Annual Report and Accounts 2010

Selected financial data:

Financial performance

The Group’s key financial performance indicators measure performance against revenue, profit, earnings per share and cash and are discussed in detail as part of this review. Non- financial key performance indicators have both a direct and indirect influence on the Group’s financial performance and are discussed in detail in the “Overview” section.

2010 saw the Group recover momentum in revenues and underlying earnings, whilst continuing to invest strongly in research and development. ARM’s licensees responded to the stabilisation of the global economy by signing a record number of licences in both the Processor Division (PD) and the Physical IP Division (PIPD), demonstrating how the semiconductor industry is increasingly choosing ARM’s technology. An analysis of the PD and PIPD licences signed during the year is provided in the progress against strategy section.

US dollar royalty revenues increased by 37% from 2009 to 2010. As there is virtually no cost of sale associated with royalty revenues, gross profit has continued its recent trend of increasing as a proportion of revenues. An analysis of the PD and PIPD unit shipments in 2010 is provided in the progress against strategy section.

The cash generative nature of the ARM business allowed the Group to continue to grow its cash balance as well as making increased dividend payments in the year. Normalised cash generation for the Group in 2010 was £179.9 million (2009: £86.1 million) and the directors have recommended payment of a total dividend of 2.90 pence per share in respect of 2010.

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 research and development, sales and marketing or general and administrative expenses as appropriate. In addition, the issuance of ARM share-based remuneration to employees of the Group gives rise to share-based payment charges. Figures excluding these charges, restructuring charges Linaro-related charges, and impairment of available-for-sale investments are referred to as “normalised” in this narrative to aid comparability.

Revenues

Total revenues for the year ended 31 December 2010 amounted to £406.6 million (2009: £305.0 million). In US dollar terms, revenues were $631.3 million in 2010 compared to $489.5 million in 2009, an increase of 29%, against an increase in US dollar industry revenues of 23% over the same period. The average dollar exchange rate for ARM revenues in 2010 was $1.55, compared to $1.60 in 2009. As a result, the year-on-year growth in sterling revenue was slightly higher than that of US dollar revenue at 33%.

Licensing revenues

Total licensing revenues in 2010 were £132.5 million, being 33% of total revenues, compared to £98.5 million or 32% of total revenues in 2009. In US dollars, total licensing revenues in 2010 were $208.2 million compared to $164.1 million in 2009, an increase of 27%. £105.9 million of licensing revenues came from PD and £26.6 million came from PIPD. In US dollars, PD licensing revenues were $166.9 million (up 30% on $128.2 million in 2009) and PIPD licensing revenues were $41.3 million (up 15% on $35.9 million in 2009).

Royalty revenues

Total royalty revenues for 2010 were £217.7 million, comprising £189.4 million (2009: £132.5 million) from PD and £28.3 million (2009: £22.9 million) from PIPD. Dollar royalty revenues earned in PD were $291.5 million (including catch-up royalties of $9.0 million, reported in Q2 2010), an increase of 40% over 2009 PD royalty revenues of $208.1 million. Dollar royalty revenues in PIPD were $43.8 million (including catch-up royalties of $1.8 million), an increase of 21% over 2009 PIPD royalty revenues of $36.2 million (including catch-up royalties of $5.0 million).

Royalties in PD came from unit shipments by ARM licensees of 6.1 billion, up from 3.9 billion in 2009. This represents a 55% increase, compared with the overall industry’s unit shipment growth of around 30%, demonstrating ARM’s continued increase in market share with equipment manufacturers.

Other revenues

Total revenues from sales of development systems and services were £56.4 million in 2010, compared to £51.1 million in 2009. In US dollars, revenues from sales of development systems and services were $87.8 million in 2010, up 8% on $81.1 million in 2009.

Profit and operating expenditure

The following table shows normalised costs and expenses reconciled to IFRS costs and expenses:

Gross margin
Gross margin in 2010 was 93.6% compared to 91.6% in 2009. Normalised gross margin in 2010 was 94.3% (2009: 92.2%). Licensing and royalty revenues have very few direct costs and the increase in gross margin can be largely attributed to the increase in those revenues.

Operating expenses
Total net operating expenses in the year to 31 December 2010 were £273.6 million, compared to £233.9 million in 2009. Normalised total operating expenses in 2010 were £219.0 million (2009: £186.2 million), an increase of 18%. This was due largely to increased staff costs, primarily as a result of the increased recruitment in research and development and also because of increased staff bonuses, following a year of record revenues.

Research and development expenses in 2010 were £139.8 million compared to £112.2 million in 2009. Normalised research and development expenses in 2010 were £107.6 million, compared to £89.7 million in 2009. As a research and development outsourcing business, the majority of our costs are people-related. Average headcount in research and development increased to 1,208 in 2010 from 1,141 in 2009. The increased investment in research and development has enabled the Group to take advantage of some new market opportunities in areas such as computing and microcontrollers and facilitated several new product launches during the year.

Sales and marketing costs in 2010 were £70.1 million compared to £61.7 million in 2009. Normalised sales and marketing costs in 2010 were £54.1 million compared to £48.5 million in 2009. Additional investment was made in sales and marketing during 2010, resulting in record revenues and significantly increased order backlog.

General and administrative costs in 2010 were £63.7 million compared to £60.0 million in 2009. Normalised general and administrative costs in 2010 were £57.3 million compared to £47.9 million in 2009. The increase is largely attributable to increased staff costs and foreign exchange movements.

Earnings, taxation and returns to shareholders

The following table shows non-GAAP measures used in this annual report, including reconciliations from the IFRS measures. They exclude acquisition-related charges, share-based payment costs, restructuring charges, profit on disposal and impairment of available-for-sale investments, and Linaro-related charges:

Earnings and taxation
Profit before tax in 2010 was £110.0 million or 27% of revenues, compared to £47.3 million or 15% of revenues in 2009. Normalised profit before tax in 2010 was £167.4 million or 41% of revenues, compared to £96.8 million or 32% of revenues in 2009.

The Group’s effective taxation rate in 2010 was 21.9%, compared to 14.4% in 2009. The increase was primarily due to accounting for tax on share-based payments in the respective years.

Fully diluted earnings per share in 2010 were 6.36 pence compared to 3.11 pence in 2009. Normalised diluted earnings per share in 2010 were 9.34 pence (2009: 5.45 pence).

Dividend
The directors recommend payment of a final dividend in respect of 2010 of 1.74 pence per share which, taken together with the interim dividend of 1.16 pence per share paid in October 2010, gives a total dividend in respect of 2010 of 2.90 pence per share, an increase of 20% over 2.42 pence per share in 2009. Subject to shareholder approval, the final dividend will be paid on 18 May 2011 to shareholders on the register on 3 May 2011.

Total dividends actually paid in 2010 amounted to £34.3 million (2009: £29.0 million).

Share-buyback programme
The Group initiated a rolling share-buyback programme in 2005 to supplement dividends in returning surplus funds to shareholders. Since inception, the Company has bought back 213 million shares (being 16% of issued share capital) at a total cost of £261 million.

No share buybacks were undertaken in 2010. The rolling authority to buy back shares given by the shareholders at the 2010 Annual General Meeting (AGM) remains in place and a resolution to authorise the directors to make purchases in appropriate circumstances will be proposed at the 2011 AGM.

Capital structure
The authorised share capital of the Company is 2,200,000,000 ordinary shares at 0.05 pence each (2009: 2,200,000,000). The issued share capital at 31 December 2010 was 1,344,055,696 ordinary shares of 0.05 pence each (2009: 1,344,055,696). As a result of the buyback programme, the Company owns 21,624,158 of its own shares at 31 December 2010 (2009: 60,321,361).

Balance sheet and cash flow

Balance sheet
Goodwill at 31 December 2010 was £532.3 million, compared to £516.8 million at 31 December 2009. The increase in goodwill in 2010 is due primarily to foreign exchange movements. Goodwill is not amortised under IFRS but is subject to impairment review on at least an annual basis. The review performed in 2010 concluded that no impairment was required.

Other intangible assets at 31 December 2010 were £12.1 million, compared to £24.7 million at 31 December 2009. The movement in other intangible assets in 2010 primarily reflects amortisation of the intangible assets and foreign exchange movements. Further analysis can be found in note 16 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 2010 were £105.7 million, compared to £65.2 million at 31 December 2009. The allowance against receivables was £2.1 million at 31 December 2010, compared to £2.4 million at 31 December 2009. Deferred revenues were £92.7 million at 31 December 2010, compared to £39.6 million at the end of 2009.

Treasury
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 resources1.

The consolidated cash, cash equivalents, short- and long-term deposits and marketable securities balance was £290.1 million net of accrued interest of £1.7 million as at 31 December 2010 (2009: £141.8 million).

Net interest receivable was £3.1 million for 2010 compared to £1.6 million in 2009. The increase is due primarily to the higher cash balance carried by the Group throughout 2010.

Principal risks and uncertainties
The principal risks and opportunities faced by the Group are included within the “Risks and risk management” section. Details of other risks and uncertainties faced by the Group are noted within the Annual Report on Form 20-F for the year ended 31 December 2010 which is available on ARM’s website at www.arm.com. Further details of the Group’s internal controls and risk management procedures are included in the Corporate Governance Report.

Tim Score,
Chief Financial Officer

1 The Group’s treasury policies are discussed in detail in note 1c “Financial risk management”.