Thank you for standing by, and welcome to the Arm Q1 Results Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone. I must advise you that this call is being recorded today, on Tuesday the 23rd of April, 2013. Let me hand the conference over to your first speaker today, Ian Thornton. Please go ahead, sir.
Thank you, Oksana. Good morning, everyone. This is Ian Thornton, VP of Investor Relations at Arm. On today's Q1 results conference call, we have John Buchanan, Chairman, Warren East, Chief Executive Officer, Tim Score, Chief Financial Officer, and Simon Segars, President and CEO Designate. On today's call, John, Warren, Simon, and Tim will take us through the highlights and comments from the quarter's results, then we'll open up the call to a Q&A session. As a reminder, the presentation and release can be found on the Arm Investor Relations website at www.arm.com/ir. Before I hand over to them, I just have to read out a few words with respect to this conference call and what we're about to discuss.
The contents of this conference call are being directed only to those of you who have professional experience in matters relating to investments, the information communicated on this call is being made available only to investment professionals. Any persons present on this call who does not have professional experience in matters relating to investment should not act or 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 that note, I'll hand over to John.
Thank you, Ian. Good morning, and welcome everybody. I'm John Buchanan, the Chairman of Arm. Thank you for joining our Q1 2013 results conference call. As you will be aware, this is the last time that Warren will be reporting Arm's results, as he'll be retiring as CEO at the end of June. Simon Segars, who joins us on the call today, will be taking over as CEO from July the 1st. As you will hear, these are another strong set of quarterly results delivered by Warren and the team. More importantly, for a long-term business such as Arm, these results are part of the foundation for Arm's future growth opportunity. In a moment, I will hand over to Warren.
He will run through the business highlights before handing over to Simon to say a few words. Tim will then provide some more detail on the numbers. As usual, I expect we will cover much of the content in the Q&A. Warren, over to you, please.
Great. Thank you, John. Good morning, everybody. After an excellent year for Arm in 2012, we're very pleased to be starting 2013 in this way this morning, where momentum has continued into the first quarter of 2013. There are some very healthy indicators that underpin the long-term growth opportunity for our business in these results. As consumer electronic and embedded devices are increasingly becoming smarter and more connected, we're seeing our customers choosing Arm's technology for high performance and low power, and the demand is driving both our licensing and our royalty revenues. In the first quarter, we saw particularly strong uptake of our most advanced Arm version eight processor technology. Our customers are licensing this technology for use in smart mobile devices and computers.
The continued growth of the smartphone and tablet markets, along with the substantial demand for technology in other end markets like microcontrollers and digital TVs, has helped increase our royalty revenues by 33% year-over-year this quarter, that was significantly ahead of the overall semiconductor industry. Before we get too carried away, it's worth noting that in that year-over-year growth, we're comparing with a relatively low base, that's because royalties in Q1 2012 were, you might recall, adversely impacted by a semiconductor inventory correction, that was particularly biased towards the mobile industry. That said, much of Arm's outperformance versus the semiconductor industry was based on our partners continuing to grow their market share.
The revenue momentum has enabled us to grow earnings by 58% in Q1 at the same time as continuing to invest in our R&D capability, hiring people, enhancing our ability to innovate and develop new products. As we look forward, we note that the semiconductor activity in the first quarter, which of course is the relevant shipment period for our Q2 royalties, was down by about 10%. In this context, we expect our revenues for Q2 to be in line with current market expectations. Although, of course, there's still some uncertainty in the wider macroeconomic environment. Nevertheless, we expect group dollar revenues for the full 2013 to be at least in line with current market expectations. I'll just delve into a little more detail on the revenue drivers in different parts of the business, we'll start with licensing.
We signed 22 processor licenses in the quarter. They were signed for a broad range of end applications, going from smartphones and mobile computing through to digital TVs and wearable technology. Half of the licenses signed were for Cortex-A technology. This included seven licenses for our latest Cortex-A53 and A57 processors. We continued to see traction in enterprise networking, signing a further V8 architecture license for use in this area. Some of the previous licenses that we've signed for high-end networking and servers are starting to bear fruit. We saw significant design win momentum during Q1. That included Marvell announcing the deployment of some of the first commercially available Arm based servers with Baidu, as well as LSI Logic, announcing its Axxia 5500 range of communications processors for high performance, power efficient networks.
We also signed seven licenses for Cortex-M and Cortex-R processors for use in a huge range of different applications, including the Internet of Things. This included two more licensees for Cortex-M0+. That's our smallest, lowest power processor. For example, that has the potential to control an embedded sensor application for up to 10 years on a single watch battery. This quarter, Freescale announced a range of Cortex-M0+ based microcontrollers designed to help migrate consumer and industrial applications, which currently use legacy eight and 16-bit microcontrollers over to Arm. Finally, we signed three more Mali graphics licenses. Two more POPs. POP physical IP is the IP that's been optimized to enhance the performance of both Cortex-A and Mali processors. Now I'll switch to royalty. Our royalty revenues, don't forget, are reported one quarter in arrears.
Royalty for Q1 was generated from chips sold in Q4. Processor royalty, the revenue was up 33% year-on-year compared with relevant industry revenues increasing by about 2%. That royalty was generated from 2.6 billion Arm processor based chips reported during the quarter. In volume terms, that's a 35% year-on-year increase. That was driven by growth across all of Arm's end markets. Shipments of Arm based storage chips were particularly pleasing, as Arm based flash and storage state drives more than eclipsed any decline that we've been seeing in PC hard disk drive controllers. The growth of functionality in consumer devices like smartphones, tablets, and digital TVs is also continuing to benefit us. During the quarter, we saw a near trebling of Cortex-A class product shipments and a near fivefold increase in Mali processor shipments. That's year-on-year.
Typically, of course, we receive a higher royalty percentage for Cortex-A class processors and an incremental royalty for chips containing Mali. Our average royalty per chip in Q1 was flat year-on-year, as the growth in these higher value but lower volume application processors was balanced by strong growth in shipments of higher volume, lower cost chips like microcontrollers, smart cards, touchscreen controllers, and wireless connectivity chips. Now let's look about the operational and marketing highlights of the quarter. We've continued our investment in R&D. We're growing our engineering teams, working on advanced processors and graphics. We've added 69 people in the quarter. We expect that investment to continue in Q2. Q1 is a very busy and exciting time for Arm and the companies within the Arm ecosystem with big world events.
Events like Consumer Electronics Show, Mobile World Congress, and Embedded World, which give our customers the opportunity to demonstrate their new technologies that will be going into products and services that we will all be enjoying as consumers in the years to come. From having visited most of these shows, I came away with the following impressions. We are truly in a post PC era. The mobile computer is increasingly being used as the primary device in our digital lives. Sensors that are smart and connected are enabling new products, services, and business models. Some of the most innovative technologies are solving old fundamental problems that are coming out of the embedded smart sensor space. Our technology is ready for servers and enterprise networking.
That's demonstrated by design wins by Marvell at Baidu, the recent HP announcement to use Arm-based chips from Calxeda and TI, as well as the traditional X86 chips in their new server products. With that, I'll hand over to Simon to give his view of the quarter.
Thanks, Warren, and good morning, everyone. I'm not going to go into a lot more detail on the quarter since Warren has just covered that, obviously that will be my role next time. However, when I look at this quarter, and indeed the last few reporting periods, it's the quality of the licensing that I find particularly encouraging. It's that installed base that underpins Arm's future royalty growth. The higher license revenue run rate that we've seen in recent quarters, together with the growth in the order backlog, bodes very well for the trajectory of future royalty revenues. The world's largest semiconductor companies continue to choose to license Arm's latest technology for use in their main product lines. In mobile computing markets, they're licensing our latest processors, and many are planning to implement big.LITTLE implementations. They're not just choosing to deploy processors.
They're often also combining our processor technology with both Mali graphics and physical IP technology from Arm. Talking of physical IP technology, during the quarter, we signed our first license for our new graphics POP IP product, that optimizes the implementation of the Mali graphics processor. Also, we reached the milestone of our 100th royalty-bearing physical IP platform. Again, something that bodes well for future growth in physical IP royalties. For me, of course, this is all very exciting, as more and more chips incorporate multiple technologies from Arm. It's a great base for us to build on for the future. With that, I'll hand over to Tim, who will provide some more details on the numbers.
Thanks, Simon. Morning, everyone. Hopefully, many of you have had a chance to have a brief review of our Q1 earnings release and the financial details therein. The quarterly slide set that you're used to seeing is on the website to help you review your models. I'm not going to go into massive amounts of detail on the numbers. Warren's touched on a lot of them. I will provide a little bit of color to help as we think about the balance of the year. Processor license revenue in Q1 was GBP 81 million, lower than Q4 2012 when we reported GBP 85 million. On the positive side of my guidance that I gave with the Q4 results for quarterly license revenue of ±GBP 75 million.
Looking out for the balance of the year, that remains the guidance, ±GBP 75 million for license revenue. Going into Q1, the backlog was at record levels. We exited the quarter with backlog up about 5% sequentially. In this quarter, Q1, over 70% of PD license revenues were generated from the backlog, a higher contribution than the normal range that we typically see of sort of 40%-60%. Given this relatively high contribution from backlog to the strong license revenue number reported in Q1, it is very encouraging to see the order backlog increase again sequentially, indicative of another very strong bookings quarter in Q1. The usual analysis of backlog maturity and composition is included in the slide set that I mentioned, it shows that approximately 25% of total backlog is expected to be recognizable as revenue over the next two quarters.
Process royalties once again outperformed the industry in Q1, up 33% year-on-year against an industry that was broadly up around 2%, so it's a bigger differential than we have typically seen, which is usually more in the sort of 15%-20% range. As Warren says, probably flattered to some extent by the semiconductor industry correction at the back end of 2011, which was reported in our royalties in 2012. Looking at operating expenses, the headline normalized OpEx in the first quarter was GBP 74.6 million. After taking into account foreign exchange mark-to-market credit of around GBP 4 million, offset by two or three smaller one-off items, I think the appropriate base for normalized OpEx when thinking about forecasts for the balance of the year is about GBP 76 million for Q1, broadly in line with consensus coming into these results.
Given, as Warren said, that we are still investing in our research and development capability and our business infrastructure, normalized operating expenses in the second quarter, assuming effective exchange rates similar to current levels, expected to be in the range of GBP 77 million-GBP 79 million, consistent with the current consensus for Q2, which is about GBP 78 million. A little bit of color on tax. The headline normalized rate in the first quarter was just under 17%. You may recall from my comments at the Q4 results that we didn't recognize the benefit of the U.S. federal R&D tax credits in 2012 because that legislation was enacted at the very beginning of January rather than at the end of December, which is typical, and therefore the 2012 benefit of U.S. R&D tax credits has fallen into the first quarter this year.
That's why the Q1 rate is lower than the rate that we are forecasting for the balance of the year, which is just under 20%. That reflects the introduction and the partial benefit that we now will be receiving in 2013 for the Patent Box legislation in the U.K., which is effective from April. You'll remember from previous presentations that the full benefit gets introduced over 5 years, with 60% of the benefit coming in year 1. We'll be getting effectively 9 months of 60% of the benefit for Patent Box this year. Our full-year rate is expected to be just under 20%. Looking forward and reiterating what Warren has already said, we've made an encouraging start to 2013. More companies are deploying Arm technology in their products.
We therefore expect group revenues for this year to be at least in line with current market expectations. Relevant industry data for the first quarter, i.e., our shipment period for Arm's Q2 royalties, points to the sequential decrease of 10% in industry-wide revenue that Warren referred to. In this context, we expect group revenues for the second quarter to be in line with current expectations, which are
Just over $250 million, so $253 million, $254 million is the current expectation for the second quarter, which we are confirming we expect to be in line with. With that, I'll hand over to questions. Thank you.
Thank you very much. If you wish to ask a question, please press star one 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. Please ask your question.
Thanks. A few if I could. Firstly, I just noticed the licensing of Skymir high-end graphics. I just wondered whether you expect an upward drift in graphics ASP over time, similar to what we've seen on the mobile side and processor side. Secondly, I wonder if you could just give us a sense, Warren or Simon, in terms of attach rates of Mali within tablets and low-end smartphones. It feels like you're seeing a very real impact of that market taking off. I just wondered whether you could give us a sense of whether it's DTV driving it or whether it's low-end tablets and smartphones that's really driving that Mali volume forwards. Finally, just on PIPD royalties. Again, really quite strong in the quarter. Just wondered whether we're now at an inflection in terms of royalty revenues on PIPD. Thank you.
Yeah. Right. Okay. Let me start, Gareth. I'll chat about Mali. Then we'll ask Simon to comment on those physical IP royalties. Yes, good that you've noticed the licensing of Skymir. There's no specific guidance here on royalties going forward in our graphics products. The general principle is, if there's more value in the product that we're licensing, then we do charge more. The next generation graphics processors do deliver more value than the previous generation graphics processors. Exactly the same sort of trajectory that we've seen in our general purpose processors where when there's more value added, there's a higher rate of royalty associated with it. Our plan is to continue to execute that with our graphics processors. As we license more of the next generation graphics processors, hopefully we're going to sign those licenses with incrementally higher royalty rates.
The second question about Mali was what's really sort of driving the volumes here. I think the answer is both. As we've commented before, our graphics presence is relatively strong in what digital TVs as we see as a sort of greenfield area for graphics. It's very encouraging that our share in digital TVs is very strong for Mali. You're right. In the more cost-effective smartphones and in the lower priced tablets, we are very strong as well. Last year we saw Mali being in 60% of the world's Android tablets. That trend is continuing. As the low-end smartphones continue to grow, then we're seeing more Mali there. The trajectory of Mali volume increase is driven by all of those things. Simon, would you like to comment on the physical IP royalties?
Yeah. As you've observed, the royalty growth has been strong. A lot of that does come from the work we've been doing over the last many years to develop technology for leading-edge processes. Develop technology that the POP IP to allow our customers to get a more optimal implementation of an Arm core, and now the Mali graphics core as well in their SoC. The fruits of that work are starting to come through in the royalty. That's driving the growth. Quite a significant proportion of physical IP royalty now comes from advanced technologies, 40 nanometer, 32 nanometer, 28 nanometer, and so on. We expect to see some continued growth there as all of the design-ins that have been going on over the last few years do come to fruition. The wafers start shipping.
Thanks, guys.
Your next question comes from Didier Scemama. Please ask your question.
Good morning, gentlemen. Thanks for taking my question. A couple of quick ones. First, maybe a question for Tim Score on licensing. I just was wondering why you were not a bit more optimistic on licensing growth given the presumably initial recognition of 64-bit licenses over the course of this year. That would be my first question. Secondly, just a question on the broader Arm ecosystem. It seems as though TSMC is going to start making 20 nanometer wafers already towards the later part of this year and is bringing forward 16 nanometer FinFET. Do you have a sense of when the Arm ecosystem will start producing 16 nanometer FinFET chips and perhaps associated to be 64 bit just so that we understand where you are relative to your main competitor? Thank you.
Didier, on licensing. Obviously as you know, licensing is potentially quite lumpy and the guidance I give is to try and take into account
How we see the backlog maturing into revenue and how we see our opportunity pipeline unfolding in future quarters. You can see from last quarter in Q4 we did GBP 85 million. In the two quarters before that we did sort of GBP 67 million and GBP 69 million, and now we've done GBP 81 million. It's quite hard and it's going to move around a bit. Observing the consensus coming into these results, I note that effectively licensing consensus averages out at about GBP 79 million to GBP 80 million per quarter. Relative to the guidance of GBP 75 million ±, that's already on the upside. I don't think it's sensible this early in the year to fan the flames any further than that. There's already an expectation in the market that licensing is going to unfold at the top end of my guidance. I think that's broadly the appropriate level.
There will be quarters where license starts with an 8, like we've just seen. There will be quarters where it starts with a 7, we shouldn't be concerned about that. That's why I'm reiterating GBP 75 million ±.
That makes sense. Thank you.
I'll take the question on FinFETs and availability for the Arm ecosystem. The foundries are continuing to invest aggressively in their development of FinFET technology. I think it was two weeks ago, TSMC had their annual forum here in San Jose, reiterated their expectation that their 16 FinFET technology would go into risk production at the end of this year. What risk production in TSMC-speak typically means is that their very early adopter customers would be in a position to tape out some devices. We've been working with them, we've been working with others on making sure that the Arm ecosystem is going to get the best out of FinFET technology. We announced a couple of weeks ago that we had collaborated with TSMC on an early tape-out of Cortex-A57 on their 16 FinFET process.
That's running in a fab right now, and we'll see the results from that a bit later this year. I think the Arm ecosystem is set to take advantage of FinFET technology. I think the development schedules from the foundries are progressing well. I think the timing of that is about right for the kind of SoCs that our partners want to build.
Yeah, brilliant. Maybe just one quick follow-up. Is it fair to assume that you have yet to see the benefit of the licensing you've done recently in the base station and router market and networking division? Because you had very strong volume growth year-over-year. I would have thought you have not yet seen those share gains coming in your P&L yet.
That's correct. Absolutely, you've seen the order book increasing. Part of that is due to V8 licensing. Some of these networking designs are where companies have taken V8 licenses. We've seen the first of those products really sort of launched this year. I mentioned LSI's product launch. They were at Mobile World Congress with their product.
Brilliant. Many thanks.
February. It's to come.
Thanks.
Your next question comes from Sandeep Deshpande. Please ask your question.
Hi. I have a question for Tim. A couple of questions, Tim. When we look at your revenues on a year-on-year basis, your revenue is up very strongly, but your gross margin is down. Can you talk us through this gross margin dynamics? Secondly, on your operating expenses as well, how should we be looking at operating expenses in Q2? You have guided, but there is some dynamics in Q1 which I would like to understand what happened on your costs in Q1 and how you see this OpEx going through 2013.
Well, on the gross margins, if you look at it back over the last N quarters, you'll see that the gross margin has sort of vacillates between sort of 94% and 96%. There are a number of variables in there. Service revenue, where engineering cost time is applied to service revenues. There are support in parts on the software tools business. In the physical IP division, some engineering time is split between cost of sales and OpEx, depending on the precise nature of the projects being undertaken. It's really those factors combined contribute as to whether the answer is sort of 94%+ or 96% minus. It's a fairly narrow range in which we operate.
You're saying that the higher percentage of royalties as a percentage of revenue is not helping the gross margin?
I don't think I referred to that at all, actually. Obviously in the long term as royalties increase as a proportion of total revenue, that is an underlying positive driver. Precisely the question around why 94, why not 95? Those are the short-term reasons.
Okay.
On OpEx, as I say, Q1 headline was 74.6. Q1 base for forecasting forward is 76. We had an FX mark to market credit of about four in the first quarter. We also had about an aggregation of about GBP 2.5 million worth of things offsetting that. A couple of doubtful debt provisions, and a minor settlement cost of a legal case, which don't normally recur, which is why I'm sort of drawing out GBP 76 million as the appropriate base. With the ongoing increase in our headcount, guiding 78 for the second quarter, consistent with I think what's already in the market.
One final follow-up. You grew very strongly in terms of your royalty units with microcontroller, et cetera, which is why the royalty per device was flat year-on-year. Would you comment on how you, because you probably see it, how the royalty per device did in the mobile space?
Sandeep, we won't comment specifically on the mobile space. We have in the presentation, which is on the website, given you a sort of waterfall chart showing the positive contributions and the sort of downward contributions from the different sectors. We have building off where we were 12 months ago, an uplift of getting on for GBP 0.01, GBP 0.015, based on higher value chips going into home and mobile and mobile computing, and about another GBP 0.005 from the positive contribution of Mali. We've got negatives from microcontroller growth and from the lower cost connectivity and touchscreen chips in mobile, which brings it back to flat over the year. As you know, the answer just simply depends on the relative volumes of those buckets. The little chart is shown in the slide on the website.
Thank you.
Your next question comes the line of Andrew Gardiner. Please ask your question.
Good morning. Thank you. I had a question regarding where we are in terms of the V8 licensing process. You're clearly highlighting, I think, in the release here that mobile and tablets continue to be sort of the key end market. Are you seeing your partners sign up for a broader range of end markets at the moment? Also, what's the latest in terms of when you expect actual sort of commercial silicon on the market for some of the initial chips? Thank you.
Okay. It's Warren. I'll answer that. We are seeing v8 taken up for some of the other markets as well. For servers and for high-end networking, we're seeing Cortex-A57 being licensed there, and we've had another v8 architecture licensee for this enterprise space as well. We are seeing it. Obviously, that's a licensing activity. It will be at least a couple of years before we see any silicon from those licenses. Some of the very early licenses, however, we are getting close to silicon. We're starting to see trial silicon from initial v8 architecture licensees, and we would expect some of the initial implementations to be in silicon before the back end of this year. It's really a 2014 phenomenon, as far as royalty is concerned, though. Anything you see in 2013 is going to be very first silicon.
Understood. Thank you.
Thank you.
Your next question comes from Francois Meunier. Please ask your question.
Yes, thank you guys for taking my question. First, a personal question maybe for a change. The headcount went up something like 13% in Q1, mostly with engineers. Could you please explain what type of engineers you hired? Is it newbies or more experienced people? Maybe where they come from, and how easy or how difficult is it to integrate those new guys, probably from other organization into something which is still a bit of a startup, I would say, in Arm? That's my first question. Thank you.
Okay. Answer that, Francois. I think probably the 13% you refer to is year-on-year. We hired 69 people during the quarter. If we look year-on-year at the people that we have hired, then just over a third are graduates. It's important that we hire graduates and get these people and train them. The remainder are more experienced people. The areas of the business that they're going into are primarily general purpose microprocessor design teams. Specifically over the last 12 months, we have been growing our graphics business as well and the graphics resource. Last year, we also hired a small number of people. For the first time in several years, we hired a small number of people, some tens of people into our physical IP division. That's because, you'll see, we've been growing the activity there.
As Simon described, the emphasis there is very much on the leading-edge technology. We needed some more resource to do that as well. Geographically, the ratios are about constant with roughly 40% of that hiring being in the U.K. That's where most of the hiring goes. As Tim mentioned, as we scale up the business, we do need to hire some people into more of the sort of the infrastructure of the business to enhance our IT capability, so that our engineers can be more productive. We don't experience any specific difficulties. The absolute number of people that Arm needs to hire is relatively small compared with some of the big semiconductor companies. We are able to access the talent that we need.
Okay, very good. Warren as well, I think in your opening remarks, you talked about both the Internet of Things and wearable technologies. How big do you think this market could become in terms of a mix? Is it more a Cortex-M market or a Cortex-A market?
Yeah. I'll start and then maybe Simon can make a comment on that as well. I think the answer is both. We are seeing microcontrollers typically when we talk about low cost sensors and so on, then we are saying it's very much microcontrollers. However, this quarter we have seen a Cortex-A5 based microcontroller family launched from one of our partners. When we get into wearable technology, then obviously that demands a little bit more of a user interface, and so I think we probably see some A-class processors going into those as well. I don't know, Simon, you want to add anything to that?
Yeah. I think a lot of the initial applications for wearable technology are going to be M-class with a lot of connectivity to a mobile phone. If you take some of the applications like the Nike+ FuelBand, for example, that has a small display built in. Really the idea is that you track your data on your mobile device, and I think you're going to see a lot of that. In our partners' microcontroller products, there are Cortex-A based microcontrollers and lots and lots of M-class. There is a whole wide range performance spectrum, many hundreds of megahertz. Cortex-A8 based devices are being shipped by TI, for example, as well as all the M-class that Warren mentioned in his talk there.
I think for wearable, I think a lot of that will be M, and the device is basically going to contain some form of sensor to determine what you're doing, some form of connectivity to your phone, and a very small battery, and the whole thing will be built for very low power.
Okay.
I think the market for that can be very big. I happened to be sat next to a guy from a textiles company on a flight the other day, and we got chatting, and he said he was in kind of high-end textiles for sporting equipment, and he said all his customers wanted to integrate our technology, i.e. Arm's technology with his technology. I think it's going to be a big market.
Okay. Thank you very much.
Your next question comes from Simon Segars. Please ask your question.
Yes, thanks so much. Wanted to ask a follow-up question on PIPD royalties. I know you sort of alluded already that TSMC and other people's shrink roadmaps are benefiting you in terms of unit momentum. I think in Q1 you saw something like a 30-point spread compared to industry growth, i.e., 50% growth for you guys. I think foundry industry only growing 20%. Is that a sustainable run rate in terms of being able to outgrow the industry or does that change or even see a step function as 22 nanometer gets introduced and even lower down?
Yeah. Thanks, Simon. Simon, I think probably best if you comment on that.
Yeah. I think that when you look at the foundry market, there are lots of mature technologies. There's still an awful lot of wafers shipped every day on 0.18 micron, 0.25 micron, even 0.35 micron. Our physical IP business has quite a large installed base there. I'd expect that portion of the royalties to be fairly constant, slightly growing up and down as the industry kind of ebbs and flows. Again, in that area, there is big opportunity around these microcontrollers for a lot more growth. There's obviously a lot of action though at the more advanced technology nodes. As the process nodes themselves get more complex and it gets harder and harder to build any form of chip utilizing that technology, then more of our partners are looking for any help they can get. That's where the POP IP is becoming so popular.
I think with the design-ins that we have, the momentum that we have behind that technology, the licensing that we've done on the advanced nodes at the foundries, then I do think there is potential for us to grow at a faster rate than the foundry industry as a whole.
Got it. Thank you. My second question would just be on the sort of quality and anatomy, if you will, of the PD licenses number. I think you said 70% of the license number in the quarter was recognized from backlog. More broadly, is there a risk that your backlog starts to go down? I know it's up plenty in the second half of last year specifically. It just seems like an unusually high percentage to be recognizing from backlog. Is there a risk in that?
No, I don't think so, Simon. I think in any quarter, the license revenue number is going to be comprised partly of contribution from backlog and partly from turns business where revenue is recognizable immediately. I think in different quarters, depending on the nature of the deals and the number of the deals, that the balance will shift. As I say, if you look back over the last few quarters, 50%-60% is more typical. This one was 70% because we had some engineering milestones that were met that yielded revenue. As I said in my comments, the fact that the backlog was more than topped up by bookings which didn't yield revenue in the quarter, I think is very encouraging as we look forward. I wouldn't expect typically
The contribution from backlog to be beyond outside of the normal range of 40-60. I think this is probably quite an unusual quarter. As I say, very reassuring that the backlog still went up sequentially.
Okay. Thanks, Tim.
Your next question comes from Sumant Wahi. Please ask your question.
Hi, thanks for taking my question. I guess I had two. One actually was on the market share gains you reported in this quarter. I'm just trying to understand really, it says that it was primarily driven by embedded businesses, and then you made the comment on the fact that the base station hasn't really started showing up in your royalties. I was wondering if you could give us a little bit of a color on which aspects of the non-mobile market essentially are the drivers for this market share gains. Are we talking microcontrollers, TVs, networking equipment? That's really my first question, and then I have a follow-up on Patent Box, I'll let you answer this one first.
Let me answer that one first. Yes. If you look at the 2.6 billion chips reported as shipped by our partners in the reporting quarter, the market share gains that we're seeing are primarily in microcontrollers, digital TVs. Just to put some color on that, and we've got this data on the website as well. Overall, chip shipments are Arm up 35%, industry up 7%. Mobile up 20% for Arm, industry flat-ish, -1%. Microcontrollers, Arm up 40%, industry up 20%. Digital TVs, Arm up 100%, industry up 10%. For storage, Arm up 20%, industry up 10%. There isn't any enterprise networking to speak of in those numbers. The networking share gains that we're seeing at the moment are Arm's traditional networking areas, which is very much consumer home networking, ADSL modems and those sorts of things.
The gains in enterprise networking are all at the designing stage and the licensing at the moment. The benefit that we'll see from that in royalties is yet to come.
Okay. Thank you. Just a quick one on that. Simon mentioned that the wearable market could be a significant market over. Is there any possibility of giving a rough idea of how we can quantify that? Is it big enough to actually be another line on your Analyst Day the way that you split up the whole market? Do you think this wearable technology could actually be another line over there? Is it that big?
I can tell you, the Analyst Day material is in preparation. We haven't got anything on that in the Analyst Day material specifically. In years to come maybe we'll see, it's far too early to talk about scaling that right now.
Okay.
At the moment, I'm including those sorts of things in the microcontroller market.
Okay. Cool. I think I had a quick follow-up on the Patent Box side. If I understand that law correctly, it probably allows for a much lower tax rate on royalties which are achieved from patents signed or registered in the U.K. I was wondering from a long-term strategic point of view, does that really change your hiring or investment strategy in the coming years? I know that you mentioned only 40% of your new hires were in U.K., but I was just wondering the way it would affect your tax rate blended. Would this change the way you invest in U.K.?
No, I don't think so, Sumant. The way we structure our affairs and our patent ownership is actually that most of our technology is already owned actually out of the U.K. We've structured it in that fashion in years gone by pre-Patent Box. I think it's unlikely that this type of tax legislation would influence our overall strategic approach to resourcing. In a sense, or almost fortuitously, if you like, a lot of our qualifying profits from this legislation already come out of the U.K.
That's because of the historic patents you sign and the way your business works, essentially.
The way we've structured the ownership of our patents.
Okay. Thank you very much.
Your next question comes from the line of Kai Koschelk. Please ask your question.
Yes. Hi, thanks for taking my question. I had a couple. The first one was just going back to this slide 14 where the ASP bridge for the process effectively. It does seem to suggest that enterprise is currently a drag on chip ASP. I'm just curious. I would have thought that the ASPs in that market are fairly high. Just wondering why they seem to be a drag on the GBP 0.048.
Yeah.
my second question was just on the tax rate. Not entirely sure, but it sounds like this U.S. legislation is maybe new, and it seems to be an addition to the U.K. regulations. I'm just wondering what you think your blended tax rates could be next year and maybe in three years as a consequence of both the U.K. and the U.S. Patent Box. Thank you.
Let's do last in, first out, shall we, on that one? On the tax, the U.S. R&D tax credit, which I referred to, is not new, Kai. The issue is we've been receiving R&D tax credits based on our U.S. R&D effort for a number of years. It just so happens that in 2012, the legislation was not enacted. It was enacted on the 2nd of January, and therefore, we couldn't recognize the benefit of those R&D tax credits coming out of the U.S. until Q1 2013, which is why we had a slightly higher rate in Q4 2012 and a slightly lower rate in Q1 2013. Looking forward, accepting, if you like, that that issue doesn't impact. The thing that does impact is obviously the full realization of the Patent Box benefits.
Again, I said earlier that about 60% of the benefits accrue in the first year, and it was introduced in April, so we're getting nine twelfths of them in 2013. I think I showed at the Analyst Day last year or the year before, that the tax rate would continue to gradually go down from current levels. I think, in due course, in the out years, you can expect it to be in the mid, just over mid-teens area, all other things being equal.
Okay. Let me just explain the chart that you referred to there, Kai. Yes, enterprise, what we mean by enterprise in this particular context, it's about the storage chips. As I said, the network infrastructure and the service piece is not really contributing to royalties yet. That particular enterprise thing, you'll note storage overall industry up 10%, Arm up 20% as we gain share in the solid state disk drive market as PCs are switching more to solid state disks, and those are low-cost devices for us. That's what's responsible for that part of the chart.
Okay. Thank you for the color. Thanks.
Your next question comes from Janardan Menon. Please ask your question.
Hi. Thanks for taking the question. I just want to go back to the outlook for licensing. Tim, over the last two years, you've given guidance over a range, and the reality is that Arm has sort of blown past that guidance, taking the licensing number higher and higher into the next range of GBP 10 million and so forth. When you look at your current outlook, and you've given a range, which is it's going to likely start with a seven or an eight, have you gone through the sort of diversification of applications into new areas and signing up of a number of architectural licenses in the last couple of years, which makes it less likely that you are going to beat these numbers very significantly, which is move into the nines or something like that?
Are you going to be more in line with your long-term guidance of mid to high single-digit growth rates? Second question I had was just on your Q1 results. You had guided revenues down to GBP 250 and with an implication of royalties being down in the quarter. I was just wondering what surprised you in the quarter? What came in much higher than your initial expectations at the beginning of the quarter? Was it more on the smartphone side, or was it more on the embedded processing side of things?
Janardan. You've heard me say before that we have been going through in the last couple of years, a very strong period of license growth. There were a lot of questions over the last few quarters about whether this was sustainable, whether it was a short peak or all our Christmases were coming at once or a post-downturn bounce or whatever. What we've said is, looking forward from this higher base, the medium-term outlook for licensing is, as you said, mid to high single digit. That's what we see as the longer run sustainable growth rate for our processor licensing. What is a little bit harder to call is the exact transition period from the much higher licensing that we've enjoyed over the last couple of years to that longer-term rate.
Taking all that into account, as I say, I still think, GBP 75 plus or minus when we're looking out over the next few quarters is the right way to think about it. I think that's the answer on licensing.
On your other question, I'm not sure that I'm interpreting the question correctly. Are you referring to the quarter that we're just reporting or what lies behind our guidance for Q2 at the previous-
No, the quarter that you just reported.
Yeah. Actually, as we've said in the numbers, the upside is across the piece. The royalty numbers reported absolutely a little bit higher, but I think you're seeing seasonality in the smartphone piece and strong market share gains in the microcontrollers and embedded. It's as simple as that.
Okay. Is your visibility any different for different parts of the business? You have some visibility as you go into the quarter, as you sort of get initial receipts from your customers, which gives you an idea of what the quarter is likely to look like. As you're sort of diversifying your revenue base, do you have similar levels of visibility to give that guidance, or is it very much different for different segments?
Well, in terms of the direct reporting from our partners, they have 90 days after the end of the quarter to report the chips shipped during that preceding quarter. As we sit here on the 23rd of the month, we have relatively few royalty reports in from our 120-odd royalty payers. By the time we get through to two-thirds of the way through the quarter, we've had most of the royalty reports in, we've got direct information. If you think about what's feeding our guidance today, we're drawing people's attention to the fact that companies who have already reported their Q1, combined with companies who haven't reported yet but have already guided their Q1. That's where we're coming up with this sort of minus 10% for the industry at large.
If you think about color on that, there's rather more commentary around some of the higher profile companies supplying chips into the mobile space, into tablets and those sorts of things. Many of our customers who are starting to ship Arm in microcontrollers, many of them are small companies who are not such high profile, we don't get such a lot of commentary and analysis on those companies. If you wanted to look for a longer term trend as we diversify our customer base more and get more exposed to these companies that, frankly, the analyst community doesn't cover in such detail, then there's less sort of ancillary color. Hopefully that's painted a view as to where we get our data from and how it builds up.
Got it. Thank you very much.
Thank you.
Your next question comes from Jerome Ramel. Please ask your question.
Yeah, good morning. Can you give us a little bit more color on the dynamic with big.LITTLE, when you expect to see some variety of revenues coming from big.LITTLE and the traction with clients?
Yeah. I'll kick off. Simon, you may want to add some color onto this. The first big.LITTLE implementations will be Cortex-A15, Cortex-A7 combinations. We saw the leading companies with those showing off their wares initially at that Mobile World Congress back in February. As I said, these are very sort of early things which are showing off in Mobile World Congress will not really be in production until the back end of this year at the very earliest. In terms of you noticing any impact in royalty, it is probably going to be a next year thing rather than a 2013, perhaps very much the back end of this year. Simon, do you want to add some color on that and maybe on the V8 big.LITTLE combinations?
Sure, yeah. I would agree with Warren there about products being shipped late this year, so royalties starting to flow right at the end of the year or into Q1 next year. When you look at the licensing momentum behind big.LITTLE, we've got something like 17 big.LITTLE customers right now. As Warren said initially, that's Cortex-A15 plus Cortex-A7 combinations. big.LITTLE is a technology that spans multiple architectures. We have V8, version eight architecture, big.LITTLE customers as well. In fact, three of the licenses that we did in Q1 were for big.LITTLE combinations. Cortex-A57 plus Cortex-A53 form that same big.LITTLE pairing. As a technology, we're expecting to see this in many devices.
Being able to switch between very high performance processors and then very small processors optimized for power, I think is going to be a vital tool for providing increased performance while managing power consumption in an end device.
Okay. Thanks, Simon. I think we've got time for just one more question, please.
Your next question comes from Matt Ramsay. Please ask your question.
Good morning. Thanks very much. I just wanted to follow up on the graphics questions that were asked earlier with Mali up 5X year-over-year. You talked a bit about the digital TV market, but in the smartphone market in particular, maybe you could comment on your potential for future share gains, given that some of your processor partners in this space seem pretty set with their graphics plans going forward with maybe Qualcomm and Cupertino dominating most of the high-end share that's not Samsung and MediaTek and Qualcomm's QRD looking to take a lot of share at the low end of the market. Maybe you could talk about some share gain opportunities going forward for Mali and mobile. Thanks.
Yeah. Righto. I'll deal with that. You're absolutely right in your observation. Qualcomm have their own solution, and they are very wedded to their own solution. Qualcomm are enjoying a lot of success at the moment with their integrated devices and the fact that they are ahead of the curve in LTE modems. Clearly from a Mali graphics point of view in mobile, that is a headwind for us. That said, other chip suppliers are benefiting from the tremendous growth in demand that we're seeing for lower end smartphones in developing regions. People are expecting smartphones across the piece to continue to grow very strongly this year. That growth overall is tapering, but nobody could possibly describe a 40% growth in the number of smartphones in the year as being in any way modest. That is very significant growth.
The high-end solutions, of course, being sold into the developed regions of the world, clearly growth is much lower there. The activity is happening in the emerging regions, the faster growing economies of the world, and they are lower priced phones, and they are chipsets from a broader range of semiconductor companies. Many of these companies do use Mali, and that is a driver for our expected growth in Mali as we look forward to this year and next year. Meanwhile, digital TVs, as you observe in these numbers, our growth compared with that of the market is very, very strong. Our share in digital TVs for Mali is very, very strong as well. Putting those two things together, we are seeing some growth from that. You've got all the low-cost tablets as well. That's what's fueling it.
We said with the results last time, this year we expect Mali volumes to increase from around 150 million units in 2012 to at least 250 million units this year. Hopefully, some of these markets that I just described will make that grow even more. We'll wait and see.
All right. Thank you very much.
Okay. With that, thank you very much for all your questions and for dialing in. As noted at the start of the call, this is actually the last time you're going to hear from me reporting these results. Thank you to everybody for your support over the last multiple quarters. The business is in great shape going forward. Meanwhile, the rest of the team will be back to tell you all about it in July. Thank you very much.
That does conclude the conference for today.