ARM royalties hit by 3G-4G transition July 22 2014

UK firm reports seasonal slowdown, but licensing revenues up by 42%, pointing to stronger growth ahead

By Caroline Gabriel

ARM reported a seasonal slowdown in its second quarter results, but these were still better than the markets had expected, with pre-tax profit up more than fourfold at £68m (from £15m the year before). The dominant mobile processor IP company expects an uptick in the second half, as does one of its most important customers, Qualcomm, but these smartphone powerhouses know they need to diversify their revenue streams too, to avoid these seasonal dips becoming permanent.

ARM's revenues were up 17% year-on-year to $309.6m (though top line growth in UK pounds was 9%, to £187.1m), which was solid for the time of year, though slower

The UK company said its adjusted operating margin improved to 48.9%, from 48.6% in the year-ago period and earnings per share were 3.91p, from 0.75p. The results included an £8.4m restructuring charge connected to layoffs of 130 staff.

The biggest contributor to revenue growth was licensing, up 42% in dollar terms to $146.1m. ARM signed 41 new licences during the quarter. Overall shipments also rose in the quarter, up 11% year-on-year to 2.7bn chips.

By contrast though, royalty revenue grew by only 2% in dollar terms, and the company blamed slowing demand for smartphones because many operators are trying to sell off 3G models while transitioning to 4G. That has created some slowdown at the high end, amid a general rebalancing of the handset industry's growth towards emerging markets and lower cost smartphones.

CEO Simon Segars acknowledged, on the analyst call, that royalties had been hit by "seasonal trends in inventory management in parts of the electronics supply chain" as carriers worked through their 3G inventory. However, he believes this trend will create a shift towards higher end and 4G models in the second half of the year and pointed to a "healthy pipeline of opportunities", which should boost revenue growth in the third and fourth quarters.

"Our continued strong licensing performance reflects the intent of existing and new customers to base more of their future products on ARM technology," Segars said. "This bodes well for growth in ARM's medium and long term royalty revenues."

However, many analysts are cautious about ARM because of its exposure to smartphones, a segment in which prices and growth are slowing. Jasmeet Chadha of Bernstein Research told the Financial Times: "Long term, the view across the market has been that smartphone growth will slow. Half of ARM's business is exposed to smartphones. There are opportunities in the internet of things and wearables, but these will ramp over several years and are small today and do not yet represent half of ARM's business. Structurally, the group's royalty growth is likely to slow." The rising threat of Intel in core markets, and the strength of the British pound, are also negatives around ARM at the moment.

But the firm has been investing huge efforts in diversifying its business and building on its dominance in handsets. It has released processor designs, and announcing licensing deals, in several new areas. Its first 64-bit platform is targeting high performance devices and servers, while it has been expanding its microcontroller and ultra-low power architectures for the internet of things.

The biggest bellwether of the mobile processor market, Qualcomm, reports its quarterly results on Wednesday. Like ARM, it expects the second half of the year to be significantly stronger than the first as it deals with falling handset average selling prices and the 3G-4G transition in China and other key markets.