What’s Significant

Despite a beat, Arm’s stock was down after hours. One of the main challenges we feel facing investors is Arm is better evaluated on a yearly basis and not a quarterly one. Investors were negative due to a lower-guide for the next quarter which hinges solely on the timing of a customer deal. But licensing and IP business models are better evaluated on yearly performance. Within that context, Arm increased its yearly guidance, which signals a few important things:

If Arm increased its full-year guidance, it would generally suggest a few key points of significance:

Business Strength: Arm perceives that its business is performing better than previously anticipated, possibly due to increasing demand for its chip designs, higher licensing fees, or expansion in new markets.

Market Confidence: Increasing guidance signals to investors and the market that Arm is confident in its financial health and future prospects. This might attract more investment and positively affect the company’s stock price.

Operational Efficiency: It also indicates operational improvements or cost efficiencies within the company, allowing for higher profitability.

Strategic Advancement: It reflects the successful execution of Arm’s strategy, perhaps through winning new contracts, launching new products, or making successful acquisitions.

Competitive Position: Arm increasing its guidance may imply it is gaining a competitive edge in the semiconductor industry, which can be highly volatile and competitive.

Sector Health: It may also suggest overall health in the semiconductor sector or increased demand for technology products that include Arm’s designs.

Investors and analysts often view an increase in full-year guidance as a positive indication of the company’s performance and its outlook on the market it serves.

It still appears some of the dynamics of Arm’s business model are still not totally understood.  Below is a summary of the pillars of their core revenue models.

Key Changes to Arm’s Business Model

• Increased Royalty Rates: With the introduction of v9 architecture cores, Arm is positioned to charge higher royalty rates, potentially up to 5% of the chipset price, which is a considerable increase from the roughly 1.5% for v7 designs and 2-3% for v8. However, for customers doing extensive custom CPU work, the royalty rates might not see as much uplift and could remain closer to rates for v8 due to the value they add through their own designs.
• Compute Subsystem Royalties: Arm now offers compute subsystems for licensing, which could raise royalty rates to 7-8%. These subsystems support memory integration, GPU design, and other SoC components. Segments like mobile (‘TCS’) and infrastructure have their subsystems, with automotive expected soon. However, IoT is not likely to receive a one-size subsystem due to the diversity in design demands. The increased need for compute in automotive, coupled with the trend towards software-defined vehicles, positions Arm to play an integral role in setting new hardware compute standards.
• Subscription Licensing Model: Arm has shifted from a ‘pick and mix’ approach to a subscription-based model (Arm Total Access, or ATA), requiring an annual fee for full access to Arm’s IP offerings including v9 products. Aimed at smoothing out the erratic nature of quarterly licensing revenues, this model adopts an Annual Contract Value (ACV) metric that averages contract values across a three-year period. This new model includes:
  • ATA: Appeals to large chipmakers with access to Arm’s entire portfolio on a subscription basis.
  • Arm Flexible Access (AFA): Lowers initial costs, with payments due upon device shipment.
  • Technology Licensing Agreements (TLA): Traditional single-use, term licensing.
  • Architecture License Agreements (ALA): Offers full architecture access without being core-specific, used by companies for custom CPU work. Despite potentially larger licensing deals here, royalty rates to Arm might be lower.

Short-Term Growth Drivers to Watch: 

Cloud/Data Center Growth: The infrastructure sector, encompassing networking equipment and cloud servers, is emerging as a promising growth avenue for Arm’s ISA despite the company not being a significant player in the Enterprise market. Growth in cloud-related capital expenditures, projected at 15-20%, aligns with increased demand for computing power, especially as cloud AI adoption accelerates. This sector is expected to boost Arm’s infrastructure royalties significantly, with a CAGR of around 53% projected up to FY26e. Additionally, the trend towards AI inference over training, where CPUs can outperform GPUs in cost efficiency, may further escalate Arm’s infrastructure revenue. With industry shifts towards high-value v9 Neoverse designs and notable collaborations, such as NVIDIA’s Grace Hopper chips and Amazon’s Graviton chips using Arm-based architectures, there’s potential for a broader market share and increased royalty rates for Arm, signaling an “AI, R&D supercycle” and enhanced growth prospects in this segment.

Summary of Key Earnings

• Total Revenue: Arm reported a total revenue of $806 million for the quarter, which is above the expected $744.3 million and significantly higher than last year’s $630 million.
• Earnings Per Share (EPS): The adjusted EPS was $0.36, surpassing the analyst’s estimate of $0.26.
• Shares Performance: Despite the positive revenue and EPS, Arm’s shares dropped due to the weaker-than-expected revenue forecast for the upcoming quarter, with an overall decline of over 7.52%, trading at $52.31.
• Future Projections: For the upcoming quarter, Arm forecasted revenue between $720 million to $800 million, with EPS guidance of $0.21 to $0.28, which is below the Street’s expectation.
• Full-Year Forecast: The company projects a full-year revenue for FY2024 between $2.96 billion and $3.08 billion with non-GAAP fully diluted EPS from $1 to $1.10.

Arm’s strong quarter results were dampened by the lower-than-expected guidance for the upcoming quarter and uncertainties around deal timings. Despite this, the company remains optimistic about its future revenue, particularly driven by AI and chip design activity.

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