Business Week: Royalties put ARM on top

‘I think the numbers are going to be fine for the fourth quarter and the year,’ an analyst at UBS Warburg told Accountancy Age. ‘It’s done everything it told the market it would do and its results for the year are likely to be in line with expectations.’

It is the company’s business model which has been its saving grace, according to the analyst, who estimates that about one third of the company’s revenue is derived from its royalties.

Each time another company sells a product using ARM’s products, it receives a royalty, a model which has saved the company from going the way its competitors have in the semiconductor industry. ‘They don’t manufacture anything themselves,’ explained the analyst. ‘But they license their products and benefit from royalties on their products.’

Unlike other technology companies, ARM has relatively high revenues and low operating costs, resulting in a positive bottom line. The company announced pre-tax profits of #25.3m for the first nine months of their business year.

‘Revenue growth for the third quarter was stronger than expected,’ said chief financial officer Jonathan Books, ‘with higher royalty revenues accounting for most of the increase’.

A CIMA qualified accountant, Brooks joined the company as chief financial officer in February 1995. He was previously finance director at Accor Group SA, holding several positions including group management accountant in Paris, and finance director of WL Japan KK.

The analyst added: ‘ARM’s earnings tend to have a greater visibility,’ explaining that because of the nature of the business, the company’s income has more to do with the end product and is less likely to suffer from the fluctuations in the market.

Among the company’s significant moves this year, ARM signed agreements expected to enable it to build on its presence in the mobile market. Last quarter, the company struck a partnership deal with Motorola in which the global mobile phone manufacturer will offer ARM’s processor core implementations to its OEM customers, and a licensing agreement with Parthus Technologies.

‘It has an encouraging portfolio,’ said the analyst, ‘it’s growing faster than the market and they still seem to be the leaders in their sector.’ In the last quarter, ARM acquired US-based software development tools provider Allant Software Corporation and launched its SecurCore microprocessor cores for the Smart Card industry.

But despite the company’s encouraging prospects, UBS Warburg has downgraded the company’s stock from a ‘buy’ to a ‘hold’ rating. According to the analyst the profit warnings in the sector have prompted the move. Additionally, valuation looks like it’s going to be increasingly important and the market is going to be less tolerant of results next year.

In the long-term, the analyst believes results are not likely to be as encouraging as they are now, with the negative trends in the sector and the cyclical downturn of the industry. ‘They’ll be fine for the fourth quarter and the first quarter of next year, but they may see a few problems in the second quarter.’

The company’s website is at www.arm.com

SNAPSHOT – NINE MONTHS TO 30.09.00

Turnover: #70.9m

Operating expenses: #40.6m

Pre-tax profit: #25.3m

Earnings per share: 2.0p

Executive directors: Robin Saxby, Jonathan Brooks, Jamie Urquhart, Warren East

Auditor: PricewaterhouseCoopers

Company activities: Develops Reduced Instruction Set Computing (RICS) microprocessors and systems chips,sells software systems and provides consulting services.