Thank you, Abigail. Good morning, good afternoon, everybody. My name is Ian Thornton, and I'm the Head of Investor Relations at Arm. I'd like to welcome you to our earnings conference call for the second quarter of the fiscal year ending March 31, 2024. I'm joined today by Rene Haas, the Chief Executive Officer of Arm; and Jason Child, Arm's Chief Financial Officer. Hopefully, you will all have downloaded and read the shareholder letter. If not, it is available on the Arm Investor Relations website at investors.arm.com. As the shareholder letter provides a rich update on our strategic progress in the quarter, we will dispense with the prepared remarks from the CEO and CFO, and instead focus on Q&A. Before we begin, I'd like to remind everyone that during the course of this conference call, Arm will discuss forecasts, targets and other forward-looking information regarding the company and its financial results. While these statements represent our best current judgment about future results and performance as of today, our actual results are subject to many risks and uncertainties that could cause actual results to differ materially from what we expect. In addition to any risks that we highlight during this call, important risk factors that may affect our future results and performance are described in our registration statement on Form F-1 filed with the SEC on September 14, 2023. Arm assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. In addition, we will refer to non-GAAP financial measures during the discussion. Reconciliations of certain of these non-GAAP financial measures to their most directly comparable GAAP financial measures and a discussion of certain projected non-GAAP financial measures that we are not able to reconcile without unreasonable efforts and supplemental financial information can be found in the shareholder letter that we released earlier today. The shareholder letter and other earnings-related materials will be available on our website at investors.arm.com. And I'll now hand you over to Rene, who will make a brief opening statement before we go to your questions.

Thank you, Ian. And as Ian mentioned, we have given you the shareholder letter in an attempt to minimize the opening remarks by myself and Jason, but I can't resist; I'll just start with a few comments to kick off. We are very pleased following the IPO process to kick off our very first quarter as a public company, and the quarter was excellent. We had record revenue, really fueled by demand for all Arm products, which has driven our licensing numbers up over 100% year-on-year. This is largely driven by what I would consider an AI R&D super cycle where people are investing more and more in new technologies to take advantage of the huge opportunity going forward. On the royalty side, slightly down year-on-year. However, the new businesses that we have emphasized in terms of our new growth strategy into the cloud and automotive were up approximately 20%. And the financial results relative to profitability were excellent. So in summary, very, very pleased about the first quarter and very, very pleased about the results we've shown as the first of our many quarters going forward as a public company. So with that, I will turn it over, I suppose to Abigail to queue up the questions.

At this time, we'll conduct the question-and-answer session. Our first question comes from Toshiya Hari with Goldman Sachs.

I had two questions, maybe one for Rene. I think your royalty business was up mid-single digits or 5% sequentially. And I think units were down about 5% sequentially. So can you speak to what drove your revenue there? Is it chip ASPs? Is it royalty rates? Or is there a combination of both? I think during the IPO, you guys had talked extensively about the transition from v8 to v9. So I'm guessing that was one of the bigger drivers but if you can provide a little bit of context to what drove your royalty business on a sequential basis, that would be helpful.

Sure. Yes, thanks for the question. And you're right, it is largely driven by the transition to v9 accelerating, particularly across the smartphone segment. Additionally, as we had mentioned earlier in our discussions with analysts, we're seeing growth now across the automotive and cloud infrastructure business. And those have different royalty rates than our smartphone business does. So as a result, what you're seeing is that even with units down, the overall numbers are actually up in terms of revenue.

Great. And then as my follow-up, during the IPO, you had shared with us that roughly, I think it was 97% of estimated royalties under contract in fiscal '25 kind of being locked in from a royalty rate perspective, 81% for fiscal '26. So I was hoping now that a couple of months has gone by, if you can provide an update on those numbers.

Yes. Yes, again, thanks for the question. And I would say we're about at the same level in terms of where we are in terms of mile markers towards progress. We're still confident in terms of the numbers that we had talked about in the past. But more importantly, everything's tracking as we would expect at this point in time. So those numbers are still unchanged.

Our next question comes from Ambrish Srivastava with BMO Capital Markets.

My first question is, if I look at the fiscal year guide, given you had such a big upside on the licensing side versus what we were modeling for, what's the mix embedded in the guide between royalties and licensing?

Yes. To outline our expectations for the second half of this year, particularly the next two quarters, we anticipate royalties will shift to positive, with an estimated single-digit growth in Q3. By Q4, we expect to see double-digit growth on a percentage basis. We believe licensing will continue to perform strongly. For Q3, we expect to experience some variability in our licensing business, particularly with ASC 606. As usual, we have some significant deals in progress. Currently, it appears there will be a bit more activity moving into Q4 rather than Q3 compared to our previous quarter's expectations. For Q3, we’re anticipating a growth range of about 0% to 10% year-on-year. However, we project substantial growth for Q4 as we expect several large licensing deals to come through. Regarding the revenue mix, it’s tough to predict right now. It seems likely to be closer to a 50-50 split, but this really hinges on how strong the royalty recovery is in Q4. Regardless, industry reports and our comparatively easier year-ago figures might push that closer to 60% of the total, but we will have to see how it unfolds.

I understand. You provided sufficient details. My second question is more about the long-term outlook. Regarding AI, you have shared specific percentages, and if I'm correct, you mentioned that 43% of royalties are driven by AI. I would like to know what the future drivers will be. I assume that most of the 43% comes from edge computing. As we move forward, will it be similar to what we've seen with Grace Hopper, where volumes are quite small, or will it be more infrastructure-driven, like Hopper or the data center hyperscalers? Alternatively, will it remain focused on the edge, particularly in the mobile sector?

Yes. So this is a very, very fast-moving market relative to the models that are being released that are almost on a daily basis, combined with just how quickly some of these agents are moving across different devices. So when you think about, for example, the endpoints, a PC or a smartphone, that could be running a ChatGPT agent or Microsoft Copilot, just a quarter or two ago, we may not be classifying them as devices that were running AI. So our expectation is that increasingly, all of the devices that exist in the overall value chain from the cloud to the endpoint, and the endpoint can be the smallest sensor with a compute engine, will need some level of AI capability, which is why our licensing activity has been as strong as it is. People are looking to add as much capability in terms of compute to capture the workloads that are being developed. And in some cases, it's really a function of making sure you have enough compute capacity to run the model when you don't even know yet what the model is. So I think we are in a very interesting time relative to how this overall market is going to play out. To specifically answer your question, whether it's the endpoint or the cloud, both. And I think it's going to be a rapid acceleration across the next few years, where a few years from now, we won't talk about the percentage of devices that have AI in them. It will be sort of table stakes that they all do.

Our next question comes from Vivek Arya with Bank of America.

Rene, for my first one, I'm curious, you had the IPO 2 months ago and the process started before that. What have been the big changes in your macro and industry assumptions, positive or negative? Since the team went through that process, any color by end market, geography? And specifically, what I'm trying to get to is that if you look at the way you were thinking about royalty revenues in December and the next few quarters, have they changed in any way, positive or negative, given any potential changes in your macro assumptions?

Thank you for the question. We haven't made any changes to our publicly discussed models regarding long-term forecasts or related assumptions. However, I believe we are observing a trend where everyone involved in developing end devices, whether smartphones, base stations, or laptops, is working to ensure they have sufficient computing power to utilize the new applications, models, and agents that are being introduced frequently. To clarify, we have not updated our models in public discussions, but the current environment shows a significant increase in licensing activity, indicating a strong push to secure enough computing capacity in end devices. A major challenge for our growth is achieving adequate computing power, and we are still far from that goal. This highlights a need for research and development to address these new capabilities.

And for my follow-up, there's recently been excitement about the combination of Windows and Arm. I know there have been previous attempts, which, right, were not as successful. I'm curious, Rene, how do you think about the potential for Windows to succeed on Arm-based devices? Is that a tangible factor for 24? Is that a factor for '25 and beyond? Just give us your perspective on how successful it can be and what is different this time versus the prior attempts that Windows has had in dealing, interacting with Arm technology?

Yes. The Windows and Arm ecosystem is one that I have a personal history with having been there from the very, very beginning. And we have come a long, long way from that point relative to readiness of the application ecosystem, readiness of developers, native applications. So I think from a software standpoint, everything is now in place for the next growth cycle. One major ecosystem, not called Windows, has moved over 100%. And I think what they've proved is that there's an amazing battery life, amazing performance and amazing application compatibility across a number of different dimensions. You can run Windows on that alternate ecosystem and get really, really good performance. So I think we are on the cusp of getting over this hill. I feel very, very good about the growth projections for Windows and Arm.

Our next question comes from Charles Shi with Needham & Company.

Maybe the first one, I want to ask since export control, U.S. government put out there all the rules and they recently updated that. I wonder if you can provide a comment on whether that has any impact on Arm's business? And specifically, since you have a really distinct business model, especially on the royalty side, to the extent when your customers may be put on the end of the list, are you able to collect the royalties? That's a related part of the question.

Yes. So for starters, every time these new export rules come out, we have a team of folks in our trade compliance group that go through the information in a very detailed way and trying to understand exactly how it might impact our company. I can say that we obviously would comply with any kind of export restrictions that apply to our technology or what we build. The latest round of documentation that came back from the U.S., I would say not so much. In fact, probably not at all in terms of the impact there. Generally speaking, the impact to Arm is not that significant for two reasons. One, the components and pieces that we build are generally under the thresholds that have been listed by the United States government in terms of export control. And secondly, in the areas where there's a de minimis content in terms of U.S. people working on the design because much of our technology is actually designed and developed outside the United States in Continental Europe and the United Kingdom, we're not impacted quite so much. So generally speaking, the last set of rules did not impact Arm, and we have, broadly speaking, not seen a large impact there. To your question relative to how it works in terms of do we collect royalties if someone's on the entity list, et cetera. It's pretty simple. If an end product that contains our technology can't be shipped and there's no revenue to be derived then we feel the ripple effect of that. Again, in the last quarter, no impact from that. And as we forward a forecast to the guidance that we gave for the remainder of the year, nothing that we see on the horizon that's impacted there.

I have a second question regarding operating margin. You provided the expected full year operating expenses, which suggests that the margin for fiscal Q4 may decline. Even after excluding the one-time increase in Social Security taxes of about $45 million, it still appears to be down slightly. How should we understand the factors contributing to this year-end margin weakness? Additionally, how should we approach the transition into the next fiscal year? I know you have a long-term target of a 60% operating margin, but what steps will we take to reach that goal on an annual basis?

Yes. I'll let Jason take that one.

The way I would answer your question is that the margin, at the midpoint, is in the high 20 percent range. The expenses I mentioned are separate from whether we land at the middle, high, or low ends of the range. If you factor in the operating expenses and also consider the one-time impact of Social Security related to the stock vesting from the IPO, that accounts for about 600 basis points of impact. So, at the midpoint, it's expected to be around 28 percent; removing that adjustment would suggest mid-30s at the bottom end of the estimate, and low 40s or high 30s at the top end of the guidance. This is how we see the mechanics operating in Q4. Looking ahead, we anticipate achieving incremental margin in the medium term, over the next few years, getting closer to our 60 percent target. However, we've added around 1,000 people in the last year, primarily engineers, constituting about 85 percent of that increase. These engineers are focused on the compute subsystem and the increasing complexity associated with the designs purchased this quarter and expected to be bought in the upcoming quarters. This may exert a bit of pressure in Q4, but I still forecast that we will achieve solid margins of over 40 percent for this year and definitely next year. I remain confident that our path to reaching the 60 percent margin target in the following years is unchanged.

Our next question comes from Chris Caso with Wolfe Research.

A question is another one on AI. And obviously, a lot of discussion about AI capabilities and client devices. Can you go into a little more detail about how Arm monetizes that? Is it from a higher per chip royalty? From a better mix at your customers, maybe some higher device ASPs? How do you see that playing out over time as AI gets embedded in client devices?

Broadly speaking, the way I would think about it is whenever you're running one of these AI clients or assistants or agents, it's going to require a significant uptick in terms of compute capability, both in terms of if there's an in-situ accelerator and/or through the CPU complex, keeping in mind that in a client device, when you run these AI agents or whenever you're running something that's going to be a copilot of some sort, nobody wants to see their battery life suddenly go down 40% in terms of everything that was involved in running the algorithms. So what that means for us in the broad sense is I expect it's going to be a higher need for more compute capacity. We'll see more advance cores, we'll see larger cores, more v9, which in the end game should mean higher royalty rates for us. That would be our belief going forward in terms of just the mega trend.

Got it. I'd like to revisit some of the comments on operating expenses you just made regarding operating margin. As we plan for next year, it seems we should exclude that one-time Social Security tax from the fourth quarter. What do you see as the trajectory of operating expenses for next year? To what degree is that tied to the revenue stream? Are you adjusting operating expenses based on revenue, or are you spending as necessary?

I'm not prepared to provide guidance for next year at this time. Our long-term model remains unchanged, so I can't give any updates on that. However, I do expect that our operating expenses will grow at a slower rate than our revenue, which should result in incremental margin. I can't specify exactly what that will look like for next year until we progress further into the year.

Our next question comes from Andrew Gardiner with Citi.

I have one on licensing to start with. Clearly, you beat expectations quite handily in the quarter on that front. And I suppose this was a part of the business that during the IPO process you explained was an area where you guys had pretty good visibility, it was fairly predictable given the timing of contract renewals. So was the beats a pull forward of demand? Or are you seeing the, as you put it, Rene, the AI super cycle? Is that driving upside to the pipeline that you had there earlier in the year?

Yes. Thank you for the question. It's a good question. I would say it was expansion of deals that we had visibility on. What we have generally pretty good visibility is when our renewals do and/or when our customer is going to be looking at uptakes of new technology. I think what we saw, broadly speaking, was the partners that we knew about that we were expecting deal closure, their appetites got bigger over the quarter, and they took more technology.

I'd say the one thing I would add versus expectations, in the quarter, if you look at revenue, certainly growing 28% is strong, but also RPO or total backlog actually grew $700 million both year-on-year and even sequentially quarter-over-quarter. And if you actually do the math on total bookings or RPO bookings, revenue plus change in RPO, you could actually see that we did over $1.1 billion in bookings in the quarter, which is the best quarter in our history. So that definitely, to Rene's point, while we had insight into the pipeline, the size of the deal did expand and get bigger. And certainly, a lot of that, we think, is tied to this kind of deeper investment in R&D, given everything that's happening in AI currently.

You mentioned in your letter that you anticipate recognizing 28% of your RPO over the next 12 months. Based on previous expectations that were communicated during the IPO process, it appears that you have already secured two-thirds of your licensing revenue. Therefore, even if you don't sign many additional deals, you seem to be in a strong position for the remainder of the year regarding licensing. Is the expectation on this front not overly conservative at this point?

You're talking about expectations for next year or the back half of this year?

Well, they're sort of 12 months forward, right? So what you're saying about 28% of the RPO to be recognized over the next 12 months.

Well, we feel good about the guidance, and we did increase the targets for the back half of this year versus what we thought at IPO. And we haven't talked about next year, but certainly, given the tailwinds that I think exist on the licensing side, and then now that we are seeing signs of progress on the royalty side, we're not ready to finalize the numbers, but there definitely are tailwinds.

Yes, I believe you're interpreting it correctly. To Jason's point, achieving $1 billion in bookings within a single quarter is significant, especially considering there were years when we didn't reach that annual total, falling short by several hundred million. We have a strong belief in the backlog we've created and how it will be recognized over time. Additionally, while it's important not to downplay the financials, they reflect a very robust demand for Arm technology in relation to the R&D investments being made. Despite inflationary pressures, geopolitical issues, and uncertainties about end markets, we are not witnessing companies delaying deals, refraining from investments, or sticking with the current generation of technology. Instead, we observe a trend toward acceleration in ensuring that enough compute capacity is integrated into the end devices being developed. This is largely driven by AI, as the evolution of models is rapid and the required compute capacity to leverage new capabilities remains somewhat uncertain. What is clear is that many current device designs likely lack sufficient compute capacity, making it crucial to expand this capacity, which explains the significant growth we experienced in the last quarter.

Our next question comes from Harlan Sur with JPMorgan.

Another one on licensing. As you mentioned, there is some timing-related dynamics and revenue rec dynamics regarding licensing in the December and the March quarter. Some of the uncertainty is to be expected, especially on large deals, as you mentioned. So on the fiscal second half, is more of the uncertainty on timing of licensing deal closure or more around the revenue recognition profile of those signed deals?

Yes, as Rene mentioned earlier, deals can certainly vary in size. However, this typically presents more opportunity. In this situation, it's primarily about timing. Given that we achieved $1.1 billion in bookings last quarter, these are substantial deals that require extensive approvals from top levels of these organizations, which can take time. This makes prediction challenging for us. Therefore, I recommend looking at both Q3 and Q4 together, as we have adjusted our guidance based on expectations for Q4 and we feel very positive about the trajectory.

Yes. So having been with the company 10 years and watched how this process works, we generally have pretty good visibility on a six-month basis. But to tell you whether something is going to close in December or January, given the fact that there may be a lot of legal language to review, it takes approvals, December is a holiday period, could be a bit about our control. So to the level of being potentially conservative on a quarter timing, I think that's potentially the detail you're extracting here; but our confidence that the deal will actually close is quite high, given that we know what the needs are, which is why to Jason's point, the guidance went up. But more importantly, and I give that example of December, January as both a figurative one and a real one because that's exactly what we'd be looking at here, and it makes a big difference on which side of the boundary it hits. But our degree of confidence that the technology will be needed by the end customer is quite high.

Perfect. And then maybe mid to longer term, the step-up in royalty rates over the next few years is, in large part, driven by the adoption of your total compute or compute subsystem solutions where we're not only delivering more CPU or MCU cores to your customers, but also integrating some of the key subsystem blocks like bus architecture, cache memory management, memory controllers, security, et cetera, saves your customers a significant engineering, design and validation costs and return you guys get a higher royalty rate. TCS has been very successfully adopted by several of your large mobile customers. Can you guys just give us a sense on the traction of driving more subsystem solutions into your automotive, industrial, PC, data center compute customers? And any sort of way to quantify the momentum there?

We recently announced our CSS partner program for our infrastructure business, engaging with companies like TSMC, Cadence, Synopsys, and Intel to expedite the transition for partners into this solution space. The heightened demand for these solutions has exceeded our expectations. When you consider why this is of such high interest to end customers, if a customer is designing a system on chip with one or two microcontroller cores, they develop their chip and integrate their IP to ultimately create a product. This model works well for specific segments. However, when building solutions for laptops, cloud infrastructure, or 5G switches, where you might integrate 16, 30, or even 100 CPUs along with fabric and cache memory interfaces, the process becomes more complex. Projects that used to take 16 weeks from TSMC now extend to 26 weeks, adding 10 weeks to the cycle time, making the integration of subsystems quite challenging. In cases where these subsystems include the compute blocks provided by Arm, it makes a lot of sense for partners to seek our assistance. This is particularly relevant in automotive, ADAS, and mobile markets. We are experiencing significant demand for this and, as for our guidance, we will not alter our outlook for the future. We believe this initiative represents a substantial value driver for our end customers, and we anticipate continued growth in this direction.

Our next question comes from Ross Seymore with Deutsche Bank.

For my first question, I wanted to discuss the implied guidance for December and the actual December figures, as well as the implied guidance for March. It seems like you're slightly missing expectations in December but then exceeding them in March. Is this just due to the fluctuations in licensing that you've mentioned several times? And more specifically, what is the general expectation regarding royalties, particularly in March, given the various cyclical factors at play? Additionally, seasonally, that period typically isn't the strongest for your mobile business, including smartphones. Any insights on these factors would be appreciated.

Sure. So yes, on the licensing side, exactly as we described. Our six-month visibility is very, very good. Our month to week visibility is a little fuzzier. And as a result, we're going to err on the side of caution and not overstep but make sure we deliver on what we say we're going to do. And as I said, we're extremely confident in the deals that we've identified and the need for the technology. I'll let Jason comment a bit more in terms of the direct of travel on royalties. But broadly, we've seen three quarters of sequential growth. We have a lot of strong indicators from partners that we are out of the trough and climbing out of the trough. Relative to the direction of travel, the slope of the curve, I'll let Jason sort of speak to that. But generally speaking, our indicators are pretty strong as far as that market goes. And as I said, in the other markets where we continue to grow and gain share in cloud and automotive, our confidence level is quite good.

In the most recent quarter, we observed a positive return to sequential growth in royalties. Our largest partners have experienced similar trends. Our guidance is informed by industry reports and forecasts from our partners, leading us to anticipate mid- to high single-digit sequential growth over the next two quarters. Considering the downturn from last year, we expect year-on-year growth in royalties to reach positive single digits in Q3, and move into double-digit growth by Q4. The comparisons will be easier in the first half of next year, which sets us up well. If the recovery we and our partners are seeing continues, we believe it will lead to a strong performance.

I guess for my second question, this has been a bit of a rolling correction. You just talked about some of the dynamics coming out of the other side, thankfully. But some of the other markets, automotive, industrial, broad-based ones, seemingly like they are just rolling over now to the downside. What's the impact to Arm if some of your more client businesses improve? I realize you have a bigger exposure to those. But as far as implied royalty revenue rates, those sorts of things, if the automotive and the industrial IoT side of things weakened, can you make up for that with the mobile side of things, the client side, or are there trade-offs that we all need to appreciate?

Our expectations include an increase in v9 products that are beginning to ship, although we are still early in the royalty phase for these shipments. Currently, about 10% of our royalties are associated with v9. Many designs sold over the last couple of years are just now entering the market, which will contribute positively to our growth as we see a recovery in unit sales and improved royalty rates. Additionally, the infrastructure business is showing strong growth drivers. While the industry has been slow this past year, there are signs of improvement, especially with various hyperscaler AI initiatives, and we expect to continue gaining market share in infrastructure, particularly in cloud computing. The automotive sector has also seen significant gains. However, our expectations for this market may not be as strong as they were over the past year, as inventory levels have likely stabilized. From an automotive inventory perspective, we anticipate there may be challenges, though not specifically regarding chip inventory. Regarding IoT, we do not foresee it being a major growth driver in the short term, though it may see more significance as AI develops in edge computing. For now, we do not expect IoT to contribute significantly to growth next year. We will keep you updated as we gather more information and progress throughout the year.

Our next question comes from Pierre Ferragu with New Street Research.

I'd like to revisit the topic of operational expenses. You've provided a lot of clarity on the numbers, which I appreciate. However, my question is more general. If we compare Q4 from last year to this year, it seems your operational expenses have increased by about 20%. I would like to gain a better understanding of the operational factors driving that increase and how your operational expenses are growing overall. Perhaps I have a simplified view of your model, but it appears to me that your operational expenses are largely focused on product development. Subsequently, you license these products, and eventually, these licensed products are incorporated into your clients' offerings. Therefore, I would have anticipated that operational expenses would rise significantly at the beginning of this process, rather than when your licensing activities are accelerating and your clients are starting to integrate your intellectual property. There may be aspects of your model that I am not fully grasping, so I would appreciate any insights you can provide. Additionally, it would be helpful to know whether the increase in operational expenses is primarily due to product development and research and development, or if there is also a significant component related to business development and managing client relationships as part of this new licensing program that we might be overlooking.

Thank you for the question. Over the past year, we've seen a 17% rise in our headcount, which translates to about 1,000 new employees, with 85% of these roles concentrated in R&D. The remaining 15% covers G&A and sales. Our total R&D personnel account for around 80% of our overall operating expenses, indicating that we are focused on enhancing our capabilities for the future. Much of our R&D effort is dedicated to creating designs that we subsequently sell, while we are also continuously developing the next generation of our products. The significant hiring over the last year is largely due to our sales of compute subsystem capabilities, which our customers and partners have been seeking. This has necessitated the formation of a solutions engineering team, which has grown from being very small a year ago to approximately 1,000 members now. This area has seen a lot of hiring, and while we will begin to see contracts and royalties from these hires, the real impact will likely not materialize until we reach our fiscal year-end in 2026. This is part of our forward investment strategy, and I should mention that approximately 81% of our royalty contracts for fiscal year 2026 are already signed. Therefore, the majority of the benefits from these contracts are confirmed, but they will not start shipping until late 2025 and early 2026.

Yes. And as far as the product development cycle goes, your question is a very good one relative to how to think about product development and cycle times. We put out products very, very frequently. The mobile and PC world, they need to see new CPUs every single year. They need to see new GPUs every single year. So we are developing the next-generation product and releasing something literally on an annual beat. The hyperscaler market is probably every two years but we also do performance scores and efficiency scores on a bit of a tick-tock basis. And then automotive cores are probably anywhere between two to three years. So our people are always working. And I would also say that one of the things we did during the SoftBank years to invest is we actually got out of a number of commodity businesses that we were in, such as video IP, display IP, where we were highly undifferentiated and use those resources to develop a Neoverse CPU roadmap and to develop an automotive AE roadmap. So there is a constant treadmill of products and CPUs and GPUs and NPUs that are being developed. And then to Jason's point, when we start to put those into subsystems, that's a new output and a deliverable. So the IP group provides those IP cores to the Solutions Engineering Group, which is then essentially the group responsible for stitching them together as a subsystem. So it is an ongoing engineering flywheel that does not abate. And as I said, relative to the broader market demand, we're nowhere close to good enough. People want smaller, faster, better all the time, which is what we're working on.

That's very, very clear. Like subsystem engineering really answers the question I had. Maybe one quick follow-up, if I may. If I look at where you're guiding and how it compares to like sell side consensus, you're kind of quite significantly higher on OpEx for Q4. And so my question here is maybe a bit provocative but does that mean that the sell-side analysts didn't listen to you carefully in us during the IPO process and mis-modeled a bit OpEx in the near term or does that mean that today compared to three months ago, you've actually built up OpEx faster than what you were thinking three months ago?

I can answer that. The brief explanation is that the assumptions we had during Analyst Day in early August were based on a lower stock price than what we ended up issuing most of the equity at, as well as higher social security taxes, particularly in the U.K., where they are about twice as high as in the U.S. When we consider the increased stock price along with the raised taxes, that accounts for the changes. It's not an ongoing cost driver. This is why we still expect to achieve a non-GAAP operating margin in the 40% range in the near term this year, and we maintain our long-term target of reaching around 60%. There are no changes to those targets. The short-term factors related to some IPO-related costs are simply slightly higher than what we had previously projected.

Our last question comes from John DiFucci with Guggenheim Securities.

My first question has to do with the related party revenue, which was flattish year-over-year versus the rest of the revenue was up just almost 40%. Can you provide more color around the license versus royalty mix for the related party business? And how we should think about that going forward?

Sure. Thanks for the question, John. The related party revenue comes from Arm China, where we have a couple hundred customers in China that are all grouped together due to the nature of the joint venture. China did experience low single-digit growth, but its share of total revenue decreased from about 25% in the recent period to around 20%. This change is mainly because the rest of the world grew much faster. Regarding the mix of license versus royalty, it's roughly 50-50, with slightly more than 50% coming from licenses and slightly less than 50% from royalties. However, all the revenue from Arm China is categorized as other due to the structure of the Arm China joint venture.

Got it. Okay. Great. That's really helpful. And actually, how about going forward? How should we be thinking about that mix going forward for Arm China?

I think the mix is quite similar. Historically, they have been closer to a 50-50 distribution compared to the rest of the world, which leans more towards 40% license and 60% royalty. We'll definitely keep you informed if we notice any changes, but that's our expectation for the second half of this year.

Okay, great. For my second question, regarding the guidance for the next quarter and the year, the macro environment clearly has an impact, and you all have your own forecasts. I suppose we all do. This influences both licenses and royalties, but the royalty aspect is something you likely have less control and visibility over, even though there have been numerous questions about licenses, where you have more clarity. Jason, you touched on the visibility of royalties in one of the questions, but I want to ensure I understand what is entailed in the guidance concerning units. I recognize that many factors influence royalty revenue, most of which are moving in a positive direction. We can all observe industry analysts' forecasts for units, and since you maintain close relationships with your customers, your visibility may be even better. I'm just wondering, when you evaluate industry analyst projections for units, do you expect them to be about the same, slightly below, or possibly even a bit better, or do you see things as richer than what the industry analysts project?

Sure. In the recently reported quarter, our royalties decreased by 5%. When I compare this to our three closest competitors—MediaTek, Qualcomm, and TSMC—they reported royalty declines ranging from 11% to 24% in the past few weeks. Therefore, we experienced stronger growth, mainly due to our market share gains in infrastructure and automotive sectors, as well as the adoption of Armv9 technology. We anticipate, along with industry analysts, a shift to positive sequential growth in the last quarter and this ongoing quarter, with expectations of growth in the high single digits approaching double digits. This outlook is consistent for Q4 as well. Based on our observations, we earn royalties on over 7 billion chips each quarter, showing significant engagement with various customers. Overall, we're seeing comparable impacts across the board, but our Armv9 integration likely contributes to our faster growth compared to others. Does that address your question?

Yes, that's really helpful.

Our last question comes from Matt Ramsay with Cowen.

Rene, my first question is about the trend we've observed with generative AI computing over the past year. I'd like to hear your perspective on what this could mean for Arm. Do you see it as a positive development that could accelerate various Arm server designs potentially used for accelerators in data centers? Or are you concerned that it might limit or reduce the addressable market for CPUs that you could grow into organically? How do you assess the pros and cons of this situation?

Yes, thank you for the question, Matt. I believe it's overall a positive development. As more large language models are utilized in cloud data centers for training, it’s important to note that any accelerator or GPU requires a CPU, which is a given. When examining the type of CPU needed, energy efficiency is crucial, along with very low power consumption and the ability to customize it within the overall system. This leads to exciting opportunities because when you consider total cost of ownership and total system power, developing a custom Arm-based system on a chip that interfaces with these accelerators allows for a high degree of customization in terms of power efficiency and throughput. One of the primary power demands from these applications is in providing memory bandwidth to the engine. Therefore, designing something custom that interacts with the accelerators can be greatly advantageous. A lot of work is currently happening in the community to develop custom Arm-based chips, which I see as a net positive. Furthermore, Nvidia is a leading player in the accelerator field and has been beneficial by making CUDA drivers for their A100 and H100 models available on Arm. Whether using standard products from Ampere or building custom chips based on Arm cores, the push of generative AI workloads onto AI clouds offers a tailwind for Arm, and we are quite excited about it.

As my follow-up, I think in another question, Jason, you spoke a little bit about Arm China and given all the things that are going on regulatory-wise. I wanted to step back a bit and you guys control the IP that gets given to Arm China for them to then do things within license into China and the royalties come back out the other end. I guess what I want to get a little bit more granular on given the dynamic environment we're in, is just what kind of visibility do you actually have through the structure of Arm China into the forward licensing trends and then from an audit perspective, the royalties that are coming out on a sort of quarterly basis. Just like the level of visibility you have to sort of the operations that go on within that organization as IP goes in and royalties come back out.

Yes. So Matt, I'll let Jason kind of comment on the audit component and also sort of the integrity of the information that comes back. But just a couple of things I wanted to note on Arm China so that you and rest of the group can understand. First off, from a delivery standpoint, when Arm China signs a contract with a PRC customer, the IP actually goes from Arm Limited directly to the customer. It doesn't go into Arm China. So they are not a holder, if you will, of the product. The product is essentially downloaded directly from our servers to the end customer. Secondly, for many of the high-value designs, particularly whether we're working in the networking space or the cloud space or automotive, they're generally working with our latest edge technology. And because of that, there is a lot of interaction between the customers in China, the Arm China salespeople and Arm Limited marketing and engineering. So we have really, really good visibility in terms of when these large strategic deals are being consummated because generally speaking, everything around demand creation and the technical interactions between the engineers at the customer and the engineers at Arm is something we have complete visibility into. So we have a very, very good idea of when large deals will close in China just by the nature of the relationship between our engineers, the partners' engineers and the sales folks for Arm China. I'll let Jason talk about audit and things of that nature.

Yes. The Arm China customers go through the same process as all of our other customers, which includes conducting royalty audits after the fact. This is consistent with our practices globally. Occasionally, we discover findings, and we address those, leading to recoveries or adjustments, which works effectively. Additionally, we have independent audits conducted by Deloitte Touch for Arm China, following the same audit requirements as the rest of Arm and SoftBank. All of this work occurs in parallel, and I believe the integrity of information and responsiveness is on par for Arm China as it is for all other regions and sectors of the organization.

Our last question comes from Sara Russo with Bernstein.

Rene, Jason, so it's been about three years since you launched Flexible Access, more than three years and about three years since Total Access has launched, and the letter gave some helpful details around a slight increase in ACV. Just wondering, for renewing customers, are you seeing any trend on increasing IP adoption because they're sort of into an all-you-can-eat-to-subscribe mode? And for those renewing customers then after they've been in Total Access for a while, are you seeing any increasing spend from those Total Access customers?

Total Access has been in operation for about three years, and we've observed several developments as the program progressed. Initially, customers who adopted it early on have increased their consumption in subsequent cycles, opting for more tape-outs or additional IP. Additionally, the program has validated our expectations, demonstrating that the churn rate among our major partners is minimal, if not nonexistent, with an average relationship duration of around 16 years and a median of 19 years. This longevity has allowed our Field Application Engineers to be more involved in promoting other IP solutions. Notably, with the rise of AI, the program’s impact has been significant. ATA has exceeded our expectations by reducing churn in the sales cycle, and it has proven to be convenient for our partners, who frequently spend on subscriptions for EDA tools. Many of these customers have had long-standing relationships with Arm, some exceeding 10, 15, or 20 years. We anticipate that most of our partners will adopt this model, especially given our low churn rate and the strategic allocation of resources to enhance the chip tape-out process.

That's great. Just a quick follow-up. As part of that program, since you're working with customers in a slightly different manner, are you gaining more insight into customer design programs that boosts your confidence in forecasting royalties and what to expect from a royalties standpoint compared to the traditional licensing models?

Yes. I think one of the things that was a byproduct of that, and I would say combination of industry trends/Total Access, is compute subsystems. Because once we started to get involved with partners more deeply, we started to understand exactly what their tape-out schedules were, exactly what they were trying to use from a process standpoint, what libraries they were using. We were suddenly in a completely different domain relative to how we were interacting with partners in terms of schedules. So what it's done for us is, I think it's accelerated subsystem engagements. And at the same time, our understanding and visibility of customer programs is at a level that we've never had before.

That concludes the question-and-answer session. At this time, I would like to turn the call back to Rene Haas, CEO, for closing remarks.

Okay. Thank you, Abigail. And on behalf of myself, Jason and Ian, I'd like to thank everyone for their excellent, thoughtful questions. This was the first time around for us in terms of as a trio doing this. We'll get better each time, but thankfully, we had a very good quarter to come off on and talk about, which made the job a bit easier. As mentioned before, we're very, very excited about the prospects going forward. Very, very excited about the opportunity and look forward to continuing to engage with you all. Thank you so much.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.