Despite Arm Holdings (ARM.US) reporting better-than-expected results for the first quarter of fiscal year 2027, the stock fell in after-hours trading on Wednesday. The company highlighted that sluggish growth in the smartphone industry is overshadowing the substantial opportunities from its expansion into data center technology, and its second-quarter revenue guidance fell short of the most optimistic market expectations.

Following a broad selloff in global semiconductor stocks, chip companies, including Arm, are facing intensified scrutiny. Even when companies report overall positive earnings, they are increasingly struggling to meet investor expectations. For the first quarter, Arm reported revenue of $1.289 billion, up 22% year-over-year and exceeding the analyst consensus of $1.26 billion. Adjusted net profit was $480 million, a 28% increase, while adjusted earnings per share rose 29% to $0.45, surpassing the consensus estimate of $0.40.

By segment, license revenue grew 23% to $574 million in the first quarter. This revenue comes from customers who use Arm's chip design architecture and other technology solutions to bring their own products to market, and is considered a key indicator of future business growth. Royalty revenue increased 22% to $715 million, above the market consensus of $700 million, driven by data center royalties more than doubling year-over-year. However, royalties paid by smartphone manufacturers constitute a significant portion of Arm's total revenue. While this market is still growing for Arm, the pace is decelerating.

Arm charges manufacturers a royalty for each smartphone that uses its technology, and the stability of this revenue stream is declining. As memory chip prices have surged, phone makers are cutting production. Previously, Arm expected royalty revenue to grow by about 20%, but now it forecasts current-quarter royalty revenue growth to be in the "low to mid single-digit percentage range." Arm Chief Financial Officer Jason Child said during the post-earnings analyst call, "We do see royalty revenue softening. There is weakness in the smartphone space."

Arm emphasized that its expansion into data center chips is offsetting the impact of the slowing smartphone market, but this outlook has nevertheless intensified investor pessimism. During the call, Arm shares fell about 7% in after-hours trading and were down more than 6% at press time. Simultaneously, the data center business is opening a significant new revenue stream. Arm CEO Rene Haas stated that royalty revenue from data center products more than doubled from the same period last year, and demand for the next-generation chip product line has exceeded expectations.

He said, "Our existing business is very strong and healthy, and the new business is a very attractive addition." Earlier this year, Arm announced plans to start selling its own designed chips, a move that breaks from its long-standing business model of only licensing technology to other companies. The company is developing a central processing unit (CPU) designed to help run artificial intelligence data centers. When Arm launched this product in March, it had already secured approximately $1 billion in orders. Haas said he is now confident in obtaining sufficient supply to exceed this figure, with the order backlog having expanded to over $2 billion.

Arm also noted that the shift of AI infrastructure to the Arm architecture accelerated this quarter, with increasing adoption by major cloud service providers and chip manufacturers, including NVIDIA, Amazon Web Services, Google, Microsoft, and Qualcomm. Arm stated that shipments of its Neoverse data center processors have now exceeded 1.5 billion cores. Looking ahead, Arm expects second-quarter revenue of approximately $1.38 billion. While the analyst consensus is $1.35 billion, some forecasts were as high as $1.5 billion. The company forecasts adjusted earnings per share of $0.47 for the second quarter, above the consensus estimate of $0.45. First-quarter royalty revenue reached $715 million.