ARM Holdings released its fiscal year 2025 fourth-quarter earnings report for the period ending in March after the market closed on Wednesday. Sluggish growth in the smartphone industry is pressuring this critical revenue source for the company, although management has assured that expansion in the artificial intelligence data center business will be sufficient to offset the decline. The company reported quarterly revenue of $1.49 billion, a 20% year-over-year increase, surpassing market expectations of $1.47 billion. Net income reached $641 million, while adjusted earnings per share came in at 60 cents, also exceeding forecasts. Following the earnings release, the stock experienced significant volatility, initially surging 12.6% before quickly reversing course and falling nearly 10%.

For the outlook for the next quarter, the company anticipates first-quarter revenue of approximately $1.26 billion, slightly above the analyst consensus estimate of $1.25 billion. Adjusted earnings per share are projected to be 40 cents, compared to the average market expectation of 36 cents. Despite the seemingly strong results, investors were not entirely reassured. After the report, ARM's stock initially rose over 12% in after-hours trading but then rapidly reversed gains, and was down approximately 6.03% at the time of writing.

During the analyst call, company executives indicated that they have not yet secured sufficient supply chain capacity to meet demand for a new chip. Analysts also probed deeply into the costs associated with its in-house chip business. The fluctuating market sentiment reflects investors' complex assessment of the weak smartphone market, lower-than-expected royalty revenue, and risks in the supply chain for its self-developed chips.

Weakness in the smartphone market is impacting royalty income, with pressure in the low-end segment but relative stability in the high-end. ARM holds a significant position in the vast handset device market, with its designs powering nearly every smartphone globally. Its business model is heavily reliant on the smartphone industry, generating revenue through royalties charged on each device shipped. However, this core business faces challenges, as memory chip shortages are pressuring the industry, driving up consumer electronics prices and dampening sales, which could subsequently drag on ARM's royalty revenue.

In the fourth quarter, ARM's royalty revenue was $671 million, below market expectations ranging from $693 million to $697 million. CEO Rene Haas acknowledged on the call that smartphone shipment growth turned negative last quarter, primarily affected by memory chip shortages, weak consumer electronics demand, and contraction in the low-end smartphone market. However, Haas noted that the weakness is concentrated mainly in the low-end segment, while ARM's royalty revenue is more dependent on high-end models, thus keeping the overall impact manageable. Nevertheless, the structural downturn in the smartphone market continues to cast a shadow over ARM's short-term performance.

Downstream chip manufacturers like Qualcomm have previously issued similar warnings. Chip design company Qualcomm provided a subdued quarterly revenue forecast last week due to inventory issues, although its stock rose on optimistic comments about a demand rebound.

In stark contrast to the weakness in the handset business, robust demand from AI data centers is becoming ARM's most prominent growth driver. Cloud computing providers are increasing investments in AI infrastructure, and the Arm architecture, with its advantages of low power consumption and high performance, is rapidly gaining market share in this area. Haas stated, "We are very optimistic about the demand in data centers." He revealed that royalty revenue related to data centers is expected to show "considerable growth" in the current quarter. Fourth-quarter licensing revenue reached $819 million, exceeding expectations of $775 million, indicating strong customer interest in adopting Arm technology for future applications like AI computing.

AMD has previously projected that the addressable market for server CPUs will grow at an annual rate exceeding 35%, reaching over $120 billion by 2030. As a fundamental architecture licensor, ARM stands to benefit significantly from this trend. ARM is currently in a "two-speed" growth phase, with its traditional handset business under pressure, while AI data centers and in-house chips provide strong upward momentum.

To further capitalize on the AI computing wave, ARM has expanded from a pure design licensing model into developing its own chips. The company's AGI CPU, an AI chip for data centers launched earlier this year, is designed to handle the massive computations required for AI agents capable of performing tasks with minimal supervision. ARM expects this product to generate over $2 billion in revenue between 2027 and 2028, having already announced $1 billion in orders.

However, on the earnings call, Haas conceded that the company has not yet secured sufficient supply chain capacity for an additional $2 billion in orders. "We are working closely with the supply chain to meet demand," he said. This statement raised analyst concerns about the costs and mass-production capabilities of the self-developed chips. ARM's profit model consists of two streams: licensing fees for allowing clients to use its designs and standards, and royalties based on the number of chips shipped. The sale of its own-brand chips represents a significant shift for the company, which has historically benefited from the entire industry as a neutral technology supplier. Balancing the pursuit of higher profits without disrupting its existing licensing ecosystem will be a key challenge for ARM.

The chip designer, which went public in 2023, is still majority-owned by Japan's SoftBank Group. In April, SoftBank appointed Haas to a broader role within the group, where he will lead SoftBank's international operations and assist founder Masayoshi Son in advancing AI chip manufacturing plans. While continuing as CEO of ARM, Haas will also oversee SoftBank Group International, based in San Carlos, California, and coordinate collaboration among the group's chip and AI companies. SoftBank currently holds nearly a 90% stake in ARM and has acquired other chip firms in recent years, including Ampere Computing LLC and Graphcore Ltd.