UPDATE 2-Licensing demand for ARM's chips offsets smartphone slowdown

Tue Oct 22, 2013 7:18am EDT

* Strong demand for licensing drives sales, profit beat

* Processor royalties revenues miss forecasts

* Sees full-year revenue in line with forecasts

* Shares down as much as 7 percent before rebounding

By Paul Sandle

LONDON, Oct 22 (Reuters) - Chipmakers licensing more powerful mobile technology like the 64-bit computing in the new iPhone helped Britain's ARM Holdings' to beat expectations for the third quarter on Tuesday.

The company, whose chip designs power nearly all smartphones and most tablets, reported a 36 percent rise in pretax profit to 92.6 million pounds ($149.6 million), on revenue 27 percent higher at 184 million pounds.

Analysts had forecast sales of 175.8 million pounds and pretax profit of 88.9 million pounds, according to a poll of 25 brokers compiled by the company.

But the strong performance in licensing overshadowed weak smartphone demand over the summer, which resulted in ARM's royalty revenue missing expectations and there was no forecast that it would bounce back quickly.

ARM licenses its chip designs to chipmaking partners, and it receives a small royalty on every chip its partners ship that includes its technology.

These royalties rose 16 percent to 78.7 million pounds in the quarter, the company said, missing consensus expectations of 83.5 million pounds.

"I think there's been probably a small inventory correction around smartphones in the third quarter, which may go on for a little bit and which will have a short-term impact," Chief Financial Officer Tim Score said.

Score said there had been some rebalancing between premium smartphones and midmarket phones, but overall the outlook for smartphones across all categories looked very strong.

Analysts are looking for signs that the market for top-end smartphones, like Samsung's Galaxy S4, is becoming saturated.

ROYALTIES VS LICENSING

The royalties result initially overshadowed a strong performance in licensing. Processor licensing revenues came in at $106.2 million, up 52 percent on a year earlier and easily beating management's guidance of about $80 million.

ARM's shares, which have risen more than 35 percent since the start of the year, fell as much as 7 percent in early trade on Tuesday. They were up 0.7 percent at 1,047 pence by 0944 GMT.

Analyst Nick James at Numis, who has a "reduce" rating on the stock, said revenue was well ahead from very strong licensing.

But royalty revenue missed expectations, he said, with the growth rate slowing from an average 26 percent year-on-year over the last four quarters to 12-14 percent in the third and fourth.

Analyst Lee Simpson at Jefferies said the average royalty rate per chip, which was flat at 4.9 cents, had not delivered the increase some investors were looking for.

"(But) the royalty rate for the third-quarter was a function of what happened over the summer with the supply chain for Samsung and Apple, in other words there was a lot of inventory burndown, so it was always the case you were going to have a slightly challenged royalty number," he said.

A record 48 processor licences were signed in the quarter, the company said, including Taiwan's MediaTek licensing ARM's latest ARMv8-A processor technology and next-generation Mail graphics.

ARM's customer Apple made the leap into 64-bit mobile computing in the iPhone 5S, unveiled last month.

ARM, which receives a higher royalty for its newest designs, reports royalty revenues a quarter in arrears. The iPhone 5S was only on sale for 10 days at the end of the third quarter, and analysts at Morgan Stanley said the impact of 64-bit computing would be minimal in the fourth quarter.

ARM said it expected to meet market forecasts for revenue of $290 million for the fourth quarter.

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