Arm Q1 and next quarter guidance are positive, but the full-year outlook is lukewarm, with a 10% drop in after-hours trading | Financial Report News

After the U.S. stock market closed on Wednesday, SoftBank's British chip design company Arm Holdings, which is actively participating in the "AI arms race", released its financial performance for the fourth quarter of the 2024 fiscal year (i.e. the first quarter of the 2024 calendar year).

Despite the comprehensive outperformance of the financial report, with total revenue hitting record highs for multiple quarters and guidance for the next quarter exceeding expectations, concerns arose in the market about the slowdown in the AI spending frenzy in the technology industry due to the "lukewarm" revenue guidance for the 2025 fiscal year ending in March next year, leading to a sharp 10% post-market plunge.

Arm closed down 1.6% on Wednesday, still hovering near a three-week high. Analysts had previously stated that in this financial reporting season, given the high market expectations for AI development, the financial reports and performance outlook of related concept stocks must "far exceed expectations" to impress investors.

Arm is still 90% owned by the Japanese SoftBank Group, which acquired Arm for $32 billion in 2016. Arm raised $4.9 billion in its IPO last year, making it the largest U.S. IPO of 2023.

The company's stock price has doubled since the IPO period, rising 41% this year, significantly outperforming the S&P 500 index and the industry benchmark Philadelphia Semiconductor Index, but falling 35% from its peak at the beginning of the year.

Both total revenue and royalty income in the fourth quarter hit record highs, with 2024 fiscal year revenue surpassing $30 billion for the first time

The third complete quarter financial report after the IPO showed that Arm's total revenue in the fourth quarter of the fiscal year increased by 47% year-on-year to $928 million, hitting another record high. This growth rate was significantly faster than the 14% increase in the previous quarter and higher than analysts' expectations of $880 million.

The company stated that adjusted operating profit for the quarter "strongly increased" to $391 million, surpassing analysts' expectations of $355.9 million. In the same period last year, the company had an operating loss of $1 million. The non-GAAP operating profit margin was 42.1%.

Adjusted EPS was $0.36 per share, higher than the market's expectation of $0.30, compared to earnings per share of $0.02 in the same period last year. EPS for the previous quarter increased by nearly 32% to $0.29 per share, and combined with positive performance guidance, the stock price surged by about 50% the next day.

In terms of business segments, Arm's royalty revenue in the fourth quarter hit a record high, increasing by 37% year-on-year to $514 million, exceeding the market's expectation of $504 million, benefiting from the rapid adoption of chips based on the Armv9 architecture and the recovery of the semiconductor industryAt the same time, licensing revenue increased by 60% year-on-year to $414 million, exceeding the company's expectations. This was due to other companies increasing their investments in artificial intelligence technology based on Arm architecture in all terminal markets and signing multiple high-value licensing agreements with Arm.

For the 2024 fiscal year, Arm's total revenue increased by 21% year-on-year to $3.233 billion, marking the first time in the company's history that annual revenue exceeded $30 billion. Royalty usage fee revenue increased by 8% to $1.802 billion, while licensing revenue increased by 43% to $1.431 billion, both reaching historical highs. Non-GAAP operating profit increased by 80% year-on-year to $1.408 billion, with a non-GAAP operating profit margin of 43.6%.

Analysis shows that Arm exceeded its own expectations for the fourth quarter and full-year performance of the 2024 fiscal year. Previously, it was expected that revenue for the fourth quarter would be between $850 million and $900 million, with the midpoint of the range representing a 38% year-on-year increase, and adjusted earnings per share of $0.28 to $0.32. Total revenue for the 2024 fiscal year was expected to increase by nearly 19% to $3.18 billion, with the full-year profit guidance raised from $1.05 per share to $1.22 per share.

Next quarter guidance exceeds expectations, but 2025 revenue forecast barely meets expectations, triggering concerns about industry capital expenditures

In the quarterly guidance for June, Arm expects revenue for the first quarter of the 2025 fiscal year to be between $875 million and $925 million, with the midpoint slightly higher than analysts' expectations of $868 million. Adjusted EPS is expected to be between $0.32 and $0.36, higher than analysts' expectations of $0.31. Operating expenses are expected to be $475 million, basically in line with the market's expectation of $477.6 million.

For the 2025 fiscal year ending in March, Arm expects annual revenue to be between $3.8 billion and $4.1 billion, with the midpoint even slightly lower than analysts' expectations of a 26% increase to $4.01 billion. Full-year adjusted EPS is expected to be between $1.45 and $1.65, compared to analysts' expectation of $1.53.

Some analysts point out that Arm's full-year revenue guidance for 2025 is "only" in the middle of the market's estimated range, which is considered a "lukewarm annual forecast," raising concerns that the AI spending boom in the tech industry is slowing down.Arm CEO Rene Haas stated in the financial report that as artificial intelligence is driving increasing demand for Arm-based technology in all terminal markets, it will bring strong momentum for the next fiscal year:

"From the cloud to edge devices, all AI software models from GPT to Llama rely on and run on the Arm computing platform. As these models become larger and smarter, their requirements for more computing power and higher energy efficiency can only be achieved through Arm."

For example, the continuous popularity of the Armv9 architecture for AI, especially in the smartphone, server, and automotive markets, has brought in innovative high royalty revenue. Additionally, due to the increasing demand for Arm's AI energy-saving technology from data centers to edge computing, as well as several high-value agreements, the licensing revenue is also substantial, with expected strong growth in revenue and profit in the next quarter.

In other key indicators, Arm stated that its customers shipped 7 billion Arm-based chips in the fourth quarter of the 2023 calendar year, bringing the cumulative shipment of Arm-based chips since its launch to 287.4 billion.

As of the end of the first quarter of the 2024 calendar year, driven by several high-value licensing agreements, the company's remaining performance obligations (i.e., the total value of unfulfilled contracts) increased by 45% year-on-year to $2.484 billion, having increased by 38% to $2.4 billion in the previous quarter. During the quarter, 4 comprehensive licensing agreements for AI-specific chips (Arm Total Access, ATA) were added.

This brings the total number of signed high-value agreements to 31, "including more than half of Arm's top 30 customers." These agreements are signed with semiconductor companies to help licensees accelerate chip development plans and shorten the time to market for new chips, providing the "most comprehensive IP products, tools and models, support and training, software and physical design packages" in an easy-to-use subscription manner.

Arm Financial Report Format Detailed Explanation

Arm does not produce any chips itself, but licenses its chip designs and architectures to semiconductor companies and device manufacturers, who then use Arm's intellectual property to manufacture processors and components for electronic devices such as smartphones and computers, including central processing units (CPU), neural processing units (NPU), and graphics processing units (GPU).

Therefore, Arm's revenue model consists of two types: license fees and royalties. Architecture license fees are one-time payments, while royalties are continuous income streams extracted from each chip manufactured based on the Arm architectureWall Street News once mentioned that Arm's client list spans the entire tech industry. For example, Apple uses Arm instruction set to design processor chips for iPhone and Mac computers, Amazon relies on Arm's design to develop its Graviton server processors for data centers, while Qualcomm and MediaTek are major users of Arm's smartphone processor blueprints. Other clients include Google, Microsoft, and NVIDIA.

In the previous fiscal quarter, royalty revenue increased by 11% year-on-year and 12% quarter-on-quarter to $470 million, mainly driven by the semiconductor industry recovery and the growth in sales of Armv9 architecture chips focusing on AI. Architecture license fees increased by 18% year-on-year to $354 million, with adjusted operating profit growing by 17% to $338 million, as partners increased AI investments driving demand for high-performance Arm CPUs.

The latest chip architecture Armv9 was released in 2021, aiming to enhance the AI capabilities of chips. The industry adoption rate is rapidly increasing, leading to 15% of royalty revenue in the third quarter coming from this architecture, higher than the previous quarter's 10%. The royalty usage fee for Armv9 architecture is twice that of the previous generation, helping to increase company revenue.

How does Wall Street view this?

Some analysts point out that in the context of accelerated AI application promotion, market expectations for AI hardware manufacturers such as Arm and NVIDIA are also rising. Arm's revenue and EPS market expectations have been raised 17 times each in the past three months, without any downward revisions.

Wall Street generally believes that Arm will benefit greatly from the growing demand for AI chips, with revenue and profits expected to continue to grow strongly in the coming years. For example, profit is expected to grow at an average annual rate of 41% over the next five years, with a potential 77% upside in stock price.

In addition, the company is also striving to expand its business beyond the smartphone sector, such as server chips, to drive diversified growth and improve profitability. The smartphone business accounts for less than one-third of the company's sales, with the Chinese market representing approximately 25% of total revenue.

However, Arm is currently the most expensive chip stock in the Nasdaq 100 index, even surpassing NVIDIA, the biggest beneficiary of AI computing hardware demand. Depending on different calculations, Arm's valuation is 27 times the estimated sales for the next 12 months, while NVIDIA's is 19 times. Arm's valuation is also 82 times the expected profitability

The excessively high valuation on one hand makes investors hesitate, while also raising the "benchmark" threshold for financial reports, which may require a significant surpassing of market expectations to rationalize the high valuation.

However, Michael Sansoterra, Chief Investment Officer of Silvant Capital Management, believes that this is mainly due to SoftBank holding about 90% of the shares, leading to a limited number of Arm shares available for trading, thereby exacerbating the expensiveness and volatility:

"This is an expensive stock, but also a stock that is expanding into new markets and growing rapidly."

Overall, analysts believe that Arm will continue to benefit from the significant increase in capital expenditure on AI from large tech companies such as Meta, Microsoft, Amazon, and Apple, and will be able to fully capitalize on the growing demand for AI chips