First quarterly report since going public shows a red light! Arm's fourth-quarter guidance falls short of expectations, causing the stock to drop more than 8% after hours. | Earnings Report Insights

Driven by the AI boom, British chip design giant Arm's sales in the third quarter of this year exceeded expectations, but the guidance for the fourth quarter fell below expectations, sounding the alarm for weaker performance in the following quarter since its listing.

Jason Child, CFO of Arm, said that the lower-than-expected guidance for the fourth quarter and the higher-than-expected guidance for the full fiscal year were due to a large licensed order that is expected to be delayed by one quarter.

Analysts commented that there are doubts about whether Arm's growth is sustainable. The performance in the third quarter looks good, but the guidance for the fourth quarter is not satisfactory, and the customer cycle of Arm is not truly understood.

Before the release of the financial report, Arm's stock price listed on Nasdaq fell nearly 1.6% on Wednesday, and the decline expanded rapidly after the release of the financial report, with an after-hours decline of more than 8%.

Q3 revenue YoY growth exceeds expectations by 28%, reaching a record high, EPS doubles

After the US stock market closed on Wednesday, November 8, Arm announced that in the second quarter of the fiscal year 2024, which ended on September 30, 2023 (referred to as the third quarter), both revenue and non-GAAP adjusted earnings per share (EPS) exceeded expectations, but the guidance for the fourth quarter, i.e., the fourth quarter of the calendar year, fell short of expectations.

Key performance indicators for the third quarter:

• Revenue increased by 28% YoY to $806 million, surpassing analysts' expectations of $746.9 million, marking the first time in the company's history that quarterly revenue exceeded $800 million.
• Adjusted EPS was $0.36, a YoY increase of 112%, exceeding analysts' expectations of $0.26.
• Adjusted operating profit increased by 92% YoY to $381 million, and the adjusted operating profit margin was 47.3%, a YoY increase of 15.9 percentage points.

Arm announced that the chip shipments based on Arm's architecture in the third quarter reached 7.1 billion, a YoY decrease of 6%, with a cumulative chip shipment of 272.5 million.

Increase in enterprise customers' AI investment drives a YoY surge of 106% in licensing revenue

According to Wall Street CN, Arm's revenue comes from two main sources: licensing fees and royalties. Data disclosed in the prospectus shows that licensing fees account for about 40% of the revenue, while royalties account for about 60%. Licensing revenue refers to the licensing fee paid by companies that adopt Arm's architecture. Royalty revenue comes from Arm's share of chip sales to chip manufacturers. In this earnings report, Arm stated that the better-than-expected revenue in the third quarter was due to the signing of multiple high-value long-term licensing agreements with leading technology companies in the industry, as well as an increase in market share and a rise in royalty fees, which drove the growth of copyright income.

Arm pointed out that enterprise customers have an urgent need to increase investment in AI in all terminal markets, which has contributed to a doubling of the company's licensing revenue compared to the same period last year.

Arm mentioned that companies such as Google, Meta, Nvidia, Renesas Electronics, and Xiaomi have announced their withdrawal from Arm-based new energy-saving AI technology support products, and more companies are taking action. Arm is making AI ubiquitous.

The earnings report showed that Arm's royalty income in the third quarter decreased by 5% year-on-year to $418 million, while revenue from licensing and other businesses increased by 106% year-on-year to $388 million. The decline in royalty income reflects the impact of chip shipments.

Q4 revenue guidance exceeds expectations with a MoM decline of nearly 6% and EPS decline of over 30%

In terms of performance guidance, Arm's fourth-quarter expectations are lower than the third quarter.

Among them, the revenue guidance for the fourth quarter ranges from $720 million to $800 million, with a median of $760 million, equivalent to a MoM decline of 5.7%, lower than analysts' expectations of $773 million.

In terms of adjusted EPS guidance for the fourth quarter, it is expected to be between $0.21 and $0.28, with a median of less than $0.25, equivalent to a MoM decline of nearly 32%, and lower than analysts' expectations of $0.27.

Arm also expects adjusted EPS for the full fiscal year to be between $1.00 and $1.10, and the full-year revenue is expected to be between $2.96 billion and $3.08 billion, both of which are higher than analysts' expectations, with analysts' expectations being $1.04 and $2.96 billion, respectively.

Stock price decline since listing, Q4 guidance may continue to impact stock price

Arm is one of the new stocks that created the three major IPOs in the US this year. Earlier this week, comments stated that the earnings reports of Arm, Klaviyo, and Instacart are related to whether investors can regain confidence after the weak performance of their stocks since their listing.

On the first day of listing on September 14th, Arm rose sharply by about 24.7%, but has since fallen overall. By this Wednesday, Arm's closing price had fallen more than 14% from the closing price on the first day of listing, reaching $63.59.

Usually, newly listed companies provide reliable guidance to investment banks to help set a fair valuation and leave room for performance to make a deep impression. However, considering that investors may consider selling if they perceive the company as a loser, if the performance falls short of expectations, it could severely impact their stock price. Greg Martin, co-founder of Rainmaker Securities, commented that if new stocks cannot guarantee better-than-expected quarterly performance in their first and second releases after listing, they may run into trouble and be punished by the market for a considerable period of time.

Prior to Arm's earnings report, marketing automation platform Klaviyo announced that its third-quarter revenue exceeded expectations, but its net loss far exceeded expectations, and the midpoint of its fourth-quarter revenue guidance was lower than expected. As a result, Klaviyo's stock price plummeted on Wednesday, closing down 15.3%.

There are comments suggesting that Arm is facing the impact of new accounting regulations, which affect how the company recognizes revenue from long-term and large-scale licensing agreements.

Some analysts believe that the unpredictability of Arm's revenue recognition has raised doubts about the company's high valuation. Through its IPO, Arm's valuation exceeded $65 billion, surpassing other chip companies' annual revenue.

In a shareholder letter announcing its third-quarter performance on Wednesday, Arm stated, "There may be changes in the recognition of revenue from future agreements."