Apologies for our limited publishing schedule last week. We were traveling in Asia on client work.
Arm reported a strong quarter comfortably beating consensus for their fiscal Q2. They guided right on top of consensus for Q3, but then left their guidance for the full year unchanged. Mathematically that implies Q4 estimates need to come down by the amount that Q2 beat.
Despite that math, management expressed a strong degree of confidence during their call. Which presents a puzzle. We detected a clue to this puzzle in the Q&A portion of the call. We regularly track and analyze Q&A sessions to parse trends, looking in particular at the way management teams construct their answers and also the questions analysts are asking those questions (let us know if you would like this for your company). Arm has now been public for five earnings calls and the team has gotten markedly better in how they structure their answers. We think that their guidance is at least in part due to the company getting a handle on its strategy for issuing forecasts. Put simply, they are getting more conservative with their guidance to keep estimates from getting too far ahead. They do not need to issue blow out guidance every quarter, and by leaving this year’s guidance unchanged on an otherwise strong quarter, they set themselves up better for next year.
One of the other themes of this call was the long term visibility of their revenues. This topic came up repeatedly in the Q&A, and makes sense given their long-term revenue model. A big concern among some investors is the extent to which their license payments seem highly variable quarter to quarter, reflecting upfront payments at the start of a new customer contract. These are lumpy and create quarterly distortions. Instead the company is urging investors to track Annualized Contract Value (ACV) which evens out the quarterly lumps by essentially looking at the number on a rolling basis.
A couple other highlights we picked up:
- Historically, the company was only able to increase prices at the time of new contracts, which effectively meant every ten years. Now the company has put price increases into the contracts, so they occur much more frequently.
- CSS looks increasingly compelling for customers, which if true, is another avenue for value accretion to the company. CSS adoption is spreading beyond mobile to PC and now automotive.
- The company confirmed what we all sort of know anyway – Arm Windows laptops are coming from more vendors than Qualcomm.
Overall, Arm looks very well positioned. That being said, the lawsuit with Qualcomm remains a significant overhang. We tend to view the risks here as fairly asymmetrical in Arm’s favor – if they lose, there is little impact to their forecasts, but if they win it could signal a further increase in their value capture. The one caveat to that is Qualcomm’s new Snapdragon still uses v8 of the Arm IP, while the latest Mediatek chip is already on v9. Despite that, Qualcomm’s chip looks more performant than the Mediatek solution, calling into question the importance of Arm’s upgrade cycle. We actually saw a hint of this in numbers this quarter, where v9 adoption held at the 25% level of last quarter. There is a lot of nuance to these numbers, and it is still hard for us to see a major bear case emerging for Arm, but the lawsuit is an event horizon beyond which the forecast frontier opens up significantly.
Leave a Reply