Arm (ARM) Q2 2027 earnings review
Arm's upfront license sales jump, but smartphone royalties lose speed
Arm, the British designer of processor blueprints for phones and cloud servers, beat its revenue target on upfront license deals while chip royalties fell short. Total revenue rose 27% from a year ago to $1.44 billion because license sales jumped 50%, well above what the company's own plan pointed to. By our math, royalty growth of 8% missed management's 13% target as high memory prices hurt smartphone demand.
| Revenue from external customers | $1,019M +43% from a year ago |
|---|---|
| Royalty revenue | $670M +8% from a year ago (below ~13% plan) |
| License and other revenue | $773M +50% from a year ago (annualized contract value +12%) |
| Third-quarter revenue outlook | $1.54B middle of the range: +24% from a year ago |
⚖️ Verdict: ⚪ Neutral
The story is unchanged because lumpy upfront license signings masked a slower royalty stream and cooling contract growth. On the positive side, cloud data center royalties doubled again, external customer sales rose 43%, and chief executive Rene Haas secured extra factory supply for the new Arm AGI CPU server chip. One caution: the yearly value of active license contracts grew just 12% while unbilled contract assets reduced free cash flow.
The question now is whether the 50% jump in upfront licensing will soon lift royalties or simply pulled revenue forward from a slowing contract pool. One side sees new server and car blueprints about to enter production; the other sees annualized contract growth down from 28% to 12% and deferred revenue shrinking. Next quarter's royalty growth and the promised update on fiscal 2028 server chip sales will decide it.
🐂 Bull Case
Data Center Royalties Doubled as Server Share Passed 50%
Arm designs the basic blueprints for computer chips and collects a royalty on every chip its partners ship. In cloud data centers, its server processor share at the largest cloud providers more than tripled from 15% in calendar 2024 to over 50% in calendar 2025. The UK chip designer expects that share to top 60% by the end of calendar 2026 as Google Axion, AWS Graviton, Microsoft Cobalt, and Nvidia Vera processors ramp up.
Data center royalties doubled from a year ago once again, helped by the shift toward autonomous AI software agents that need power-efficient central processors to coordinate tasks. During the quarter, the group launched Neoverse CSS N4, a pre-integrated server chip subsystem that doubles performance per socket and improves power efficiency by 25%. That matters because data center power shortages make electricity efficiency the main selling point for cloud buyers.
What to watch: whether Arm discloses the exact dollar size of data center royalties in its annual report. Until then, total royalty growth must recover from 8% this quarter to prove cloud gains can outweigh phone weakness.
Extra Supply Backs Up to $2 Billion in Chip Sales
Alongside licensing blueprints, Arm is starting to sell its own finished server processors, called the Arm AGI CPU. Critics worry that selling physical chips will bring supply bottlenecks and dilute the company's 97.9% gross margin, because finished silicon carries a much lower margin than blueprints. Even so, customer orders improved this quarter.
Chief executive Rene Haas and finance chief Jason Child wrote: "Our confidence in achieving up to $2 billion in Arm AGI CPU revenue over FY27–28 has increased over the last 90 days, supported by additional supply and customer mix." However, phrasing the target as "up to $2 billion" is more cautious than the prior quarter's talk of demand exceeding $2 billion. The company has "purchase orders secured from multiple customers extending through calendar 2027 and first commercial deliveries on track for fiscal Q4’27", with Oracle Cloud Infrastructure planning to offer the chips in 2027.
What to watch: next quarter's detailed update on fourth-quarter chip shipments and fiscal 2028 supply. That disclosure will show how much of the $2 billion target is locked in and how much the new chips will lower gross margin.
Engineering Scale Lifted Operating Margin Excluding One-Offs
Heavy hiring for chip development has kept investors worried about runaway operating costs and reliance on parent company SoftBank. This quarter, revenue from external customers jumped 43% from a year ago to $1,019 million, while sales to related parties like SoftBank and Arm China stayed flat at $424 million, or 29.4% of revenue by our math.
Because revenue grew 27%, operating margin excluding one-offs rose 3.1 percentage points from a year ago to 44.2%. Research and development excluding stock pay grew 17% to $547 million on "investment in engineering headcount and other expenses", but fell 3.2 percentage points as a share of revenue to 37.9%. Selling, general and administrative costs excluding one-offs rose 25% to $227 million, dipping 0.3 percentage points of revenue to 15.7%.
What to watch: third-quarter operating expenses excluding one-offs against the $825 million plan. Holding costs near that mark while revenue rises to $1.54 billion would keep operating margin above 44%.
🐻 Bear Case
Smartphone Memory Costs Cut Royalty Growth to 8%
Royalties are the fees Arm collects after customers ship devices using its designs, making them the purest read on end-market demand. Three months ago, management forecast second-quarter royalty growth of about 13%, which pointed to $701 million by our math.
Instead, royalty revenue rose just 8.1% from a year ago to $670 million, and fell 6.3% from last quarter. Higher royalty rates on newer Armv9 blueprints and pre-built chip subsystems were "partially offset by the impact of memory pricing on the smartphone market". That $31 million shortfall against the implied target shows that expensive memory chips are hurting phone production more than management anticipated one quarter ago.
What to watch: third-quarter royalty revenue during the holiday phone season. Another single-digit growth rate would make management's full-year royalty growth target in the high teens very hard to reach.
Upfront License Deals Outran the Recurring Backlog
License and other revenue is what customers pay upfront to access Arm's chip blueprints. In the shareholder letter, management wrote: "Strong licensing momentum is an important leading indicator of future royalty growth as these new designs enter production where we expect royalty revenue to accelerate." Upfront license revenue jumped 50.1% from a year ago to $773 million, beating the $670 million implied by the prior plan.
- Annualized contract value (ACV, the yearly value of active license agreements): $1,790 million, up 11.9% from a year ago
- ACV growth trajectory: slowed from 28% three quarters ago to 22%, 13%, and now 12%
- Total contract liabilities (deferred revenue on the balance sheet): $875 million, down 15.0% from a year ago by our math
- Total contract assets (revenue booked before billing the customer): $1,450 million, up 62.0% from a year ago by our math
The company noted that the 50% jump came partly from "fluctuation in the timing and size of multiple high-value license agreements and contributions from backlog". Over the last four quarters, license revenue ran at 1.49 times ACV by our math, up from 1.20 times a year ago. Because accounting rules let Arm book point-in-time license revenue on delivery, upfront revenue is outrunning the underlying contract pool.
What to watch: annualized contract value growth next quarter. A drop below 10% would show that underlying customer commitments are cooling even after lapping last year's big SoftBank deal.
Stock Pay Drove Operating Profit and Cash Flow Down
While profit excluding one-offs rose 36% to $566 million, reported operating margin fell 0.5 percentage points from a year ago to 13.9%. Reported net profit dropped 45.4% to $130 million, though last year included a $131 million one-time gain from selling the Artisan business; without that gain, last year's net profit was $107 million by our math.
The gap between reported profit and profit excluding one-offs widened because equity share-based compensation and related payroll taxes rose to $425 million, or 29.5% of revenue by our math, up from 26.8% a year ago. Meanwhile, free cash flow excluding one-offs fell 73.2% to $110 million because Arm booked $203 million of unbilled contract assets in the quarter.
What to watch: operating cash collection in the third quarter. When upfront licenses are booked into contract assets rather than billed in cash, cash flow lags reported profit until customers pay their milestones.
Risks this quarter didn't answer
Two standing concerns from our prior work received no test in the second-quarter release because they depend on future customer behavior once Arm's own server chip ships in volume.
- AI data center spending pause: cloud server royalties doubled again, so only a future slowdown in cloud capital budgets would test whether licensing and chip orders can hold up.
- Competition with its own customers: selling the Arm AGI CPU puts the company in the same server chip market as licensees Nvidia, Amazon, Google, and Microsoft; fourth-quarter commercial deliveries and next year's license renewals will show whether partners push back.
👓 Other Themes
Physical AI Royalties Grew 50% on Car Chips
In cars and robotics, which Arm calls Physical AI, royalty revenue grew 50% from a year ago as carmakers added driver-assistance and cabin computer chips. The company launched Arm Total Design for Physical AI with more than 80 partner firms to speed up robot and car chip development. For smartphones and laptops, it released the Mali G2-Ultra NX graphics blueprint, adopted by Xiaomi, and noted that Arm-based laptops now make up about 20% of global PC shipments.
💲 Other KPIs
Cash and short-term investments fell by $267 million from last quarter's $3,888 million, but remain above the $3,601 million held at the end of March. The British chip designer spent $249 million in cash during the quarter to close its purchase of networking specialist DreamBig Semiconductor, while holding no bank debt.
Weighted average diluted shares rose 0.9% from 1,069 million a year ago and stayed flat against last quarter's 1,078 million. Management does not run a share buyback programme, though the group paid $129 million in withholding taxes on vested employee shares to limit dilution.
🔮 Guidance
New. The middle of the range is $1.54 billion, which means revenue grows 24.0% from a year ago and 6.7% from this quarter by our math. That 24.0% pace is slightly slower than this quarter's 27.1% growth. Arm has beaten the middle of its revenue plan for four straight quarters by an average of 2.4%; if the pattern holds, third-quarter revenue would reach about $1.58 billion by our math.
New. Management plans for operating expenses excluding one-offs to rise 15.2% from a year ago and 6.6% from this quarter's $774 million by our math. That 15.2% annual increase slows down from this quarter's 19.4% expense growth, matching management's earlier statement that engineering costs would grow at a mid-single-digit quarterly pace as chip development hires settle in.
New. At the $0.56 middle of the range, profit per share excluding one-offs rises 30.2% from a year ago and 7.7% from this quarter by our math. The UK group has topped the middle of its profit per share outlook in each of the last four quarters by an average of 7.9%; if the pattern holds, third-quarter profit per share would land at $0.60 by our math.
Unchanged. Chief executive Rene Haas said confidence in reaching up to $2 billion of revenue from the new server chip across fiscal 2027 and 2028 rose over the last 90 days as the company secured more factory supply and customer orders through calendar 2027. However, writing "up to $2 billion" is slightly softer wording than the prior quarter's statement that demand topped $2 billion. First commercial shipments remain set for the fourth quarter of fiscal 2027.
❓ Key Questions
Why did royalty growth miss the 13% target?
Three months ago, management planned for 13% royalty growth in the second quarter, but royalties grew only 8% to $670 million. Did smartphone unit shipments drop more than expected, or did phone makers delay launches of chips using higher-rate blueprints?
What splits Q3 revenue between royalties and licenses?
The shareholder letter gives a $1.54 billion third-quarter revenue target without breaking out royalty and license expectations. After upfront licenses carried the second quarter, how much of the third-quarter rise comes from recurring royalties?
Why are contract assets rising while deferred revenue falls?
Total contract assets jumped 62% from a year ago to $1,450 million, while contract liabilities fell 15% to $875 million and free cash flow dropped 73%. How quickly will those unbilled license contracts turn into cash?
Why did the chip target change to "up to $2 billion"?
Last quarter, management said customer demand for the Arm AGI CPU exceeded $2 billion across fiscal 2027 and 2028; this quarter, the letter targets "up to $2 billion". Is $2 billion now the ceiling on secured factory supply?