Arteris - Q3 2024

Transcript

Operator (participant)

Good afternoon, everyone, and welcome to the Arteris Third Quarter 2024 Earnings Call. Please note this call is being recorded and simultaneously webcasted. All material contained in this call is protected by the property and copyright of Arteris, with all rights reserved. For opening remarks and introductions, I will now turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead.

Erica Mannion (Partner and Founder)

Thank you, and good afternoon. With me today from Arteris are Charlie Janac, Chief Executive Officer, and Nick Hawkins, Chief Financial Officer. Charlie will begin with a brief review of the business results for third quarter ended September 30, 2024. Nick will review the financial results for third quarter, followed by the company's outlook for fourth and full year of 2024. We will then open the call for questions. Before we begin, I'd like to remind you that management will make statements during this call that are forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties that could cause actual results or events to differ materially from those anticipated, and you should not place undue reliance on forward-looking statements.

Additional information regarding these risks, uncertainties, and factors that could cause results to differ appears in the press release Arteris issued today and in the documents and reports filed by Arteris from time to time with the Securities and Exchange Commission. Please note, during this call, we will cite certain non-GAAP measures, including non-GAAP loss, non-GAAP net loss per share, and free cash flow, which are not measures prepared in accordance with U.S. GAAP. The non-GAAP measures are presented as we believe they provide investors with a means of evaluating and understanding how the company's management evaluates the company's operating performance. These non-GAAP measures should not be considered in isolation from, as substitutes for, or superior to financial measures prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the nearest GAAP measure can be found in the press release for the quarter ended September 30, 2024.

In addition, for a definition of certain of the key performance indicators used in this presentation, such as annual contract value, confirmed design starts, active customers, and remaining performance obligations, please see the press release for the quarter ended September 30, 2024. Listeners who do not have a copy of the press release for the quarter ended September 30, 2024, may obtain a copy by visiting the Investor Relations section of the company's website. In addition, management will be referring to the Q3 2024 earnings presentation, which can be found in the Investor Relations section of the company's website under the Events and Presentations tab. Now, I will turn the call over to Charlie.

Charlie Janac (CEO)

Thank you, Erica, and thanks to everyone for joining us on our call today. In third quarter of 2024, we achieved a record annual contract value plus royalties of $60.5 million. We also delivered positive free cash flow of $1.1 million, making it our third consecutive quarter of positive free cash flow. Our success during the quarter was in particular fueled by demand for AI-driven enterprise computing and automotive SoC solutions, along with growing momentum in our other verticals. Business in third quarter was primarily driven by increasing adoption of our technology by our current customer base. As an example, a top five global technology company increased their deployment of Arteris products to enable development of their high-end AI chiplets and SoCs. This expanded engagement provides our customers with broader access to our system IP.

We expect to see designs from this customer used in a wide range of products, such as hyperscale cloud data center applications, as well as high-volume consumer electronics. Similarly, NIO, a pioneer and a leading company in the global smart electric vehicle market, deployed Arteris technology for its next generation of ADAS and LiDAR SoCs, using our physically aware NoC technology to reduce silicon implementation risks and schedule. This is yet another example of our continued success in accelerating automotive electrification and autonomous driving, with over nine car makers already using Arteris directly as the gold standard for functionally safe high-end automotive computing. During the quarter, we also announced the adoption of Arteris NoC IP and SoC integration automation software products by TIER IV for intelligent vehicle SoC, then Tenstorrent for next generation of chiplet-based AI solutions, and VeriSilicon for HPC data center SoCs.

The majority of the new designs in third quarter came from enterprise computing, followed by automotive, consumer electronics, and communications verticals. The demand for multiple types of AI chips and chiplets, from data centers to endpoint devices, including the smart edge, continues to be a key factor in our success this year. Nearly half of our licensed deals, in dollar terms, in the year have enabled AI SoC development, more than doubling year over year. We continue to work with market-leading customers to further advance our technology, accelerating the broad shift towards smarter electronics. Accordingly, in October, we announced the addition of NoC tiling, supported by mesh, an innovation in our IP products to accelerate the design of AI SoCs by providing scalable performance, power reduction, and increased design reuse.

By organizing network interface units, or NIUs, into modular, repeatable blocks, both FlexNoC and Ncore IP users can replicate verified functional modules into larger AI compute clusters. These support sophisticated workloads for vision, machine learning, deep learning, natural language processing, including large language models and generative AI, both for training and inference applications. Earlier this year, we announced expanded support for Armv9 architecture CPUs with Arteris Ncore IP extensions for joint customers. Additionally, we announced a partnership with Andes Technology to accelerate RISC-V SoC adoption and are pleased to have been named by them as Partner of the Year. We recently expanded our collaboration with SiFive, announcing pre-verified RISC-V solutions for data centers, with our Ncore product providing faster, lower-risk SoC design for AI workloads and power efficiency requirements. Moreover, Arteris joined the Synopsys ARC Access Program.

The aim is to provide interoperable and optimized solutions for mutual customers using Synopsys processors and Arteris NoCs. Our strategy of supporting mid and high-end SoCs and expanding our footprint within large customers appears to be paying off. In dollar terms, the majority of our licensed deals in the quarter were with the top 10 technology companies, as they create ever more sophisticated electronics that increasingly need AI-enabled, high-performance, and energy-efficient SoCs. To further expand our footprint at large customers, we have broadened our focus to include the support of microcontroller chips, many of which are now complex enough to benefit from our system IP technology. These designs are numerous and are often produced in large volumes. As microcontrollers are used to control the operation of electronic systems, such as industrial machinery, automotive functions, and IoT devices, they require low latency and low power consumption.

To address these requirements, we have achieved the ability to create data packets with zero latency penalty for these types of devices. This strategy aims to expand customer usage of Arteris technology from complex SoCs to their mid to upper-range microcontroller product lines and demonstrates the technological flexibility and scalability of our products. We are also aiming to address an even broader set of designs at our large customers. We believe the scale and scope of our long-term opportunity remain robust, supported by our current products and strong product pipeline of new system IP technologies, as well as growing relationships with some of the largest and most advanced electronics companies in the world. Our customers continue to innovate in exciting growth areas, such as generative AI and autonomous driving, using Arteris technologies.

Before I hand the call over to Nick, we're excited to have two seasoned individuals join our leadership team. We recently announced that Joachim Kunkel joined our Board of Directors, having most recently served as a general manager of the IP business unit at Synopsys, where he grew revenue from nearly zero to over $1.5 billion. In addition, Ken Way joined as Arteris EVP of Sales, leading our global and application engineering force, bringing with him a wealth of experience and industry knowledge gained from Achronix, Xilinx, Freescale, and others. With that, I'll turn it over to Nick to discuss our financial results in more detail.

Nick Hawkins (CFO)

Thank you, Charlie, and good afternoon, everyone. As I review our third quarter results today, please note that I'll be referring to GAAP as well as non-GAAP metrics. A reconciliation of GAAP to non-GAAP financials is included in today's earnings release, which is available on our website. Also, as a reminder, I'll be referring to the 3Q 2024 Earnings Presentation, which can be found in the Investor Relations section of the company's website under the Events and Presentations tab. Turning to slide four of the presentation, total revenue for Q4 was $14.7 million, up 11% year over year, and at the midpoint of our guidance range. At the end of Q4, annual contract value, or ACV + Royalties was $60.5 million, at the midpoint of our guidance range, and a record high for the company.

Remaining performance obligations, or RPO, at the end of the third quarter were $78.4 million, representing a 25% year-over-year increase, also growing to the highest level we have ever reported. GAAP gross profit in the quarter was $13.3 million, representing a gross margin of 90%. Non-GAAP gross profit in the quarter was $13.5 million, representing a gross margin of 92%. Now, turning to slide five, total GAAP operating expense for the third quarter was $21.2 million, representing a 4% year-over-year increase. Non-GAAP operating expense in the quarter was $16.8 million, flat both sequentially and year-over-year. This reflects the team's continued focus on prudent management of our operating expenses. As we look ahead, we will continue to limit spending to strategically critical areas while investing in profitable revenue growth. GAAP operating loss for the third quarter was $7.9 million, compared to a loss of $8.5 million in the prior year period and $7.4 million in the second quarter.

Non-GAAP operating loss was $3.3 million, which is better than the top end of our guidance. This represents a $1.2 million improvement compared to the prior year period and a slight improvement sequentially. Net loss in the quarter was $7.7 million, or diluted net loss per share of $0.20. Non-GAAP net loss in the quarter was $3.1 million, or diluted net loss per share of $0.08, based on approximately $39.3 million weighted average diluted shares outstanding. Moving to slide six and turning to the balance sheet and cash flow, we ended the quarter with $54.5 million in cash, cash equivalents, and investments. Free cash flow, which includes capital expenditure, was positive $1.1 million. This was above the midpoint of our guidance range and in line with the company's goal to be free cash flow positive for the full year of 2024.

I would now like to turn to our outlook for the fourth quarter and for the full year 2024 and refer now to slide seven. For the fourth quarter of 2024, we expect ACV + Royalties of $63 million-$67 million, revenue of $14.7 million-$15.7 million, with non-GAAP operating loss of $5 million-$4 million, and non-GAAP free cash flow of negative $0.9 million to positive $1.1 million. For the full year 2024, our guidance is as follows: ACV + Royalties to exit 2024 at $63 million-$67 million, up over 16% year-over-year at the midpoint, midpoint unchanged from the prior guidance. Revenue of $56.9 million-$57.9 million, increasing the midpoint of our guidance by $0.4 million. Non-GAAP operating loss of between $17.1 million-$16.1 million, improving the midpoint of our guidance by $3.4 million.

Non-GAAP free cash flow of positive $0.7 million-$2.7 million, which is $1.6 million higher than the prior guidance at the midpoint and represents an improvement of $18.9 million year-over-year. We are very encouraged by our top-line trajectory and by our effective cost management in the first three quarters of the year that resulted in strong performance for the third quarter and improved guidance for revenue, operating income, and free cash flow for the full year. We are particularly excited about achieving positive free cash flow for three consecutive quarters. With that, I will turn the call over to the operator and open it up for questions. Operator.

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press the star followed by the two. If you're using a speakerphone, please pick up the handset before pressing any keys. Our first question is from Joshua Buchalter from TD Cowen. Please go ahead.

Joshua Buchalter (Managing Director)

Hey, guys. Thank you for taking my questions and congrats on solid results in a choppy backdrop. To start, and speaking of the choppy backdrop, I mean, this has been an interesting earnings season with China autos positive and the rest of the world weak. Maybe you could spend a couple of minutes talking about, in an environment where China continues to take share in the global auto market, I mean, is that a net positive, or is that a headwind for you guys? Because obviously, one of your lead customers, Mobileye, has been losing share in that market, but also there's a lot of local vendors that are also building up their semiconductor portfolios where you have partnered. So I'd just be curious to hear your view on that backdrop and the impacts to your business. Thank you.

Charlie Janac (CEO)

Yeah, I mean, this sort of discussion is kind of difficult to pin down answers ahead of time, right? Our strategy has been to be in as many projects as we can capture. We are in startups, we're in automotive car manufacturers, we're in tier ones. Regardless of market share shifts, Arteris should benefit. We do have a strong presence in the China automotive market. I think NIO was kind enough to allow us to announce that they are using us for some of their automotive SoC projects, right? There's a number of others. From the Arteris perspective, it doesn't make a whole lot of difference. However, the Chinese have put a huge amount of effort in their electric vehicles. They're very nice vehicles. We've been in a number of them.

But because of the tensions, the rest of the world is going to probably throw up some protective barriers, right? And so I don't know how much the market share is really going to shift, except that the electric car inside China is going to be eventually the predominant technology.

Nick Hawkins (CFO)

Can I just add a little bit of color to Charlie's excellent comments, Josh? There are, I mean, as he rightly points out, we have a very small number of Chinese auto OEMs that we can actually—we're entitled to use their names, but you recognize most of the names that we do have if we are able to tell you. Some of the ones that we can tell you that are in that area, that Chinese auto area that are public include Black Sesame, which I'm sure you know, Horizon, SemiDrive. Those are all very powerful vendors in that space. But there are many others we can't mention, unfortunately. On the subject of Mobileye, excellent question. Mobileye is obviously facing a few headwinds and also is facing some headwinds specifically in China. But Mobileye is still very strong. It's one of the strongest in the market.

They have an excellent set of products. There has definitely been some headwind to our royalties, as you've seen, and we've talked about in previous calls, solely derived from Mobileye weak shipments in the first and second quarters. To an extent, that was started to be remedied in the third quarter. But the whole impact of short, let's call it short royalties from Mobileye versus our previous expectation has a less than 1% impact on revenue for the whole year. So it's not as dramatic as you might think.

Charlie Janac (CEO)

Yeah. And in terms of, if I may add, in terms of Mobileye, Mobileye is not going anywhere. They are designed into a bunch of very impressive vehicles, and they are going to continue to be the leader despite short-term headwinds or those kinds of things. We're strong believers that Mobileye is going to continue to do well in this market because of their superior software technology.

Joshua Buchalter (Managing Director)

No, thank you both for all the color there. To follow up and move away from the auto space, I mean, it was great to see that enterprise computing design was sort of the leading contributor this quarter. Any more details you can give us on sort of the contribution today and maybe what that funnel can look like over the next year or so as you diversify the revenue base? Thank you.

Charlie Janac (CEO)

Yeah. I mean, the business continues to be strong. As you said, it's a choppy market with us having to be nimble and responsive to various developments. However, one of the things that we were talking about on the earnings call is we are making a move also into the microcontroller market. Microcontrollers have now become sophisticated enough that at least the mid-range to upper range of the microcontroller market can benefit from our system IP technology. So that opens up an additional segment. So we're very excited about that. And we're also excited about our strong product pipeline for next year. So we continue to be prudent but optimistic.

Nick Hawkins (CFO)

Yeah. One thing I would just add to that, Charlie, is that, as you can actually see, Josh, from the investor deck that's on our website now, the enterprise computing actually still remains slightly our biggest revenue contributor, slightly larger than automotive. It's in the low 30% of total revenue, and it's growing quite nicely. A lot of that's driven out of the sort of enterprise space, sorry, the AI element of the enterprise space. If you look at AI/ML as its own sector, I can't call it a vertical because it's really a horizontal, that actually contributes to about 40% of total revenue. That goes across all our verticals, as you probably know. There's some really interesting dynamics going on there.

Joshua Buchalter (Managing Director)

Thank you both. Appreciate it.

Operator (participant)

Your next question is from Kevin Garrigan from Rosenblatt Securities. Please go ahead.

Kevin Garrigan (Equity Research Analyst)

Yeah. Hey, Charlie, Nick, good afternoon. And let me echo my congrats on the solid results. Going off of Josh's question on the Chinese auto market, so I guess a different way to kind of ask the question, are you seeing design activity in the Chinese EV market increasing at a faster clip versus other parts of the world? And I think you guys had mentioned the average time from licensing to production for automotive is about two and a half to three years. Are you seeing these Chinese customers looking to accelerate that timeline?

Charlie Janac (CEO)

Yes. I mean, we're seeing design activity throughout the world, right? I mean, people, precisely as you said, the design cycles for automotive chips are long. And so right now, people are really building chips for the 2030 automotive model year, right? And so people typically try to design their way out of recessions. And so even when there's shipment volume impact, the impact on the design activity, from our perspective at least, doesn't seem to be great. And certainly, the Chinese design activity is robust. But there's also a number of designs that are being done in the U.S. and in Europe.

Kevin Garrigan (Equity Research Analyst)

Okay. Got it. Got it. That makes sense. And then in the microcontroller market, do the licensing deals in this market, do they have the same ASPs as those in complex SoCs?

Charlie Janac (CEO)

I was afraid you were going to ask that. So the answer is no. The ASPs are lower typically. But the royalty volumes are very, very high, and the designs are numerous. So our strategy in the microcontroller market is really to engage with the largest microcontroller suppliers and essentially not just capture one design, but to capture an entire generation of microcontrollers, which is typically designed together. So that would essentially improve the account yield because, as your question implies, if you focus on one or two microcontroller projects, the ASP will be lower than what we're seeing in the SoC market. But if you bundle everything together, then essentially things will go to the right.

Kevin Garrigan (Equity Research Analyst)

Yep. Okay. Yeah. That makes sense. And then just last one, if I could, and congrats on the announcement of the NoC tiling. How has kind of customer feedback been for this product?

Charlie Janac (CEO)

That particular product is just coming out. People have been asking for that for a long time, so we're finally started or about to commence deliveries, but we have a significant number of customers waiting for it because what it does is that the AI sections are very, very complicated, and so what customers want to do is they want to design a certain section, get it verified, and then replicate it across the chip to basically build larger clusters out of these tiles, if you will. That's why it's called tiling, and so this is built at the request of our AI customers, and we think that the reception is going to be very good, but we've had lots of requests for it, but the orders and the revenue impact will probably not start till next year.

Nick Hawkins (CFO)

Hey, Kevin. It's Nick. Just a little bit of extra color. I didn't want to interrupt Charlie midstream. But going back to the MCU's question, it is definitely a new incremental sort of product area for us to an extent. Having said that, we have had some history in MCUs in the past. I can't name the customer, unfortunately, but it's a very large U.S. semi, top semi company. And the volumes that we had, this is actually for a Bluetooth application, were very, very substantial. And so the royalties also out of that were very substantial. So just to give you an understanding that we have actually visited this space before, we're just emphasizing it much more now.

Kevin Garrigan (Equity Research Analyst)

Okay. Perfect. I appreciate the color, guys. Thank you.

Operator (participant)

Ladies and gentlemen, as a reminder, should you have any questions, please press the star followed by the number one. Your next question is from Gus Richard from Northland. Please go ahead.

Gus Richard (Managing Director)

Yes. Thanks for letting me ask some questions. And let me add my congratulations on the quarter. The cloud service providers are designing their own ASICs. There's quite a bit of data suggesting that those are in flight and starting to ramp. And I'm just wondering if you could talk about how many of the top CSPs are you involved with now, or maybe even better yet, how many of the top 30 tech companies that actually design chips you're involved with?

Charlie Janac (CEO)

So yeah. So we sort of created our own top 10 index, a top 30 index by market cap, right, of technology companies. And so out of those 30, about 15 are designing chips, about half of them at the moment. And basically, 10 out of those 30 are using our IP for something.

Gus Richard (Managing Director)

Got it. And you had a large deal with one of the top five tech companies, this deal to expand the use of your products, correct?

Charlie Janac (CEO)

Correct. So this would be one of the large hyperscalers, yeah.

Gus Richard (Managing Director)

Got it and then, Nick, for you, I calculate from cash flow, your bookings were on the order of like $23 million-24 million. Am I in the right zip code?

Nick Hawkins (CFO)

Close. I think that's sort of a good blended average between third quarter and fourth quarter. We do have a bit of seasonality on bookings, as you know, Gus. Typically, the fourth quarter is our strongest bookings quarter by some way. Last year was a little different. We had sort of a reasonable third quarter and a weaker fourth quarter in terms of bookings. This year is back to kind of normal, which is a decent third quarter, but a much stronger fourth quarter. So the number that you quoted there is, I guess, kind of an average between the two?

Gus Richard (Managing Director)

Between Q3 and Q4.

Nick Hawkins (CFO)

Yeah. Exactly.

Gus Richard (Managing Director)

Q2 and Q3. Okay.

Nick Hawkins (CFO)

Q3 and Q4.

Gus Richard (Managing Director)

Got it. And then you guys have talked about a new product, and it doesn't sound like the tiling and mesh network is that new product. And I'm just wondering if you guys have any updates on how many companies you're engaged with and when you expect to launch.

Charlie Janac (CEO)

So as you say, the tiling and the mesh features is not the product that we were sort of alluding to earlier. We do have installations, and we hope to provide more information on the fourth quarter earnings call.

Gus Richard (Managing Director)

Okay. Got it. And have you recognized any revenue on that product at this point?

Nick Hawkins (CFO)

Not yet. No.

It's more of an early access, more of an early access thing at the moment, Gus. So revenue will follow in due course.

Gus Richard (Managing Director)

Got it. That's it for me. Thanks so much.

Nick Hawkins (CFO)

Thanks, Gus.

Operator (participant)

There are no further questions at this time. I would now like to turn the call over to Charlie Janac for closing comments.

Charlie Janac (CEO)

Thank you, everyone, for your time and interest in our earnings. We look forward to meeting with you at the upcoming investor conferences that we're participating in during the next couple of months. We look forward to updating you on all of our business progress in the quarters to come. Thank you.