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ARM Holdings Works Out

Two-time Motley Fool Stock Advisor recommendation ARM Holdings (Nasdaq: ARMHY  ) , a semiconductor intellectual property firm, reported healthy fourth-quarter and full-year results today, with a promising outlook for 2006. The stock was up 4.5% in noontime trading.

Revenue for the fourth quarter increased 8% sequentially (51.6% year over year), and GAAP earnings per share jumped 33.8%. Royalties continued their strong growth, increasing to 40% of sales (up 2% from last quarter). The only bad news: Backlog was flat on a sequential basis.

In yesterday's earnings preview, Fool contributor Rich Smith cautioned investors to watch the gross margin. It has been falling since the big Artisan acquisition in late 2004. Luckily, the news was good. Gross margin improved from 87.7% to 90.6% sequentially, though it fell from 91.1% in the year-ago period. Operating margins were also back on track, rising from 31.3% to 35% sequentially, up from 29.4% in the year-ago quarter.

Year-over-year revenue growth came in at about 51.6%, while receivables grew by 61.8%. That leaves some lingering concerns about receivables, but it's still leaps and bounds better than ARM's previous statistics.

ARM has a robust outlook for 2006 as well. The company signed 71 processor licenses in 2005, for a total of 398. It also inked 19 new physical intellectual property licenses, bringing that total to 176. With licensees like Intel (NYSE: INTC  ) and Texas Instruments (NYSE: TXN  ) , and its products in everything from Apple (Nasdaq: AAPL  ) iPods to cell phones from Sony's (NYSE: SNE  ) Sony-Ericsson joint venture, ARM is a market leader that is well-positioned for growth.

Analysts expect ARM to earn $0.25 a share in 2006, pricing the stock at 28.4 times forward earnings. The company is expected to grow earnings 17% a year for the next five years, though that growth rate is down from the 22.5% analysts were forecasting in mid-2005. If the company can sustain margins like this quarter's, however, the valuation might start looking a bit different by my standard.

ARM is debt-free and boasts a significant sum of liquid assets and cash. That's a necessity for a company that lives in the rapid-fire semiconductor industry. And as ARM proved in acquiring Artisan, it can make a supersized purchase, successfully digest it, and get operations back up to speed in short order.

I'd say ARM Holdings is now on a roll. Investors would be wise to see whether it's a good fit for their own portfolios.

David and Tom Gardner are waiting to introduce you to the best investments on Wall Street. Each month, you'll get their two newest picks in every issue ofMotley Fool Stock Advisor. Sign up today for a 30-day free trial.

Fool contributor W.D. Crotty does not own any shares in the companies mentioned. Clickhereto see The Motley Fool's disclosure policy.

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