 10 years ago, and are now starting to see that as a technology, it's really, really important.
FIDO, as an industry body, is one of the many industry bodies that we work with to drive acceleration and standardization in the right places. As a growing area of mobile payments, it's important, and that's why we're contributing to it.
Perfect. Thank you very much.
Thanks.
Your next question comes from the line of Vijay Anand from Espírito Santo. Please ask your question.
Morning, guys. Thanks for taking the question. I just wanted to go back to the backlog discussion, and I was basically hoping you could talk a bit more about your product roadmap. It has been roughly 18 months since you launched the A53 and A57. My question is, based on your current thought process and customer discussions, at what point would you be looking to launch sort of the next generation of v8 processors?
Well, we have, with Cortex-A53 and Cortex-A57, lots of designs in flight right now with our customers. We have a healthy set of sales opportunities ahead of us for those products, and I think we're going to see them very broadly deployed. We are, of course, always talking to our customers about the next generation, about what learning we can take from the deployment of the current products. What new design opportunities there are out there, and how we can further optimize our products to take best advantage of these new opportunities. At the right point in time, we'll go public on those and talk more broadly about what we're doing. For now, they are NDA discussions with our customers.
All right. As a quick follow-up, I understand you said that chip pricing in mobile was relatively flat, but I was wondering if you can talk about the royalty revenue per unit in mobile. How did that trend in Q1?
Yeah. Overall, it's moving up. We're seeing more and more chips with using multi-core devices. We're seeing the volumes of Mali, as we were talking about earlier, going up. The attach rate of Mali in mobile devices is increasing. Overall, there is an upward trend on the royalties per mobile device that we're receiving.
Are you able to give us a figure?
Not today.
All right. That's clear. Thank you.
Thanks.
The next question comes from the line of Alex Gauna from JMP Securities. Please ask your question.
Thanks so much for taking my question. Good morning. I was wondering, you've given a lot of helpful information around ARMv8, and you just touched on royalty revenues now. I'm wondering, seeing as how you've seen a faster than typical uptake of ARMv8, does that also imply in the latter part of this year perhaps a faster than typical pull into the royalty impact from ARMv8? For the full year in terms of getting to normal type of average of royalty growth, are you more optimistic about unit volumes or about royalty rates continuing to improve sequentially as they have here in the first quarter?
I think based on what we see going on in the industry, what we're seeing being reported, I think we're certainly more optimistic about units. In terms of the uptake of ARMv8, that has certainly been strong. It's been more rapid than it was at the early stages of ARMv7, and ultimately, with higher royalty rates there, that will start to go through. That is a trend that I think we'll see play out relatively slowly. Given the volumes of Arm chips, given the large numbers of microcontrollers based on single core ARMv7 devices, you need to ship an awful lot of something else to really see the noticeable effect come through. We always view our royalty streams as built up of multiple layers.
The ARMv8 layer will start to grow, and it's probably into next year before we start to see that in a real meaningful way. The trends are definitely in the right direction.
Okay. GlobalFoundries and Samsung have announced collaboration on 14 nanometer. Their timeline seems relatively aggressive. I'm wondering how involved you are in that, how optimistic you are about them hitting their targets, and then similarly, when that really starts to work its way into benefiting you.
We have worked very closely with both Samsung and GlobalFoundries for a long time in working on physical IP to support their foundry businesses. We have a range of IP that is targeted for both companies' technologies. I think the collaboration between Samsung and GlobalFoundries is a very good thing for the industry. It's going to provide more manufacturing choices, especially with leading-edge technologies. I would hope that a lot of our physical IP is used by the foundry customers who adopt those processes. This represents a further opportunity for us.
All right. Thank you.
Your next question comes from the line of Dan Gardiner from Arete. Please ask your question.
Good morning, guys. Thanks for taking the question. In terms of licensing, what are the next generation technologies that you think Arm still needs to develop and license beyond what's available today in ARMv8? Can you give us a sense of what specifically you're focused on and whether employee hiring is currently taking place?
Well, as we said in the report, a lot of the employee hiring is going into developing next generation products. A lot of it is going into our processor developments, generally, CPUs, GPUs. Also we're hiring into all the other teams who create all the other supporting technologies, the software compilers, the physical libraries to allow optimized implementations, and so on, and support our customers. We are recruiting across the board to allow us to successfully deliver on our roadmap and support our customers in the adoption of that technology. In terms of what's coming next, can't really talk much about that today.
suffice to say, as we look at the adoption of Arm in the data center into networking, into the continued opportunities that come from mobile, there are new technologies coming, new ways in which we can see for making these products more and more efficient in terms of their power efficiency, the way they use resources, the way they connect to networks. We see a lot of opportunities ahead to develop new products which will help drive further licensing and ultimately help make better products that we as consumers enjoy.
Okay, thanks. As a follow-up on Mali, one of your competitors here talking about benchmarks which demonstrates significantly better power efficiency, particularly in gaming applications. Clearly you're still expecting to gain share in Mali this year, but do you acknowledge that there's further work to do here in terms of the technology to make Mali competitive again?
Well, I think there will always be work to do to make these products better. I think Mali is very competitive. We're seeing very strong uptake of Mali into many mobile devices. That's because the technology is very good. The graphics processors can occupy quite a significant area in an SoC, so there is always work to do to try and make them more efficient as the demands for GPU compute performance goes up and up. Again, this is an area where I think the industry has many generations ahead of it to provide scope for further optimizations and make products better.
Great. Thanks.
Your next question comes from the line of Jerome Ramel from Exane BNP Paribas. Please ask your question.
Good morning. Can you hear me?
Yes, we can.
Yeah. Question. How far do you think the spec of the application processor in a smartphone will go? Beyond octo-core 64-bit, what kind of performance do you think eventually we need in a smartphone for, let's say, 80% of the usage?
That's a very hard question to answer because one of the beauties of smartphones is that the software development environment is so open. As new features are brought out into the hardware devices, software programmers all over the world, big companies, small companies, individuals working out of their basements, can write code, write applications that exploit the technology. That helps create a pool for more devices. We've seen applications come up that rely on smartphones that nobody was thinking about five or 10 years ago. I don't see that that trend is going to change anytime soon. I wouldn't want to call when enough is enough in terms of performance.
I think the way that applications have developed and the way people use technology has a lot of innovation left in it, and I think there'll be many, many generations where we're looking to provide more performance in different ways to make these devices more efficient because software developers will keep thinking of new ways to use them. As more and more sensors get embedded into these smart devices, that further creates an opportunity for new applications. I don't see the ingenuity there running out of steam anytime soon.
Thank you very much.
I think at that point, we'll take one more question, if that's okay.
Your next question comes from the line of Janardan Menon from Liberum. Please ask your question.
Hi. Good morning. Thanks for squeezing me in. Just two small questions, if I may. One is, can you give us an update on the server market? Where are you in terms of the ecosystem? Roughly by when do you think we can see commercial shipments of Arm-based servers? Is that something we can see before the end of this year or is that likely to be more a 2015 phenomenon? A second question is on enterprise networking. Just going back to your answer to a previous question where you saw 150% growth. I'm just wondering, since that's quite a wide market, which goes from low-end stuff like network interface cards all the way up to base stations, routers, et cetera. The growth that you're seeing, where is it coming from?
More specifically, in the current quarter, in the reported quarter, was that a positive to your GBP 0.047 of average royalty per unit? Is it already adding to that? Is the big additions going to come as you see more and more shipments to the switch and base station markets going forward?
Okay. Let me just briefly talk about servers. I think progress there is good. We're starting to see silicon devices. We're seeing a lot of effort go into software development for Arm-based servers. Recently, as an example, we just saw Oracle introduce Java SE which brings Java to many Arm-based devices, and that's very important technology for servers. Again, SBSA as a vehicle for accelerating software development is also very important. I think we'll start to see commercial deployments later this year. I've been saying that for some time. I still think that's on track to happen. We'll start to see volumes start to take off, I think, probably next year. I do expect to see commercial deployment this year. On enterprise networking, you mentioned there's a whole wide range of end markets that could be targeted and where are we seeing success.
It really is across the range. We've been in routers for a long time, more kind of commercial grade. We are starting to see use of Arm in switches, in base stations, big base stations, small base stations. It really is across the board. In that enterprise space, that is something that is very positive for our blended average royalty rate, and we are seeing the effect of that. A lot of the bigger chips, as I was saying, are using multiple cores. There are large numbers of Cortex-A15s being used, for example, in some of the bigger chips today, and that obviously has a positive impact on the royalty rate per chip and the average. Again, given the volumes, this is one of those things where every little helps and makes a small change. As volumes grow, we are starting from a low base.
We will see that become more of a factor, that is probably for years to come.
All right. Thank you very much.
Well, with that, thank you very much for joining us this morning, we will see you all on the road and at the Analyst Day on the 20th of May. Thanks very much.
Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for participating.