ARM Community: Post Q2 2011 Roadshow - Frequently asked questions on licensing - ARM Community

In our Q2 2011 results, ARM reported Q2 processor licensing revenues at $58 million, the third successive quarter with license revenue over $50 million. Investors have been questioning whether this level of license revenue is sustainable, or whether there were some temporary effects over the last few quarters.

Before I address these questions, here are few remarks for readers that are not familiar with ARM’s business model and how we recognise license revenue.

Introduction
ARM generates its processor license revenues from the sale of processor designs. These revenues are fees that semiconductor companies pay to gain access to the design of a processor. Typically these are either:

• Product licenses: One-off fees paid to gain access to a specific processor product, with defined usage rights.
• Subscription licenses: On-going fees paid to have access to a family of product designs, which can include products that are still in development. A subscription license will be for a fixed number of years.

In addition to license revenues, ARM also receives a royalty on every chip shipped containing ARM technology, and we sell software tools and services. We will discuss these other revenues another day.

Revenue Recognition of License Fees
Accounting standards define how ARM recognises the revenue associated with licensing fees.

• Product license: Most of ARM’s processor designs are mature products and the majority of the revenue is recognised in the quarter that the agreement is signed. ARM also signs licenses for products that are still under development. In this case, revenue is recognised as engineering or contract milestones are achieved with the unrecognised revenue going into backlog (see below).
• Subscription license: Revenue is recognised rateably, on a quarterly basis, through the period of the agreement. For example, if the agreement is for three years, then 1/12th of the revenue is recognised per quarter over the period. Again unrecognised revenue goes into backlog.

Backlog
ARM’s order backlog is the value of all the agreements that have been signed but ARM has not yet recognised the revenue associated with those agreements. As described above, most revenue in backlog is related to licenses for products under development or subscription licenses.

From Q2 2010 to Q2 2011 ARM’s order backlog increased by approximately 75%.

Selected Data from recent results


* Total backlog as measured in USD at the end of the quarter. For Q2 2011 the comparison is the value of backlog on 30 June 2011 compared with the value on 30 June 2010. In Q2 2011, processor backlog made up ~75% of total backlog.

Investors have been asking what is behind the increase in the number of processor licenses and the value of license revenues.

There are five drivers of ARM’s recent processor licensing:

1. Broadening range of applications
ARM processor technology is becoming increasingly applicable to a broadening range of end-markets. Although semiconductor companies often originally deployed ARM technology in low-power mobile devices, for some time now they have been licensing ARM technology for applications beyond mobile.

In most quarters about three quarters of ARM processor licenses are taken for initial use in non-mobile applications such as cameras, digital TVs, printers, servers and microcontrollers.

2. Broadening range of customers
As ARM technology becomes more broadly applicable, more semiconductor companies are acquiring their first ever ARM processor license.


In most quarters about 25% of licenses are signed with new customers.

3. Product cycle for Cortex-A and Cortex-M processors
ARM’s latest processor families, Cortex-A and Cortex-M are both licensing very strongly.

• The Cortex-A family is suitable for applications processors found in smartphones, mobile computers and digital TVs.
• The Cortex-M family is being designed into microcontrollers and wireless communications chips from Bluetooth to Zigbee

4. Higher pricing for advanced processors
ARM charges higher license fees, and higher royalty percentages, for its more advanced processors. Cortex-A15 is ARM’s most advanced processor to date, and commands the highest up-front licenses fee, and a higher royalty than previous generations of ARM processor.

5. Increased contribution to revenue from backlog
Licenses signed in previous quarters have built backlog to historically high levels. The contribution from backlog each quarter is higher in absolute terms, so helping to increase license revenues in the quarter.

Licensing Guidance
ARM expects annual license revenues to grow in the range mid-to-high single-digits percentage in the medium term. However, as we only sign a small number of major deals each quarter, we expect that license revenues will continue to be lumpy on a sequential basis.

Ian Thornton, Head of Investor Relations, ARM. He joined ARM in 1999 and has held various technical and commercial marketing roles. Prior to taking charge of ARM’s investor relations Ian was responsible for training the ARM sales force in the breadth of ARM’s product portfolio, managing ARM’s ecosystem and leading the company’s competitive analysis program.
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