Qualcomm’s forecast shakes confidence in mobile royalties

Arm’s stock got slammed on Wednesday night, dropping by 7.48% after hours, and by Thursday morning, the crash had widened to 10%, even though the company pulled in record revenue.

The problem here is Wall Street wanted to see $519.9 million in licensing revenue, and Arm only brought in $505 million, so the trading floor got kind of pissed.

But that wasn’t the only reason traders bailed. They also didn’t like the company’s weak guidance or the bad news from Qualcomm, one of Arm’s biggest clients.

Qualcomm’s forecast shakes confidence in mobile royalties

Qualcomm said memory shortages were hurting smartphone production, and own stock dropped nearly 10% after hours, as Cryptopolitan reported. That spooked everyone watching Arm too, since a big chunk of its business still depends on phone makers.

Andrew Jackson from Ortus Advisors said what a lot of people were already thinking. “Arm is trying to diversify into AI chips used for DC/servers, but the success of this remains uncertain, and its business model is still heavily reliant on royalties from chips used in consumer products such as handsets.”

That dependency is now a problem. Qualcomm’s warning about memory supply raised serious questions. If phone production drops in China this year, Arm’s royalty income could take a big hit. And royalties were the biggest piece of Arm’s revenue this past quarter. They came in at $737 million, which was a 27% jump from last year.

Despite the licensing miss, total revenue for the quarter was a record $1.242 billion, up 26% year over year. That beat SmartEstimates from LSEG, which favors analysts with better track records. CEO Rene Haas tried to keep the mood positive.

“Arm delivered a record revenue quarter as demand for AI computing on our platform continues to accelerate,” he said. He also added that the third quarter had record royalty results as more customers built systems using Arm’s technology.

Still, numbers tell a different story. Non-GAAP operating margin dropped to 40.7%, down from 45.0% the same time last year. Free cash flow was cut in half, falling to $169 million. And even though Arm spent heavily on research and development, that didn’t seem to calm investors.

Partners adopt pre-built CSS chips as design costs rise

One area where Arm is gaining traction is its Compute Subsystems, also called CSS. These are pre-built chip templates that help companies cut down on time and cost. Arm says 21 CSS licenses have already been signed, and more customers are choosing this model because designing chips from scratch takes too long.

The Arm Total Design program is supporting that shift. It now includes over 35 partners across software, chiplet, backend, and ASIC services. Big players in smartphones, data centers, and even cars are using CSS to speed up chip development. Arm said the longer it takes to make complex chips, the more pressure there is to shorten the design cycle. CSS helps with that.

On top of that, Arm’s Total Access licensing program reached 50 active deals, up from 40 last year. These licenses target products in smartphones, AI, cars, embedded computing, and more. The Flexible Access program, which focuses on startups, hit 318 licenses, up 23% year-over-year.

But that growth didn’t stop costs from rising fast. Non-GAAP R&D spending jumped 46%, hitting $512 million. General and admin expenses went up 19%, reaching $204 million. Operating expenses overall rose 37%, landing at $716 million for the quarter.

Net income falls as bookings shrink and expenses jump

Despite the revenue beat, profit metrics weren’t as strong. GAAP net income fell 12% to $223 million, and earnings per share dropped from $0.24 to $0.21. Non-GAAP net income hit $457 million, a 10% increase, but again, margins were under pressure.

Operating income came in at $185 million under GAAP, while non-GAAP income reached $505 million, up 14%. GAAP operating margin dropped to 14.9%, compared to 17.8% last year. And while taxes were low at 2.2%, operating cash flow was down 14%, landing at $365 million.

Cash and short-term investments totaled $3.54 billion, which gives Arm breathing room. But future bookings slipped. Arm’s remaining performance obligations dropped 8%, falling to $2.15 billion. That could mean fewer contracts were signed or renewed.

There was one bright stat: Annualized contract value rose 28%, hitting $1.62 billion. That shows bigger average deals, even as total obligations dipped. But in today’s market, traders care more about short-term results. And they didn’t like what they saw.

Arm, which went public in 2023, is now down 4% for the year. And with phone production still shaky and AI revenue not yet stable, traders are staying cautious.

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