On Thursday, stocks of major chip design companies arm holdings (arm 1.16%) Sales soared 48% after the company released a strong third-quarter fiscal 2024 report yesterday afternoon. For the period ended December 31, 2023, growth was driven by robust adoption of artificial intelligence (AI) across end markets. With the recovery of the smartphone market.
For context, the UK-based company held an initial public offering in September 2023. The Company's principal business is the licensing of intellectual property (IP) related to the design of central processing unit (CPU) chips and related software and tools.
Arm's third-quarter sales rose 14% year-over-year to $824 million, beating Wall Street's expectations for 5% growth. Adjusted earnings per share rose 32% to $0.29, beating analysts' consensus estimate of 14% growth. Additionally, management has guided for fiscal fourth-quarter revenue growth of 34% to 42% year over year, with adjusted bottom line growth of 1,300% to 1,500%. I made it. Both estimates handily beat Street expectations.
Earnings releases only tell part of the story. Here are two important things to know about Arm's fiscal third quarter conference call.
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1. Benefit from a virtuous cycle
From CEO Rene Haas:
Arm is the most fundamental, foundational, and widespread computing platform in the history of digital design. Over 280 billion pieces [based on Arm IP] for over 30 years [the company was founded in 1990] Arm is a company built on history. And that's supported a software and hardware ecosystem like no other. And given the fact that CPU design is actually driven by hardware and software, it creates a flywheel for continued development.
There are several reasons why Arm has a great business model. The main reason is that the company benefits from a virtuous cycle. As more hardware is built using Arm IP, more software is written for Arm. And the more software is written for Arm, the more popular the hardware based on that IP will be because the hardware has more or better applications and features. etc.
This virtuous cycle is a big part of what makes Arm's hardware and software ecosystem the world's largest open computing system.
2. Customers benefit greatly by moving from v8 architecture to v9 architecture
First, a note about royalties: Arm licenses its IP; Several Of these licenses, the company accrues royalties. This means that the company's revenue comes from both licenses and royalties.
Comment from CFO Jason Child:
The future growth of royalty income is mainly due to Armv9 has a royalty rate that is at least twice the rate for comparable Armv8 products.. Additionally, the amount of Arm technology in chips introduced is increasing. And as the amount of Arm technology in the chip increases, so does the royalty rate. [Emphasis mine]
Let's forget the second part of Child's comment for a moment and focus on the first part in bold. On average, Arm's royalty rate for products using its latest chip architecture, Armv9, is at least twice the rate for comparable products using earlier architectures. This is an increase of at least 100% in just one generation. AI is a key reason for this giant leap forward, driving the need for chips in things like cloud servers, smartphones and cars to have significantly more computing capabilities.
Arm's v9 architecture, introduced in early 2021, accounted for 15% of the company's total royalties in the fiscal third quarter, up from 10% in the previous quarter, CEO Haas said. CEO Haas said on a conference call that he sees this growth as “accelerating.” Customers continue to migrate to license v9.
Where does the company fit into this upgrade cycle? It depends on the end market. Almost all premium smartphones are moving to v9-based CPUs, and Arm expects the entire market to be upgraded within the next three to four years. Other markets are slower to transition because they do not update products as frequently as the smartphone market. So, all in all, Arm still has great runway for growth through this upgrade cycle.
The second part of Child's comment is self-explanatory. Arm not only benefits from higher loyalty rates when customers move to the latest architecture, but also when customers use more of its technology in its products. There is also an advantage.
Beth Mr. McKenna has no position in any stocks mentioned. The Motley Fool has no position in any stocks mentioned. The Motley Fool has a disclosure policy.
