Arm’s AGI Chip Demand Doubles Amid Supply Chain Concerns

AGI Chip Demand Surges

Arm’s first self-developed server chip, the AGI CPU, has seen customer demand double from $1 billion at the end of March to over $2 billion for FY27-28. However, due to supply chain capacity constraints, management has kept its guidance unchanged at $1 billion, indicating that demand is not the issue, but capacity is.

Data Center Royalties Continue to Double

Royalties from Neoverse IP-driven data centers have increased by over 100% year-on-year for the second consecutive year, with management expecting another doubling by FY2027. Major supercomputer clients now account for nearly 50% of Arm’s share.

Licensing Revenue Growth Masks Royalty Slowdown

In Q4, total revenue reached $1.49 billion, exceeding expectations with a 20% year-on-year increase. However, when broken down, licensing revenue was $819 million (+29%), serving as the main growth driver, while royalty revenue was $671 million (+11%), slowing due to a weak mobile market and a high base from MediaTek last year.

Non-GAAP Operating Margin Hits New High

The Non-GAAP operating margin reached 49%, a record for a single quarter, but the GAAP margin was only 29.4%. This discrepancy arises from $1.052 billion in stock-based compensation, which accounted for 21.4% of revenue, a cost often overlooked in Arm’s valuation narrative.

Business Model Transformation Underway

Arm is transitioning from a pure IP licensing company to a dual-track model of IP and chip production, targeting $25 billion in revenue by FY2031 ($10 billion from IP and $15 billion from chips), with an EPS exceeding $9. This is a significant gamble on its identity.

Q1 FY2027 Guidance

The guidance for Q1 FY2027 is set at $1.26 billion ± $50 million (with a year-on-year increase of 20%), and Non-GAAP EPS is projected at $0.40 ± $0.04, maintaining a growth rate of around 20% for both royalties and licensing throughout the year.

Royalty Revenue: Data Center Growth vs. Mobile Weakness

Q4 royalty revenue was $671 million, a year-on-year increase of 10.5%, marking the lowest growth rate in the past five quarters. This slowdown is primarily attributed to the mobile market. CFO Jason Child acknowledged that MediaTek’s strong performance last year created a high base, combined with a continued decline in global smartphone shipments in the low-end market, which pressured mobile royalties. However, the penetration of the Armv9 architecture into high-end models is gradually increasing the royalty rate per chip, partially offsetting the decline in shipments.

The real highlight is in the data center sector. Royalties from Neoverse architecture-driven data centers have doubled for the second consecutive year, and management expects another doubling by FY2027. Google announced at Cloud Next that its TPU 8t and 8i training/inference chips will fully transition to Arm’s Axion CPU, improving performance by 80%. AWS is expanding its Graviton deployment, and NVIDIA’s Vera CPU is also based on Arm architecture. CEO Rene Haas predicts that by the end of this decade, Arm will hold the largest market share in data centers by CPU type.

However, it’s important to note that data center royalties currently do not constitute a large enough share of total royalties to fully offset cyclical fluctuations in the mobile and IoT markets. Management’s guidance for annual royalty growth is approximately 20%, suggesting that data center growth will accelerate to fill the gap left by Q4.

Licensing Revenue: ACV Growth Indicates Long-Term Health

Q4 licensing and other revenue reached $819 million, a year-on-year increase of 29.2%, with SoftBank’s technology licensing and design services contributing $200 million (unchanged from the previous quarter). Excluding SoftBank, third-party licensing revenue was approximately $619 million, still showing strong growth.

More importantly, the ACV (Annual Contract Value) reached $1.66 billion in Q4, a year-on-year increase of 22%, maintaining levels above management’s long-term expectations. New next-generation CSS (Compute Subsystem) licenses—one for smartphone chips and another for data center networking chips—along with an AI technology strategic cooperation agreement with the Indonesian government, indicate Arm’s technology stack is penetrating more endpoints and regions.

RPO (Remaining Performance Obligations) decreased from $2.226 billion to $2.071 billion, a 7% decline. This drop needs to be viewed in conjunction with Arm’s revenue recognition rhythm: large licensing contracts are recognized as one-time revenue upon signing, so RPO naturally declines after being fulfilled, which does not indicate weakened demand. The continued rise in ACV is a better forward-looking indicator.

Profit Margins: The Contrast Between Non-GAAP and GAAP

In Q4, the Non-GAAP operating margin reached 49.1%, a record high since the IPO, with Non-GAAP EPS at $0.60 (consensus expectation was $0.58). However, the annual Non-GAAP operating margin decreased from approximately 47% in FY2025 to about 43%. This is because the margins for Q1-Q3 were only 39.1%, 41.1%, and 40.7%, reflecting concentrated R&D expenses during the first three quarters.

The GAAP perspective tells a different story. The Q4 GAAP operating margin was 29.4%, with an annual margin of only 18.3%. The core difference arises from stock-based compensation (SBC): $261 million in Q4 alone and $1.052 billion for the year, accounting for 21.4% of annual revenue. This SBC intensity is rare in the semiconductor industry for a company valued at over $250 billion.

R&D expenses are also rapidly increasing. Non-GAAP R&D expenses in Q4 were $493 million, a year-on-year increase of 33%, with total annual R&D expenses reaching $1.911 billion, a 43% increase. The total number of employees grew to 9,584 (+15%), with engineers numbering 8,058 (+16%), reflecting ongoing investment in the AGI CPU product line and next-generation architecture. Management has pledged to achieve expense growth below revenue growth by the end of the year, returning to positive incremental profit margins.

Cash Flow: Correction of FY2025’s Anomaly

In FY2026, operating cash flow was $1.524 billion, a significant improvement compared to $397 million in FY2025. The previous year’s unusually low level was primarily due to a massive increase in contract assets and accounts receivable consuming cash; this year, these changes have normalized. Non-GAAP free cash flow was $882 million (only $99 million in FY2025), but capital expenditures surged from $219 million to $545 million, reflecting the true costs of AGI CPU and data center infrastructure development.

The balance sheet remains clean: cash and short-term investments total $3.6 billion, with zero interest-bearing debt.

AGI CPU: Transition from Blueprint Seller to Builder

This marks the most significant business model transformation in Arm’s 35-year history. Previously, Arm was the “Switzerland of the semiconductor industry”—selling design blueprints to everyone without taking sides or competing. Now, the AGI CPU allows Arm to sell finished chips directly to data center customers, entering the same arena as its licensing clients AWS, Google, and NVIDIA.

Analysts directly questioned this “sensitive issue” during the call: how do existing IP customers view Arm’s chip production? Rene Haas responded that every partner was informed in advance and expressed support—because the expansion of the Arm software ecosystem benefits everyone. Over 50 partners publicly endorsed this at the Arm Everywhere event.

On the numerical side, customer demand has surged from $1 billion at the end of March to over $2 billion within six weeks. Demand comes from two categories: existing customers like Meta who have announced additional orders, and new customers—companies that need Arm’s computing power but do not wish to develop their own chips (such as SAP, Cloudflare, SK Telecom, OpenAI, etc.), which can directly purchase Arm racks produced by ODM partners like Lenovo and Supermicro.

However, management cautiously maintains guidance at $1 billion (approximately $90 million contribution in Q4 FY2027 and about $910 million in FY2028) due to uncertainties in wafer, memory, and packaging testing capacities. More precise supply chain progress will be provided in the Q3 earnings call.

Long-term vision: FY2031 chip revenue of $15 billion + IP revenue of $10 billion = total revenue of $25 billion, with EPS exceeding $9. The long-term operating margin target for the chip business is around 35%, while for the IP business, it is about 65%. The development costs for chips can largely be shared with CSS IP R&D (the core design is the same), so the incremental team size is expected to be in the tens rather than hundreds—management anticipates that the chip business will achieve positive operating margins by FY2028.

Outlook: Can Two Growth Curves Coexist?

Arm faces two key variables that will determine its valuation path over the next three years.

The first is the ramp-up speed of AGI CPU mass production. The $2 billion demand translating into revenue bottleneck lies in the supply chain, not the market. Allocation of TSMC’s advanced process capacity, supply of HBM/DDR5 memory, and scheduling of advanced packaging like CoWoS may all become limiting factors. AMD faced similar GPU supply bottlenecks last year, which only began to ease this year. Arm’s AGI CPU features a 136-core design, requiring advanced packaging.

The second is the evolving attitude of licensing customers. Currently, the public support from over 50 partners is more in the “pleased to see it” phase. As Arm’s chips begin to substantially capture their data center revenue, whether this harmony can continue is uncertain. However, Rene Haas’s argument holds some weight: AWS has already started selling Graviton computing power to external customers, indicating that the demand for the Arm ecosystem far exceeds what any single supplier can meet.

Analysts have set an average target price of about $180, with a high of $255. On the earnings day, the stock price surged to $237, already trading above most analysts’ bullish scenarios. This suggests that the market has partially priced in the success of the AGI CPU—subsequent updates on supply chain progress will serve as catalysts or risk points for the stock price.

Recently, AMD raised its 2030 data center CPU TAM from $100 billion to $120 billion, aligning with Arm’s previous estimate of over $100 billion. In this rapidly expanding market, Intel’s share has dropped from over 90% to about 62%, while AMD holds 29% and continues to expand. All three companies claim they can capture 50% market share—adding up to 150%, indicating that some will inevitably be disappointed.

Arm’s unique advantage is that whether it’s Graviton, Axion, Vera, or AGI CPU, all these Arm architecture chips contribute royalties to Arm. Even if it loses in chip competition against its customers, royalty income remains Arm’s moat. However, the ambition of the AGI CPU clearly seeks more than that—a $15 billion FY2031 target implies that Arm aims to establish an independent growth pole on the chip dimension, rather than continuing to act as a “toll collector.”

This earnings report marks the last complete annual response from Arm as a pure IP company. The next time we examine Arm, it will carry an additional label: chip manufacturer. For the first time in 35 years, the designer of blueprints has decided to build houses— the question is whether its tenants will continue to pay rent or seek another architect.