Commentary:

Electronics IP Industry - A May 2005 Update

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by Dr. Russ Henke and Dr. Jack Horgan
Henke Associates

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In their September 2003, December 2003, February 2004, May 2004, August 2004, November 2004 and February 2005 Electronics IP Industry Commentaries, the authors examined the recent financial histories and future outlooks of the remarkable phenomenon of Electronics Intellectual Property (IP) providers, a niche that has emerged in its own right to claim a substantial amount of revenue in the world of Electronics Design Automation. We had arbitrarily selected eight (8) publicly-traded companies originally (then known as the "Group-of-8" or "G8"), as representative of the current financial state of the Electronics IP industry. At the end of 2004, ARM completed its acquisition of Artisan Components, Inc., thereby reducing our "G8" to "G7". In the interest of more timely reporting, we have further chosen to remove Monolithic System Technology, Inc. (MoSys) from our coverage. Accordingly, in this May 2005 Commentary, we look at the financial performances of the "G6" Electronics IP vendors during the first quarter 2005.

Group-of-8 (G8):

For the "G6" companies above, we assume that all of their revenues are Electronics IP sales and directly related IP services.



Recent Electronics IP News Highlights

On March 23, 2005, a San Jose, CA jury found Toshiba Corporation and Toshiba America Electronic Components, Inc. liable for $381.4 million in damages for breach of fiduciary duty and theft of trade secrets in the case of "Lexar Media, Inc. v. Toshiba Corporation." A day later, the same jury awarded Lexar Media, Inc. an additional $84 million in punitive damages. The financial total awarded to Lexar in the case now totals $465.4 million, which is believed to be the largest IP award in California history and the third-largest in the United States. Based on the jury's verdict and findings, Lexar intends to ask the Court for an injunction that bars the sale of related Toshiba products in the United States.

On March 21, 2005 Infineon and Rambus announced that the two companies have reached an agreement settling all claims between them and licensing the Rambus patent portfolio for use in current and future Infineon products.



How did the Electronics IP G6 perform in the First Quarter of 2005?

On the revenue front, Table 1 below reveals that the G6's combined Q1 2005 performance was up a remarkable 41% compared to the same quarter a year ago and also up 19% compared to the previous sequential quarter. Year-over-year percentage growth leaders were LogicVision at 66% and ARM (also at 66% due largely to its acquisition of Artisan). MIPS and Rambus also had strong quarters relative to a year earlier. Virage Logic was the only decliner. On a sequential basis, LogicVision and ARM were again the percentage leaders, this time with growth of 38% and 34%, respectively. Sequentially, Virage Logic was again the only decliner with a revenue drop of nearly 20%.

Figure 1 below provides a bar graph of each vendor's revenue for Q1 2004, Q4 2004, and Q1 2005 in sequence.

As shown in Table 2 below, in Q1 2005 the combined earnings of the G6 were $23 million (12.6% Return On Sales). Combined earnings were up 17% from the $20 million a year earlier and up 31% from the $18 million in the just previous quarter. Rambus and Virage Logic were the only firms with a drop in earnings relative to both the prior year and the prior quarter. Almost all of the quarter-over-quarter G6 combined earnings growth in Q1 2005 came from ARM. LogicVision and Virage Logic both had losses in the first quarter of 2005.



Q1 2005 Results of Individual Electronics IP Providers

On April 19, 2005 ARM Holdings plc announced its results for the quarter ending March 3, 2005. Total revenues amounted to $55.0 million. In US dollar terms, first quarter revenues of $103.2 million were up 23% compared to the aggregate of ARM and Artisan revenues of $83.6 million in Q1 2004. (Last quarter, ARM had forecast both ARM and Artisan businesses to grow by at least 20% year-over-year). Revenues from the original ARM business were $79.2 million, up 6% sequentially and 27% ahead of Q1 2004. Licensing and royalty revenues were up in dollar terms 23% and 31% respectively, on Q1 2004. Seventeen licenses for microprocessor cores were signed in the quarter. Revenues from the "Physical Intellectual Property Division" (PIPD), a.k.a the Artisan Division, were $24 million, up 12% on Q1 2004. Licensing and royalty revenues were up in dollar terms 6% and 28% respectively, on Q1 2004. PIPD backlog remains near a historically high level at end Q1 2005.

Total license revenues in the Q1 2005 were £24.7 million, representing 45% of group revenues. License revenues comprised £16.3 million from the original ARM business and £8.4 million from PIPD. In US dollar terms, license revenues from the original ARM business of $30.0 million in Q1 2005 were 4% ahead of Q4 2004 and 23% up on Q1 2004.

Total royalty revenues in the first quarter were £20.9 million, representing 38% of total group revenues. Royalty revenues comprised £16.8 million from the original ARM business and £4.1 million from PIPD. In US dollar terms, royalty revenues from the original ARM business of $31.6 million in Q1 2005 were up 7% sequentially and up 31% on Q1 2004.

In Q1 2005, the proportion of total unit shipments accounted for by the wireless segment was 65%, representing 252 million units. The 35% relating to the aggregate shipments in all sectors other than wireless represents 137 million units in Q1 2005, an increase of 68% on Q1 2004. In Q1 2005 unit shipments have grown particularly strongly compared to Q4 2004 in the consumer and storage segments.

Sales of development systems were £5.7 million, representing 10% of total group revenues. In US dollar terms, development systems revenues were $11.0 million this quarter, 6% up sequentially and 53% up on Q1 2004. Consistent growth in recent quarters in development systems sales has been enhanced by sales of ESL tools following the acquisition of Axys in the second half of 2004. Service revenues were £3.6 million, representing 7% of total group revenues.

Total revenues earned by PIPD in Q1 2005 were $24.6 million, compared to $15 million in Q4 2004 and $21.4 million in Q1 2004. Reported revenues in Q1 2005 were comprised of license revenues of $16.2 million and royalty revenues of $7.8 million, compared to $7.0 million and $8.0 million respectively in Q4 2004.

Total group dollar revenues in the first quarter of 2005 were 23% ahead of the aggregate revenues reported by ARM and Artisan in Q1 2004 and up by 27% with the original ARM business and ahead 12% with PIPD.

Income before income tax at £12.5 million, including acquisition-related charges of £6.0 million and other deferred stock-based compensation of £0.3 million. Income before income tax, excluding these charges, was £18.8 million.

Commenting on the first quarter results, Warren East, Chief Executive Officer, said: "I am pleased to announce that the integration of Artisan and ARM is progressing to plan and that the momentum in the business continues with dollar revenues up 23% on the aggregate ARM and Artisan revenues in Q1 2004. We are well placed to capitalize on the opportunities that the combination of ARM and Artisan brings and are encouraged that Q1 has seen the first instances of existing ARM licensees taking Artisan's physical IP. This progress gives us further confidence that both underlying businesses can achieve at least 20% growth in dollar revenues as outlined at our Q4 results."

On April 28, 2005 Ceva, Inc. reported its results for the first quarter, the period ending March 31, 2005. Total revenue for the quarter was $10 million, an increase of 9% compared to the $9.2 million in both the first and fourth quarters of 2004. First quarter licensing revenue of $7.1 million increased 22% from the fourth quarter of 2004, and 7.5% from the first quarter of 2004. As in the fourth quarter 2004, seven license deals were completed in the first quarter 2005. First quarter royalty revenue was $1.8 million, a decrease of 13% compared to $2.0 million reported in the fourth quarter 2004, reflecting the seasonality of consumer-oriented licensees' product shipments, but up 49% compared to $1.2 million reported in the first quarter of 2004. The seasonality in royalty revenue in the first quarter of 2005 is similar to the 17% sequential decrease in royalty revenue from the fourth quarter 2003 to the first quarter 2004.

In early January 2005 Ceva launched TeakLite-II, a capability that delivers a fully synthesizable soft core and a process-independent design that allows licensees to specify the silicon area, power consumption and speed that best suits their needs. CEVA-TeakLite-II, a single Multiply-Accumulate (MAC) 16-bit fixed point DSP core, achieves a 30% increase in performance compared to its predecessor core, reaching 200 MHz @ TSMC 0.13u G (worst-case conditions and process), for a fully synthesizable core.

Net income for the quarter increased to $627 thousand compared with fourth quarter 2004 net income of $187 thousand. The company reported net income of $409 thousand in the year ago first quarter.

Commenting on the quarter, Chet Silvestri, Chairman and CEO of CEVA remarked: "I am pleased to announce that the momentum we established in 2004 has continued into the first quarter of 2005, as we report a solid financial quarter with revenues and earnings both growing and the Company remaining cash flow positive. Licensing partners reported shipments of 30 million units in the first quarter of 2005 representing a 55 percent increase over the 19 million units shipped by our customers in the first quarter of 2004. We completed seven major licensing agreements during the first quarter of 2005, including major multi-use agreements for our Serial ATA and GPS 4000 technologies. During the quarter, the Company completed its first CEVA-TeakLite-II license. Teaklite-II is an enhanced design of the Company's highest-volume DSP and offers better performance, functionality and speed with backward software compatibility. CEVA expects many of its existing Teaklite licensees to be interested in this upgrade, and we look forward to seeing continued growth for this product in the coming quarters."

On April 26, 2005 LogicVision, Inc. reported its results for the first quarter, the period ending March 31, 2005. Total revenue in the quarter was $3.7 million, an increase of 66% over the $2.2 million in the same quarter a year earlier, and a 35% improvement sequentially. (The firm had forecast Q1 revenues to be in excess of $3.4 million). License revenue was $2.7 million, accounting for 73% of total revenue and an increase of 73% year-over-year, and an increase of 71% sequentially. Service revenue of $928 thousand, accounting for 25% of total revenue, was essentially flat compared with a year earlier and down 17% from the prior quarter.

Net loss for the quarter was $1.8 million, compared to a net loss of $2.2 million in the periods a year earlier and a quarter earlier.

James T. Healy, president and CEO of LogicVision said, "We are excited about our LV2005 product release, scheduled for June 2005. Our LV2005 product encompasses a new generation of embedded test and diagnostic capabilities that will provide superior test quality and accelerated time-to-market capabilities for nanometer scale designs. In addition, during the first quarter we secured two overseas distributorships: HTT GmbH as the exclusive distributor for our products in Europe, giving us our first-ever European presence; and, we renewed our partnership with AMOS Technologies as our exclusive distributor in Israel."

On April 19, 2005 MIPS Technologies, Inc. reported the results for its third quarter of fiscal 2005, the period ending March 31, 2005. Total revenue for the quarter was $16.8 million, an increase of 33% compared to $12.6 million for the same quarter a year ago and an increase of 8% compared to $15.5 million a quarter earlier. This was consistent with the company forecast. This is the fifth quarter in a row with year-over-year growth of over 30%. Contract revenue was $8.2 million or 49% of total revenue, an increase of 23% compared to $6.7 million in the comparable period in fiscal 2004, and a 3% increase sequentially. Royalties were $8.6 million, an increase of 45% compared to $5.9 million in the same quarter a year ago and a 13% increase sequentially.

Net income for the quarter 2005 was $4.0 million, an increase of 237% compared to a net income of $1.2 million for the same quarter a year ago and a 13% increase sequentially.

John Bourgoin, president and CEO of MIPS Technologies said, "The breadth and strength of our licensee base is evidenced not only in our royalty growth this quarter, but also by the fact that over half of our royalty paying customers generated more than $100,000 in quarterly royalties. Our licensing revenue also grew again as global industry leaders and startups alike continue to realize the compelling cost, power, and performance advantages of designing their SoCs with MIPS-Based solutions from MIPS and our licensees. The 24K and 4KE core families in particular, continue to hit the 'sweet spot' of higher total system performance with low power and area savings for a broad range of digital entertainment and networking applications."

On April 14, 2005 Rambus, Inc. reported its results for the first quarter. Total revenue in the quarter was $39.6 million, an increase of 22% year-over-year and an increase of 3% sequentially. (This was in the middle of the range forecast by Rambus three months ago). Contract revenues at $6.6 million, accounting for 17% of total revenue, were up 30% over the first quarter last year and up 9% from the previous quarter. These increases primarily reflect revenues from contracts signed in 2003 for XDR memory and FlexIO interface technologies. Royalty revenues at $33.0 million, accounting for 83% of total revenue, were up 20% over the first quarter last year and up 1% from the previous quarter. The increase in royalties over the first quarter last year primarily reflects an increase in SDRAM and DDR royalties.

Net income for the first quarter was $4.4 million (11% ROS), compared to $8.3 million in the first quarter last year and $6.5 million in the previous quarter. Litigation expense for the quarter was $11.1 million, up 167% from $4.2 million a year ago and up 50% from the previous quarter.

On January 11, 2005 Rambus announced that Geoff Tate had assumed the role of Chairman of the Board, replacing Bill Davidow who is stepping down as Chairman while remaining a member of the Board of Directors. Effective immediately, Harold Hughes, a current member of the Rambus board, assumed the position of Chief Executive Officer, replacing Mr. Tate. Mr. Hughes brings extensive technology industry experience to the chief executive position including numerous executive leadership roles at Intel Corporation. He was most recently the Chairman and CEO of Pandesic LLC, an Intel and SAP joint venture.

On March 21, 2005 Rambus and Infineon announced that the two companies had reached an agreement settling all claims between them and licensing the Rambus patent portfolio for use in current and future Infineon products. The suits had been going on for over 5 years. The Hynix suit continues.

Rambus has granted to Infineon a worldwide license to existing and future Rambus patents and patent applications for use in Infineon memory products. In exchange, Infineon will pay a quarterly license fee of US $5.85 million starting by November 15, 2005 through November 15, 2007. After November 15, 2007, and only if Rambus enters into additional specified licensing agreements with certain other DRAM manufacturers, Infineon will make additional quarterly payments which may accumulate up to a maximum of an additional $100 million.

NEC has signed patent license renewal agreement. Other patent licenses that are due to expire in the near term are under negotiation for renewal.

In early February Rambus revealed that the "Cell processor" incorporates Rambus's XDR memory and FlexIO(tm) processor bus interface solutions. Cell is the highly-anticipated advanced microprocessor developed by Sony Corporation, Sony Computer Entertainment, Toshiba Corporation and IBM. The memory and processor bus interfaces designed by Rambus account for 90% of the Cell processor signal pins, providing an aggregate processor I/O bandwidth of approximately 100 gigabytes-per-second.

Harold Hughes, chief executive officer at Rambus, said, "Delivering record quarterly revenue is a great way to start the year. In addition, we made significant progress on a number of fronts this quarter, including signing new patent license agreements with Infineon and NEC Electronics. We also witnessed the strong validation of our technology by both our XDR and FlexIO high-speed interfaces being incorporated into the revolutionary Cell processor. And we continued to demonstrate leadership in innovation with our micro-threading technology for DRAM memory, which promises to make significant contributions to graphics performance in future computing and consumer electronics applications."

On April 21, 2005 Virage Logic Corporation reported the results for its second quarter of fiscal 2005, the period ending March 31, 2005. Total revenues for the quarter were $12.8 million, a dip of 1.5% compared to the $13 million in the same quarter a year earlier and a drop of 19% sequentially compared to $15.9 million in the prior quarter. (The firm had forecast revenues to be in the range of $16.3 million to $16.6 million). License revenue in the quarter was $10 million, accounting for 79% of total revenue, a drop of 10% year-over-year and a drop of 23% sequentially. Royalty revenue was $2.7 million, accounting for 21% of total revenue, an increase of 52% year-over-year and a decline of 4.4% sequentially.

The net loss for the quarter was $988 thousand. This compared with net income of $189 thousand in the same quarter a year ago and with net income of $1.7 million in the previous quarter.

During the quarter, Virage Logic recorded revenue under licensing agreements from 44 customers -- three new. The firm signed a total of five new direct royalty-bearing agreements for the STAR Memory System bringing the total number agreements signed to date to 114 and signed another 65-nanometer agreement, marking the third 65-nanometer agreement signed to date for Virage Logic's semiconductor IP.

Adam Kablanian, Virage Logic's president and chief executive officer said, "While we believe the fundamentals of our business are solid, we are disappointed with our results for the second (fiscal) quarter which were primarily impacted by delayed customer purchasing decisions due to what we believe to be a temporary slow down in the business. Beyond the impact of these business conditions, we also experienced some operational issues that negatively impacted our ability to fulfill existing orders. We are addressing these issues and are confident that these measures together with our leading technology offering and solid business model will enable us to bring the company's financial performance back to profitability."



Stock Market Prices of the G6 Electronics IP Providers

As shown in Tables 3 and 4, and Figure 2 below , the combined stock prices for the G6 were down 15% in absolute dollars from the same quarter last year. As a group, the G6 trailed accordingly the major stock indices that increased only slightly. MIPS rose 100% year-over year while Rambus dropped 46%.

On a sequential basis, the combined G6 stock prices declined 23% in absolute dollar terms and 13% from the prior quarter, more severe than the declines of the major stock indices. MIPS was the only firm to enjoy an increase in stock price. Rambus and Virage Logic had the largest quarter-over-quarter declines of 34% and 41%, respectively.



Forecast Guidance from Individual IP Providers

The next quarter's forecast figures shown in Table 5 below are for the midpoint if a range was specified. Combined G6 growth year-over-year was forecast at nearly 34%, but the quarter-over-quarter forecast was a more modest 1% due to seasonality. ARM, the industry leader, is expecting 61% growth year-over-year, due largely to its acquisition at the end of 2004 of the number two player in the IP industry Artisan.



Individual Company by Company Guidance

ARM said that it remained confident of achieving dollar revenue growth of at least 20% in both underlying businesses in the full year 2005 despite its view that overall semiconductor industry will be flat for 2005. A growth rate of 20% over Q2 2004 would yield $105 million for Q2, and $450 million for the year compared to aggregate revenue of $370 million in 2004.

CEVA: For guidance Christine Russell, CFO of CEVA said, "Our full year guidance remains unchanged as we see revenue in the range of $44 million to $46 million, gross margin in the range of 88 percent to 90 percent, operating expense in the range of $36 million to $37 million, and net income in the range of $3.5 million to $4.5 million."

As guidance LogicVision expects revenue in the next quarter to be $2.4 million to $2.6 million compared to $3.6 million in the quarter just completed and to $2.5 million in the second quarter of 2004. Net loss in Q2 is expected to be in the range of $3.2 million to $3.5 million.

Given a historical decline in royalties for its fourth quarter in two out of the last three years, MIPS is cautious about its next quarter guidance. The company expects total revenue to be down 5% to 10% compared to the quarter just completed; royalties are forecast to decline 10% while license are forecast to be flat to up 5%.

For guidance Rambus expects revenue in the second quarter to be in the range of $38 million to $42 million.

Virage Logic currently anticipates total revenues for the third quarter of fiscal 2005 to be in the range of approximately $14.5 million to $15.0 million compared with $12.7 million in the quarter just completed. Expected total revenues for the quarter are anticipated to include royalties of approximately $2.9 million. The company expects to report GAAP net income of approximately $0.02 to $0.03 per diluted share.

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