Arm Stock Drops as the Artificial Intelligence (AI) Chip Designer's Earnings Guidance Disappoints Investors

Key Points

• Fiscal Q1 revenue grew 12% year over year, slightly exceeding the 11% Wall Street expectation.

• Adjusted earnings per share (EPS) declined 13%, which was in line with the analyst consensus estimate.

• Fiscal Q2 guidance for both the top and bottom lines was slightly lower than Wall Street was expecting.

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Arm Holdings (NASDAQ: ARM) stock dropped 8.6% in Wednesday's after-hours trading, following the leading central processing unit (CPU) chip designer's release of its report for the first quarter of its fiscal year 2026 (ended June 30, 2025).

The stock's decline is attributable to investors being disappointed with second-quarter guidance for both revenue and adjusted earnings per share (EPS). The midpoint of the guidance ranges for these metrics fell a bit short of the analyst consensus estimates.

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Arm's first-quarter revenue slightly surpassed Wall Street's estimate, while adjusted EPS was in line with the consensus estimate.

Image source: Arm Holdings.

Arm's key numbers

Data source: Arm Holdings. GAAP = generally accepted accounting principles. Fiscal Q1 2026 ended June 30, 2025.

Investors should focus on the adjusted numbers, which exclude one-time items. Wall Street was looking for adjusted EPS of $0.35 on revenue of $1.04 billion, so Arm hit the earnings estimate on the target and slightly beat the revenue estimate. Both results were at or near the midpoint of the company's own guidance ranges, which were for adjusted EPS of $0.30 to $0.38 on revenue of $1 billion to $1.1 billion.

So why did year-over-year revenue grow but adjusted operating income, net income, and EPS decline? The culprit: Adjusted operating expenses increased by 33% year over year, significantly more than revenue rose. The company said this surge in operating expenses was "driven primarily by an increase in engineering headcount."

Arm generated $332 million in cash running its operations during the quarter, whereas it used $290 million in cash in the year-ago period. On an adjusted basis, free cash flow was $150 million, versus an outflow of $348 million in last year's first quarter. The company ended the quarter with cash, cash equivalents, and short-term investments of $2.91 billion. It has no long-term debt.

Revenue breakdown

Data source: Arm Holdings. YOY = year over year.

Royalty revenue was a record high for a first quarter. Its growth was driven by continued adoption of the company's newest architecture, Armv9, which has a higher royalty rate than its predecessor; the ramp-up of chips based on its computer subsystems (CSS); and increased usage of Arm-based chips in data centers. Data centers have been increasing in size and number largely to process surging artificial intelligence (AI) workloads.

License and other revenue declined slightly "due to normal fluctuations in the timing and size of multiple high-value license agreements and contributions from backlog," the company said in the release.

What the CEO had to say

CEO Rene Haas' statement in the earnings release:

Arm is powering AI workloads everywhere with unmatched performance and energy efficiency. Our Q1 FYE26 [fiscal year 2026] results exceeded $1 billion in revenue for the second straight quarter as royalties grew across all target end markets, demonstrating the strength of Arm as the AI platform of choice -- from the cloud to the smallest edge devices.

Guidance for Q2

Arm issued fiscal second-quarter guidance:

• Revenue of $1.01 billion to $1.11 billion (midpoint $1.06 billion), which equates to growth of 20% to 32% year over year.
• Adjusted EPS of $0.29 to $0.37 (midpoint $0.33), or a change of (3%) to 23% year over year.

Going into the report, Wall Street had been modeling for Q2 revenue of $1.07 billion and adjusted EPS of $0.35, so Arm's outlook at both midpoints was a little lower than these expectations.

A richly valued stock, but worth watching

In short, Arm turned in a very good quarter. Investors shouldn't be concerned that license revenue declined 1% year over year, as this revenue stream will be "lumpy" from quarter to quarter based on sizes and timing of license signings.

That said, it makes sense that investors drove the stock down moderately after the release. Arm stock sports a high valuation. It was priced at 89 times Wall Street's estimated forward adjusted EPS, as of the close of Wednesday's regular trading session. Arm's Q1 adjusted EPS result and Q2 adjusted EPS guidance are not good enough to support a stock valued this richly.

Arm, however, remains a stock worth watching and considering buying during pullbacks. The company has a great business model featuring recurring revenue (royalty revenue) that can have a very long tail in some cases.

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Beth McKenna has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.