Earnings Call: Q2 2016

Jul 27, 2016

Earnings release

Ladies and gentlemen, good morning. Thank you for standing by and welcome to the Arum Q2 Results Analyst Conference Call. All participants are in a listen only mode. N1 on our telephone keypad. I must also advise you that this conference is being recorded today, Wednesday, 27th July 2016. I'm now handing the call over to your first speaker today, Mr. Ian Thornton. Please go ahead, sir. Thank you, Andre. Good morning, everybody. This is Ian Thompson, VP of Investor Relations at Arm. On today's Q2 results conference call, we have Simon Segars, Chief Executive Officer and Chris Kennedy, Chief Financial Officer. On today's call, Simon and Chris will take us through the highlights and comments on the quarter's results and then we'll open up the call to a Q And A session. As a reminder, the press release and some financial data can be found at Arm's Investor Relations website at www.arm.com/ir. I now have a few words that respect 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 related to investments, and the information communicated on this call is being made only available only to investment professionals. Any persons present on this call who does not have professional experience in matters related to investments should not act on or rely on the contents of this call. The following conference call may include forward looking statements, which will be statements, which are other than statements of historical facts. The company's actual results 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. Clearly this quarter is a little different from our normal quarterly results. As a reminder, on 18th July 2016, SoftBank and Arm announced we had reached agreement on the terms of recommended all cash acquisition of $1700 per share to revenues up 12% year on year. This quarter, more thought leading companies made long term commitments to Arm Technology and our semiconductor partners announced many new and exciting ARM based products for a wide variety of applications, including sensors, supercomputers, and satellites. These design wins characterized the drivers of our long term growth, more advanced arm technology being chosen by more partners, to be deployed in more markets. Putting some detail on this. Fujitsu and Rykin announced that their next generation supercomputer will be based on armed V8A based chips. When that machine goes into operation in 2020, I can expect it to have a 100 times the performance of their current supercomputer, which is ranked number 5 in the world. At the smaller end of the spectrum, we are seeing ARM technology being deployed in an increasingly wide range of devices. As an example, NASA recently completed a 3 year study into high performance based computing requirements and selected the ARM cortex A53 processor for its onboard computers. We saw dozens of ARM partners, including Applied Micro Broadcom, Cavium, Mellanox, and NXP, all announced new chips for networking infrastructure and servers. And Qualcomm ST, Xilinx, and many others announced new embedded intelligence chips for smart sensors, medical equipment, automotive applications, and so on. ARM has been investing and developing technology for many years in these areas, it is great to see our partners being so successful. Arm is continuing to invest in new technologies. During the quarter, we announced the Cortex a 73 CPU and Mali G71 graphics processor. Together, these processes will enable virtual reality and augmented reality in smart mobile devices. We also announced the supporting technologies needed to integrate these processes into an SOC, including on chip interconnect, physical IP libraries, software tools and support from our ecosystem partners. 10 of our customers now have access to the Cortex A73 and or Mali G71, and we are building them into and are building them into their next generation mobile application chips. In May, ARM announced the acquisition of Apicore for 1,000,000. Atagull is at the forefront of embedded computer vision technology, building on its leadership in imaging products. Together with our existing technology, this will help the Arm Partnership to address some of the challenges of next generation products, such as driverless cars, robotics and sophisticated security systems. At acquisition, the Apoquel team was about 100 people strong, the majority being R and D engineers. We're very pleased with the integration process so far. The companies have similar cultures, which is helping with integration of teams, processes, and roadmaps. In June, we entered into a strategic partnership with Hohoku Investment Management, a Chinese Private Equity Firm through which we are fun we are launching a fund that will be focused on the internet of things, smart devices, big data, and cloud computing. Also in June, we signed an architecture license with Guizhou, Washington, a joint venture between Qualcomm and China's Guizhou province. Wejo Washington's stated aim is to develop advanced server chipset technologies in the rapidly expanding Chinese server market the 2nd largest data center market in the world. Now I'll discuss the revenue drivers in the different parts of the business in more detail starting with technology licensing. We signed 25 licenses with 23 customers in the quarter, Just as in Q1, over half of our customers this quarter were new to Arm. 5 of the licenses signed were for Arm's Cortex A Processors, mainly for use in smartphones and networking infrastructure. 13 of the licenses were for Cortex M Processors for use in embedded devices and in the internet of things. 2 of the licenses were for Cortex R class processes, the use in advanced memory controllers and wireless communications. We also signed 2 licenses for our Marley multi media processors for smartphone and digital TVs. Physical IP licensing was down 37% compared with the to the strong number reported in Q2 2015. This was a result of the timing of engineering milestones and a higher proportion of semiconductor companies opting to take single use licenses rather than multi use licenses for our POP IP technology. We also signed a major deal in the quarter to develop a 10 nanometer library of physical IP for a foundry's most advanced manufacturing process, which was backlog building. And now I'll switch to the royalty side of the business. Arm's royalty revenues are reported 1 quarter in arrears. So our royalty for Q2 was generated from chips sold by our licensees in Q1. Processor royalty revenue was up 11% year on year. By comparison, the semiconductor market declined 3% in the relevant period, So we outperformed the industry by 14 percentage points. In Q1, the smartphone market was down around 10% sequentially, and there was also a widely reported inventory correction in the smartphone supply chain. We saw an impact from both of these factors in Q2. The sale of application process into smartphones also declined by about 10% sequentially and the sales of peripheral chips the use in a smartphone declined to a much greater extent. During the quarter, approximately 250,000,000 shipped contained armed V8A Processors and $110,000,000 of these chips were octa core. Around 65% of all smartphones sold in Q1 contained an arm V8A processor and around 30% contained an octa core chip, up from around 25% in the prior quarter. Physical IP royalty grew, revenue grew 17% year on year due to the increase in shipments of wafers using ARM's physical IP at advanced nodes. I'll now hand over to Chris who'll provide some further details on the numbers. Thank you, Simon. Good morning, everybody. Hopefully, many of you will have had a chance to have a quick look at Arm's Q2 2016 earnings release. The quarterly results and financial data are on our website as usual. Q2 dollar revenues of $388,000,000 were up 9% year on year with 7% growth in technology licensing and 12% growth in technology royalties. In Q2 twenty fifteen, the sterling dollar effective exchange rate was 156. In Q2 this year, it was 1.45%. That's an 8% weakening of sterling versus the dollar, so Q2 sterling revenues were up 17%. We also had the release of a tax provision following receipt of correspondence from a tax authority. Combining these together resulted in EPS growth of 18% year on year. Without the tax provision release, EPS would have increased around 7%. For those wondering about the impact of Brexit and the subsequent weakening of sterling, As it happened right at the end of the quarter, there was very little impact on our Q2 results. As we have often discussed on these calls, quarterly license revenue can be lumpy. In Q2, process of licensing was particularly strong, up 14% year on year. This was driven by 25 processor licenses, including a high value architecture license. In contrast, Physical IP license revenue was down 37 percent year on year to $14,000,000 for the reasons that Simon has already covered. About 50% of our process of licensing revenue came from backlog in the quarter, which is within the typical range of between 40% 60%. Group backlog was down around 10% sequentially. Normalized OpEx in Q1 was 1,000,000, up 32% year on year and down 2% sequentially. As you will recall, we announced a step up in R&D investments in Q3 last year. Most of that step up was achieved in H2 last year, and we're now in a period of more stable headcounts and cost growth. Excluding the acquisition of Apoquel, headcount was up about 1.5% sequentially. The group's effective normalized tax rate was 6% in Q2 2016. This is much lower than prior quarters due to the release of a tax provision of 11,500,000 Excluding the tax provision release, our tax rate would have been around 15%. Normally at this point, we talk about outlook However, given the restrictions based on forward looking statements as a result of the SoftBank offer for Arm, it's not appropriate for us to provide the usual guidance for full year 2016 revenues or next quarter's cost range or the full year's tax rate. I'll now come back to Simon. Thanks, Chris. And now we'll go to Q And A. As usual, if I could ask you just to ask one question at a time, be able to get everyone's question in. And if there's time at the end, we can come back for a second round. And also as a reminder, We will not be disclosing, sorry, discussing the details of the offer from SoftBank to Art nor will we be giving any forward looking statements. So if I can hand back to the operator to manage the Q And A, please. Session. And your first question comes from the line of Francois Munier from Morgan Stanley. Please go ahead. Morning, gentlemen. Hey, Francois. Hey, yes. So just a quick question on Q2. I think on Q1, you disclosed the growth, which you had in Networks, which was plus 10%. I don't know if you could disclose or give some flavor around network infrastructure revenue growth in Q2, if you can? No, off the top of head of any of that in front of me. But in terms of, proportion of, units, we did see a bit of sequential growth in that split. But up about a percentage point, sequentially and year on year into that enterprise segment. Okay. Thanks for the clarification. Thank you. It was up it's all right. I understand it. It was also up 10% in Q2 as well Q1. Your following question comes from the line of the Matt Ramsey from Canaccord Genuity. Please go ahead. Thank you very much for taking my questions. Good morning guys and Obviously, congratulations on the deal. It's been a pleasure to work with you guys over the years. I guess, Simon, don't know how much you can comment on this, but I'd be interested in just any feedback you've gotten from licensees around the SoftBank announcement. There's been lots of debate of that potentially freeing you guys up to invest more heavily. But I mean, one of the things I've always admired team is the ability to balance the needs of all the different licensees as you guys have moved forward with the business. So, any comments there? And Chris, if you could break out at all for us? Any contributions, either costs or revenue from apical in the quarter? That would really help. Thanks guys. Okay. Thanks, Matt. Well, you know, as I said, I can't comment on structure of the deal. We spent a lot of time communicating with all constituencies. You know, a key message that we said previously is that there would be no change to our business model, no change to the way that, that we go about, working with our partners. So, but beyond that, I don't want to go into any specifics. Yes. And on, Africa, I appreciate that you haven't had much time to look at the statement. Bottom of page 18, we break out the ASCO results. So in Q2, added about a 1,000,000 in revenue and £1,000,000 that is in revenue and pretax profit of 100,000. Pounds. And we also give the sort of pro form a had it been consolidated for 6 months, which is GBP 6,900,000 of revenue and 400,000 pre tax profit. All right. Thanks guys. Appreciate it. Thank you. Your next question comes from the line of Sandeep Deshpande from JPMorgan. Please go ahead. Hi, thanks for letting me on Simon, you've announced a few wins in the server market in the quarter. Do you see yourself, I mean, with what you've already, in terms of the wins you've announced and what you've not announced publicly that you are on track to do the 25% share in units by 2020 at this point in the server market? And secondly, do you see that you're already seeing the impact of the smartphone slowdown in your numbers and that that this is now actually already in the number. And so from here onwards, you will not see a further impact. Thank you. Well, I'll just answer those questions in the context of Q2. I mean, if you look sequentially, units are down, if you look, at the split of where those units have gone, you'll see that mobile and connectivity, for Q2 sits at 40% versus 45% in Q1, which obviously relates to chips that were sold in Q4. Now that's a seasonality that we would typically see Q1 being slower for smartphone shipments than off of Q4. And obviously during Q1, there was a lot of pessimism and discussion about supply chain inventory. So I think it's reasonable to say that that effect is seen in Q2. Can't say anything about future because that would be a forward looking statement. And as we said, we won't be making any of those today. And similarly, with service, very pleased with the progress that we've demonstrated to date, very pleased with the deals that we've closed and announced in Q2. But beyond that, can't go into any more detail. Thanks. All the best. Thank you. Your following question comes from the line of Andrew Gardiner from Barclays. Please go ahead. Good morning guys. Yes, sort of congrats from my side as well. Certainly, Arm will be missed within the coverage. Just within the sort of what you can comment in terms of the quarter and how you're seeing the smartphone space. I'm just interested in hearing your thoughts on the level of sort of content gain or feature gain in terms of VA and multicore and Mali. Certainly, if you look at V Eight, it seems to have flattened out at least quarter on quarter. I presume it's sort of seasonal, but I'm just interested in your thoughts on how the licenses are progressing there and whether you're seeing any slowing in terms of assets processes through sort of mid and low end of the smartphone market? Thanks. Well, again, focusing on it, all of that around Q2. If we look back at the growth of VAA into smartphones, That was about 30% or that was 30% a year ago, grew to 50% in Q4. Q1 was was at 65% Q2 as we just reported 65%. I'm seeing a growth in, optical in that time period. So Q2 2015, optical was at 5% penetration, up to 30% in Q2. Now, as I just said, Q1 was a slower quarter for smartphones. So I don't think you can read too much into This sequential changes in those numbers from Q4, well, our Q1 to our Q2, obviously market Q4 to market Q1. And time will tell. But again, that's a, to make any further comment on that, I'd be talking about in the future. And in terms of general appetite appetites to upgrade, I think the Q2 licensing reflects continued demand for our technologies across the different categories of our product lineup. So we're very pleased with the breadth of licensing in Q2, and that would seem to continue our historic trend. Okay. Thank you. Best wishes for the future. Thanks, Andrew. Thank you. The following question comes from the line of Kai Korsheld from Mary Lynch. Please go ahead. Yes, good morning, gents. And again, yeah, congratulations on the year of getting a good deal for the company. So my first question was really a bit broader, and it was particularly around IoT. So what do you think has been we've been talking about it for some years. What do you think so far has been holding back to sort of breakthrough adoption and what do you think can or could be a catalyst for that sort of product category to take off? And then just a quick follow-up on the tax rate was very low. Were there any sort of unusual effects in the second quarter? Yes, just so we've been talking about IoT for a long time. We've been, we believe building or creating the building blocks that will be required for IoT systems. Cortex AM is a big part of that. And you've seen in the quarter very strong licensing of Cortex M again. And our embed platform that we've discussed for some time has continued to make good progress in terms of delivering against the objectives that we set out. And we believe that these are key technologies that will help IoT become a reality. What we've seen up till now is people developing, IoT platforms in a very vertically oriented way. And I think, that's a, that's an understandable step for the industry to be making at this stage. As people really work out what the benefits of IoT are going to be. So up till now, I think we have made good progress. How this proceeds from here is, again, a projection of the future. So I'm not going to make one of those, but I think the work that ARM has done has been has been the right things for us to have done over the last couple of years to prepare for this market. On the tax rate, Yeah. I mean, it is unusually low at 6%, as I said, with underlying, we'd expect that to be around 15%. And that's because, in the quarter, we released a tax provision, which actually goes back over 10 years. And we've concluded we no longer need it following some recent correspondence with potential authorities. Okay. Thank you. Best of luck. Thank you. Your next question comes from the line of Lee Simpson from Stifel Please go ahead. Great. Thanks for letting me on and congratulations to all on such a strong deal. Couple of questions if I could. Just trying to understand maybe you kind of can't answer this one. Could you maybe outline again first, what is the nature of the relationship with ThunderSoft? I mean, is this an arm's length investment or do you see something more strategic developing from that And maybe alongside that, a couple of quick ones, 1695, the number of U. K. Employees, does that now include APACAL? And could you just remind me when the scheme documents actually release to investors? Multiple questions in there. Well, I'm for not following the rules. So very quickly, 16 95 UK employees includes applicable. The question about fundersoft, we made a completely arm's length investment in them a long time ago, they went public, I think it was last year. We still hold shares in front of itself. So, you know, from an investment point of view, it's just completely arm's length. There's no, overlap in the way that they're managing their business or we're managing ours. They are a partner of ours in, our accelerator program in China. So we have a joint venture with Undersoft that has set up a number of accelerators or incubators around China, which is bringing in entrepreneurial start up companies into the ARM ecosystem. So we're very pleased about that. Schedule document, can't put a concrete date on that. Sometime over the next couple of weeks that will be published. Thank you. Next question comes from the line of Jaguar Bajuah from Arete Research. Please go ahead. Hi guys, thanks for taking my question. Just the first one, maybe if just can I get a clarification on that turns number that you gave during the prepared remarks? Is that okay? Yes, so 50% of the license revenue came from backlog and 50% returns. Okay, great. And then, just for the question, despite the big architectural deal you did in the quarter, backlog in the maturity of your licensing now. Did you recognize more from the architectural deal in the P and L this quarter than you kind of usually have done historically? And maybe could you give us a rough estimate of how much of that architectural deal went into the P and L this quarter? So we don't disclose details about individual licenses, but you know, it's a rules driven process. So The amount we recognize in the quarter is to do with the IP that, that license involves. If it's mature IP that the customer is capable of using and we take that to revenue. If it's a future delivery, then that goes into back in is released when that, that, IP is delivered. But there's no difference in the handling of that, license than any other similar Your next question comes from the line of Douglas Smith from Agency Partners. Please go ahead. Yes, good morning. I was wondering if you could talk a little bit about what you're seeing in the automobile market? I know it's one you've always said you had a lot of hopes for. Many other people seem to think it's very strong right now. Could you comment particularly, are you seeing strengthen? Is it navigation infotainment, self driving capabilities? Well, I mean, our arm has historically played a role in automotive electronics. We've had our processes have been designed into many different parts of the car over the years. We've been in airbags and ABS systems and infotainment systems within cars, over the last few years as interest around, autonomous driving has grown. And as the sophistication of driver assistance systems have grown, We've seen increased demand for embedded processing and many of our partners have been working on products based on our technology to go and address that space. So, clearly, the trends are towards a greater silicon content in cars. We've talked about that for, how it plays out, how much market share on gains, not in the position to talk about today as as that's a discussion about the future. But as I said, we've just seen over the last few years an increasing amount of semiconductor content, an increasing amount of processor based semiconductor content going into cars. Okay. Thanks a lot for all that. And it's been a pleasure working with the management and the investor relations team as well. Thank And your next question comes from the line of Johannes Schaller from Deutsche Bank. Please go ahead. Yes, thanks and congratulations on such an amazing deal from my side as well. Just two questions, around IoT given that we heard about that so much. I know you can't talk about things going forward, but could you give us a sense just where in your view IoT related royalty revenue stood in the second quarter and how that grew? I know it's probably not a lot and there's some definition to that, but maybe you can give us a bit of a feeling. And then also if you just look at the deals you have so far, most of your would you imagine most of your IoT related deals to just get you a percentage royalty rate on the silicon like most of your other deals? Or is there maybe also something where you can derive more of the value of the services, etcetera, that are related to IoT. If you can give us a bit of a feeling on that, that would be great. So we don't break out royalty dollars between the different segments. But again, if you look at the table that's on page 7, you can see that 42% of the volume in Q2 went into embedded. And it's a very broad category. That can be all manner of devices. Some of those are connected IoT like systems and some of them are more unconnected control, control applications, controlling the motor in a dishwasher, for example, a standalone black box type application. So embedded very broad space, 42% of 3,600,000,000 chips. I can't do that math in my head, but that's a large number of chips. How many of those are connected how many of those aren't? We don't have breakdown here. And in terms of today's business, and today's business model, the IoT opportunity, sorry, not IoT opportunity, revenues from the IoT space are about the percentage royalty on the chips that contain, CORTEX Ms that are going into these connected devices. Again, whether or not that changes over time, we'll be talking about the future. So I better not speculate on that. That's helpful. Thank you very much, Simon. All the best. Thank you very much. There are no further questions. Please continue. Thank you. Well, if there are no further questions, then, thank you very much for joining us today. And, We'll call that a day. Thank you very much. Goodbye. That does conclude the conference for today. Thank you all for participating. You may all disconnect. Have a good rest of the day.