Arm’s Smartphone Royalty Slowdown Overshadows AI Data-Center Growth

Arm Shares Slide as Smartphone Weakness Clouds Strong Earnings

Arm Holdings (ARM) shares plunged approximately 10% on Thursday, November 5, despite reporting better-than-expected fiscal second-quarter earnings and revenue. The British semiconductor technology company posted 27% revenue growth, supported by licensing demand and expanding adoption of its technology in AI data centers.

The selloff reflected disappointment with Arm's slower royalty revenue growth, which fell short of expectations as rising memory prices weighed on smartphone production. Although data-center royalties doubled, investors focused on the company's continued exposure to mobile devices and a revenue outlook that offered only a modest improvement over Wall Street forecasts.

Key Points

• Royalty growth disappoints: Arm's royalty revenue increased just 8%, missing expectations as higher memory costs pressured smartphone production.
• AI and licensing remain strong: Licensing revenue jumped 50%, while data-center royalties doubled and partners shipped more than 10 billion Arm-based chips.
• Growth outlook faces scrutiny: Third-quarter guidance slightly exceeded estimates, but investors remained concerned about smartphone exposure, future royalty growth and the profitability of Arm's expanding chip business.

Why Did Arm Stock Fall Despite Strong Earnings?

Arm reported fiscal second-quarter revenue of $1.44 billion, up 27% from a year earlier and ahead of Wall Street's $1.38 billion estimate. Adjusted earnings reached $0.52 per share, exceeding expectations of approximately $0.48. The results marked Arm's fifth consecutive quarter of revenue growth above 20%, reflecting continued demand for its semiconductor designs across smartphones, cloud computing and connected devices.

The royalty business, however, was less encouraging. Royalty revenue increased only 8% to $670 million, below the approximately $705 million analysts expected. These payments are generated when semiconductor manufacturers ship chips incorporating Arm's designs and technology, making royalty growth an important indicator of underlying chip demand. The shortfall highlighted continued pressure in smartphones, where expensive memory components and constrained supply have affected production.

Smartphone Demand Remains a Significant Challenge

Arm's technology is widely used in smartphones, including devices produced by Apple (AAPL) and Android manufacturers. Higher memory prices have increased production costs across the industry, limiting demand and weighing on the number and mix of chips generating royalty payments.

The pressure extends beyond Arm. Qualcomm (QCOM) also reported a sharp decline in handset chip revenue, reinforcing concerns about weakness across the broader smartphone semiconductor market. Arm's management indicated that stronger adoption of its newer technologies helped offset some of the pressure, but not enough to deliver the royalty growth investors had anticipated. The disappointment was particularly significant after a substantial rally in Arm shares earlier in the year, which left investors sensitive to signs of slowing growth.

AI Data-Center Demand Drives Licensing and Royalty Expansion

Arm's results also demonstrated substantial growth outside its traditional smartphone business. Licensing and other revenue surged 50% to $773 million, supported by strong demand for intellectual property, high-value agreements and contributions from its existing contract backlog. Unlike royalties, which depend on chip shipments, licensing revenue comes from agreements allowing customers to use Arm's semiconductor technology, so large contracts can create significant quarterly fluctuations. Arm's annualized contract value, a measure of its ongoing licensing commitments, increased a more moderate 12% to $1.79 billion, providing additional context for the sharp rise in reported licensing revenue.

Data-Center Royalties Double as Arm Expands Beyond Mobile

Data-center royalties doubled from a year earlier as cloud operators and AI developers increased adoption of Arm-based processors. The company's technology has gained traction in data centers where power efficiency and computing performance are increasingly important. Nvidia (NVDA) is among the companies using Arm-based technology in AI infrastructure, including its Vera CPU platform. Arm also reported 50% growth in Physical AI royalties, reflecting demand for semiconductor technology used in systems interacting with the physical world.

Across its broader ecosystem, partners shipped more than 10 billion Arm-based chips during the quarter, approximately 1.5 billion more than a year earlier. That record volume demonstrated the scale of Arm's technology adoption, even as the slower increase in royalty revenue highlighted the importance of product mix and pricing.

Can Arm’s New AGI CPU Business Support Future Growth?

Arm is expanding beyond its traditional intellectual-property licensing model by developing processors that it will sell directly to customers. The company's emerging AGI CPU business targets AI computing workloads and represents an additional opportunity within the data-center market. Management expressed greater confidence in achieving up to $2 billion in cumulative chip revenue across fiscal 2027 and fiscal 2028, supported by additional supply arrangements and purchase orders from multiple customers. First commercial deliveries are expected in the fourth quarter of fiscal 2027.

Selling physical processors, however, introduces a different financial model from licensing semiconductor designs. Arm expects its initial AGI CPU products to carry gross margins in the high-30% to low-40% range, substantially below the margins associated with its established intellectual-property business. The expansion also introduces manufacturing, delivery and working-capital requirements.

Third-Quarter Guidance Points to Continued Revenue Growth

For its fiscal third quarter, Arm expects revenue between $1.49 billion and $1.59 billion, with a midpoint of $1.54 billion, slightly above Wall Street expectations. Adjusted earnings are projected between $0.52 and $0.60 per share, while operating expenses are expected to rise as the company continues investing in new products. Management also indicated that royalty growth could remain subdued in the near term, with year-over-year growth expected in the low single digits during the December quarter.

Chief Executive Rene Haas said the company remained pleased with its quarterly performance and market-share gains, while acknowledging that political developments could influence the pace of AI data-center construction. The outlook therefore presents a mixed picture: expanding AI opportunities and continued revenue growth alongside near-term smartphone weakness and rising investment requirements.

What It Means for Investors

Arm's earnings illustrate the gap between strong demand for AI-related semiconductor technology and the performance of a company's broader revenue base. Data-center royalties are expanding rapidly, licensing activity remains strong, and Arm is entering new markets through its AGI CPU business. Smartphones, however, remain a significant source of royalty revenue, leaving the company exposed to memory pricing and device production trends.

Investors will be watching whether royalty growth improves as smartphone conditions stabilize, whether data-center adoption continues expanding, and how the transition toward direct chip sales affects profitability.

Conclusion

Arm's sharp post-earnings decline reflected concerns about smartphone royalties and the pace of future growth rather than weakness across its entire business. Strong licensing revenue, record chip shipments and accelerating data-center adoption demonstrated continued demand for Arm technology, but slower royalty growth and the financial implications of entering the processor market introduced additional uncertainty.

The central question is whether expanding AI and data-center opportunities can generate enough sustained growth to offset smartphone weakness while preserving the profitability that has characterized Arm's licensing business.

FAQs

Why did Arm stock fall after its earnings report?

Arm shares declined because royalty revenue grew more slowly than expected, despite better-than-anticipated quarterly earnings and total revenue. Smartphone weakness and a modest third-quarter outlook contributed to investor concerns.

How much did Arm's royalty revenue grow?

Arm's royalty revenue increased 8% year over year to $670 million in its fiscal second quarter, below analysts' expectations of approximately $705 million. Higher memory prices and weaker smartphone production limited growth.

How is AI contributing to Arm's growth?

AI demand is supporting greater adoption of Arm technology in data centers and other computing applications. Data-center royalties doubled year over year, while Physical AI royalties increased 50%.

What is Arm's AGI CPU business?

Arm's AGI CPU business develops processors that the company plans to sell directly to customers. Management is targeting up to $2 billion in cumulative chip revenue across fiscal 2027 and fiscal 2028, with initial commercial deliveries expected in fiscal fourth-quarter 2027.

What is Arm's revenue outlook for the next quarter?

Arm expects fiscal third-quarter revenue between $1.49 billion and $1.59 billion, with a midpoint of $1.54 billion. The forecast is slightly above Wall Street expectations, although management anticipates continued pressure on royalty growth.

This article was created with AI assistance and reviewed by an editor. For details, please refer to our Terms of Use.

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