Income taxes are computed using the liability method. Under this method, deferred income tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established against deferred tax assets where it is more likely than not that some portion or all of the asset will not be realized.
Basic earnings per common share is computed based on the weighted average number of ordinary shares. Diluted earnings per common share is computed by including potential common shares where the effect of their inclusion would be dilutive. The diluted share base for the year ended December 31, 2005 excludes incremental shares of approximately 39,614,000 (2004: 38,143,000; 2003: 18,948,000) related to employee stock options. These shares are excluded due to their antidilutive effect as a result of the exercise price of these shares being higher than the market price. The ordinary equivalent shares for share options were determined using the treasury stock method.
The Company has elected to use the intrinsic value-based method to account for all its employee stock-based compensation plans, under the recognition and measurement principles of APB Opinion No. 25, “Accounting for stock issued to employees,” and related interpretations. Stock-based employee compensation cost in respect of certain SAYE options (see below) of £417,000 (2004: £341,000; 2003: £310,000), in respect of the LTIP of £3,814,000 (2004: £619,000; 2003: £241,000) and in respect of stock options issued as part of a business combination of £5,496,000, (2004: £nil; 2003: £nil) is reflected in net income. Approximately £3.2 million of the charge for the LTIP in 2005 was due to an increase in the number of awards that were expected to vest, predominantly from the 2003 scheme, due to an improvement in the Company’s total shareholder return compared to the comparator groups in the year. No compensation cost is recorded in respect of the other stock option plans, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Apart from certain options issued to executive directors, there are no performance conditions attached to the exercise of options. For executive directors, discretionary share options of up to two times base salary may be issued each year that will vest after seven years. If, however, the Company achieves defined levels of EPS growth above the rate of inflation over a period of three years, then the options are exercisable after three years.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for stock-based compensation,” to stock-based employee compensation.
The fair value of options granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in 2005, 2004 and 2003: risk-free interest rate of 4.0% (2004: between
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4.0% and 4.5%; 2003: between 3.2% and 4.9%); expected life of between one and five years; between 40% and 50% (2004: between 44% and 96%; 2003: between 60% and 127%) volatility; and dividend yield of 0.7% (2004: between 0.5% and 0.7%; 2003: nil). The grant date fair value of options granted during 2005 ranged from £0.21 to £0.54 (2004: £0.30 to £0.88; 2003: £0.21 to £0.55) .
The Company operates Save As You Earn (SAYE) schemes in the UK and an Employee Share Purchase Plan (ESPP) in the US. Options under these schemes are granted at a 15% discount to market price of the underlying shares on the date of grant. The UK SAYE schemes are approved by the Inland Revenue, which stipulates that the savings period must be at least 36 months. During 2002, the Emerging Issues Task Force (EITF) reached a consensus, contained within EITF 00-23, that savings plans which have a savings period in excess of 27 months should be treated as compensatory. In accordance with EITF 00-23, which applies to new offers after January 24, 2002, the Company has recognized a compensation charge in respect of the UK SAYE plans offered since that date. The compensation charge is calculated as the difference between the market price of the shares at the date of grant and the exercise price of the option and is recorded on a straight-line basis over the savings period. The compensation charge recorded in 2005 is £417,000 (2004: £341,000; 2003: £310,000). The deferred compensation at December 31, 2005 was £329,000 (2004: £599,000; 2003 £1,081,000).
In addition, the EITF reached a consensus that an employer’s offer to enter into a new SAYE contract at a lower price than an existing contract causes variable accounting for all existing awards subject to the offer. Variable accounting commences for all existing awards when the offer is made, and for those awards that are retained by employees because the offer is declined, variable accounting continues until the awards are exercised, are forfeited, or expire unexercised. New awards are accounted for as variable to the extent that previous higher priced options are canceled. The compensation charge recorded in 2005 as a result of these provisions is £206,000 (2004: £115,000; 2003: £109,000). The number of options to which variable accounting applies is approximately 867,000 (2004: 908,000; 2003: 950,000).
The Company has an LTIP on which it is also required to recognize a compensation charge calculated as the difference between the exercise price and the fair market value of the shares at the period end, over the vesting period of the share awards. During 2005, a charge of £3,814,000 (2004: £619,000; 2003: £241,000) was incurred and deferred compensation at December 31, 2005 was £1,233,000 (2004: £1,905,000; 2003: £1,418,000)
As part of the consideration for Artisan, the Company granted approximately 90.4 million options over shares in ARM Holdings plc to employees of Artisan with substantially the same terms of those enjoyed when they were options over Artisan shares. As a result, a significant proportion of the options were already vested at acquisition. The intrinsic value of the unvested options was recorded as a reduction in shareholders’ funds and a reduction in goodwill. This amount is then charged to the profit and loss account over the vesting period of the options. During 2005, a charge of £5,496,000 was incurred and deferred compensation at December 31, 2005 was £2,842,000 (2004: £9,579,000).
Treasury Stock Treasury stock represents the cost of shares in the Company held by the Company, the Employee Benefit Trust (“ESOP”) and the QUEST.
During 2005, to supplement the payment of dividends to shareholders, the Company began a rolling share buyback program under the shareholder authority conferred at the 2005 Annual General Meeting. The quantum and frequency of share repurchases is not predetermined and will take into account prevailing market conditions, the short-to-medium-term cash needs of the business and the level of employee share-based remuneration going forward.
In 2005, a total of 13,868,000 shares were repurchased in the market at a cost of £16,211,000. At December 31, 2005, there were 12,751,107 shares in the Company still held from these purchases with a market value of £15,429,000.
The ESOP was set up on April 16, 1998 to facilitate the recruitment, retention and motivation of employees. Under the Company’s Long Term Incentive Plan, 7,760,881 shares could be awarded from shares already issued within the ESOP and treasury stock held by the Company. The market value of unearned shares at December 31, 2005 was £6,050,000.
F-13
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
All costs relating to the schemes are recognized in the income statement as they accrue and the ESOP has waived the right to receive dividends of over and above 0.01 pence per share on all shares held. For the purpose of earnings per share calculations, the shares are treated as canceled until such time as they vest unconditionally.
The Company also has a QUEST which was established to acquire new shares in the Company for the benefit of employees and directors of the Company. No shares were purchased in 2005, 2004 or 2003. During 2005, 713,034 shares (2004: 8,046) were allocated from the QUEST following the exercise of share options granted under the Company’s SAYE schemes. Under the terms of the trust deed, dividends have been waived on the shares held by the QUEST, and all costs relating to the scheme are dealt with in the income statement as they accrue. Following the allocations in 2005, the QUEST held no further shares in the Company and is in the process of being wound-up.
Employer’s taxes on share options Employer’s National Insurance in the UK and equivalent taxes in other jurisdictions are payable on the exercise of certain share options issued to employees in certain tax jurisdictions. In accordance with EITF 00-16 no provision has been made for the employer’s taxes on these share options. These amounts are recognized in the consolidated income statement when payable.
Recently issued accounting standards In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004) (SFAS No. 123R) “Share-based payment.” SFAS No. 123R will require the Company to expense share-based payments, including employee stock options, based on their fair value.
SFAS No. 123R permits public companies to adopt its requirements using one of two methods. The first adoption method is a “modified prospective” method in which compensation cost is recognized beginning with the effective date (i) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (ii) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. The second adoption method is a “modified retrospective” method, which includes the requirements of the modified prospective method described above, but also permits entities to restate, based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures, either (i) all prior periods presented or (ii) prior interim periods in the year of adoption.
ARM is required to adopt SFAS No. 123R effective as of January 1, 2006, and plans to utilize the modified prospective method of adoption. As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees under APB No. 25 using the intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options except the LTIP and SAYE Schemes. Accordingly, the adoption of SFAS No. 123R’s fair value method will have a significant impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123R in prior years, the impact of that adoption would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net earnings and pro forma earnings per share. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently presented. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption and, upon adoption in 2006, the Company will restate its prior consolidated statements of cash flows to reflect this classification.
In December 2004, the FASB issued Statement No. 153 (FAS 153) “Exchanges of non-monetary assets,” an amendment of APB opinion No. 29 “Accounting for non-monetary transactions” (APB 29). FAS 153 is based on the principle that non-monetary asset exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. This standard requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (i) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (ii) the transactions lack commercial substance (as defined). In addition, the FASB decided to retain the guidance in APB 29 for assessing whether the fair value of a non-monetary asset is determinable within reasonable limits. The new standard is the result of the convergence project between the FASB and the International Accounting
F-14
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Standards Board (IASB). We will adopt this standard for non-monetary asset exchanges beginning in 2006. The adoption of FAS 153 is not expected to have a significant impact on our consolidated financial statements.
In March 2005, the FASB issued FIN 47 “Accounting for conditional asset retirement obligations” (FIN 47) which clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143 “Accounting for asset retirement obligations” (SFAS No. 143), refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. FIN 47 requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 was effective as of December 31, 2005, and has had no impact on the consolidated results.
In May 2005, the FASB issued FASB Statement No. 154 “Accounting changes and error corrections” a replacement of APB opinion No. 20 and FASB statement No. 3 (SFAS No. 154). Previously, APB No. 20 “Accounting changes” and SFAS No. 3 “Reporting accounting changes in interim financial statements” required the inclusion of the cumulative effect of changes in accounting principle in net income of the period of the change. SFAS No. 154 requires companies to recognize a change in accounting principle, including a change required by a new accounting pronouncement when the pronouncement does not include specific transition provisions, retrospectively to prior periods’ financial statements. ARM will assess the impact of a retrospective application of a change in accounting principle in accordance with SFAS No. 154 when such a change arises after the effective date of January 1, 2006.
In November 2005, FASB finalized FSP FAS 115-1 “The meaning of other-than-temporary impairment and its application to certain investments.” The FSP provides guidance on the recognition of impairments deemed other-than-temporary. FSP 115-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. We believe that our current policy on other-than-temporary impairments complies with FSP 115-1. Accordingly, the adoption of this standard will not have a material effect on the consolidated financial statements.
Companies Act 1985
These financial statements do not comprise statutory accounts within the meaning of Section 240 of the Companies Act 1985 of Great Britain (the Companies Act). The Company’s statutory accounts, which are its primary financial statements, are prepared in accordance with International Financing Reporting Standards (“IFRS”) for consolidated accounts and accounting principles generally accepted in the United Kingdom (“UK GAAP”) for ARM Holdings plc company-only accounts. They are prepared in compliance with the Companies Act and are presented in pounds sterling. Statutory accounts (upon which the auditors gave unqualified reports under Section 235 of the Companies Act and which did not contain statements under sub-sections 237(2) and (3) of the Companies Act) for the years ended December 31, 2003 and 2004 have been, and those for the year ended December 31, 2005 will be delivered to the Registrar of Companies for England and Wales. Dividends are required to be declared in sterling out of profits available for that purpose as determined in accordance with UK GAAP and the Companies Act.
2 Related party transactions
During the year, the Company paid royalties of £33,000 (2004: £411,000; 2003: £nil) and made cross-license payments of £26,000 (2004: £14,000; 2003: £453,000) to Superscape Group plc, a company in which Mike Inglis is a non-executive director. £nil (2004: £nil) was owed to Superscape at December 31, 2005. Also during 2005, the Company received license fees of £321,000 (2004: £209,000; 2003: £157,000) and support and maintenance income of £37,000 (2004: £37,000; 2003: £nil) from CSR plc, a company in which John Scarisbrick is an executive director. £nil was owed by CSR at December 31, 2005 (2004: £nil).
3 Income taxes
Income before income tax is analyzed as follows:
| | | Year ended December 31, |
| |
|
|
|
| | | 2003
£000 | | 2004
£000 | | 2005
£000 |
| |
| |
| |
|
| United Kingdom | | 16,356 | | 34,569 | | 47,930 |
F-15
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | | Year ended December 31, | |
| | |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| Foreign | | 5,603 | | 3,886 | | 5,304 | |
| |
| |
| |
| |
| | | 21,959 | | 38,455 | | 53,234 | |
| |
| |
| |
| |
| |
| The provision for income taxes consisted of: | | | | | | | |
| | | Year ended December 31, | |
| |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| Current: | | | | | | | |
| United Kingdom | | 8,434 | | 10,619 | | 15,519 | |
| Foreign | | 1,447 | | 1,490 | | 1,430 | |
| |
| |
| |
| |
| Total current | | 9,881 | | 12,109 | | 16,949 | |
| |
| |
| |
| |
| Deferred: | | | | | | | |
| United Kingdom | | (1,622 | ) | (1,171 | ) | (1,244 | ) |
| Foreign | | 684 | | (460 | ) | (4,354 | ) |
| |
| |
| |
| |
| Total deferred | | (938 | ) | (1,631 | ) | (5,595 | ) |
| |
| |
| |
| |
| Total provision for income taxes | | 8,943 | | 10,478 | | 11,354 | |
| |
| |
| |
| |
Included in income tax payable is a current tax benefit of £370,000 (2004: £826,000; 2003: £656,000) and a deferred tax credit of £6,072,000 (2004: credit of £311,000; 2003: charge of £310,000) in relation to employee stock options. Such benefits are reflected as additional paid-in capital.
Also included in the provision for income taxes is utilization of the deferred tax liability in relation to acquired intangibles of £6,921,000 (2004: £188,000; 2003: £nil).
Total income tax expense differs from the amounts computed by applying the UK statutory income tax rate of 30% for 2005, 2004 and 2003 to income before income tax as a result of the following:
| | | Year ended December 31, | |
| |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| UK statutory rate 30% (2004: 30%; 2003: 30%) | | 6,588 | | 11,537 | | 15,970 | |
| Permanent differences – other* | | 1,803 | | 177 | | (2,527 | ) |
| Amortization of intangibles | | — | | (188 | ) | (1,730 | ) |
| Differences in statutory rates of foreign countries | | 92 | | 231 | | (45 | ) |
| Other, net** | | 460 | | (1,279 | ) | (314 | ) |
| |
| |
| |
| |
| | | 8,943 | | 10,478 | | 11,354 | |
| |
| |
| |
| |
|
| * | Permanent differences comprise permanent adjustments and the UK research and development tax credit. For the first time in 2005 the Company received tax benefits arising from the structuring of the Artisan acquisition. These benefits have been included within permanent differences. |
| ** | Other, net comprises prior year adjustments, timing differences and deferred tax adjustments. These benefits have been included within permanent differences. |
Significant components of the deferred tax assets are as follows:
| | | Year ended December 31, | |
| |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| Fixed asset temporary differences | | 2,844 | | 5,669 | | 5,214 | |
| Temporary difference on available-for-sale securities | | (446 | ) | (2,077 | ) | (1,096 | ) |
| Non-deductible accruals and reserves | | 429 | | 1,592 | | 1,662 | |
| Amounts relating to intangible assets arising on acquisition | | — | | (28,571 | ) | (28,323 | ) |
F-16
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | | Year ended December 31, | |
| |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| Losses carried forward | | 815 | | 13,825 | | 20,042 | |
| |
| |
| |
| |
| Total deferred tax assets/(liabilities) | | 3,642 | | (9,562 | ) | (2,501 | ) |
| Valuation allowance | | (503 | ) | (254 | ) | (366 | ) |
| |
| |
| |
| |
| Net deferred tax assets/(liabilities) | | 3,139 | | (9,816 | ) | 2,867 | |
| |
| |
| |
| |
Disclosed on the balance sheet within:
| | | Year ended December 31, | |
| |
|
|
| |
| | | 2003
£000 | | 2004
£000 | | 2005
£000 | |
| |
| |
| |
| |
| Assets | | 3,139 | | 2,529 | | 4,422 | |
| Liabilities | | — | | (12,345 | ) | (7,289 | ) |
| |
| |
| |
| |
| Net deferred tax assets/(liabilities) | | 3,139 | | (9,816 | ) | (2,867 | ) |
| |
| |
| |
| |
Included in the amounts relating to intangible assets on acquisition is £20,925,000 (2004: £22,150,000) relating to liabilities that are expected to accrue after more than one year.
UK income taxes have not been provided at December 31, 2005 on unremitted earnings of approximately£14,958,000 (2004: £5,670,000; 2003: £6,891,000) of subsidiaries located outside the UK as such earnings are considered to be permanently invested. If these earnings were to be remitted without offsetting tax credits in the UK, withholding taxes would be approximately £2,379,000 (2004: £1,122,000; 2003: £347,000). The valuation allowance relates to net operating loss carryforwards of certain subsidiaries, where management believes it is more likely than not such amounts will not be realized. None of the loss carryforwards expires before 2018. The future use of the net operating losses carried forward in ARM, Inc. may be restricted in the event of a purchase by a third party, whereby the level of losses to be utilized on an annual basis would be limited to 4% of the market value of ARM, Inc. at the date of the transaction.
As at December 31, 2005 the Company had federal net operating losses of £26,808,000 and a deferred tax asset thereon of £9,115,000. These losses begin to expire in 2023.
The Company also had state net operating losses of £16,816,000 and a deferred tax asset of £808,000 which begin to expire in 2013.
In addition to the net operating losses the Company also had unutilized federal R&D tax credits of £4,105,000 which will begin to expire in 2012 and unutilized state R&D tax credits of £4,388,000 which have no expiration date.
4 Earnings per share
| | | Year ended December 31, 2003 |
| | |
|
|
|
|
|
| | | Income
£ | | Shares
Number | | Per share
Amount |
| |
| |
| |
|
| Net income | | 13,016,000 | | | | |
| Basic EPS: | | | | | | |
| Income available to common stockholders | | 13,016,000 | | 1,016,484,029 | | 1.3p |
| Effect of dilutive securities: | | | | | | |
| Stock options | | | | 16,823,410 | | |
| Diluted EPS: | | | | | | |
| |
| |
| |
|
| Income available to common stockholders plus assumed conversion | | 13,016,000 | | 1,033,307,439 | | 1.3p |
| |
| |
| |
|
F-17
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | | Year ended December 31, 2004 |
| | |
|
|
|
|
|
| | | Income
£ | | Shares
Number | | Per share
Amount |
| |
| |
| |
|
| Net income | | 27,977,000 | | | | |
| Basic EPS: | | | | | | |
| Income available to common stockholders | | 27,977,000 | | 1,026,889,882 | | 2.7p |
| Effect of dilutive securities: | | | | | | |
| Stock options | | | | 22,878,223 | | |
| Diluted EPS: | | | | | | |
| |
| |
| |
|
| Income available to common stockholders plus assumed conversion | | 27,977,000 | | 1,049,768,105 | | 2.7p |
| |
| |
| |
|
| |
| | | Year ended December 31, 2005 |
| | |
|
|
|
|
|
| | | Income
£ | | Shares
Number | | Per share
Amount |
| |
| |
| |
|
| Net income | | 41,880,000 | | | | |
| Basic EPS: | | | | | | |
| Income available to common stockholders | | 41,880,000 | | 1,369,335,202 | | 3.1p |
| Effect of dilutive securities: | | | | | | |
| Stock options | | | | 57,701,294 | | |
| |
| |
| |
|
| Diluted EPS: | | | | | | |
| Income available to common stockholders plus assumed conversion | | 41,880,000 | | 1,427,036,496 | | 2.9p |
| |
| |
| |
|
5 Business risks and credit concentration
The Company operates in the intensely competitive semiconductor industry which has been characterized by price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. Significant technological changes in the industry could affect operating results.
Financial instruments that potentially subject the Company to concentrations of credit risk comprise principally cash, cash equivalents, short- and long-term investments and marketable securities and accounts receivable. The Company generally does not require collateral on accounts receivable, as many of the Company’s customers are large, well-established companies. The Company has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area.
The Company markets and sells to a relatively small number of customers with individually large value transactions. For further information see Note 13.
At December 31, 2003, 2004 and 2005, no customers accounted for more than 10% of accounts receivable.
As of December 31, 2004 and 2005, the Company’s cash, cash equivalents, short- and long-term investments and marketable securities were deposited with major clearing banks and building societies in the UK and US in the form of money market deposits and corporate bonds for varying periods of up to two years.
6 Acquisitions
Keil Elektronik GmbH and Keil Software, Inc.
On October 27, 2005, the Company purchased the entire share capital of Keil Elektronik GmbH (“KEG”), a company incorporated in Germany for total consideration of $10.9 million (£6.1 million), comprising $10.4 million cash consideration and $0.5 million of related acquisition expenses. On the same day, the Company purchased the entire share capital of Keil Software, Inc. (“KSI” and, together with KEG, “Keil”), a US company, for total consideration of $5.2 million (£2.9 million), comprising $5.0 million cash consideration and $0.2 million of related acquisition expenses.
The Company has identified the MCU market as a critical growth area for the Company’s future business and with this acquisition, the Company will be able to accelerate progress in that market by offering a more complete solution. As
F-18
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the MCU applications shift from 8/16-bit to 32-bit solutions, the combination of the ARM® Cortex™-M3 processor, which was specifically designed for microcontroller applications, the RealView® high-performance compiler, and complementary MCU tools from Keil (comprising KEG and KSI) for ARM, will enable new generations of ARM MCU solutions.
The purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the acquisition date. A further $2.3 million for KEG and $1.0 million for KSI is potentially payable on the achievement of various post-acquisition financial milestones and will be accrued when payable. Keil is a leading independent provider of software development tools for the microcontoller (“MCU”) market.
The operating results for Keil have been included in these financial statements for the period from October 27, 2005 to December 31, 2005. The acquisition was accounted for under SFAS 141.
The following table sets out the provisional fair values of the assets acquired and liabilities assumed at the date of acquisition:
| Fair Value to Company | | KEG
£000 | | KSI
£000 | |
| |
| |
| |
| Assets: | | | | | |
| Cash and cash-equivalents | | 2,911 | | 32 | |
| Accounts receivable, net | | 477 | | 169 | |
| Inventories | | 60 | | 36 | |
| Other debtors | | 71 | | 5 | |
| Property and equipment, net | | 12 | | — | |
| |
| |
| |
| Total assets acquired | | 3,471 | | 242 | |
| |
| |
| |
| Liabilities: | | | | | |
| Accounts payable and other creditors | | (1,593 | ) | (19 | ) |
| Accrued liabilities and deferred revenue | | (2,280 | ) | (62 | ) |
| |
| |
| |
| Total Liabilities assumed | | (3,873 | ) | (81 | ) |
| |
| |
| |
| Net (liabilities assumed)/assets acquired | | (402 | ) | 161 | |
| |
| |
| |
The intangible assets recognized, apart from goodwill, represented contractual or other legal rights of Keil and those intangible assets of Keil that could be clearly identified. These intangibles were identified and valued through interviews and analysis of data provided by Keil concerning development projects, their stage of development, the time and resources needed to complete them, and if applicable, their expected income generating ability. There were no other contractual or other legal rights of Keil clearly identifiable by management, other than those identified below. The provisional allocation of the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed was as follows:
| | | Useful
estimated life
(years) | | KEG
£000 | | KSI
£000 | |
| |
| |
|
|
| |
| Fair value of net (liabilities)/assets acquired | | | | (402 | ) | 161 | |
| Intangible assets acquired: | | | | | | | |
| Customer relationships | | 2-3 | | 4,290 | | 482 | |
| Developed technology | | 1-5 | | 2,744 | | — | |
| Tradenames | | 5 | | — | | 1,175 | |
| Deferred tax liability | | | | (2,673 | ) | (663 | ) |
| Goodwill | | | | 2,178 | | 1,764 | |
| | | |
| |
| |
| Purchase price | | | | 6,137 | | 2,919 | |
| | | |
| |
| |
KEG made a profit after tax for the year ended December 31, 2004 of £1.0 million and for the period from January 1, 2005 until acquisition a profit after tax of £1.0 million. KSI made a loss after tax for the year ended December 31, 2004 of £95,000 and for the period from January 1, 2005 until acquisition a loss after tax of £40,000. The results of the Company would not have been significantly different had the acquisition of KEG and KSI occurred on January 1, 2005.
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Axys Design Automation, Inc.
On August 16, 2004, the Company purchased the entire share capital of Axys Design Automation, Inc., a US company, for a total consideration of $12.5 million (£6.9 million), comprising $11.6 million cash consideration and $0.9 million of related acquisition expenses. The purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the acquisition date. A further $3 million was potentially payable on the achievement of various post-acquisition financial milestones. These were achieved during 2005 and were accrued and paid during the year. Axys is a provider of fast, accurate, integrated, processor and system modeling and simulation solutions and adds electronic system level expertise to ARM’s design tools portfolio.
The acquisition was accounted for under SFAS 141. The operating results for Axys have been included in these financial statements for the period August 16, 2004 to December 31, 2004 in the 2004 comparatives and for the entire year in 2005.
The following table sets out the fair values of the assets acquired and liabilities assumed at the date of acquisition:
| | | Fair value
£000 | |
| |
| |
| Assets: | | | |
| Cash and cash equivalents | | 107 | |
| Accounts receivable, net | | 270 | |
| Other debtors | | 74 | |
| Deferred tax asset | | 710 | |
| Property and equipment, net | | 50 | |
| |
| |
| Total assets acquired | | 1,211 | |
| |
| |
| Liabilities: | | | |
| Accounts payable and other creditors | | (17 | ) |
| Accrued liabilities and deferred revenue | | (729 | ) |
| |
| |
| Total liabilities assumed | | (746 | ) |
| |
| |
| Net assets acquired | | 465 | |
| |
| |
The intangible assets recognized, apart from goodwill, represented contractual or other legal rights of Axys and those intangible assets of Axys that could be clearly identified. These intangibles were identified and valued through interviews and analysis of data provided by Axys concerning development projects, their stage of development, the time and resources needed to complete them, and if applicable, their expected income generating ability. There were no other contractual or other legal rights of Axys clearly identifiable by management, other than those identified below. The allocation of the purchase price as at December 31, 2004, to the tangible and identifiable intangible assets acquired and liabilities assumed was as follows:
| | | Useful
estimated life
(years) | | £000 | |
| |
| |
| |
| Fair value of net assets acquired | | | | 465 | |
| Intangible assets acquired: | | | | | |
| Developed technology | | 5 | | 1,379 | |
| Customer relationships | | 5 | | 425 | |
| Trademarks | | 5 | | 96 | |
| In-process research and development | | | | 383 | |
| Deferred tax liability | | | | (760 | ) |
| Goodwill | | | | 4,914 | |
| | | |
| |
| Purchase price | | | | 6,902 | |
| | | |
| |
Axys’ profit after tax for the year ended December 31, 2003 was £0.02 million and for the period from January 1, 2004 until acquisition was a loss of £0.9 million.
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As noted above, a further $3 million consideration was paid during 2005 following achievement of various post-acquisition financial milestones. As a result, total consideration and resultant goodwill increased by £1,690,000 during the year, as reflected in Note 9.
Artisan Components, Inc.
On December 23, 2004, the Company acquired the entire share capital of Artisan Components, Inc., a leading provider of physical IP components for the design and manufacture of complex system-on-chip (“SoC”) integrated circuits. The acquisition enables the combined company to deliver one of the industry’s broadest portfolios of SoC intellectual property to their extensive, combined customer base, with highly complementary sales channels combining ARM’s channel to more than 170 silicon manufacturers with Artisan’s channel to more than 2,000 companies. It better positions the combined company to benefit from growth opportunities across multiple industries as system design complexity increases, and strengthens the links between the key aspects of SoC development, enabling the combined company to deliver solutions that are further optimized for power and performance.
The acquisition was accounted for under SFAS 141. The operating results for Artisan have been included in these financial statements for the period December 23, 2004 to December 31, 2004 in the 2004 comparatives and for the entire year in 2005.
The total consideration paid was $926.9 million (£481.7 million), comprising cash of $235.4 million (£122.3 million), 324,399,411 ordinary shares in the Company with a fair value of $524.2 million (£272.4 million), approximately 90.4 million share options issued to existing Artisan employees with fair value of $151.9 million (£79.0 million) and related direct acquisition fees of $15.4 million (£8.0 million) including legal, valuation and accounting fees. The purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their estimated fair values on the acquisition date. These provisional fair values were subsequently amended during 2005 as noted below.
The shares issued on acquisition were valued in accordance with Emerging Issues Task Force Issue No. 99-12 (“EITF 99-12”), “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination.” In accordance with EITF 99-12, the Company established the first date on which the number of the Company shares and the amount of other consideration became fixed as of August 23, 2004. Accordingly, the Company valued the transaction using the average closing price of the Company’s ordinary shares two days before and after August 23, 2004, or $1.616 per share. The assumed options to acquire ordinary shares were valued using the Black-Scholes valuation model with volatility of between 80% and 94%, an average risk free interest rate of 4.5%, an estimated life of between zero and six years, and dividend yield of 0.7% .
The following table sets out the fair values of the assets acquired and liabilities assumed at the date of acquisition as reported in the 2004 annual report:
| | | Fair value
£000 |
| |
|
| Assets: | | |
| Cash, cash equivalents and marketable securities | | 82,567 |
| Accounts receivable, net | | 15,078 |
| Prepaid expenses and other assets | | 3,225 |
| Deferred tax asset | | 15,446 |
| Property and equipment, net | | 2,509 |
| |
|
| Total assets acquired | | 118,825 |
| |
|
| Liabilities: | | |
| Accounts payable and other creditors | | 3,674 |
| Accrued liabilities and deferred revenue | | 13,245 |
| Deferred revenue | | 6,545 |
| |
|
| Total liabilities assumed | | 23,464 |
| |
|
| Net assets acquired | | 95,361 |
| |
|
The intangible assets recognized, apart from goodwill, represented contractual or other legal rights of Artisan and those intangible assets of Artisan that could be clearly identified. These intangibles were identified and valued through
F-21
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
interviews and analysis of data provided by Artisan concerning development projects, their stage of development, the time and resources needed to complete them, and if applicable, their expected income generating ability. There were no other contractual or other legal rights of Artisan clearly identifiable by management, other than those identified below. The provisional allocation of the purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed was as follows:
| | | Useful
estimated life
(years) | | £000 | |
| |
| |
| |
| Fair value of net assets acquired | | | | 95,361 | |
| Intangible assets acquired: | | | | | |
| Developed technology | | 4-5 | | 18,177 | |
| Patents/core technology | | 5-7 | | 11,719 | |
| Existing agreements and customer relationships | | 3-8 | | 36,354 | |
| Trademarks/trade names | | 4-5 | | 2,500 | |
| Order backlog | | 0-1 | | 1,354 | |
| In-process research and development | | | | 3,229 | |
| Deferred stock-based compensation | | | | 9,579 | |
| Deferred tax liability | | | | (28,042 | ) |
| Goodwill | | | | 331,432 | |
| | | |
| |
| Purchase price | | | | 481,663 | |
| | | |
| |
Developed technology. Developed technology of £18.2 million and patents and core technology of £11.7 million included intellectual property components for use in SoC integrated circuits and consisted of the following: embedded memory, standard cell, input/output components, and analog and mixed-signal products. In addition, developed technology included a combination of processes, patents, patent applications, core modular architecture and trade secrets that are the buildings blocks of the technology. At the date of acquisition, the developed technology was complete and had reached technological feasibility. Any costs incurred in the future will relate to the ongoing maintenance of the developed technology and will be expensed as incurred. To estimate the fair value of the developed technology, an income approach was used with a discount rate of 14% for existing technology and 16% for patents and core technology, which included an analysis of future cash flows and the risks associated with achieving such cash flows. All developed technologies are being amortized over the estimated useful lives of four to five years.
Existing agreements and customer relationships and order backlog. The customer base of £36.4 million and order backlog of £1.4 million represented the fair value of existing customer relationships and contracts, royalty arrangements, and support and maintenance agreements. To estimate the fair value of the customer base and order backlog, a cost approach (replacement value) was used. The customer base and order backlog are being amortized over their estimated useful lives of three to six years for customer base and one year for order backlog.
Trademarks and trade names. The fair value assigned to trademarks and trade names, including the company name Artisan, was estimated using the income approach, which discounts the present value of attributable cash flows at a discount rate of 16%.
In-process research and development. Development projects that had reached technological feasibility were classified as developed technology and the value assigned to developed technology was capitalized. Expensed in-process research and development of £3.2 million reflected certain research projects that had not yet reached technological feasibility and commercial viability or had no alternative future use at the time of the acquisition. The fair value assigned to in-process research and development was estimated using the income approach, which discounts to present value the cash flows attributable to the technology once it has reached technological feasibility using a discount rate of 19%. In-process research and development has been written-off immediately to the income statement.
Goodwill of £331.4 million represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. As stated, the acquisition enables the combined company to deliver one of the industry’s broadest portfolios of SoC intellectual property to their extensive, combined customer base and it better positions the combined company to benefit from growth opportunities across multiple industries as system design complexity increases. These, combined with the ability to hire the entire Artisan work force, were significant contributing factors to the
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
establishment of the purchase price, resulting in the recognition of a significant amount of goodwill. In accordance with SFAS 142, the Company is not amortizing goodwill relating to the acquisition. It is being carried at cost and the Company will test it for impairment annually and whenever events indicate that an impairment may have occurred.
The pro forma results of the Company for the current year, had the acquisition occurred on January 1, 2004, and for the prior year, had the acquisition occurred on January 1, 2003, would have been:
| | 2003
Unaudited
£000 | | 2004
Unaudited
£000 | |
| |
| |
| |
| Revenues | | 173,277 | | 197,852 | |
| Income from operations | | 3,730 | | 15,973 | |
| Net income | | 1,650 | | 16,365 | |
| Diluted earnings per ordinary share | | 0.1p | | 1.2p | |
Net income has been reduced in these pro forma results in relation to reduced interest income as a result of the cash portion of the acquisition consideration, amortization of intangibles acquired and amortization of deferred compensation.
During 2005, the provisional fair values were adjusted resulting in an increase in the net assets acquired of $2.9 million (£1.5 million) with a corresponding decrease to goodwill. The principal adjustments were an increase to the deferred tax asset (representing deductions arising on exercise of options issued in a business combination, in accordance with EITF00-23) of £4.8 million, an increase in intangible assets acquired (including in-process research and development but net of deferred tax) of £0.8 million, a reduction in deferred tax assets relating to carried forward losses of £1.4 million, and additional provisions for unaccrued costs of £2.7 million. See Note 9 for subsequent revisions to acquired intangible assets on finalization of the purchase price allocation.
7 Investments and marketable securities
| | Listed
investments
£000 | | | Unlisted
investments
£000 | | | Total
investments
£000 | |
| |
| | |
| | |
| |
| Cost | | | | | | | | | |
| At January 1, 2005 | | 3,340 | | | 3,733 | | | 7,073 | |
| Additions | | — | | | 274 | | | 274 | |
| Disposal | | — | | | (112 | ) | | (112 | ) |
| |
| | |
| | |
| |
| At December 31, 2005 | | 3,340 | | | 3,895 | | | 7,235 | |
| |
| | |
| | |
| |
| Aggregate movements in fair value | | | | | | | | | |
| At January 1, 2005 | | 6,922 | | | (1,760 | ) | | 5,162 | |
| Unrealized holding losses | | (3,267 | ) | | — | | | (3,267 | ) |
| Impairment charge | | — | | | (337 | ) | | (337 | ) |
| Disposal | | — | | | 7 | | | 7 | |
| |
| | |
| | |
| |
| At December 31, 2005 | | 3,655 | | | (2,090 | ) | | 1,565 | |
| |
| | |
| | |
| |
Carrying value
At December 31, 2005 | | 6,995 | | | 1,805 | | | 8,800 | |
| |
| | |
| | |
| |
| At December 31, 2004 | | 10,262 | | | 1,973 | | | 12,235 | |
Listed investments comprise investments of £2,252,000 and £688,000 in Superscape Group plc and CSR plc respectively, with aggregate fair values at December 31, 2005 of £6,995,000 (2004: £10,262,000; 2003: £4,139,000).
In 2004, the Company invested £112,000 in Zeevo Inc. and £50,000 in Reciva Limited, both unlisted companies. In 2005, the Company invested £274,000 in Luminary Micro Inc., an unlisted company.
Impairments during 2005 against unlisted investments held at the year end amounted to £337,000 (2004: £nil; 2003: £622,000) and against listed investments held at the year end amounted to £nil (2004: £nil; 2003: £938,000).
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At December 31, 2005, the Company had £8,835,000 (2004: £21,511,000; 2003: £nil) and £nil (2004: £5,438,000; 2003: £nil) of short- and long-term marketable securities respectively. These represent both the fair market value and amortized cost of these securities.
8 Property and equipment
| | December 31, | |
| |
|
|
|
| |
| | 2004
£000 | | | 2005
£000 | |
| |
| | |
| |
| Owned buildings | | 190 | | | 190 | |
| Leasehold improvements | | 21,405 | | | 20,058 | |
| Computers | | 12,291 | | | 17,944 | |
| Software | | 35,787 | | | 36,530 | |
| Fixtures, fittings and motor vehicles | | 3,215 | | | 4,176 | |
| |
| | |
| |
| | 72,888 | | | 78,898 | |
| Less: accumulated depreciation | | (58,771 | ) | | (66,095 | ) |
| |
| | |
| |
| Property and equipment, net | | 14,117 | | | 12,803 | |
| |
| | |
| |
Depreciation charged to income for the years ended December 31, 2003, 2004 and 2005 was £12,908,000, £9,927,000 and £7,750,000 respectively. The net book value of software at December 31, 2005 was £3,813,000 (2004: £5,021,000) with depreciation charged in 2005 on software of £1,851,000 (2004: £4,395,000; 2003: £6,429,000).
9 Intangible assets
| Goodwill | | Patents | | Licenses | | Developed
technology | | Existing
agreements
and
customer
relationships | | Core
technology | | Trademarks | | Order backlog | | Total | |
| £000 | | £000 | | £000 | | £000 | | £000 | | £000 | | £000 | | £000 | | £000 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| Cost | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| At January 1, 2005 | | 343,736 | | | 8,196 | | | 4,864 | | | 19,644 | | | 36,889 | | | 11,719 | | | 2,590 | | | 1,354 | | | 428,992 | |
| Additions (KEG) | | 2,178 | | | — | | | — | | | 2,744 | | | 4,290 | | | — | | | — | | | — | | | 9,212 | |
| Additions (KSI) | | 1,764 | | | — | | | — | | | — | | | 482 | | | — | | | 1,175 | | | — | | | 3,421 | |
| Additions (Axys) | | 1,690 | | | — | | | — | | | — | | | — | | | — | | | — | | | — | | | 1,690 | |
| Other additions | | — | | | — | | | 1,042 | | | — | | | — | | | — | | | — | | | — | | | 1,042 | |
| Revisions (Artisan) | | (1,542 | ) | | — | | | — | | | (1,004 | ) | | 1,004 | | | 335 | | | 111 | | | 335 | | | (761 | ) |
| Exchange differences | | 41,066 | | | — | | | — | | | 2,260 | | | 4,411 | | | 1,401 | | | 349 | | | 175 | | | 49,662 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| At December 31, 2004 | | 388,892 | | | 8,196 | | | 5,906 | | | 23,644 | | | 47,076 | | | 13,455 | | | 4,225 | | | 1,864 | | | 493,258 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| Aggregate amortization | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| At January 1, 2004 | | 3,320 | | | 5,877 | | | 4,188 | | | 244 | | | 267 | | | 51 | | | 21 | | | 30 | | | 13,998 | |
| Charge for the year | | — | | | 2,137 | | | 782 | | | 4,949 | | | 7,414 | | | 2,545 | | | 748 | | | 1,735 | | | 20,310 | |
| Exchange differences | | — | | | — | | | — | | | 308 | | | 430 | | | 153 | | | 43 | | | 99 | | | 1,033 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2004 | | 3,320 | | | 8,014 | | | 4,970 | | | 5,501 | | | 8,111 | | | 2,749 | | | 812 | | | 1,864 | | | 35,341 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net book value
At December 31,2005 | | 385,572 | | | 182 | | | 936 | | | 18,143 | | | 38,965 | | | 10,706 | | | 3,413 | | | — | | | 457,917 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| At December 31, 2004 | | 340,416 | | | 2,319 | | | 676 | | | 19,400 | | | 36,622 | | | 11,668 | | | 2,569 | | | 1,324 | | | 414,994 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Amortization charged to income for the years ended December 31, 2003, 2004 and 2005 was £3,384,000, £3,197,000 and £20,310,000 respectively.
F-24
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Until the adoption of SFAS 142 on January 1, 2002 (see Note 1), goodwill was being amortized on a straight-line basis over periods of up to three years, determined in each case by reference to employee turnover rates in the industry and the individual technology acquired with the acquisitions. In accordance with SFAS 142, goodwill is no longer amortized, and is tested for impairment at least annually.
The split of goodwill by segment is shown in Note 14. Additions in the year relating to KEG, KSI and Axys have all been allocated to the Processor division. The foreign exchange difference arises as goodwill on Artisan, Axys and KSI is denominated in US dollars and thus is subject to revaluation at the period-end rates. Changes in the carrying amount for the year are as follows:
| | Processor
division
£000 | | Physical IP
division
£000 | | Total
£000 | |
| |
| |
| |
| |
| Balance at January 1, 2005 | | 108,414 | | 232,002 | | 340,416 | |
| Additions (KEG) | | 2,178 | | — | | 2,178 | |
| Additions (KSI) | | 1,764 | | — | | 1,764 | |
| Additions (Axys) | | 1,690 | | — | | 1,690 | |
| Additions (Artisan) | | (956 | ) | (2,231 | ) | (3,187 | ) |
| Exchange differences | | 13,285 | | 29,426 | | 42,711 | |
| |
| |
| |
| |
| Balance at December 31, 2005 | | 126,375 | | 259,197 | | 385,572 | |
| |
| |
| |
| |
Licenses to use technology are being amortized over periods of three to five years. The amortization periods for licenses have been determined according to their estimated useful economic life.
Patents are being amortized over four to five years, developed technology (the main IP of the company existent at acquisition and generating revenue) over five years and customer relationships (relationships with customers which were generating revenue at acquisition) over two years, being the periods over which the Company is expected to derive benefit from them.
The estimated amortization expense of intangible assets in each of the next five years is set forth below:
| | £000 |
| |
|
| 2006 | | 18,634 |
| 2007 | | 18,519 |
| 2008 | | 17,077 |
| 2009 | | 10,216 |
| 2010 | | 6,780 |
| | | |
10 Accounts receivable
Included within accounts receivable of December 31, 2005 are £20.5 million (2004: £5.9 million) of amounts recoverable on contracts.
11 Accrued liabilities Included within accrued liabilities at December 31, 2005 are £nil (2004: £14.3 million) of acquisition-related expenses, £0.7 million (2004: £4.4 million) for staff costs and £0.7 million (2004: £2.8 million) representing the fair value of embedded derivatives.
12 Shareholders’ equity
Share options
The board is authorized to issue options to acquire ordinary shares in the Company up to a maximum of 10% of the issued ordinary share capital in any five-year period. Options issued prior to the listing of the Company are excluded from this calculation.
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Under the UK Inland Revenue Executive Approved Share Option Plan (the “Executive Scheme”), the Company may grant options to employees meeting certain eligibility requirements. Options under the Executive Scheme are exercisable between three and ten years after their issue, after which time the options expire.
Under the Company’s Unapproved Scheme (the “Unapproved Scheme”), for which it has not sought approval from the UK Inland Revenue, options are exercisable one to seven years after their issue, after which time the options expire. The Company also operates the US ISO Scheme, which is substantially the same as the Unapproved Scheme, the main difference being that the options are exercisable one to five years after their issue. Under both of these schemes options are exercisable as follows: 25% maximum on first anniversary, 50% maximum on second anniversary, 75% maximum on third anniversary, 100% maximum on fourth anniversary. Various options to directors under the Unapproved Scheme have certain performance criteria attached, which if met are exercisable after three years, otherwise they will become exercisable after seven years.
There are two further schemes for our French and Belgian employees (the “French Scheme” and the “Belgian Scheme”). In the French Scheme, options are exercisable between four and seven years after their issue, whilst in the Belgian Scheme, options are exercisable from January 1, following the third anniversary after their issue, up to seven years from issue.
Upon the acquisition of Artisan in 2004, the Company assumed the share schemes of Artisan existing at acquisition. The schemes remained substantially the same as prior to the acquisition, other than the options became options to purchase shares in ARM Holdings plc instead of Artisan Components, Inc. The number and value of options were amended in line with the conversion ratio as detailed in the merger agreement. The schemes assumed were the “1993 Plan,” the “1997 Plan,” the “2000 Plan,” the “2003 Plan,” the “Director Plan,” the “Executive Plan” and the “ND00 Plan.”
Under each plan, there are multiple vesting templates and vesting periods. The majority of the options were already vested upon acquisition, and the most common template was 25% vesting after one year, and then 6.25% vesting each quarter thereafter, until 100% vest after four years. Some options vest on a monthly basis, and some vest over five years. All options lapse ten years from the date of grant.
In 1998, the Company set up two savings-related share option schemes for all employees and executive directors of the Company. The number of options granted is related to the value of savings made by the employee. The period of savings is three or five years except for employees of ARM, Inc. and ARM Physical IP, Inc. where the period is two years. The option price is currently set at 85% of the market share price prior to the grant, and the right to exercise normally only arises for a six-month period once the savings have been completed except for ARM, Inc. and ARM Physical IP, Inc. where the right to exercise normally only arises for a three-month period once the savings have been completed. The Company set up two further savings-related option schemes in each year up to and including 2005 for all employees and executive directors of the Company, which have the same characteristics as those schemes set up in 1998.
| | Outstanding options |
| |
|
|
|
|
| | Shares
Number | | | Weighted
average
exercise price
£ |
| |
| | |
|
| Balances, December 31, 2002 | | 35,051,349 | | | 2.557 |
| Granted in year | | 37,537,323 | | | 0.468 |
| Lapsed in year | | (4,434,268 | ) | | 2.566 |
| Exercised in year | | (2,663,324 | ) | | 0.194 |
| |
| | |
|
| Balances, December 31, 2003 | | 65,491,080 | | | 1.455 |
| Granted in year | | 16,934,076 | | | 1.226 |
| Assumed on acquisition of Artisan | | 90,414,815 | | | 0.434 |
| Lapsed in year | | (5,770,196 | ) | | 1.914 |
| Exercised in year | | (3,049,960 | ) | | 0.431 |
| |
| | |
|
| Balances, December 31, 2004 | | 164,019,815 | | | 0.870 |
| Granted in year | | 27,127,630 | | | 1.051 |
| Lapsed in year | | (11,027,172 | ) | | 1.110 |
| Exercised in year | | (37,096,283 | ) | | 0.374 |
| |
| | |
|
F-26
Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | Outstanding options |
| |
|
|
|
|
| | Shares
Number | | | Weighted
average
exercise price
£ |
| |
| | |
|
| Balances December 31, 2005 | | 143,023,990 | | | 1.014 |
The weighted average grant-date fair value of options granted during 2005 was £0.47 (2004: £0.74; 2003: £0.28) .
The weighted average exercise price of options exercisable at December 31, 2005 was £1.22 (2004: £1.00; 2003: £2.45) .
The following options over ordinary shares were in existence at December 31:
| | Options outstanding | | Options exercisable |
| | |
|
|
|
|
| |
|
|
|
| Exercise Price | | Number Outstanding | | Weighted average
remaining life (years) | | Weighted average
exercise price (£) | | Number outstanding | | Weighted average
exercise price (£) |
| |
| |
| |
| |
| |
|
| 2005 | | | | | | | | | | |
| 0.026– 0.40 | | 22,988,380 | | 5.31 | | 0.26 | | 21,711,264 | | 0.26 |
| 0.405 – 0.50 | | 33,861,103 | | 5.23 | | 0.45 | | 12,148,585 | | 0.46 |
| 0.51 – 0.9475 | | 26,183,870 | | 6.49 | | 0.68 | | 7,966,134 | | 0.66 |
| 1.005 – 1.224 | | 31,257,471 | | 4.80 | | 1.09 | | 6,372,494 | | 1.22 |
| 1.25 – 7.738 | | 28,733,166 | | 3.77 | | 2.50 | | 16,232,612 | | 3.37 |
| Total | | 143,023,990 | | 5.09 | | 1.01 | | 64,431,089 | | 1.22 |
Under the Company’s Long Term Incentive Plan, a further 7,760,881 (2004: 5,003,724; 2003: 2,572,646) shares could be awarded to the extent that performance criteria are satisfied over a three-year period. These shares will be awarded from shares already issued within the ESOP and the treasury shares.
13 Commitments and contingencies The Company leases its office facilities and certain equipment under non-cancelable operating lease agreements which expire at various dates through 2018.
Future minimum lease commitments at December 31, 2005, are as follows:
| Years ending December 31, | | Operating
leases
£000 |
| |
|
| 2006 | | 6,356 |
| 2007 | | 4,300 |
| 2008 | | 3,610 |
| 2009 | | 2,542 |
| 2010 | | 2,246 |
| Thereafter | | 11,378 |
| |
|
| Total minimum lease payments | | 30,432 |
Rental expense under operating leases totalled £8,169,000, £12,627,000 and £15,809,000 for the years ended December 31, 2003, 2004 and 2005 respectively.
In May 2002, Nazomi Communications, Inc. (“Nazomi”) filed suit against ARM alleging willful infringement of Nazomi’s US Patent No. 6,332,215. ARM answered Nazomi’s complaint in July 2002 denying infringement. ARM moved for summary judgment and a ruling that the technology does not infringe Nazomi’s patent. The United States District Court for the Northern District of California granted ARM’s motion, and Nazomi appealed the District Court’s ruling. On September 7, 2004, the Court of Appeals for the Federal Circuit heard the appeal and issued its decision on April 11, 2005. Because, in the opinion of the Court of Appeals for the Federal Circuit, the District Court did not construe the disputed claim term in sufficient detail for appellate review, the Court of Appeals for the Federal Circuit remanded the
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Table of Contents
ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
dispute back to the District Court for further analysis. A supplementary “Markman” hearing to assist in a more detailed claim construction analysis was held on October 11, 2005 and we are presently awaiting the ruling of the District Court. Based on legal advice received to date, ARM has no cause to believe that the effect of the original ruling by the District Court will not be upheld.
Guarantees It is common industry practice for licensors of technology to offer to indemnify their licensees for loss suffered by the licensee in the event that the technology licensed is held to infringe the intellectual property of a third party. Consistent with such practice, the Company provides such indemnification to its licensees but subject, in all cases, to a limitation of liability. The obligation for the Company to indemnify its licensees is subject to certain provisos and is usually contingent upon a third party bringing an action against the licensee alleging that the technology licensed by the Company to the licensee infringes such third party’s intellectual property rights. The indemnification obligations typically survive any termination of the license and continue in perpetuity.
The Company does not provide for any such guarantees unless it has received notification from the other party that they are likely to invoke the guarantee. The provision is made if both of the following conditions are met: (i) information available prior to the issuance of the financial statements indicates that it is probable that a liability had been incurred at the date of the financial statements; and (ii) the amount of the liability can be reasonably estimated. Any such provision is based upon the directors’ estimate of the expected costs of any such claim.
The total provision for such guarantees was £nil on December 31, 2005, (2004: £0.5 million) and a table showing the movement of the provision during the year is as follows:
| | At January 1,
2005
£000 | | Provided in
the year on
new claims
£000 | | Released in
the year
£000 | | Utilized in the
year through cash
payments
£000 | | At December 31,
2004
£000 |
| |
| |
| |
| |
| |
|
| Indemnification provision | | 520 | | — | | (520 | ) | — | | — |
At December 31, 2005, ARM had provided in aggregate £0.8 million (2004: £1.3 million) in relation to legal matters, being the expected future costs to be incurred.
At December 31, 2005, the Company had outstanding purchase commitments of £1,371,000 (2004: £1,179,000).
14 Geographic and segment information The directors are of the opinion that the Company had only one class of business during 2004 and before, but that following the acquisition of Artisan Components, Inc. in December 2004, the Company now has two reportable business segments, namely the Processor division and the Physical IP division. Although the Chief Operating Decision Maker and the rest of the board are provided with analyses of revenues by the different revenue streams (licensing, royalties, development systems and services), costs, operating results and balance sheet items are only analyzed into two divisions, namely Processors and Physical IP. As such these are currently the only two reportable segments. The Physical IP division consists of the business stream previously undertaken by Artisan and the revenues from the Physical IP division are derived from the sale of legacy Artisan products and services. The Processor division’s revenues comprise legacy ARM products and services, including those from development systems products, including those of Axys. During the year, the Company acquired Keil Elektronik GmbH and Keil Software, Inc. and both have been included within the Processor division.
The following analysis is of revenues, operating costs, interest income, income before income tax, depreciation and amortization, capital expenditure, total assets and liabilities, net assets and goodwill of each segment and of the Company in total:
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | Processors | | | 2003 Total | | | Processors | | | Physical IP | | | 2004 Total | | | Processors | | | Physical IP | | | 2005 Total | |
| | £000 | | | £000 | | | £000 | | | £000 | | | £000 | | | £000 | | | £000 | | | £000 | |
| |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| Revenues | | 128,070 | | | 128,070 | | | 152,702 | | | 195 | | | 152,897 | | | 182,280 | | | 50,159 | | | 232,439 | |
| Operating costs | | 110,807 | | | 110,807 | | | 117,316 | | | 4,070 | | | 121,386 | | | 126,219 | | | 58,303 | | | 184,522 | |
| Interest income | | 4,801 | | | 4,801 | | | 6,891 | | | 53 | | | 6,944 | | | 2,778 | | | 2,539 | | | 5,317 | |
Income/(loss) before
income tax | | 21,959 | | | 21,959 | | | 42,277 | | | (3,822 | ) | | 38,455 | | | 58,839 | | | (5,605 | ) | | 53,234 | |
Depreciation and
amortization | | 16,292 | | | 16,292 | | | 13,150 | | | 3,586 | | | 16,736 | | | 10,251 | | | 18,144 | | | 28,395 | |
| Capital expenditure | | 3,605 | | | 3,605 | | | 5,036 | | | — | | | 5,036 | | | 4,480 | | | 1,584 | | | 6,064 | |
| Total assets | | 222,997 | | | 222,997 | | | 232,811 | | | 405,126 | | | 637,937 | | | 273,889 | | | 442,204 | | | 716,093 | |
| Total liabilities | | (34,922 | ) | | (34,922 | ) | | (47,743 | ) | | (37,867 | ) | | (85,610 | ) | | (44,356 | ) | | (22,687 | ) | | (67,043 | ) |
| Net assets | | 188,075 | | | 188,075 | | | 185,068 | | | 367,259 | | | 552,327 | | | 229,533 | | | 419,517 | | | 649,050 | |
| Goodwill | | 4,352 | | | 4,352 | | | 108,414 | | | 232,002 | | | 340,416 | | | 126,375 | | | 259,197 | | | 385,572 | |
There are no inter-segment revenues. The results of each segment have been prepared using consistent accounting policies with those of the Company as a whole.
The following analysis is of revenues by geographic segment and origin and long-lived assets, excluding deferred assets, by Group companies in each territory:
| | Year ended December 31, |
| |
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|
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|
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|
| | 2003
£000 | | | 2004
£000 | | | 2005
£000 |
| |
| | |
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|
| Revenues (by market destination): | | | | | | | | |
| Europe | | 23,118 | | | 23,837 | | | 32,971 |
| US | | 65,402 | | | 77,457 | | | 99,727 |
| Japan | | 24,135 | | | 32,754 | | | 42,270 |
| Asia Pacific excluding Japan | | 15,415 | | | 18,849 | | | 57,471 |
| |
| | |
| | |
|
| Total revenues | | 128,070 | | | 152,897 | | | 232,439 |
The Company’s exports from the UK were £115,072,000, £138,078,000 and £172,592,000 for the years ended December 31, 2003, 2004 and 2005 respectively.
| | Year ended December 31, |
| |
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| | 2003
£000 | | | 2004
£000 | | | 2005
£000 |
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|
| Revenues (by origin): | | | | | | | | |
| Europe | | 118,885 | | | 141,974 | | | 170,505 |
| US | | 4,893 | | | 6,384 | | | 59,183 |
| Asia Pacific | | 4,292 | | | 4,539 | | | 2,751 |
| |
| | |
| | |
|
| Total revenues | | 128,070 | | | 152,897 | | | 232,439 |
| | At December 31, | | | |
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| | 2004
£000 | | | 2005
£000 | | | |
| | |
| | |
| | | |
| Long-lived assets (excluding deferred tax assets): | | | | | | | | |
| Europe | | 22,730 | | | 17,550 | | | |
| US | | 3,495 | | | 3,268 | | | |
| Asia Pacific | | 127 | | | 785 | | | |
| |
| | |
| | | |
| Total long-lived assets | | 26,352 | | | 21,603 | | | |
In 2005, 2004 and 2003 no single customer accounted for more than 10% of total revenues.
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ARM Holdings plc
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15 Fair values of financial instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:
Cash and cash equivalents, short-term investments and accounts receivable
The carrying amount approximates fair value because of the short maturity of those instruments.
Long-term marketable securities The carrying amount approximates fair value because these instruments are marked-to-market.
Foreign currency forward contracts The fair value of foreign currency forward contracts and embedded derivatives is estimated using the settlement rates prevailing at the period end.
The estimated fair values of the Company’s financial instruments are as follows:
| | Year ended December 31, | |
| |
|
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|
|
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|
|
|
|
| |
| | 2004 | | | 2005 | |
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|
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| | |
|
|
|
| |
| | Carrying
Amount
£000 | | | Fair Value
£000 | | | Carrying
Amount
£000 | | | Fair Value
£000 | |
| |
| | |
| | |
| | |
| |
| Cash and cash equivalents | | 110,561 | | | 110,561 | | | 128,077 | | | 128,077 | |
| Short-term investments | | 5,307 | | | 5,307 | | | 23,990 | | | 23,990 | |
| Marketable securities | | 26,949 | | | 26,949 | | | 8,835 | | | 8,835 | |
| Accounts receivable | | 34,347 | | | 34,347 | | | 55,518 | | | 55,518 | |
| Foreign currency contracts | | 1,674 | | | 1,674 | | | (1,708 | ) | | (1,708 | ) |
| Embedded derivatives | | (2,823 | ) | | (2,823 | ) | | (722 | ) | | (722 | ) |
16 Valuation and qualifying accounts
| | | Balance at
January 1
£000 | | Charged/
(credited)
to income
statement
£000 | | | Acquired
with
subsidiary
undertaking
£000 | | | Foreign
exchange
£000 | | | Balance at
December 31
£000 |
| | |
| |
| | |
| | |
| | |
|
| 2005 – allowance for doubtful debts | | 1,451 | | 547 | | | 27 | | | 148 | | | 2,173 |
| 2004 – allowance for doubtful debts | | 1,115 | | (321 | ) | | 657 | | | — | | | 1,451 |
| 2003 – allowance for doubtful debts | | 2,193 | | (1,078 | ) | | — | | | — | | | 1,115 |
17 Post balance sheet events
At the 2006 Annual General Meeting of the Company, a final dividend of 0.5 pence per share (total cost £6,918,000) was approved in respect of the 2005 financial year and was paid on May 5, 2006 to shareholders on the register at March 31, 2006.
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