ARM: The Wings of AI, How Long Can It Fly?

ARM (ARM.O) released its third-quarter report for the fiscal year 2024 (ending in December 2023) after the US stock market on the morning of February 8, 2024 Beijing time. The key points are as follows:

Overall performance: Record-breaking revenue. In the third quarter of the 2024 fiscal year (23Q4), ARM achieved revenue of $824 million, a year-on-year increase of 13.8%, exceeding market expectations ($762 million). The continuous growth in revenue is mainly driven by the growth of the licensing and royalty businesses. The company's gross margin for this quarter was 95.6%, a slight decrease of 0.4 percentage points compared to the same period last year, slightly better than market expectations (95.4%), and maintaining a high gross margin level of over 95%.

Business segments: Licensing and royalties both grew. Driven by the demand for AI and other technologies, the number of licensing customers continued to increase. Although the number of licensed chips declined due to the semiconductor cycle, the licensing fees for individual chips increased by 13.5% compared to the previous year.

ARM's performance guidance: For the fourth quarter of the 2024 fiscal year (24Q1), the expected revenue is $850-900 million (market expectations: $781 million) and the adjusted earnings per share are $0.28 to $0.32 (market expectations: $0.21).

Dolphin Research's overall view:

ARM's earnings report significantly exceeded expectations. The company's better-than-expected performance in this quarter was mainly driven by the growth of the licensing and royalty businesses. Although the profit for this quarter fell short of expectations, the core profitability on the operational side is still good.

Compared to the financial data, the company's guidance continues to improve. The company expects the next quarter's revenue to reach $850-900 million (exceeding market expectations of $781 million) and the adjusted earnings per share to be $0.28 to $0.32 (exceeding market expectations of $0.21). The company's revenue in the next quarter is expected to reach a new historical high.

Benefiting from the growth in AI and other technologies, the company has experienced both an increase in performance and valuation. From a company worth less than $50 billion, it has now grown to nearly $100 billion. However, it should not be overlooked that the company's current compound annual growth rate of revenue is less than 20%, and annual profit is still less than $800 million, while the valuation has already exceeded 100 times. Despite the continuous better-than-expected performance on the operational side, the market will continue to have high expectations. If the performance exceeds expectations, the high valuation will also bring corresponding pressure to the company.

Below is Dolphin Research's specific analysis of $Arm(ARM.US):

1. Overall Performance: Record High Revenue

1.1 Revenue

In the third quarter of the 2024 fiscal year (23Q4), ARM achieved a revenue of USD 824 million, a year-on-year increase of 5%, surpassing market expectations (USD 761 million). The company's revenue continued to rise, reaching a new high, driven by the growth of its licensing and royalty businesses.

1.2 Gross Margin

In the third quarter of the 2024 fiscal year (23Q4), ARM achieved a gross margin of USD 788 million, a year-on-year increase of 13.4%. The growth rate of gross margin was close to that of revenue.

ARM's gross margin for this quarter was 95.6%, a decrease of 0.4 percentage points compared to the same period last year, but still better than market expectations (95.4%). The gross margin continued to remain above 95%.

1.3 Operating Expenses

In the third quarter of the 2024 fiscal year (23Q4), ARM's operating expenses were USD 654 million, a year-on-year increase of 45%. The company maintained high investment and continued to expand its research and development team.

Specifically, let's break down the expenses:

1) Research and Development Expenses: The company's research and development expenses for this quarter were USD 432 million, a year-on-year increase of 51%. Due to the development of the business, the company continued to increase its research and development investment, with the current research and development investment accounting for 52.4% of the total. In this quarter, the company continued to recruit engineers, with the number of employees increasing to 5,520, accounting for more than 80% of the total.

2) Sales and Administrative Expenses: The company's sales and administrative expenses for this quarter were USD 216 million, a year-on-year increase of 32.5%. The sales expenses are somewhat correlated with the revenue, increasing with the expansion of the revenue scale.

1.4 Net Profit

In the third quarter of the 2024 fiscal year (23Q4), ARM achieved a net profit of USD 87 million, a year-on-year decrease of 52.2%, lower than market expectations (USD 111 million). The net profit margin for this quarter was 10.6%.

Although the company's profit for this quarter fell short of expectations, considering the performance of the operating side, it is still good. Thanks to the development of the business, the company has added 1,000 engineers compared to the same period last year. Even with a significant increase in research and development expenses, the company still achieved an operating profit of USD 134 million this quarter.

2. Business Segmentation: License and Royalty, Both Growing

Looking at ARM's business segmentation, the license and royalty businesses in this quarter showed a 46% increase. Benefiting from the increase in average chip fees, royalty revenue accounted for 57% of the total. License business accounted for a decrease to 43%.

2.1 License Business

ARM's license business achieved revenue of $354 million in the third quarter of the 2024 fiscal year (23Q4), a YoY growth of 18.4%. With the growth in demand for AI and other technologies, more downstream customers are adopting ARM to develop chips.

The number of fully licensed customers and flexible licensed customers increased this quarter. The number of fully licensed customers increased to 27, and the number of flexible licensed customers increased to 218. The overall number of customers continues to rise.

2.2 Royalty Business

ARM's royalty business achieved revenue of $470 million in the third quarter of the 2024 fiscal year (23Q4), a YoY growth of 10.6%. The growth in royalty business is mainly due to the increase in average price.

Breaking it down:

Number of ARM chips: The number of ARM chips used this quarter was 7.7 billion, a YoY decrease of 2.5%. Due to the impact of the semiconductor cycle, the number has been declining in recent quarters.

Average royalty price per chip: The average royalty price per ARM chip in this quarter was 6.1 cents, a YoY increase of 13.5%. With the recent drive in demand for AI and other technologies, the average fee for licensing a single chip has increased.

Dolphin Research's Analysis Report on ARM and related companies

September 13, 2023: In-depth analysis of ARM: After selling Alibaba, is SoftBank's next cash cow really worth 50 billion USD? (Link: ARM: After selling Alibaba, is SoftBank's next cash cow really worth 50 billion USD?)

Related companies:

January 26, 2024: Intel conference call: Intel 3, is it an opportunity? (Intel 4Q23 conference call) (Link: Intel 3, is it an opportunity? (Intel 4Q23 conference call))

January 26, 2024: Review of Intel's financial report: Intel's throne as the processor king is no longer, AI battle fails to materialize (Link: Intel: Intel's throne as the processor king is no longer, AI battle fails to materialize)

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