Arm Earnings Worry: Data Center Growth Too Distant to Solve Immediate Needs, High R&D Costs Weigh on Profits

Author | Eric

The global semiconductor IP leader $Arm Holdings (ARM.US)$ After-hours, FY26 Q3 earnings were released, affected by the weak guidance simultaneously announced by the leading mobile chip company, $Qualcomm (QCOM.US)$ causing the after-hours share price to drop more than 7%. Let’s examine the actual performance of this earnings report and what exactly the market is worried about.

Three core highlights from the earnings report:

1. Data center royalty revenue continues to double, but mobile growth faces pressure

This quarter, Arm's royalty revenue reached $737 million, a year-over-year increase,27%, as a percentage of revenue59%, among whichwith the data center business achieving multiple quarters of consecutive doubling growth,，Management even expects that the data center business will surpass the mobile business in scale within a few years, becoming Arm's largest business.。

Management indicated that Agentic AI is driving strong demand for server CPUsand there is an increased focus on CPU energy efficiency, which is where Arm has an advantage. $Amazon (AMZN.US)$ AWS launched the fifth-generation Graviton Arm CPU with 192 cores, $NVIDIA (NVDA.US)$ released the 88-core Vera Arm CPU, $Microsoft (MSFT.US)$ launched the 132-core Cobalt 200 Arm CPU, $Alphabet-C (GOOG.US)$ and introduced the second-generation Axion Arm CPU. Arm also benefits from increased deployment of network chips driven by new AI data center construction, particularly in DPU and SmartNIC areas, where Arm holds a significant market share.

However, data centers currently account for only about 15%-20%of Royalty revenue, with 45% still reliant on mobile business. Although mobile Royalty revenue growth continued to outperform overall mobile market shipment growth this quarter,Mainly driven by the high royalty rate of CSS. Management stated that there are currently five customers shipping chips based on CSS, two of which are shipping second-generation CSS platforms. The top four Android smartphone manufacturers are all shipping devices powered by CSS.

But MediaTek, $Qualcomm (QCOM.US)$ the weak guidance for global smartphone shipments in 2026 has also raised market concerns about Arm's revenue growth. Management responded that rising memory prices will significantly reduce global smartphone shipments,but it will force smartphone manufacturers to focus on the high-end market, where Arm V9 and CSS have the most exposure.. Management saidassuming a 20% reduction in smartphone shipments in 2026, Arm’s royalty revenue from smartphones would be affected by approximately 2%-4%, resulting in an overall negative impact on the company of around 1%-2%.。

2. Persistently high R&D investment constrains the improvement of operating profit margins

Due to the high gross margin and monopolistic position of the IP business, Arm has long enjoyed a gross margin much higher than most companies globally. This quarter’s GAAP gross margin97.6%, but you’ll notice its GAAP operating profit margin is only15%, with R&D expenses accounting for59%(a year-on-year increase this quarter of38%, significantly higher than revenue growth), and also much higher than many semiconductor companies. Selling and administrative expense ratios have stabilized at25%, thereforewhether the R&D expense ratio can decline will directly determine whether its operating profit margin can improve。

However, management indicated that Arm will continue to increase R&D investment in areas such as next-generation architectural innovation, CSS, as well as exploration into chiplets and full SoC solutions, with guidance for next quarter’s operating expenses still showing a sequential increase.

3. FQ4 earnings guidance appears weak, with profit growth further slowing to single-digit increases

Arm expects FY26 Q4 revenue of $1.47 billion, a year-on-year increase of18%, Non-GAAP operating profit of $700 million, a year-on-year increase of7%, Non-GAAP net profit of $620 million, a year-on-year increase of6%It can be seen that while revenue growth is slowing, profit growth continues to decline to single digits.

By business segment, Royalty revenue for Q4 is expected to grow in the low double digits year over year, while license revenue is projected to grow in the high double digits year over year.

Key financial metrics at a glance:

- Revenue of $1.24 billion, up year over year26%, slightly above market consensus of $1.23 billion; previous guidance was $1.23 billion.

- GAAP gross margin97.6%, up 0.4 percentage points year over year, slightly below market consensus of 97.7%, still leading most companies globally.

- GAAP operating profit of $185 million, up year over year6%, below market consensus of $246 million; Non-GAAP operating profit of $488 million, up year over year10%, in line with market consensus; previous guidance was $474 million.

– GAAP net profit is $223 million, year-on-yearDown 12%, lower than the market consensus expectation of $232 million; Non-GAAP net profit of $457 million, a year-on-year increase.10%Higher than the market consensus expectation of $438 million, the previous guidance was $438 million.

Summary

Overall, Arm's long-term certainty still exists. In the short term, although the data center continues to double in growth, the growth rate of the mobile business, which accounts for a larger share, is under pressure. Coupled with the continuously rising research and development investment, this further suppresses profit growth.

The selling pressure from SoftBank is also a Damocles' sword hanging over us. Although the management has responded that SoftBank has no intention to reduce its holdings, the circulating shares of Arm are indeed too few.

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