Arm Heads Into Earnings With Two Businesses Growing at Different Speeds

Picture owning the toll booth on every major highway, taking a cut every time a car passes. For decades, that was Arm Holdings in your pocket. Nearly every smartphone swipe, mobile game tap, and streaming subscription ping runs through a processor blueprint Arm drew up. Arm designs the fundamental architecture inside chips rather than building or selling physical hardware — at least until this year. Chipmakers and cloud platforms license those blueprints, then pay Arm a recurring royalty of a few cents to a few dollars on every finished chip that leaves the factory.

Because Arm does not build or run multi-billion-dollar fabrication plants, that toll booth produces software-grade profitability. Last quarter, non-GAAP gross margin reached 98.1%, with GAAP gross margin at 97.2%. The AI explosion moved that toll booth inside the server rack. As artificial intelligence clusters consume massive power, cloud giants are replacing power-hungry x86 chips with custom silicon that does more work per watt. Google is actively replacing x86 host processors with its custom Arm-based Axion chips, while Amazon and Microsoft deploy Graviton and Cobalt. Arm now claims roughly 50% of CPU compute across the top hyperscalers.

The model works through a two-step mechanism. First comes licensing, where a customer pays upfront to access Arm's architecture. That business is negotiated, lumpy, and front-loaded; it generated a first-quarter record $574 million last quarter, lifting annualized contract value 13% to $1.73 billion. Management expects licensing to run at roughly $200 million a quarter for the rest of the year.

Once those designs ship, the royalty annuity begins. That per-chip stream brought in $715 million last quarter as Neoverse data-center shipments crossed 1.5 billion cores. Notably, the last 500 million arrived in nine months, after the first billion took six years.

Here is the tension Wednesday's print must resolve. Data-center royalties have doubled year-over-year twice in a row, but servers remain the smaller slice of Arm's pool. The bedrock of the business is still smartphones, where handset makers are absorbing higher memory costs. While cloud designs compound rapidly off a small base, the CFO guided second-quarter royalty growth to roughly 13%, trimming full-year royalty expectations from 20% to the high teens. The stock, which slipped about 10% on Friday during a broad semiconductor rout and trades at roughly half its June peak, is caught between those two gears.

For the stock to re-rate from here, enterprise cloud gains must decisively outrun mobile sluggishness before valuation multiples compress. The market is not pricing Arm as a mature handset licensor; it is pricing a full transition into an AI silicon pillar. In March, CEO Rene Haas laid out a five-year ambition: roughly $25 billion in annual revenue by 2031, with $15 billion of it from the new AGI CPU and earnings per share near $9. It compares against fiscal 2026 revenue of $4.92 billion.

To get there, Arm crossed an unprecedented line by selling its own finished silicon. Meta signed on as lead co-developer. Customer demand tops $2 billion across fiscal 2027 and 2028, against an initial $1 billion target, and Arm claims the chip cuts data-center capital expenditure by up to $10 billion per gigawatt.

The short thesis argues that Arm broke its golden goose the moment the toll booth started selling cars. By launching the AGI CPU, Arm turned its largest licensing customers into direct rivals. The blowback is already material. In October, a Delaware jury found Arm breached its architecture license agreement with Qualcomm and intentionally interfered with Qualcomm's work with Meta. That nominal one-dollar verdict matters: it gives a federal judge the opening to let Qualcomm suspend royalty payments for five years, risking roughly $300 million in annual high-margin revenue.

Meanwhile, the FTC is investigating whether Arm is monopolizing chip markets by restricting licenses while ramping internal silicon. Worse, the math turns dilutive. The AGI CPU carries gross margins in the high 30% to low 40% range, undermining the 98% gross margins that supported Arm's multiple. Once smartphone fleets finish upgrading to Armv9, the royalty-rate lift expires, leaving Arm tethered to a stagnant handset cycle with lower-margin silicon.

The Nov. 4 report is the first concrete checkpoint on whether hyperscaler adoption can outrun handset gravity. We are watching whether second-quarter revenue clears the top of management's $1.33 billion to $1.43 billion guidance band, because consensus sits right on the midpoint with no room for error.

Disclosure: The Signal holds no position in ARM. Positions may change. This is not financial advice.