Financial review

Performance

The Group’s key financial performance indicators include dollar revenue, margin and earnings per share. Non-financial key performance indicators include the number of ARM technology-based chips sold and licences signed. These are discussed as part of this review.

Revenues

Total revenues for the year ended 31 December 2008 amounted to £298.9 million (2007: £259.2 million). In US dollar terms, revenues grew from $514.3 million in 2007 to $546.2 million in 2008, an increase of 6%. Due to the significant strengthening of the US dollar in the second half of 2008, the actual average dollar exchange rate for ARM in 2008 was $1.83 compared to $1.98 in 2007. As a result, the sterling revenue growth of 15% is higher than the underlying US dollar revenue growth.

Total licensing revenues in 2008 were £103.5 million, being 35% of total revenues, compared to £110.7 million or 43% of total revenues in 2007. In US dollars, total licensing revenues in 2008 were $189.7 million compared to $217.9 million in 2007, a decrease of 13%.

Royalty revenues in 2008 were £147.7 million, representing 49% of total revenues in the year, compared to £104.1 million or 40% of total revenues in 2007. Total royalty revenues in US dollars in 2008 were $266.8 million, up 28% from $208.8 million in 2007.

Sales of development systems in 2008 were £31.1 million, being 10% of total revenues, compared to £27.9 million, or 11% of total revenues in 2007. Development systems revenues in US dollars were up 4% in 2008 to $57.8 million from $55.6 million in 2007. Service revenues, which include consulting services and revenues from support, maintenance and training, were £16.6 million in 2008, representing 6% of total revenues, compared to £16.5 million, or 6% of total revenues, in 2007. Service revenues in US dollars were slightly down at $31.9 million, compared to $32.0 million in 2007.

Licensing revenues

Total licensing revenues for 2008 were £103.5 million, comprising £79.3 million from the Processor Division (PD) and £24.2 million from the Physical IP Division (PIPD). In US dollars, PD licensing revenues were $145.1 million (down 11% on $163.5 million in 2007) and PIPD was $44.6 million (down 18% on $54.4 million in 2007).

Although PD licensing was lower than in 2007 after three years of strong growth, PD licensing comprised a rich mix from all processor families with about half of the licences being for the established ARM7, ARM9 and ARM11 families and half being for the newer Cortex processors and Mali 3D graphics processors. 61 new licences were signed in 2008, with 10 of the top 20 semiconductor companies re‑equipping themselves with the latest technologies. In addition, four leading OEMs licensed ARM processor technology directly.

ARM customers are using our processors in an increasingly diverse range of applications; only about one-third of the licences signed in 2008 were for mobile applications, the majority were for applications such as digital TV, networking and automotive.

Since the acquisition of Artisan® in 2004, ARM’s physical IP division has been engaged in an accelerated technology development phase, creating products suitable for licensing by tier 1 semiconductor companies who are just beginning to consider out-sourcing their chip manufacturing and physical IP development. At the beginning of 2008, this phase was largely complete and ARM has been able to demonstrate market and technology leadership through the licensing of physical IP to leading semiconductor companies. During the year, eight leading semiconductor manufacturers licensed ARM 45/40nm physical IP technology, including STMicroelectronics. In addition, leading foundries Chartered, IBM and Samsung all licensed ARM to develop 32nm and 28nm technology for their next generation manufacturing process.

Royalty revenues and unit shipments

Total royalty revenues for 2008 were £147.7 million, comprising £125.5 million (2007: £88.0 million) from PD and £22.2 million (£16.1 million) from PIPD. Royalties in PD came from record unit shipments of 4.0 billion, up 38% compared with 2.9 billion units in 2007. Dollar royalty revenues earned in PD were $226.5 million, up 28% on 2007.

ARM’s unit shipments grew strongly during 2008. Mobile devices used 40% more ARM technology-based chips in 2008 than in 2007, with an average of 1.9 ARM technology-based chips per mobile phone. Beyond mobile, ARM units grew 45% driven by strong growth in digital TVs (50% growth), hard disk drives (up 60%) and microcontrollers (up 90%). This reflects the trend for companies to use ARM technology in an increasingly diverse range of applications. The first ARM technology-based chips started shipping in the mid-1990s and by the end of 2008 over 14 billion ARM technology-based chips had been shipped by our licensees.

The total number of partners shipping ARM technology-based product at the end of 2008 was 90. 25 companies are paying meaningful royalties for physical IP products at the end of the year.

Gross margins

Gross margins in 2008 were 89.0% compared to 89.2% in 2007. Cost of sales in 2008 includes compensation charges in respect of share-based payments and related payroll taxes of £1.1 million (2007: £1.1 million). Excluding compensation charges in respect of share-based payments and related payroll taxes, gross margins in 2008 were 89.4% (2007: 89.6%). The slightly lower margin, despite a greater share of total revenue from royalties, is as a result of a larger proportion of income earned from revenue-sharing arrangements, with a resultant share being payable to our collaborative partners.

Operating expenses

Over recent years, ARM has acquired a number of companies, giving rise to the recognition of intangible assets other than goodwill. These are amortised over their expected useful lives, with the cost recorded against R&D, sales and marketing or general and administrative expenses as appropriate. In order to aid comparability, these costs have been separately identified as “acquisition related charges” in the narrative below. In addition, the issuance of ARM share-based remuneration to employees of the Group gives rise to non-cash share-based compensation charges. These are also separately identified in the narrative below.

Total net operating expenses in the year to 31 December 2008 were £206.1 million compared to £191.4 million in 2007. Operating expenses in 2008 include acquisition-related charges relating to amortisation of intangibles of £19.6 million (2007: £19.2 million), other acquisition-related charges of £0.4 million (2007: £1.7 million), impairment of an available-for-sale security of £nil (2007: £2.1 million), restructuring charges of £1.9 million (2007: £1.0 million) and compensation charges in respect of share-based payments and related payroll taxes of £14.8 million (2007: £17.3 million). Excluding these charges, total operating expenses in 2008 were £169.4 million, compared to £150.1 million in 2007.

R&D expenses in 2008 were £87.6 million, representing 29% of revenues. This compares to £84.0 million or 32% of revenues in 2007. Average headcount in this area decreased from 1,163 in 2007 to 1,115 in 2008. R&D expenses in 2008 include total acquisition-related charges of £11.1 million (2007: £11.4 million) and compensation charges in respect of share-based payments and related payroll taxes of £10.7 million (2007: £10.7 million). Excluding these charges, R&D expenses in 2008 were £65.8 million and £61.9 million in 2007, representing 22% and 24% of revenues respectively. The increase in costs is primarily as a result of the strengthening US dollar resulting in our US dollar cost base having a higher sterling equivalent.

Sales and marketing costs in 2008 were £57.4 million or 19% of revenues, compared to £55.3 million or 21% of revenues in 2007. Average headcount in this area increased from 312 in 2007 to 350 in 2008. Sales and marketing costs in 2008 include total acquisition-related charges of £8.1 million (2007: £8.6 million) and compensation charges in respect of share-based payments and related payroll taxes of £2.0 million (2007: £3.6 million). Excluding these charges, sales and marketing costs in 2008 were £47.3 million and £43.0 million in 2007, representing 16% and 17% of revenues respectively.

General and administrative expenses in 2008 were £61.1 million or 20% of revenues, compared to £52.1 million or 20% of revenues in 2007. Average headcount in this area increased from 226 in 2007 to 246 in 2008. General and administrative expenses in 2008 include total acquisition-related charges of £0.9 million (2007: £0.9 million), restructuring charges of £1.9 million (2007: £1.0 million), impairment of an available-for-sale security of £nil (2007: £2.1 million), and compensation charges in respect of share-based payments and related payroll taxes of £2.1 million (2007: £2.9 million). Excluding these charges, general and administrative expenses in 2008 were £56.2 million, compared to £45.2 million in 2007, representing 19% and 17% of revenues respectively. The increase in costs in this area not only reflects the increases as a result of US dollar cost translation, but also the impact of accounting for derivative and other foreign exchange instruments which has given rise to a net charge in the year of approximately £3.0 million.

Operating margin

The operating margin in 2008 was 20.0% compared to 15.3% in 2007. The operating margin in 2008, excluding acquisition-related charges of £20.0 million, restructuring charges of £1.9 million and compensation charges in respect of share-based payments and related payroll taxes of £15.9 million, was 32.7% compared to 31.7%, before acquisition-related charges of £20.9 million, restructuring charges of £1.0 million, impairment of an available-for-sale security of £2.1 million, and compensation charges in respect of share-based payments and related payroll taxes of £18.4 million in 2007.

Earnings and taxation

Profit before tax in 2008 was £63.2 million compared to £45.1 million in 2007. Profit before tax in 2008, excluding acquisition-related charges of £20.0 million, restructuring charges of £1.9 million, and compensation charges in respect of share-based payments and related payroll taxes of £15.9 million, was £101.0 million or 33.8% of revenues. This compares to £87.5 million, before acquisition-related charges of £20.9 million, restructuring charges of £1.0 million, impairment of an available-for-sale security of £2.1 million, and compensation charges in respect of share-based payments and related payroll taxes of £18.4 million, or 33.8% of revenues in 2007.

The Group’s effective taxation rate in 2008 was 31.0%, compared to 21.8% in 2007. This increase was primarily due to the accounting for deferred tax on share-based remuneration in the respective years and timing of recognition of benefits of restructuring.

Fully diluted earnings per share in 2008 were 3.4 pence compared to 2.6 pence in 2007. Earnings per fully diluted share in 2008, before acquisition-related charges of £20.0 million, restructuring charges of £1.9 million, and compensation charges in respect of share-based payments and related payroll taxes of £15.9 million and related tax adjustments thereon of £8.5 million, were 5.7 pence, compared to 4.8 pence before acquisition-related charges of £20.9 million, restructuring charges of £1.0 million, impairment of an available-for-sale security of £2.1 million, and compensation charges in respect of share-based payments and related payroll taxes of £18.4 million and related tax adjustments thereon of £12.5 million, in 2007.

Balance sheet and cash flow

Goodwill at 31 December 2008 was £567.8 million, compared to £420.8 million at 31 December 2007. The increase in goodwill in 2008 is due primarily to foreign exchange movements, given the significant strengthening of the US dollar against sterling from $1.99 at 31 December 2007 to $1.46 at the end of 2008. Goodwill is not amortised under IFRS but is subject to impairment review on at least an annual basis. The review performed in 2008 concluded that no impairment was required.

Other intangible assets at 31 December 2008 were £45.1 million, compared to £44.3 million at 31 December 2007. The movement in other intangible assets in 2008 primarily reflects foreign exchange movements, the additions of software and licences to third-party technologies and intangibles acquired upon the acquisition of Logipard AB, offset by amortisation of the intangible assets. Further analysis can be found in note 17 to the financial statements. Other intangible assets are amortised through the income statement over their estimated useful lives to the Group. Accounts receivable at 31 December 2008 were £76.9 million, compared to £68.2 million at 31 December 2007. The allowance against receivables was £1.7 million at 31 December 2008, compared to £1.5 million at 31 December 2007. Deferred revenues were £29.9 million at 31 December 2008, compared to £27.5 million at the end of 2007.

Resources available

The consolidated cash, cash equivalents, short-term investments and marketable securities balance was £78.8 million at 31 December 2008 compared to £51.3 million at 31 December 2007. The cash generative nature of the ARM business allowed the Group to grow its cash balance as well as continuing its share buyback programme and dividend payments (see below) in the year. Free cash flow for the Group in 2008 was £91.2 million (2007: £57.1 million).

Interest receivable

Net interest receivable was £3.2 million for 2008 compared to £5.4 million in 2007. The reduction is due to lower interest rates and the reduced average cash balances held by the Group during the year (even though cash grew over the year, the average balance in 2008 was lower than in 2007 as a result of returns to shareholders in the latter part of 2007).

Returns to shareholders
Dividend

The directors recommend payment of a final dividend in respect of 2008 of 1.32 pence per share, which, taken together with the interim dividend of 0.88 pence per share paid in October 2008, gives a total dividend in respect of 2008 of 2.2 pence per share, an increase of 10% over 2.0 pence per share in 2007. Subject to shareholder approval, the final dividend will be paid on 20 May 2009 to shareholders on the register on 1 May 2009. Total dividends actually paid in 2008 amounted to £26.4 million (2007: £18.5 million).

Share buyback programme

In 2008, the Group continued its share buyback programme to supplement dividends in returning surplus funds to shareholders. During the year, the Company bought back 41.2 million shares (2007: 94.5 million) at a total cost of £40.3 million (2007: £128.6 million).

Since the introduction of dividend payments in 2004 and commencing the share buyback programme in July 2005, £338 million has been returned to shareholders and 213 million shares, being 15.9% of issued share capital, have been bought back. This has contributed to a net reduction in the fully diluted shares in issue from 1,424 million in 2005 to 1,286 in 2008.

Capital structure

The authorised share capital of the Company is 2,200,000,000 ordinary shares of 0.05 pence each (2007: 2,200,000,000). The issued share capital at 31 December 2008 was 1,344,055,696 ordinary shares of 0.05 pence each (2007: 1,344,055,696). As a result of the buyback programme, the Company owns 91,160,488 of its own shares at 31 December 2008 (2007: 65,201,176).

Treasury policies and objectives

The Group has established treasury policies aimed both at mitigating the impact of foreign exchange fluctuations on reported profits and cash flows and at ensuring appropriate returns are earned on the Group’s cash resources.

Principal risks and uncertainties

In line with the guidance for the preparation of an operating and financial review, certain risk factors faced by the Group are identified in the trends, risks and opportunities section on pages 16 and 17. Furthermore, due to economic uncertainties in our key markets, many industries may delay or reduce technology purchases and investments. The impact of this on ARM is difficult to predict, but semiconductor companies may defer the licensing of our technology and require fewer support services, OEMs may require fewer development tools, service providers may delay the rollout of new services and consumers may choose not to purchase new electronic products. In such circumstances our revenues could decline, leading to an adverse effect on the results of our operations and could have an adverse effect on our financial condition. A more detailed description is included in the Group’s annual report on Form 20-F. Details of the Group’s internal control and risk management procedures are included in the corporate governance report on page 24.

Tim Score, Chief Financial Officer

Cumulative cash returned £m

Dividend Share buybacks

Reliable cash generation allows dividend growth.