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ARC INTERNATIONAL PLC ANNUAL REPORT AND ACCOUNTS 2008 ANNUAL REPORT AND ACCOUNTS 2008 Enabling the Multimedia Revolution

ARC 2008 Annual Report

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  1. 1. ANNUAL REPORT AND ACCOUNTS 2008 Enabling the Multimedia Revolution
  2. 2. Improving the Multimedia Experience Consumers around the globe are using a growing number of electronic products to capture, share, and play high-quality multimedia content. Improving the multimedia experience regardless of the electronic device presents a signicant market opportunity and is a key part of ARCs strategy.
  3. 3. ARC Who We Are Overview 01ARC International plc Annual Report and Accounts 2008 ARC International is fuelling the multimedia revolution by licensing multimedia solutions and intellectual property (IP) to OEM and semiconductor companies globally. The companys award-winning solutions enable these customers to significantly enhance the audio and video experience at lower development costs. ARCs 150+ customers collectively ship hundreds of millions of ARC-Based chips annually in a wide range of products. ARC International maintains a worldwide presence with corporate and research and development offices in San Jose and Lake Tahoe, California, US; St Albans, England; St Petersburg, Russia; and Hyderabad, India. Overview 01 Who We Are 02 2008 Highlights 03 ARCs Markets 04 ARCs Sound-to-Silicon Solutions Breathe Life into Digital Audio 05 Chairmans Statement Operational Review 07 Chief Executive Ofcers Review of Operations 09 Chief Financial Ofcers Review 11 Corporate Social Responsibility Management and Governance 13 Board of Directors 14 Directors Report 20 Remuneration Report 25 Corporate Governance 28 Statement of Directors Responsibilities 29 Independent Auditors Report Financial Statements and Notes 30 Income Statement Statements of Recognised Income and Expense 31 Balance Sheets 32 Cash Flow Statements 33 Notes to the Accounts 71 Five Year Summary Additional Information 72 Shareholder Information 73 Advisers and Corporate Information 2008 Contents We use ARC because its an industry standard and its low power profile. Intel, an ARC customer A collaboration between industry leaders in media- oriented applications. Toshiba, an ARC customer We are pleased to standardise a key element of our technology strategy on ARC. Broadcom, an ARC customer
  4. 4. Royalty revenue US$000* 08 07 06 05 04 14,334 9,726 6,288 3,913 5,408 2008 HighlightsOverview 02 ARC International plc Annual Report and Accounts 2008 Strategic direction is strengthened Acquisitions strengthened product offerings New Sound-to-Silicon solutions were introduced Entered new market segments New wins with OEM and chip customers Strengthened management team Restructuring Generates annual cost savings in excess of 25% Signicantly lowers ARCs cost base while maintaining development programmes Enhances ability to deploy multimedia solutions Revenue by year US$000* 31,188 28,930 24,754 19,007 22,265 08 07 06 05 04 * based on an average exchange rate for the respective year 1 Includes short-term investments Revenues and royalties increased Total revenue up 18% at 17.0 million Royalty revenue up 61% at 7.9 million Licensing revenue at at 7.3 million Net loss increased to 7.3 million Cash balance1 at 12.7 million Royalties drove revenue growth Increase in post-2003 contracts contributing royalty revenues Recognised new higher value royalties from OEM customers Increase in ARC-Based shipments Operational Financial Total bookings US$000* 08 07 06 05 04 29,291 37,256 30,531 22,003 22,0580.0 Growth of ARCs worldwide customer base 08 07 06 05 04 152 144 137 112 96
  5. 5. ARCs Markets Overview 03ARC International plc Annual Report and Accounts 2008 ARCs technology is driving an increasing number of high growth markets relating to how multimedia content is captured, shared, and played. Whether its audio or video players, digital or mobile TVs, media-enabled cell phones, portable storage cards, or PCs and laptops, ARC-Based electronic devices are helping consumers around the world experience high-quality multimedia content. PCs and laptops Media enabled cell phones Digital TVs Flash devices Portable media players Set-top boxes ARC is focusing on increasing licensing and royalty revenues from OEM and chip companies in regions driving the design and development of consumer electronics devices. North America represented 55% of revenue Europe represented 20% of revenue Asia represented 25% of revenue
  6. 6. Todays music, movies and games suffer from degraded audio fidelity. Because of digital compression, much of the clarity, warmth, and realism of the original recording or live performance are lost. The result is a significant market opportunity to restore these emotions to a wide range of home and portable consumer electronics devices. ARCs Sound-to-Silicon solutions take the audio performance of todays consumer products to a completely different experience level. Using technology created by artisans and engineers from the music industry, they can help customers gain a competitive advantage by delivering more compelling experiences at significantly lower costs. ARCs Sound-to-Silicon Solutions Breathe Life into Digital Audio Overview 04 ARC International plc Annual Report and Accounts 2008 ARCs Sound-to-Silicon Multimedia Studio in Truckee, California.
  7. 7. Chairmans Statement Overview 05ARC International plc Annual Report and Accounts 2008 In 2008 ARC traded against the backdrop of an increasingly challenging economic environment that worsened in the second half of the year. Despite this ARC was able to grow top line revenues driven by higher value royalty payments from new customers. Going forward into 2009, we remain cautious as visibility is limited and uncertainty in the semiconductor industry with lengthening sales cycles may affect the timing of new licence revenues and royalty volumes. However, a rapid transition to protability and positive cash ow continues to be our overriding goal, and in response to the challenging semiconductor market and global economic conditions we have taken swift and decisive action to further enhance our ability to achieve this goal within planned timescales. To accelerate growth in our revenues and customer base, we have strengthened our product portfolio through the acquisition of Sonic Focus, transformed our ability to deploy integrated multimedia solutions, broadened our target market to include the higher royalty OEM and consumer electronics sectors, strengthened our worldwide sales and marketing organisations and made signicant new appointments to the senior management team. In addition, the company-wide restructuring announced in September 2008 has been substantially completed, and already is delivering improved operational efciencies, a rationalised and streamlined management structure and product portfolio, and a signicantly lower cost base. We will continue to assess industry conditions throughout 2009 to ensure that the companys cost structure is aligned with revenue opportunities. Over the medium to long term we expect consumer demand for devices delivering increasingly higher quality multimedia content to continue to grow, driving OEM and semiconductor companies to create innovative next-generation products with better performance and lower development costs. Feedback from ARCs worldwide customers and partners underpins our condence that our integrated solutions and more efcient organisation can continue to provide compelling value. We remain condent in our strategy and our ability to execute. Richard Barfield Chairman ARC International plc 11 March 2009 A rapid transition to profitability and positive cash flow continues to be our overriding goal. To accelerate growth in our revenues and customer base, we have strengthened our product portfolio of multimedia solutions, broadened our target market to include more lucrative consumer electronics sectors, and strengthened our worldwide organisation. Going forward into 2009 we will continue to assess industry conditions to ensure that ARC is best positioned to take advantage of revenue opportunities in the consumer electronics industry.
  8. 8. OperationalReview 06 ARC International plc Annual Report and Accounts 2008 High Quality Audio Experience ARCs solutions create a home entertainment centre listening experience on PCs and laptops. A leading consumer electronics company was able to achieve real competitive differentiation for their device by providing a high-quality audio experience. The ARC customer also was able to reduce the number of speakers and eliminate costly audio components thus saving millions of dollars in development costs.
  9. 9. Chief Executive Ofcers Review of Operations OperationalReview 07ARC International plc Annual Report and Accounts 2008 ARCs strategy is to monetise the increasing trend of consumers to capture, share, and play high-quality multimedia content on a variety of electronics devices. By developing and delivering integrated Sound-to-Silicon solutions to OEM and semiconductor companies globally, ARC is helping these customers create new types of devices at lower development costs that deliver a better experience to consumers. In 2008 ARC grew revenues and strengthened its competitive position in an increasingly challenging economic environment. The acquisition of Sonic Focus, a leading provider of audio enrichment technology, was completed in February and brings to ARC a complementary class of customers and markets. This is helping stimulate new revenue opportunities in an uncertain economic climate from new companies as well as ARCs historical base of more than 150 customers worldwide. Today ARCs Sound-to-Silicon solutions are receiving strong interest from OEM and semiconductor companies. An industry rst, they offer a complete solution for a number of high growth consumer electronics markets: ARC Portable Media Device Solution Implemented on a portable media device, the ARC PMD Solution enables consumers to enjoy music, movies, and games anywhere and anytime with a home entertainment centre listening experience and extended playback time. ARC Digital TV and Home Theater Solution The ARC Digital TV and Home Theater Solution creates a compelling home entertainment centre listening experience that provides for the ear what high- denition video provides for the eye. The ARC solution eliminates costly components, such as centre channel speakers and woofers. It also enables ARC customers to create a single device that addresses numerous market opportunities, such as set-top boxes, digital TVs, and home theaters. ARC PC and Laptop Solution The ARC Personal Computer and Laptop Audio Solution provides a home entertainment centre listening experience using existing speakers or headphones. The solution renes the sound so it resembles the original studio performance. To ensure ARC is best positioned to deliver on its strategy in the current economic uncertainty, management undertook a strategic review of the business. The result was a company-wide restructuring that lowered ARCs cost base and brought visible improvements to ARCs planning and execution by creating: A new integrated worldwide sales team and eld organisation to accelerate engagements with OEM and semiconductor customers globally. Audio on the HP TouchSmart PC is simply amazing. HP, an ARC customer Sound for an ultra thin notebook thats astounding. Lenovo, an ARC customer ARCs Sound-to- Silicon Multimedia Studio in San Jose, California.
  10. 10. Chief Executive Ofcers Review of Operations OperationalReview 08 ARC International plc Annual Report and Accounts 2008 An enhanced global product development organisation to ensure ARCs integrated solutions meet the needs of customers creating products for high-volume multimedia markets. A worldwide marketing team under new leadership with in-depth experience and understanding of the consumer electronics industry and OEM customers. These skills will assist ARC to continue its focus on delivering integrated multimedia solutions. The industry adoption of ARCs products continued throughout 2008. OEM and semiconductor companies worldwide announced they have taken licenses for, or are shipping products containing, an ARC solution. They included: PC and Laptop applications Hewlett Packard introduced its new TouchSmart PC computer, which has been heralded as redening personal computing and includes ARCs Sonic Focus technology. Lenovo launched the x300 laptop computer running the Microsoft Vista operating system with ARCs Sonic Focus technology. N-Trig has signed a multi-year license agreement for ARCs processor products for use in N-trigs DuoSense technology for PCs. Digital televisions A leading mobile digital TV company signed a multi-use agreement for ARC solutions to provide high-quality digital TV reception in nearly every global geographic region. Abilis announced it has standardised its mobile DTV product development on ARC technology. Fujitsu extended its long-term relationship with ARC and took a new license for use in its next-generation HDTV products. ViXS has taken a license for ARCs multimedia solutions for use in its XCode chipset family, which enables the processing of multiple HD video streams. Other electronic market applications A leading ash company took an ARC license for ash applications because of ARCs recognised leadership in the industry. A top ten Taiwan chip company is incorporating ARCs low power solution into cellular design that is targeting the worldwide handset market. A leading smart card provider signed a new license enabling the existing ARC customer to create new ARC-Based solutions for high volume smartcard- related devices. Toshiba extended its collaboration with ARC by taking a new license for development of leading-edge processor technology. For the year, these developments helped ARC grow the top line despite a deteriorating industry climate. ARC enters 2009 with a strengthened product portfolio and Sound-to- Silicon solutions that are helping drive new revenue opportunities and deliver higher value royalties. The restructuring plan has lowered ARCs cost base and strengthened the management team. For the year, management remains cautious as visibility is limited due to the ongoing economic uncertainty. However, we have condence in ARCs strategy, strengthening position in the industry, and attractiveness of our solutions that help customers increase competitiveness in the growing consumer electronics market. Carl Schlachte President and Chief Executive Ofcer 11 March 2009 ARCs technology has played a significant role in the success of our product. SanDisk, an ARC customer ARCs technology enhances our competitive differentiation. Inneon, an ARC customer
  11. 11. Chief Financial Ofcers Review OperationalReview 09ARC International plc Annual Report and Accounts 2008 Strong revenue growth in 1H was offset by deteriorating confidence of certain customers in 2H. Net loss was greater than planned due to the acquisition of and incremental costs from Sonic Focus, the restructuring charges, and the delayed revenue from two licensing contracts. Without these incremental expenses and charges, operating costs were in line with managements plan for 2008. Revenue Total revenue in 2008 in US dollars was up 8% to $31.2 million (2007: $28.9 million). Total revenue in sterling was 17.0 million, up 18% over the same period last year (2007: 14.4 million). License and engineering revenue in US dollars was down 11% to $13.4 million (2007: $15.0 million). In sterling, license and engineering revenue was at at 7.3 million compared to 2007 (2007: 7.4 million). Maintenance and service revenue in US dollars was down 17% to $3.5 million (2007: $4.2 million). In sterling, maintenance and service revenue was down 14% at 1.8 million (2007: 2.1 million). In US dollars, royalty revenue was up by 47% to $14.3 million (2007: $9.7 million). In sterling, royalty revenue increased 61% to 7.9 million (2007: 4.9 million). Sales in Europe were 20% (2007: 20%) of total sales, North America 55% (2007: 65%) and Asia 25% (2007: 15%). Cost of sales and operating expenses Cost of sales decreased 7% to 1.3 million (2007: 1.4 million). Gross margin increased to 92% (2007: 90%). Without the restructuring effects, net operating expenses increased by 25% to 22.8 million (2007: 18.3 million). The company had 163 employees at 31 December 2008 compared with 196 at 31 December 2007. The 17% decrease in headcount was due to a company-wide restructuring to be completed in Q1 of 2009, and was offset by increase in headcount from the Sonic Focus acquisition. Excluding the effects of the restructuring, research and development costs increased 30% to 9.6 million (2007: 7.4 million). Sales and marketing cost was essentially at at 5.5 million compared to 2007 (2007: 5.5 million). General and administration costs increased 22% to 4.5 million (2007: 3.7 million). Other expenses, comprised of depreciation and amortisation, increased to 3.1 million (2007: 1.7 million) due to additional amortisation of intangibles included in the acquisitions. The incremental operating expenses excluding amortisation as a result of the acquisition during the year was 1.2 million in 2008. Incremental amortisation expenses associated with technologies and intangible assets acquired in 2008 was 0.3 million in 2008. Restructuring costs for 2008 were 2.3 million (2007: nil). Finance income Interest income was down 40% to 0.9 million (2007: 1.5 million) due to the decrease in average cash balance and decrease in interest rates earned on investments. Loss for the period Net loss was 7.3 million (2007: 2.5 million). The charge for the reorganisation of 2.3 million, and the incremental expenses from the acquisition of Sonic Focus gave rise to the increase in the net loss. Loss per share increased to 4.93p (2007: 1.69p). +18%Total revenue up 18% to 17.0 million 7.9million Royalty revenue in 2008
  12. 12. Chief Financial Ofcers Review OperationalReview 10 ARC International plc Annual Report and Accounts 2008 Cash flow and balance sheet The net cash outow from operations before restructuring costs decreased to 4.8 million (2007: 5.1 million). Capital expenditure, including payments made for acquisitions and investments in associate, was 4.6 million (2007: 8.1 million). Net cash outow in connection with the reorganisation was 1.6 million, including the share repurchases. The movement in cash and short-term investments during the year was an outow of 8.5 million (2007: 10.4 million). Net assets at 31 December 2008 were 21.5 million (31 December 2007: 30.3 million), including cash and short-term investments of 12.7 million (31 December 2007: 21.2 million). Dividend No interim dividend payment was made and no dividend has been proposed for the year ended 31 December 2008 (2007: nil). Acquisitions During the period ARC acquired Sonic Focus, Inc. for a total consideration of 2.8 million. See note 31 for details. Treasury policy The groups treasury policy seeks to ensure that adequate nancial resources are available for the development of the groups businesses whilst managing its currency, interest rate and counterparty risks. Group treasury operates within clearly dened guidelines that are approved by the Board. The groups policy is not to engage in speculative transactions. The groups policy in respect of major areas of treasury is set out below. Currency transaction The currency gains and losses arise where actual sales and purchases are made by a business unit in a currency other than its own functional currency (2008: gain 108,000, 2007: gain 133,000). Most of the groups sales are in US dollars which provides a natural hedge against US dollar purchases made within the group. The groups policy is to use forward contracts as a hedge against exchange rate movements to cover net US dollar exposures for customer receivables where collection dates are certain. The group maintains the majority of its cash and short-term investment balances in sterling and is therefore not subject to currency exchange risk. Funding and deposits The group ended the year with net funds of 12.7 million (2007: 21.2 million). The majority of the funds have been placed with a leading UK clearing bank to manage on behalf of the group under guidelines provided by the Board. The balance continues to be managed in house. The group expects that future funding requirements will be met by the funds available currently as at 31 December and revenue from existing licensees (royalty, support, license renewals) and future operating activities. While losses made in 2008 reduced the liquidity position of the group between 31 December 2007 and 31 December 2008, the group restructure has been undertaken to reduce ongoing costs in 2009 onwards and therefore reduce cash outow. Counterparty risk The group monitors the investment of its funds against pre-determined limits so as to control exposure to any territory or institution. Victor Young Chief Financial Ofcer 11 March 2009 12.7million Net funds
  13. 13. Corporate Social Responsibility OperationalReview 11ARC International plc Annual Report and Accounts 2008 In addition to the needs of the groups shareholders, the group recognises the interests of employees, customers, suppliers and the local communities and environments in which we operate. The Board accepts that it must be mindful of the needs of all of its stakeholders and seeks to enhance all relationships with the differing groups concerned. The following policies reflect the Boards commitment to corporate social responsibility (CSR). Employee relations policy The group values its employees and believes they are one of its best assets. Policies and practices are in place to attract, motivate, retain and develop the groups employees. As an intellectual property (IP) development group with over 70% of the employees working within research and development, continual professional development and training is paramount. In order to retain and integrate the new employees from the recent acquisitions the group has reviewed the working practices and culture within the group. This has enabled the new employees to understand the groups operations and move smoothly into its processes. During 2008 the group undertook a restructure programme that reduced the number of employees. The restructure and subsequent employee reductions were handled in accordance with local customs and laws. As part of the process the group undertook to assist those employees leaving the group through programmes of outplacement assistance, as well as liaising with recruitment companies or other local companies. The group has also undertaken a programme of measures to ensure that those employees remaining are fully engaged with the group and the strategic objectives for the future. The group seeks to benchmark the salary and total remuneration of the employees to the industry best practice. To that end the group partakes in various salary surveys to enable the management to understand the remuneration currently on offer within the groups operational sectors. Employees are given the opportunity, where legally possible, to share in the rewards of its future success through the groups operation of a share option scheme. Other benets such as pension contributions to either state sponsored or dened contribution schemes and health insurance programmes are available to employees. The group communicates regularly with the employees through the use of regular all employee meetings and conference calls chaired by the Chief Executive Ofcer (CEO). These cover a wide range of topics that allow each employee easy access to the senior management to ask questions and quiz them on recent activities and/or general strategy. These meetings are supplemented by site level meetings where information is spread across departments and managers can receive feedback on any topic or development. The CEO has also implemented an e-mail update system and web-blog of recent activities. This has proved popular in spreading news quickly throughout the group. The group has a policy of helping employees achieve an appropriate work/life balance. This is accomplished through the use of policies on maternity and paternity leave, exible working arrangements and part time working where appropriate. The group believes that recent improvements in technology within the workplace should be implemented to assist employees. The group has policies that cover grievances and disciplinary procedures as well as recruitment processes. The annual appraisal system has been reviewed during the year to ensure that it is meeting the needs of both the group and the employee. This review has reinforced the recognition that development of employees will lead to better designs and products from the group. The group will continue to invest in appraisals, training and development to assist employees in their skills development, both professional and personal. The group likes to promote from within so all vacancies are advertised internally, and the group operates a system for employees to refer people for advertised positions. Environmental policy The Board acknowledges that the group has a role to play in environmental issues. The group does not perform any manufacturing activities and therefore has negligible impact on the environment. The group operates from ofces with the main activity being the development of hardware and software designs by employees working on computers, which does not involve the use of hazardous substances or waste. The group policy is to endeavour to minimise the impact of its activities on the environment and to comply with all relevant environmental laws and regulations. The group has a policy of recycling as much as possible, ranging from paper waste to printer cartridges, reducing energy usage through the use of efcient lighting products and computer equipment and reducing travel wherever possible. Under the Waste Electrical and Electronic Equipment (WEEE) directive the group has a responsibility to dispose of its computer equipment safely and responsibly. The group operates with several partners to ensure that all old computer equipment is recycled or disposed of in a safe manner. Community The group aims to work appropriately with the local community in which it operates. The group encourages its employees to take part in charitable activities and offers support whenever possible. The group has also worked with various educational establishments to provide training and work experience to young people. This involvement has ranged from one-week work experience projects to summer internships with the group. The group has an ongoing relationship with the University of Edinburgh, whereby the group provides research projects to the students and the University provides research services to the group.
  14. 14. ManagementandGovernance 12 ARC International plc Annual Report and Accounts 2008 Extended Playback Time Portable media players containing ARCs solutions can deliver a natural and realistic experience with extended playback time. ARCs multimedia products provide an integrated solution to manufacturers and chip makers, cutting overall development costs and extending battery life. Consumers benet by having a device that adds clarity to the audio spectrum with a rich surround sound and reduced listener fatigue.
  15. 15. Board of Directors ManagementandGovernance 13ARC International plc Annual Report and Accounts 2008 From left: Richard Barfield Carl Schlachte Victor Young Dr Geoff Bristow Steven Gunders Richard Bareld Chairman of the Board Richard Bareld, 51, joined the Board as a non-executive director and Chairman of the Audit Committee in September 2003, becoming Chairman in April 2007. Mr Bareld also chairs two other private venture capital backed businesses in the IT stafng and IT reseller industries. Mr Bareld was previously Chief Executive Ofcer of Spring Group plc. Whilst at Spring, he was also Chairman of the Recruitment and Employment Confederation, the trade association of the UK recruitment sector. He previously served as Group Finance Director of Northgate Information Solutions plc and was President of Northgate's Glovia joint venture with Fujitsu and of the Group's application development tools business, PRO-IV. Prior to this he occupied senior nancial positions with Bellsouth Corporation and SmithKline Beecham. Mr Bareld is a Fellow of the Institute of Chartered Accountants, having qualied with KPMG in 1982. Carl Schlachte Chief Executive Ofcer Carl Schlachte, 45, is president and CEO of ARC International and joined the Board in 2003. Carl has more than 20 years of experience in the semiconductor industry, including CEO roles at global fabless semiconductor and IP companies, and executive positions at Motorola and ARM Holdings plc. At ARM he established its North American operations and secured strategic relationships with some of the largest chip and system companies in the United States. Carl resides in the East Bay of Northern California with his wife and children, and is active in his local community and philanthropic causes. He is also non-executive Chairman of MOSAID Technologies Inc. Victor Young Chief Financial Ofcer Victor Young, 60, is Chief Financial Ofcer of ARC International and joined the Board in 2007. Victor has over 35 years of corporate accounting and management experience with technology companies such as Selectica, Mobilitech, BOPS and Tera Systems. Victors industry experience includes service with PricewaterhouseCoopers, and multinational venture capital, technology, manufacturing, telecommunications and service corporations. He is a graduate of San Francisco State University. Dr Geoff Bristow Non-executive director Dr Geoff Bristow, 55, joined the Board as senior non-executive director in September 2003. After gaining a rst class electronics degree from Imperial College, London, and a PhD in engineering from Cambridge University, he spent ve years at Texas Instruments semiconductor division where he was responsible for SoC (System-on-Chip) devices. Subsequently at ICL plc he was director of Network Products before setting up Octagon Industries, a management services company designed to assist undervalued hi-tech companies. Under Octagon's umbrella he was attributed with a number of high prole rescues including Wordplex Information Systems plc (where he was CEO), Alphameric plc (Executive Chairman) and later in California, Poqet Computer Corp (Chief Operating Ofcer). He then became an Executive Vice President for Fujitsu and has subsequently been managing an investment portfolio of young private companies. Steven Gunders Non-executive director Steven Gunders, 65, joined the Board as a non-executive director in June 2007. Currently he is Chairman of the Remuneration Committee and a member of the Audit Committee. Steven Gunders has close to 40 years of industry experience and specialises in corporate strategy, mergers and acquisitions, and operations. He is a qualied C.P.A. and holds an MBA from the University of Chicago. A former partner with Deloitte and Touche, Steven Gunders was the global lead consulting partner at Deloitte Consulting with a particular focus on private equity clients buy and build strategies both in the United States and internationally.
  16. 16. Directors Report ManagementandGovernance 14 ARC International plc Annual Report and Accounts 2008 The directors present their report and the audited financial statements for the year ended 31 December 2008. Business review and principal activities The Group licenses award-winning consumer electronics intellectual property (IP) in the form of vertically integrated solutions, multimedia subsystems, configurable processors, and related technologies to semiconductor and OEM companies worldwide. The company is a public limited company quoted on the London Stock Exchange, registered in England and Wales and is domiciled in the UK. The address of the registered office is Verulam Point, Station Way, St Albans, Hertfordshire. The companys registered number is 3592130. The group has principal operating activities in the UK, US, Russia and in India through the associate Adaptive Chips, Inc,. The addresses of the principal offices are set out on the back cover. A list of subsidiaries is given in note 16 to the accounts on page 58, and the group also operates representative offices in Taiwan, Japan, Germany and the Netherlands. A review of the operations and future developments is included in the Chairmans statement, Chief Executives review of operations and Chief Financial Officers review on pages 5 to 10 and have been incorporated by reference. The group position at the year end includes a net funds position (including cash and cash equivalents and short-term investments) of 12.7 million (2007: 21.2 million) and a net asset position of 21.5 million (2007: net assets 30.3 million). The key performance indicators used by the directors and management are summarised below: Description Metrics Performance Comment Revenue Revenue for the company Total revenue up 18% from 2007. With all sales made in US dollars the overall is made up of licencing increase was 8%. Royalties continued to and engineering revenue, Royalties up 61% from 2007. increase as unit shipments increased. maintenance revenue and During 2008 customers shipped increasing royalties on units sold. units of new higher royalty bearing products. Royalty revenues may uctuate due to seasonal uctuations in volume shipments by licencees, economic conditions in end markets, end of life cycles or unforeseen delays in reporting royalties by licencees. Revenue per Monitoring revenue per 88,000 compared to During the year ARC has made one average headcount headcount allows the 91,000 in 2007. acquisition but this headcount increase directors to measure the has been offset by the restructuring that efciency of the group. the group undertook in September. The year end headcount was 163 which will be carried through to 2009. Therefore, the revenue per average headcount should improve. LBITDA The monitoring of the 3.9 million* versus LBITDA has increased by 5% over 2007, loss before interest, 3.7 million in 2007. partially due to the delayed revenue from tax, depreciation and two licencing contracts in 2008. amortisation allows the directors to understand the operating results of the group. *Before restructuring costs. New licences New licences signed will 27 new licences versus The group has been focusing on increasing during year drive future royalties. 34 in 2007. the average deal revenue. Renewing contracts for new products with existing customers conrms the customer valuation of the groups products. Net funds used The group is loss making, 8.6 million versus The group used 2.5 million cash for the so it monitors the cash 10.4 million in 2007. acquisition during the year. Cash outow used to ensure that the from operations increased to 5.6 million cash is put to best use from 5.1 million in 2007, due to changes for the group. including, year end working capital movements, one-off restructuring costs and absorbing the acquisitions during the year.
  17. 17. ManagementandGovernance 15ARC International plc Annual Report and Accounts 2008 The directors consider that licencing growth drives an IP licencing business model. Therefore, revenue-based metrics such as growth rates, revenue per head and new customers and licence agreements are key to company growth. The directors also consider that the move to profitability is important. This is measured by review of LBITDA and net funds used. Principal business risks and uncertainties The Board has a process for identifying and managing business risks and reviews the major operational risks and uncertainties for the ARC business at each Board meeting. This Annual Report contains certain forward-looking statements that are ARCs expectations and beliefs about our future business. These statements are made by the directors in good faith, based on information available to them at the time of the approval of the report. Undue reliance should not be placed on such statements, which are based on ARCs current plans, estimates, projections and assumptions. By their nature, forward-looking statements involve known and unknown risk and uncertainty because they relate to events and depend on circumstances which may occur in the future and which in some cases are beyond ARCs control. Actual results may differ from those expressed in such statements, depending on a variety of factors. These factors include, but are not limited to: consumer and market acceptance of the companys products and the products that use the companys products; decreases in the demand for the companys products; excess inventory levels at the companys customers; decline in average selling prices of the companys products; cancellation of existing orders or the failure to secure new orders; the companys failure to introduce new products and to implement new technologies on a timely basis; the companys failure to anticipate changing customer product requirements; the companys failure to deliver products to its customers on a timely basis; the timing of significant orders; increased expenses associated with new product introductions; the commencement of, or developments with respect to, any future litigation; the cyclicality of the semiconductor industry; and overall economic conditions. Trends and factors likely to affect future development, performance and position of the groups business The major risks and uncertainties and how the Board tries to mitigate them are: 1 Its ability to produce new products that satisfy The company undertakes extensive market analysis and has the target markets. a close working relationship with potential customers, with a view to identifying the correct product for the target market. The design cycle for the companys products can take 12 to 18 months to reach acceptance by its customer base. This long lead time can lead to difculties with the timing and scheduling of product design as well as the potential to miss a market opportunity for the products developed. Therefore, throughout the research and development cycle the company operates a tight project management schedule to ensure that products are on time and within specication. Product reviews are undertaken regularly to ensure that those being developed are in line with market expectations. 2 The company operates an intellectual property (IP) The use of the IP business model by companies has increased business model that relies on licencing IP to customers over the last years. Customers have seen the benets of licencing for integration into their own products. industry standard IP and adding to this to make their own products different than competitors. However, customers could revert to using in-house development teams and cease licencing in product. The Company undertakes development work to ensure that its products are ahead of the customers needs and available when they need them. The company has the advantage in that it licences to more than one supplier, its development costs should be recouped over more than one customer, therefore having a price advantage over in-house development teams. 3 Competitive pressures; ARCs competitors include Through the use of market analysis the company has focused major corporations that have a larger base of software on multimedia subsystems, which is a growing market. support for their product range and much larger The company endeavours to produce products that are compatible installed customer base. with industry standards and other major players so as to appeal to the widest customer base.
  18. 18. Directors Report ManagementandGovernance 16 ARC International plc Annual Report and Accounts 2008 Results and dividends The results for the year are set out on page 30. The financial statements for the group show revenue for the year ended 31 December 2008 of 17.0 million compared to 14.4 million for the year ended 31 December 2007. There was an operating loss of 7.0 million (before restructuring charge) for the year compared with an operating loss of 5.3 million for the year ended 31 December 2007. The directors do not recommend the payment of a dividend (2007: nil). Policy on payment to suppliers and financial instruments The company is a holding company and as of 31 December 2008 had no trade creditors. It is group policy that payment to suppliers is made in accordance with suppliers agreed terms and in accordance with its contractual and other legal obligations and this is expected to continue in 2009. The average number of creditor days for the group during 2008 was 62 days (2007: 40 days). The group policy in respect of financial instruments and financial risk management is contained within the financial review on pages 9 to 10 and note 4 to these accounts. Research and development The group continues to undertake research and development activities aimed at the ongoing improvement of its technology. Research and development costs charged to the income statement were 9.6 million (2007: 7.4 million) and capitalised 0.25 million (2007: 0.27 million) as internally generated development costs. The group has research and development centres in St Albans and Cambridge, UK; San Jose, US and St Petersburg, Russia. During 2008 the group has increased the amount of development undertaken in India through its associate, Adaptive Chips Inc. Adaptive Chips provides outsourced development personnel to the group. It is the groups policy that all new intellectual property is owned in the UK. Intra-company transfer agreements are in place where necessary to facilitate the ownership in the UK. Essential business arrangements The products that the company develops rely on the latest technological benefits. As such the company has arrangements in place with the major electronic design automation companies to licence their technology to assist in the groups product development. These products allow the group to design microprocessor cores in software and then convert this into microprocessor chip designs. The group has also undertaken an increase in the development of processor design through the associate, Adaptive Chips Inc. Adaptive Chips perform the productisation and development of the core design work generated by the group. 4 Factors outside ARCs control such as a downturn By focusing on the multimedia subsystems market, which is a in the semiconductor industry and adverse growing area, the company believes that this will help mitigate economic conditions. any effects of any potential downturn. However, market risks will still exist. 5 Safeguarding and enforcing its intellectual property The company invests vigorously in its patent portfolio to ensure rights, and protecting against challenges by that all new inventions are patented and protected. The company third parties. also has tight controls over the use of its technology through the licensing process. Potential claims against the company would affect the business as these are costly and take up a disproportionate amount of management time. The company seeks to minimise this risk by following strict reviews of the project objectives and how the products are intended to operate. 6 The departure of key personnel. The company has a competitive remuneration package for personnel. The company encourages a working environment where communication between employees and management is open and leads to a good working relationship. 7 Currency and hedging risks (a substantial proportion The company operates a treasury policy as detailed of ARC group revenues are in US dollars), interest rate on the Chief Financial Ofcers review on page 10 risks and credit risks. to reduce these risks. 8 Integration of the new business. ARC has completed four business acquisitions during 2007 and 2008 and there are risks and uncertainties regarding the integration of these businesses into the ARC group.
  19. 19. ManagementandGovernance 17ARC International plc Annual Report and Accounts 2008 As of the date of this report there have been no other changes to the above interests of the directors in the ordinary shares of the company. The company operates a process of orderly rotation of the directors for re-election to the Board. Richard Barfield offers himself for re-election at the AGM. Richard Barfield is the Chairman of the Board and has been with the company since September 2003. Richard has 25 years of corporate accounting and management experience. Richard Barfield has a services agreement with no notice period specified. Geoffrey Bristow also offers himself for re-election at the AGM. Geoffrey Bristow is the Senior Non-Executive Director on the Board and has also been with the company since September 2003. Geoffrey has 25 years of electronic engineering and management experience and specialises in working with technology companies. Geoffrey Bristow has a services agreement with no notice period specified. The company maintains a directors and officers insurance policy for the benefit of all directors and management of the group. Corporate governance The Boards report on corporate governance is set out on pages 25 to 27. Donations During 2008 the group made nil of charitable donations (2007: $200). No political contributions were made during the year (2007: nil). Substantial shareholdings At 20 February 2009 the company had been notified of the following interests of over 3% in the issued ordinary share capital of the company: Number of % of ordinary shares capital Gartmore Investment Limited 26,902,498 17.62 Axa Investment Managers 10,660,665 6.98 GAM Fund Management 10,527,812 6.89 Legal & General 9,659,001 6.32 Aviva 8,853,682 5.80 UBS Investment Bank 7,856,963 5.15 River and Mercantile Asset Management LLP 7,758,378 5.08 Employee Benet Trust 7,641,799 5.00 Additional information for shareholders Following the implementation of the EU Takeover Directive into UK law, the following description provides the required information for shareholders where not already provided elsewhere in this report. Information on the groups employees The group operates over three continents in 11 countries, and as such is very aware of the local environments in which its employees operate. The group is aware of the diverse local customs and takes these into account when dealing with its employees. Even with the diverse geographical locations the group minimises its environmental impact through using new methods of communications rather than flights to meetings. The product ranges that the group develops are to allow the end consumer products to be more power efficient and therefore more environmentally friendly also. The groups headcount has reduced from 196 in December 1997 to 163 in December 2008. The average number of employees during 2008 was 193 (2007: 158) with 70% (2007: 72%) working in research and development. During 2008 the group undertook a restructuring programme that reduced the number of employees. Overall the group still has 72% of employees working in research and development but concentrated on new product research and initiatives, with development undertaken by the associate in India. The group recognises that the employees play an important part in the future success of the company, and seek to recruit and retain those people who possess the requisite skills and knowledge as well as the personal commitment to respond to the challenges of working within a fast changing technology group. As part of the restructure, the group has refocused its employee skill base on multimedia based product offerings. The collaboration of the engineers within the group and those of the associate in India, should allow the group to leverage the talented employee workforce and produce new products in a cost effective and efficient manner. The restructure and subsequent employee reductions were handled in accordance with local customs and laws. As part of the process the group undertook to assist those employees leaving the group through programmes of outplacement assistance, as well as liaising with recruitment companies or other local companies. The group has also undertaken a programme of measures to ensure that those employees remaining are fully engaged with the group and the strategic objectives for the future. Directors and their interests The directors in service at the end of the year, and their interests (which are all beneficial) in the ordinary share capital of the company, are shown below and details of options held are given in the remuneration report on pages 23 and 24. Offered for Shares Shares Date of re-election at 31 December 31 December appointment next AGM 2008 2007 R Bareld 03.09.03 Yes 10,000 G Bristow 03.09.03 Yes S Gunders 21.06.07 10,000 C Schlachte 20.02.04 752,364 681,364 V Young 13.02.07
  20. 20. Share capital As at 28 February 2009, 152,703,048 (28 February 2008: 152,703,048) ordinary shares of 0.1p each were in issue and listed on the London Stock Exchange. All issued shares are fully paid up and do not carry any special rights or additional obligations. At the AGM on 22 April 2008 (the 2008 AGM), the shareholders authorised the company to make market purchases of up to 5% of the ordinary shares capital and the maximum price which could be paid was an amount equal to 105% of the average of the middle market quotation for the five business days preceding the day of purchase. As at 11 March 2009, no purchases have been made and the company has an unexpired authority to repurchase shares up to a maximum of 7,544,698 ordinary shares. At the 2008 AGM, the shareholders authorised the directors to allot shares up to an aggregate nominal value of 50,901. Since the 2008 AGM no shares have been allotted. The company is not aware of any agreements between shareholders that may result in the restriction on the transfer of the companys shares or of the voting rights attaching to the companys shares. Rights and obligations attaching to shares Voting In a general meeting of the company, subject to the provisions of the Articles and to any special rights or restrictions as to voting attached to any class of shares in the company (of which there are none): on a show of hands, every member present in person shall have one vote; and on a poll, every member who is present in person or by proxy shall have one vote for every share of which he or she is the holder. No member shall be entitled to vote at any general meeting or class meeting in respect of any shares held by him or her if any call or other sum then payable by him or her in respect of that share remains unpaid. Currently, all issued shares are fully paid. No member who is in default of a s.212 notice to provide information about his holding in shares of the company shall be entitled to receive notice of or attend or vote at a general meeting of the company in respect of the shares in which he is in default. Deadlines for voting rights For the purposes of determining which persons are entitled to attend or vote at a meeting and how many votes such person may cast, the company may specify in the notice of the meeting a time, not more than 48 hours before the time fixed for the meeting, by which a person must be entered on the register in order to have the right to attend or vote at the meeting. Directors Report ManagementandGovernance 18 ARC International plc Annual Report and Accounts 2008 Dividends and distributions Subject to the provisions of the Companies Act 1985 and the Companies Act 2006 (the Companies Acts), the company may, by ordinary resolution, declare a dividend to be paid to the members, but no dividend shall exceed the amount recommended by the Board. The Board may pay interim dividends, and also any fixed rate dividend, whenever the financial position of the company, in the opinion of the Board, justifies its payment. All dividends shall be apportioned and paid pro rata according to the amounts paid up on the shares during any portion or portions of the period in respect of which the dividend is paid. Liquidation Under the current articles, if the company is in liquidation, the liquidator may, with the authority of an extraordinary resolution of the company and any other authority required by the Statutes (as defined in the articles): divide among the members in specie the whole or any part of the assets of the company; or vest the whole or any part of the assets in trustees upon such trusts for the benefit of members as the liquidator, with the like authority, shall think fit. Transfer of shares Subject to the articles, any member may transfer all or any of his or her certificated shares by an instrument of transfer in any usual form or in any other form which the Board may approve. The Board may, in its absolute discretion and without giving any reason, decline to register any instrument of transfer of a certificated share which is not a fully paid share or on which the company has a lien. The Board may also decline to register a transfer of a certificated share unless the instrument of transfer is: i) left at the transfer office for registration; and ii) accompanied by the certificate for the shares to be transferred and such other evidence (if any) as the Board may reasonably require to prove the title of the intending transferor or his or her right to transfer the shares. The Board may permit any class of shares in the company to be held in uncertificated form and, subject to the current articles, title to uncertificated shares to be transferred by means of a relevant system. The Board may refuse to register the transfer of shares in favour of more than four persons jointly. Amendment of the companys articles of association Any amendments to the companys articles of association may be made in accordance with the provisions of the Companies Act 1985 by way of special resolution. Appointment and replacement of directors Directors shall be no less than three and no more than 15 in number.
  21. 21. ManagementandGovernance 19ARC International plc Annual Report and Accounts 2008 Directors may be appointed by the company by ordinary resolution or by the Board. A director appointed by the Board holds office only until the next following Annual General Meeting and is then eligible for election by the shareholders. The Board may from time to time appoint one or more directors to hold employment or executive office for such period (subject to the Companies Acts) and on such terms as they may determine and may revoke or terminate any such appointment. At every Annual General Meeting of the company, any director in office who: a) has been appointed by the Board since the previous Annual General Meeting; or b) was elected or last re-elected at or before the Annual General Meeting held in the third calendar year before shall retire from office by rotation. A retiring director shall be eligible for re-election. The Company may remove a director from office by passing an ordinary resolution of which special notice has been given. The Board may remove a director from office if they make a request in writing signed by at least three quarters of the other members of the Board. The office of director will also be vacated if: i) he or she resigns; ii) he or she is or may be suffering from a mental disorder; iii) he or she is absent without permission of the Board from meetings of the Board for six consecutive months and the Board resolves that his or her office is vacated; iv) he or she becomes bankrupt or compounds with his or her creditors generally; v) he or she is prohibited by law from being a director; or vi) he or she is removed from office pursuant to the articles. Powers of the directors The business of the company will be managed by the Board who may exercise all the powers of the company, subject to the provisions of the companys memorandum of association, the articles, the Companies Acts and any ordinary resolution of the company. The directors may exercise all the powers of the company to borrow money but shall not at any time without the prior sanction of an ordinary resolution of the company exceed a sum equal to 20 million. Shares held in the Employee Benefit Trust The trustee of the ARC International plc Employee Benefit Trust (EBT) hold 7,641,799 ordinary shares in ARC International plc. If any offer is made to shareholders to acquire their shares the trustee will not be obliged to accept or reject the offer in respect of any shares which are at that time subject to subsisting awards, but will have regard to the interests of the award holders and will have power to consult them to obtain their views on the offer. Subject to the above the trustee may take the action with respect to the offer it thinks fair. Change to the articles during 2008 At the AGM in 2008 the shareholders approved a change to the articles, as a result of new provisions under the Companys Act 2006, to allow the directors to authorise conflicts and potential conflicts of interest in a similar way to the current law. No conflicts have had to be approved in the period. Change of control There are no agreements between any group company and any of its employees or any director of the company which provide for compensation to be paid to the employee or director for termination of employment or for loss of office as a consequence of a takeover of the company. Details of significant agreements to which group companies are a party containing provisions which would be triggered as a consequence of a takeover of the company, and details of the effect of such provisions, are set out below. Significant agreements change of control The group has significant agreements that contain termination and other rights for our counterparties upon a change of control of the company. The group is party to licensing agreements with major Electronic Design Automation software vendors, that specify that in the event of a change of control of the company, the company must obtain their written consent for the licences to be assigned. This is a standard contract term in software licences. The group operates a Performance Share Plan, detailed in the remuneration report on page 23. On a change in control, the default position is that awards vest only subject to performance and a pro rata reduction. Annual General Meeting The Annual General Meeting (AGM) will be held at 9.30am on 22 April 2009 at Verulam Point, Station Way, St Albans, Herts AL1 5HE. Auditors Each of the directors as of the date of this report confirms the following: As far as the director is aware, there is no relevant audit information of which the companys auditors are unaware; and He has taken all the steps he ought to have taken as a director in order to make himself aware of any audit information and to establish that the companys auditors are aware of that information. During the year PricewaterhouseCoopers LLP resigned as auditors and KPMG Audit Plc was appointed. KPMG Audit Plc, have indicated their willingness to continue in office, and a resolution concerning their reappointment will be proposed at the AGM. By order of the Board Charles Rendell Joint Company Secretary 11 March 2009
  22. 22. The emoluments of directors and their interests in executive options over shares in the company and share-based awards are the only auditable elements of the remuneration report. Remuneration Committee The members of the Remuneration Committee during the year were: Steven Gunders (Chairman) Richard Bareld Geoff Bristow (Chairman until 22 April 2008) All the members of the Committee are non-executive directors and considered to be independent. The principal function of the Remuneration Committee is to determine the remuneration packages of all executive directors and for monitoring the remuneration of senior management. This includes base salaries, pension contributions, bonus payments, share-based incentives and service contracts. The Remuneration Committee prepares the Boards Annual Report to shareholders on the groups policy on remuneration of the executive directors and the directors remuneration report. The terms of reference are available on the groups website: www.arc.com/upload/company/remuneration_committee_terms _of_reference_2008.pdf. Advice provided to the Remuneration Committee During the year, the following were appointed by the Committee to provide advice that materially assisted the Committee: New Bridge Street Consultants Charles Rendell (Joint Company Secretary) Thomas Huppuch (Joint Company Secretary) Sandy OGorman (Vice President Human Resources) New Bridge Street Consultants were appointed by the Committee (and provide no other services to the company) in respect of share-based incentive plans, to ensure that any new plans fulfil the Committees long-term incentive criteria. Remuneration policy In determining the companys policy on remuneration, the Remuneration Committee has regard to the following objectives: i) Remuneration packages offered are designed to be competitive, being comparable with packages available within other groups operating in similar markets (i.e. internationally) and on a similar scale, including competitors. Remuneration Report ManagementandGovernance 20 ARC International plc Annual Report and Accounts 2008 ii) Remuneration packages are set so as to attract, retain and motivate executives of the highest calibre, and at the same time optimise the interests of shareholders. The Committee takes into account that the company is striving towards profitability when reviewing the compensation that is awarded to directors and senior management. iii) Consideration of environmental, social and governance issues. The board reviews the environmental impact of the company as a whole, together with the social impact and the governance issues. Currently there are no plans to incorporate these into the bonus plans or the variable elements to the remuneration packages. The Board will review this if the position or operations of the group change. The policy is designed to provide a mix of performance and non-performance remuneration so as to align their objectives to those of the shareholders. The remuneration mix for 2008 has changed with an increased emphasis on the performance related pay. The percentage available by way of variable measurable bonus has increased to reward increased performance. The policy on executive director and senior management remuneration and appointments is set out below. There have been no changes to policy, other than an increased emphasis on variable performance related pay, from the preceding year and no departures from this policy in the current year. The current policy is expected to continue through the current financial year. Elements of the policy i) Basic salary In assessing the level of basic salary, the Remuneration Committee takes account of the pay practices of other companies, the responsibilities of each director and senior manager, and pay awards elsewhere in the group. Salaries are reviewed annually by the Remuneration Committee. ii) Bonus payments Bonus payments are paid to executive directors, of up to 75% (2007: 50%) of base salary, and the senior management, of up to 55% (2007: 25%) of base salary, based on objectives, including revenue, operating profit and cash flow targets, set for each individual. The Chief Executive Officer received a bonus for 2008 of $61,384 or 15.3% of base salary (2007: $29,000). The bonus payment was for the first half performance. iii) Share options Share option grants are a significant element of company performance-related remuneration. Share options are awarded on the commencement of employment and are granted by the Remuneration Committee at the next available meeting. Employees of the company participates in the executive share option programme, where appropriate, and the Board considers this to be a significant employee motivator. The Committee reviews the number of share options that directors and
  23. 23. ManagementandGovernance 21ARC International plc Annual Report and Accounts 2008 employees have been awarded and the exercise price to ensure that they remain effective. The grants to individual employees are limited under the scheme rules to normal market practice of one times salary in any year. The company operates an Inland Revenue approved scheme that vests after three years, an unapproved scheme and an incentive stock option plan that have a vesting schedule of 25% on the first anniversary and then monthly over 36 months. The company has a process whereby each year the level of share options outstanding for each employee is reviewed and where necessary an evergreening grant is made to ensure that they are still receiving the same incentive. The company uses shares within the Employee Benefit Trust as well as potential new issue shares to satisfy these grants. iv) Long-term incentive plans and interests of shareholders The Remuneration Committee reviews the level of option awards to ensure that they are consistent with the industry. At the AGM in 2007 the Committee proposed and the shareholders approved, a new long-term incentive plan for executive directors and senior management. The Committee feels that this performance-driven plan will align directors performance remuneration with the interests of shareholders generally. The grant to the directors under this policy are set out in the table on page 24. v) Pensions Post-retirement benefits, which comprise only pensions, are based on contributions to a defined contribution scheme of up to 5% matched by the employee, paid into a UK personal pension plan. The contribution is based on salary and bonus payments in line with company policy for all UK employees, and is a standard UK contract term. US employees participate in a 401k defined contribution pension plan that matches contributions up to 5% of salary, with a maximum of $15,500. vi) Duration and termination It is company policy for executive directors to have contracts with less than one years notice period. There are no other termination payments. Non-executive directors have service agreements for a period of three years with no contractual termination payments. Senior management have employment agreements with between three and nine months notice periods. Performance/non-performance pay ratios If the total shareholder return growth under the long-term incentive scheme is on target, and assuming that 100% of the share options under the groups share options scheme will vest, the composition of each executive directors remuneration will be as follows: Non-performance- Performance- related related LTIP and basic salary bonus share options C Schlachte 80% 13% 7% V Young 86% 9% 5% All non-executive directors have 100% non-performance-related remuneration. External appointments During the year, C Schlachte served as non-executive Chairman of MOSAID Inc, a Canadian quoted company. Mr Schlachte has retained all of the proceeds from this appointment, $90,939 (2007: $66,650). Service agreements None of the executive directors service contracts have notice periods of over one year in line with group policy. Non-executive directors are appointed for an initial period of three years. It is group policy that they serve the three years and are then offered for re-election by the shareholders. Notice Termination Contract date period payments C Schlachte 19.02.04 Six months Contractual salary V Young 19.12.05 Six months Contractual salary R Bareld 03.09.03 None Specied None G Bristow 03.09.03 None Specied None S Gunders 21.06.07 None Specied None There is no unexpired term for any of the directors listed above, except for Steven Gunders who has 15 months from the date of this report. Service contracts are available for inspection at the registered office of the company and will be available at the Annual General Meeting. Non-executive directors interests Non-executive directors do not participate in the companys executive share option scheme or pension schemes. Details of individual directors emoluments and interests in share options are shown in the tables on pages 22 and 23. For details of directors shareholdings in the company, please refer to the table in the directors report on page 17. Non-executive directors fees are arrived at by reference to fees paid by other companies of similar size and complexity and reflect the amount of time non-executive directors are expected to devote to the groups activities during the year. The non- executive directors have service contracts that set out their terms of appointment. Their remuneration is set by the Board (with individual non-executive directors absenting themselves from discussions regarding their own remuneration) and comprises a fixed fee.
  24. 24. Remuneration Report ManagementandGovernance 22 ARC International plc Annual Report and Accounts 2008 2005 2006 2007 20082004 ARC International total return FTSE all share technology hardware and equipment total return Rebased total return index Source: Thomson Datastream, monthly average 0 5 10 15 20 25 30 Emoluments of directors (audited) The emoluments of the directors of the company were as follows: Salary Total Pension Total Pension and fees Bonus Benets2 2008 2008 2007 2007 Executive directors C Schlachte1 4 265,039 42,398 11,396 318,833 7,942 173,598 7,072 V Young1 4 (appointed 13 February 2007) 188,203 19,432 20,548 228,183 151,713 Non-executive directors R Bareld 80,000 80,000 86,875 G Bristow3 60,000 60,000 61,622 S Gunders (appointed 21 June 2007) 30,000 30,000 15,807 P van Cuylenburg4 (resigned 3 April 2007) 55,673 Total 623,242 61,830 31,944 717,016 7,942 545,288 7,072 The emoluments shown above are for the period when each individual was a director of the company. Details of dates are contained in the directors report. No directors waived their rights to emoluments. 1 Payments for 2008 made in US dollars converted at year-end rate of $1.4479 (2007: $1.9973). 2 Benefits include provision of health benefits. 3 The figure for Geoff Bristow includes 25,833 for time spent on strategic projects over and above time as a director which was paid to Decision Curve Limited, a company controlled by Geoff Bristow (2007: 36,623). 4 Includes amounts paid by ARC International I.P. Inc. Share price performance ARC International total return relative to FTSE all share technology hardware and equipment. In the opinion of the directors, this index is the most appropriate index to measure the total shareholder return of the company for these purposes because this index comprise similar companies to the company.
  25. 25. ManagementandGovernance 23ARC International plc Annual Report and Accounts 2008 Options vest 25% on the anniversary of grant and then monthly over three years. Richard Barfield, Geoff Bristow and Steven Gunders have no interest in executive options. All executive share options are issued at market value. The market price of the companys shares at the end of the year was 11.75p. The range of prices during the year was 11.00p to 34.50p. As of the date of this report, there have been no changes in the interests of the directors in options over ordinary shares of the company. Long-term incentive plan (audited) The long-term incentive plan, the performance share plan (PSP), was approved by shareholders at the AGM in April 2007. The Committee believes that a new long-term incentive policy reflects current market and best practice and ensures that share- based incentives are offered to the most senior executives in as efficient a manner as possible from an accounting cost and dilution perspective. The main features of the PSP are as follows: Conditional awards over free shares are granted, as opposed to market value options. This move away from an option- focused incentive policy reflects recent emerging trends in market and best practice. In normal circumstances, awards over shares worth no more than 125% of salary may be made each year. This limit broadly reflects emerging market practice and allows the Committee to offer competitive levels of performance-linked long-term incentive awards. All awards to executive directors will be subject to challenging performance conditions. To ensure that the PSP encourages the groups senior executives to generate above market returns for its shareholders, initial awards will vest by reference to the groups TSR performance over a three-year period compared to the fully-listed Technology Hardware and Equipment sector companies with current market capitalisations no less than 20 million. No portion of an award will vest if ARC is ranked below the median. If ARC is ranked at the median 25% of an award will vest, with full vesting if ARC is ranked at or above the upper quartile. For the awards during 2008 this group was made up of the following companies: Arm Holdings Filtronic CSR Trafcmaster Spirent Communications Zetex Wolfson Microelectronics Danka Business Systems Imagination Technologies group CML Microsystems Psion Plasmon Vislink Northamber On a change in control, the default position is that awards vest only subject to performance and a pro rata reduction. Again, this approach accords with best practice. It is currently intended that no executive director will receive PSP awards and share option grants in the same year. The charge to the income statement in respect of grants under the Long Term Incentive Plan was 90,310 (2007: 62,000). Interest in executive options over shares in the company (audited) The interest in executive options over shares in the company as at 31 December 2008 for the directors is as follows: Number at Number at Exercise Date 1 January Granted Exercised Lapsed 31 December price Date from which Expiry 2008 in year in year in year 2008 p of grant exercisable date C Schlachte 2,500,000 2,500,000 20.75 23.02.04 23.02.05 23.02.14 V Young 1,400,000 1,400,000 26.0 16.02.06 16.02.07 16.02.16
  26. 26. Remuneration Report ManagementandGovernance 24 ARC International plc Annual Report and Accounts 2008 Share-based awards (audited) During 2008 there were no share-based awards under the plan approved by shareholders in 2004 and therefore no charge to the income statement (2007: 2,964). A resolution approving the remuneration report has been drafted and will be put to the shareholders at the AGM. This report has been prepared on behalf of the Board and approved by the Board on 11 March 2009. By order of the Board Steven Gunders Chairman of the Remuneration Committee 11 March 2009 Share options awarded to directors under the Long Term Incentive Plan are: Number at Number at Exercise 31 December Granted Exercised Lapsed 31 December price Value Date Vesting 2007 in year in year in year 2008 p vested of award date C Schlachte 236,842 236,842 0.1 15.05.07 15.05.10 400,000 400,000 0.1 14.05.08 14.05.11 400,000 400,000 0.1 29.09.08 29.09.11 V Young 105,263 105,263 0.1 15.05.07 15.05.10 200,000 200,000 0.1 14.05.08 14.05.11 200,000 200,000 0.1 29.09.08 29.09.11
  27. 27. Corporate Governance ManagementandGovernance 25ARC International plc Annual Report and Accounts 2008 The directors subscribe to the principles of good governance and the code of best practice on corporate governance. The company has embedded the principles into the processes used by the directors and the establishment of the various committees of the directors. The company is in compliance with the provisions set out in Section 1 of the 2006 Combined Code on corporate governance issued by the Financial Reporting Council, except that the Chairman of the company is also Chairman of the Audit Committee. The directors supervise the management of the business and the affairs of the company and see their prime responsibility as being to determine the broad strategy of the company. The directors have embedded the principles of good corporate governance and the process by which risks are identified and controlled and effective accountability assured. with information in a form and of a quality appropriate to enable it to discharge its duties. In addition to the Board meeting as a whole during the year, the non-executive directors meet without the executive directors being present. All the directors have access to the advice and services of the joint company secretaries and the provision of independent professional advice at the companys expense. The company maintained directors and officers liability insurance throughout the year. Performance evaluation The non-executive directors met during the year to appraise the former Chairmans performance and also take into account the executive directors view. The whole Board performs an evaluation of its performance by a process of self-assessment questionnaires. This process is an external system for evaluations designed by Evalu8 Software. The Board performed an evaluation of the Board as a whole and the committees for 2008. Therefore the company considers that it was in compliance with principle A.6, in that a rigorous and formal process for evaluating the Board and committees was in place. Board committees The Board has delegated responsibility in a number of areas to three sub committees with clearly defined terms of reference. The Terms of Reference for the Remuneration, Audit and Nomination Committees are available on the companys website, www.arc.com/company/directors.html. Directors Chairman Richard Bareld Senior non-executive director Geoff Bristow Non-executive director Steven Gunders Executive director Chief Executive Ofcer Carl Schlachte Executive director Chief Financial Ofcer Victor Young The Board considers Richard Barfield, Geoff Bristow and Steven Gunders to be independent. Richard Barfield is Chairman of the Board and Audit Committee. The roles of the Chairman and Chief Executive Officer are separated, with a clear division of responsibilities between them. The Chairman of the company is responsible for running the Board, and the Chief Executive is responsible for running the companys business. Each director is provided with sufficient information for him to discharge his duties and responsibilities as a director including training and access to independent professional advice. The Articles of Association require each director to submit himself for re-election at least every three years. Operation of the Board The Board meets on a regular basis throughout the year. The Board has reserved certain items for its review and approval, including the annual and interim results; annual business plan; significant capital expenditure which is not included in the current business plan and is not in the ordinary course of business of the company; and senior management appointments. Other matters are delegated to Board committees including those detailed below. The Board is supplied, in a timely manner, Audit Committee Committee Chairman Richard Bareld Committee member Steven Gunders The Board has established an Audit Committee comprising two non-executive directors. The directors are responsible for ensuring that a sound system of internal control to safeguard shareholders investments and the groups assets is being maintained. The Committee assists with this process. The Committee meets at least twice a year and reviews the annual and half-yearly financial statements and the other documents to be sent to shareholders before they are submitted to the Board. The Committee also meets with the auditors without the presence of executive management. The Committee considers the appointment of auditors, receives a report from them at each meeting where financial statements are reviewed and ensures that appropriate relationships are maintained with the auditors (in respect of audit and non-audit fees). As part of ensuring that the appropriate relationship is maintained, the Committee recommends that different firms are invited
  28. 28. Corporate Governance ManagementandGovernance 26 ARC International plc Annual Report and Accounts 2008 to tender for non-audit work. The Audit Committee reviews non-audit services undertaken by the auditors to ensure that auditor objectivity and independence are safeguarded. However, the group moved its UK taxation services to KPMG as it believed that they would be able to provide an efficient and cost effective service. The group continues to use independent companies for taxation services outside of the UK. * Attended Audit and Remuneration Committee meetings by invitation. ( ) Those eligible to attend. Operational management The executive directors are supported by a team of senior managers who are responsible for assisting in the development and achievement of the groups corporate strategy. The senior management includes the Chief Technology Officer who assists in the development of the product line. Internal controls The directors have overall responsibility for establishing financial reporting procedures to provide them with a reasonable basis to make proper judgements as to the financial position and prospects of the group, and have responsibility for establishing the groups system of internal control and for monitoring its effectiveness. Internal control systems are designed to meet the particular needs of the group and the risks to which it is exposed and include financial, operational and compliance controls and risk management. The internal controls have been in place for the year under review and up to the date of the approval of the accounts and are periodically reviewed by the Board and Audit Committee. During 2007 the Board put in place a process whereby the risks facing the company were reviewed at each Board meeting and this continued in 2008. This ensures that the review remains up to date and accords with the guidance in the Turnbull report. The Board conducts an annual assessment of the internal controls. Although no system of internal control can provide absolute assurance that physical and financial assets are safeguarded, the system of control is designed in such a way that transactions are authorised and properly recorded and material errors and irregularities are either prevented or detected with the minimum of delay. The Board has considered the need for an internal audit function and, given the scale and nature of the groups operations, has concluded that one is not required at the present time. Remuneration Committee Committee Chairman Steven Gunders Committee member Richard Bareld Committee member Geoff Bristow (until April 2008) The Board has established a Remuneration Committee comprising two non-executive directors. The role of the Committee is to set the companys policy on the remuneration of the executive directors and senior management and to determine their specific remuneration packages, including bonus and share option arrangements. The report on directors remuneration is set out on pages 20 to 24. The whole Board decides upon the remuneration of the non-executive directors, although no director is involved in deciding his own remuneration. Nomination Committee Committee Chairman Richard Bareld Committee member Geoff Bristow The Nomination Committee is responsible for reviewing the Board structure, size and composition and to make recommendations to the Board with regard to any adjustments that are deemed necessary; to be responsible for identifying and nominating candidates for the approval of the Board; to fill Board vacancies as and when they arise as well as put in place plans for succession, in particular, of the Chairman and Chief Executive Officer; and to make recommendations to the Board for the continuation (or not) in the service of an executive director as an executive or non-executive director. It is noted that the Board met as follows: Remuneration Audit Nomination Board Committee Committee Committee In person 5 1 2 By teleconference 3 11 2 In committee 1 And the directors attendance at Board and Committee Meetings was: Remuneration Audit Nomination Board Committee Committee Committee R Bareld 9 (9) 12 (12) 4 (4) C Schlachte* 9 (9) 2 1 V Young* 9 (9) 1 3 G Bristow 8 (8) 5 (5) S Gunders 8 (8) 12 (12) 4 (4)
  29. 29. ManagementandGovernance 27ARC International plc Annual Report and Accounts 2008 Financial reporting and monitoring of operations A detailed annual plan is collated from submissions by each functional department. The plan is reviewed by executive directors and approved by the Board. The annual plan is used to monitor and control actual performance. The process of maintaining a sound system of internal control includes the use of financial reports both for weekly information and on a monthly basis. The group has a weekly management meeting that discusses sales and software development schedules. Each site and function manager must prepare a weekly report of activities for discussion. This is then followed by a monthly report of results, where these are compared with the annual plan and forecasted results. Monthly meetings discuss results and a report is prepared and sent to the Board for review. The Board meets each quarter to discuss the results and review the future plans. Treasury operations The groups treasury function operates within clearly defined risk management guidelines monitored by the Board. Its policies and procedures are designed to set guidelines for the management of interest rates on cash deposits and the exposure to foreign exchange movements. All these policies and positions are regularly monitored and conservatively managed. It is a group policy not to undertake any speculative transactions which create additional exposures over and above those arising from normal trading activity, and to manage the counterparty risk to protect the capital of the group. Whistleblowing policy In 2004 the Board established a whistleblowing hotline operated by a third party. Employees are encouraged to use this to report possible improprieties directly to the Board through this anonymous process. The Chairman of the Audit Committee is the nominated director to receive these calls and follow up with appropriate action. To date, however, there has been nothing reported. Annual Report In submitting this Annual Report and the financial statements to the shareholders, the Board has sought to ensure that a balanced and understandable assessment of the groups position and prospects has been presented to the shareholders. Auditor independence The company operates a policy that non-audit work is only undertaken by the external auditors when they are most suited to undertake it. The company had appointed an independent firm to advise on taxation matters in general and especially for specific projects such as UK Research and Development tax credits, however a review of taxation advisers in the UK was undertaken and KPMG were appointed as taxation advisers in the UK. When KPMG were appointed auditors it was felt that it was still appropriate to keep KPMG as taxation advisers. The company has also undertaken royalty audits of its licensees and has used the previous auditors, PricewaterhouseCoopers, as well as a smaller more specialised audit firm. The amount paid to the external auditors during the year for audit and other services are set out in note 7 on page 50. The Board considers that the auditor independence is not compromised. Relations with shareholders In addition to ensuring that sufficient information is disseminated in order to maintain an orderly market in the shares of the company, the company maintains a regular dialogue with major institutional shareholders. The company reports its financial results on a half-yearly basis to its shareholders. The management presents to shareholders and the analyst community and receives feedback from the companys financial PR advisers and brokers who obtain feedback after the investor and analyst meetings. The company operates an investor relations section on the company website. This is updated regularly with information including the results of the AGM voting, any financial press releases and the ability to register to receive all press releases the company makes. The company prides itself on the comprehensive business information that is provided not only on itself but its products and partners. The Chief Executive Officer and the Chief Financial Officer have met with shareholders, obtaining their views and reporting to the whole Board. The senior non-executive director and Chairman of the Board have had extensive correspondence with shareholders during the year. The AGM of shareholders will be held on 22 April 2009. The company sees this as an opportunity to communicate with all shareholders, including private investors in the company. The AGM will be held at the companys offices at St Albans which will enable not only employee shareholders to easily partake in the meeting but investors to meet with local management. The Chairmen of the Audit and Remuneration Committees will be in attendance to respond to any queries, and it is expected that all directors will attend the AGM. Going concern On the basis of current financial projections and facilities available, the directors have a reasonable expectation that the group and the company has adequate resources to continue in operational existence for the foreseeable future and, accordingly, consider that it is appropriate to adopt the going concern basis in preparing the financial statements. By order of the Board Charles Rendell Joint Company Secretary 11 March 2009
  30. 30. Statement of Directors ResponsibilitiesIn respect of the Annual Report, the directors remuner