Arm Holdings plc American Depositary Shares (NASDAQ:ARM) Q3 2024 Earnings Call Transcript February 7, 2024

Arm Holdings plc American Depositary Shares isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to Arm's Third Quarter Fiscal Year-End 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Head of Investor Relations, Ian Thornton. Please go ahead.

Ian Thornton: Thank you, Latif. Thank you, everybody. My name is Ian Thornton, and I'm the Head of Investor Relations at Arm. I would like to welcome you to our earnings conference call for the third quarter of the fiscal year ending March 31, 2024. I'm joined today by Rene Haas, the Chief Executive Officer of Arm; and Jason Child, Arm's Chief Financial Officer. Hopefully, you will all have downloaded and read the shareholder letter. If not, it is available on the Arm Investor Relations website at investors.arm.com. The shareholder letter provides a rich update on our strategic progress in the quarter. Before we begin, I'd like to remind everyone that during the course of this conference call, Arm will discuss forecasts, targets and other forward-looking information regarding the company and its financial results.

While these statements represent our best current judgment about the future results and performance as of today, our actual results are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during this call, important risk factors that may affect our future results and performance are described in our registration statement on Form S-1 filed with the SEC on September 14, 2023. Arm assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. In addition, we refer to non-GAAP financial measures during the discussion. Reconciliations of certain of these non-GAAP financial measures to the most directly comparable GAAP financial measures and a discussion of certain projected non-GAAP financial measures that we were not able to reconcile without unreasonable efforts and supplementary financial information can be found in the shareholder letter that we released earlier today.

The shareholder letter and other earnings related materials are available on our website at investors.arm.com. And with that, I'll turn the call over to Rene, who has some prepared remarks.

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Rene Haas: Thank you, Ian, and good afternoon, good evening, everyone. So I'd like to take a few different comments about the quarter, and then I'll turn it over to Jason for some specifics and then, we'll open it up to Q&A. We had an outstanding third quarter inside the company. We could not be more pleased. Record revenues, we exceeded the high end of the range for the guidance and extremely pleased about results overall. For Q4, we're expecting another record quarter, and to that end, we've also raised guidance on which Jason is going to give more color on. But a little bit regarding the why and how we got here. Arm has the most fundamental, foundational pervasive compute platform really in the history of digital design. Over 280 billion units in the 30 plus years that Arm has been a company have been built.

And that has underpinned a software ecosystem and hardware ecosystem like no other. And given the fact that a CPU design is really driven by the hardware and the software, it creates a flywheel for continuous development. That is the more hardware that exists on Arm, the more software that's written for Arm, the more software that's written for Arm, the more popular the hardware. So we're building off a fantastic base that when we look at what happened in the last quarter, not only did we see growth driven by a number of factors but growth that we think is long term and sustainable. For royalties specifically around some of the products that shipped in the quarter, we've seen a significant transition now continuing from our v8 product to our v9 product.

Our v9 product garners roughly 2x the royalty rate of the equivalent v8 product, and whereas in the previous quarter that was about 10% of our revenue for royalties. It's now moved to 15%. And that has seen growth in not only the smartphone sector but also in infrastructure and other markets, which drives growth. We are also seeing strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm. And what that has done is driven a very strong set of tailwinds for our licensing growth. When we look at demand for new products from a licensing standpoint, what we are finding from the end market is that we've reached nowhere near good enough relative to the capability of the technology, and end customers for new designs are needing more and more Arm technology to keep up, particularly with the AI demands.

So with that, our licensing growth has been very strong. We've also seen proof points around one of our strategies that we call Compute Subsystems. These are complete finished blocks of designs that we put together for our end customers that will save them significant time around validation of their engineering work and also around time-to-market relative to cycling products to the fab. One of the very first designs that was made public that uses this is the Microsoft Cobalt, which uses our Neoverse cores of 128 CPUs to be specific. We worked very closely with Microsoft around these designs using Compute Subsystems, and we see this trend only going to continue. So between strong growth in royalties that are driven between v8 to v9, all things AI needing energy efficient compute and Compute Subsystems, we feel very, very strongly positioned for growth.

And again, this is completely underpinned by an ecosystem of devices that are in the installed base and a very, very large software community that develops on Arm. So with that, I will turn it over to Jason and then we'll open it up for Q&A.

Jason Child: Thank you, Rene. I'm going to briefly touch on guidance for the fourth quarter and full year. Starting with revenues. For fiscal Q4, we are guiding to a range of $850 million to $900 million with a mid-point of $875 million. This represents a raise of over $95 million compared to our prior implied guidance for the fourth quarter. When combined with our strong Q3 performance, the full year revenue guidance rises to $3.155 billion to $3.205 billion, an increase of $160 million at the midpoint versus prior. Within Q4 total revenue, we expect royalty revenues to grow mid-single digits sequentially and to be up over 30% year-over-year as we compare against the bottom of the industry wide inventory correction that occurred in prior year Q4.

Royalty revenue sequential growth is mainly coming from increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate. With around 35% of Arm's total, sorry, Arm's royalty revenue coming from smartphones, we have benefited from recovery in the smartphone market. But with 65% coming from markets beyond mobile, we are seeing more revenue growth from share gains and market share growth outside of mobile. Additionally, we are expecting another strong quarter for licensing with revenue up sequentially to near record levels.

As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems. Turning to expenses. We expect non-GAAP OpEx of approximately $490 million in Q4 and $1.7 billion for the full year. On a like-for-like basis, our full year guidance has increased by $10 million, driven by slightly higher spend in R&D. As detailed in the guidance section of our shareholder letter, to increase transparency and improve the comparability of our results, beginning in Q4, the presentation of our non-GAAP measures will be modified to exclude employer taxes related to equity classified awards. These taxes are dependent on our stock price at the time of vesting and, as a result, fluctuate independently of the operating performance of our business.

The impact of this change has been factored into today's non-GAAP Q4 and full year guidance for operating expenses and fully diluted EPS. On an EPS basis, revenue strength will flow through to profit, driving Q4 non-GAAP fully diluted EPS up to between $0.28 and $0.32 and full year non-GAAP fully diluted EPS to up between $1.20 and $1.24. In summary, we had an outstanding Q3 and expect our momentum to accelerate through Q4 and beyond. With that, I will now turn it back over to the operator to kick off the Q&A portion of the call.

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