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ARM Gets Slapped

By Rich Smith – Updated Nov 16, 2016 at 2:38PM

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ARM Holdings reports strong profits, then sells off.

Motley Fool Stock Advisor ARM Holdings (NASDAQ:ARMHY) reported some pretty spectacular results in its earnings release yesterday -- and, in response, the market dropped it like a hot potato. To see why, let's first take a look at this semiconductor intellectual property firm's profits; then we'll turn to the projections for 2005 that so spooked the market and caused it to (unfairly, I think) brand ARM a near-term loser.

It's first important to note that ARM is not a U.S. company; it's British. So the numbers we'll be using here are pounds sterling, rather than U.S. Dollars, except where noted. For reference, the current exchange rate between the two is 1:1.88, i.e., one pound sterling buys a buck eighty-eight. Last year, the average exchange rate was 1:1.64. Thus, these results have a built-in buffer that depressed the value of ARM's dollar receipts by 13% in comparison to 2003's results, when converted into pounds-sterling profits.

In 2004, ARM grew its revenues by 19% while more than doubling net profits from 1.3 to 2.7 pence per diluted share. (To calculate what that equates to in dollar terms, you need to take two steps: first, recall that each American Depositary Share (ADS) of ARM represents three actual shares of the company's common stock. Then apply the exchange rate to convert the British pence into American cents. Result: dollar-denominated earnings per diluted ADS increased from $0.068 to $0.154 per diluted ADS.)

You'll probably also recall that ARM made a pricey acquisition of chip designer Artisan (NASDAQ:ARTI) last year. The above results include costs from that acquisition, but none of the benefits from Artisan's own sales and earnings. So things are probably actually going even better at the combined company than these results would indicate. Finally, in its own right, ARM continued paving the way for future growth by increasing its backlog of orders still to be fulfilled by 30% over last year.

Now for the bad news. ARM sees bad times ahead for its industry in 2005, and doesn't expect sales to grow at all industry-wide. However, with its strong backlog of orders already placed, ARM expects its own dollar-denominated revenues to grow at a 20%+ rate year-on-year. It's important to note that "dollar-denominated" caveat, because ARM does receive most of its revenues in U.S. Dollars. If the dollar-to-pound exchange rate continues to deteriorate in 2005, that would have a material effect on depressing the company's pounds-sterling profitability.

Considering all the above in light of ARM's nearly 4% drop yesterday, it seems the market discounted ARM's predictions that it could rise above its industry's problems next year. That, or the market expects the dollar to continue sliding against the pound. Or both.

Get a better hand(le) on ARM's business with these recent Foolish articles:

Fool contributor Rich Smith holds no position in either company mentioned in this article.

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