Arteris - Q4 2023

Transcript

Operator (participant)

Good afternoon, everyone, and welcome to the Arteris fourth quarter and year-end 2023 earnings call. Please note this call is being recorded and simultaneously webcast. All material contained in the webcast is sole property and copyright of Arteris Inc with all rights reserved. For opening remarks and introductions, I want to turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead.

Erica Mannion (Founder and Partner)

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 the fourth quarter and full year ended December 31, 2023. Nick will review the financial results for the fourth quarter and full year, followed by the company's outlook for the first quarter and full year of 2024. We will then open the call for questions. Before we begin, I'd like to remind you 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 materially differ 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 actual results to differ appear 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 net 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 December 31, 2023. 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 December 31, 2023. Listeners who do not have a copy of the press release for the quarter ended December 31, 2023, may obtain a copy by visiting the Investor Relations section of the company's website. Now I will turn the call over to CEO Charlie Janac.

Charlie Janac (CEO)

Thank you, Erica, and thanks to everyone for joining us on the call this afternoon. We're excited to report a strong finish to 2023 with annual contract value plus trailing 12-month variable royalties of $56.1 million. We added four new customers in the fourth quarter, totaling 23 new customers for the year. Our customer base continues to expand across all of our key verticals and regions, with particular success in automotive, enterprise, consumer, and communications. Our customer base has now delivered approximately 3.5 billion SoCs to their electronic systems customers. The continued growth of SoC design complexity and associated design costs increasingly drives our customer base toward commercial system IP.

As we look back at 2023, this accelerating industry adoption of commercial system IP solutions is demonstrated by a record number of license deals and record high customer chip design activity, with 29 confirmed design starts for the quarter and 95 for the year. I'm delighted to note that we added four new major semiconductor and system house companies as customers during the year. Not only are we seeing growth in a number of our customers, but we're also seeing further design penetration within our existing customer base. License revenue was strong across all of our vertical markets and balanced across geographies. Notable achievement includes strong adoption of FlexNoC 5 of the physically aware network-on-chip, which now represents the majority of FlexNoC sales.

Customer design wins from the past years are developing into a growing royalty base for Arteris, as we've seen a 32% year-over-year increase in royalties in 2023. Historically, our royalty revenue was primarily driven by leading-edge applications within the consumer space, but today we see that our royalty stream is comprised of a broader mix across numerous customers in automotive, consumer electronics, and enterprise computing and other applications. Our continued momentum in artificial intelligence and machine learning, or AI/ML, space remains strong, with AI/ML representing over 50% of our license deals in a quarter across a broad section of our verticals. For example, Rain AI is another innovative AI chip company which recently selected the Arteris FlexNoC 5 physically aware network-on-chip IP for use in its edge AI accelerator.

The low-power, low-latency, and high-bandwidth capabilities of FlexNoC 5 will be critical in helping Rain and its customers to process the large data requirements needed for generative AI applications. Communications, where AI supports the globally accelerating transition to 5G, is another vertical where we saw strong adoption of Arteris products per the growing need for high-bandwidth, low-power 5G chips that can only reach their performance goals by leveraging Arteris system IP. As an example, EdgeQ, a leading innovator in 5G and AI technologies, has licensed Arteris FlexNoC for use in its comprehensive multimode 4G/5G base station chip. It is a RISC-V-based device that offers a scalable architecture, high throughput, and low-power consumption, effectively shrinking an entire base station onto a single SoC.

TCL is another innovator in communications infrastructure, which has licensed both our Ncore and FlexNoC interconnect IPs for use in their next generation modem SoC, with the aims to provide telecom players with power to deliver ultra-high capacity, multi-gigabit links over longer distances, at an optimized total cost of ownership. In automotive, we have seen an accelerating proliferation of AI-enabled advanced driver assistance systems, ADAS, and other advanced electronics to support electrification, automated driving, and electronic control unit ECU consolidation, ensuring all electronics adhere to automotive functional safety standards and other mission-critical applications. To continue to expand our technology to better support this endeavor, in Q4, we announced that Ncore cache coherent interconnect IP has achieved ISO 26262 certification, a key milestone to ensure safe technology is incorporated into modern vehicles and other autonomous systems.

Similarly, our Magellan SoC integration automation software also received its ISO 26262 TCL1 functional safety certification, further expanding upon Arteris' ongoing commitment to support mission-critical safety applications. This strong focus on automotive was recognized in the fourth quarter, with Arteris being awarded the Autonomous Vehicle Technology of the Year award by Autotech Breakthrough. Finally, in the fourth quarter, Arteris achieved ISO 9001 quality management system certification, further supporting customer confidence in our commitment to product and process quality. Currently, certain macroeconomic dynamics, including geopolitical uncertainties and the U.S. BIS restrictions with respect to China-U.S. trade, continue to impact our business. While these dynamics do create near-term headwinds, we believe that the scale and scope of our long-term opportunity remains robust.

This is illustrated by a robust product pipeline of new system technologies and solid relationships with some of the largest electronics companies in the world, who continue to innovate in exciting areas such as generative AI and autonomous driving. 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 fourth quarter and earlier results today, please note I'll be referring to non-GAAP metrics. A reconciliation of GAAP to non-GAAP financials is included in today's earnings release, which is available on our website. Total revenue for the fourth quarter was $12.5 million, up 12% year-over-year and above the top-end of our guidance range. At the end of the fourth quarter, annual contract value, or ACV, plus trailing 12-month variable royalties and other revenue, was $56.1 million, also above the top-end of our guidance range. Remaining performance obligations, or RPO, at the end of the fourth quarter was $72.7 million, representing 26% year-over-year growth, going through its highest level on record for Arteris. GAAP gross profit for the quarter was $11.1 million, representing a gross margin of 88%.

Non-GAAP gross profit for the quarter was $11.3 million, representing a gross margin of 90%. Total GAAP operating expense for the fourth quarter was $20.3 million, compared to $20.4 million in the third quarter, down 1% sequentially. Non-GAAP operating expense in the quarter was $16.8 million, flat sequentially. As we've done throughout 2023, we will continue to proactively and prudently manage operating expenses, limiting spending to strategically critical areas. GAAP operating loss for the fourth quarter was $9.2 million, compared to a loss of $9.1 million in the year-ago period. Non-GAAP operating loss was $5.5 million, or 44%, compared to a loss of $5.8 million in the year-ago period. Net loss in the quarter was $10.5 million, or diluted net loss per share of $0.29.

Non-GAAP net loss in the quarter was $6.8 million, or diluted net loss per share of $0.18, based on approximately 36.8 million weighted average diluted shares outstanding. Turning out the balance sheet and cash flow. We ended the quarter with $53 million in cash, cash equivalents, and investments. Cash flow used in operations was approximately $3 million in the quarter. Free cash flow, which includes capital expenditure, was approximately -$3.4 million, coming in better than the top-end of our guidance range. Moving on to our annual results. Total revenue for 2023 was $53.7 million, up 7% year-over-year, reflecting our switch to a fully ratable revenue model at the end of the second quarter. Total operating expenses were $83.7 million, compared to $75.7 million in the year-ago period, while non-GAAP operating expenses were $69.1 million, compared to $62.8 million in the year-ago period.

Net loss in 2023 was $36.9 million, or net loss per share basic and diluted of $1.03. Non-GAAP net loss was $21.6 million, or net loss per share basic and diluted of $0.60, based on approximately 35.7 million weighted average shares outstanding. Cash flow used in operations was $15.7 million in 2023, while free cash flow, which includes capital expenditure, was negative $17.2 million, or 32% of revenue. I would now like to turn to our outlook for the first quarter and full year of 2024. For the first quarter, we expect ACV plus trailing 12-month variable royalties of $55 million-$59 million, and revenue of $12.1 million-$13.1 million, with non-GAAP operating loss margin of 41%-61%, and non-GAAP free cash flow margin of -9% to +11%, reflecting strong sales in the prior quarter.

For the full-year 2024, our guidance is as follows: ACV plus trailing 12-month variable royalties to exit 2024 at $62 million-$68 million, up 16% year-over-year at the midpoint. Revenue of $54.5 million-$57.5 million. Non-GAAP operating loss margin of 33%-43% and non-GAAP free cash flow margin of -5% to +5%. We are encouraged by the above guidance performance and strong deal activity in the prior quarter. While we expect some quarter-to-quarter cash flow fluctuations throughout the year due to timing of deals, we expect that with the actions we have taken in 2023, we will become free cash flow positive in 2024. With that, I will turn the call over to the operator to open it up to 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 telephone keypad. You will hear a three-tone prompt acknowledging a request. Questions will be taken in the order received. Should you wish to cancel your request, please press the star followed by the two. If you are using a speakerphone, please leave the handset before pressing any keys. One moment, please, for your first question. Your first question comes from the line of Matt Ramsay from TD Cowen. Please go ahead.

Matt Ramsay (Managing Director and Senior Equity Research Analyst)

Thank you very much, gentlemen. Good afternoon. I guess one thing I wanted to get an update on, Charlie, and you mentioned some of it in your script, but over the last couple of quarters, just on a run-rate basis, licensing in China was a fairly material headwind. I'm just trying to get an idea of if the environment has improved at all, if the headwind is at least sort of stabilized in the run rate going forward, and if there's been any real change in China versus 90 days ago when we had this chat. Thanks.

Charlie Janac (CEO)

Yeah, Matt. So yeah, we saw a significant decline in the middle of Q3, but things have not gotten, I think things are stable at the moment. I don't think the economy in China has improved. I think there's some other cockroaches to be revealed. But there is a significant deal flow coming from China, and we do not see things getting any worse. Where our strategy in response to this has been, as the capital has gotten tight for the smaller companies in China, we have shifted our attention to larger companies that are designing SoCs. And so we anticipate that the situation in China will be stable going forward. It might get better, but we're planning on we're planning on stability.

Nick Hawkins (CFO)

Hey, Matt. This is Nick. Just a couple of bits of color to Charlie's excellent commentary. When we come to looking at the numbers side and I'm just looking at revenue here. I'm not looking at ACV, which is obviously a separate beast, but just the impact on ratable revenue, GAAP revenue. The impact that we felt in 2023 from the China headwind was approximately $2 million. That was only obviously representing third and fourth quarter. The impact in 2024, and this is assuming that nothing gets better. It also assumes that nothing gets worse, obviously. That impact would be approximately double that at $4 million headwind.

Matt Ramsay (Managing Director and Senior Equity Research Analyst)

No. Thank you both for that. And thanks, Nick, for the numbers. I guess since I have you, Nick, I noticed in the full-year 2024 outlook I mean, you have to squint a little at the numbers, but the midpoint is roughly free cash flow break-even. I think our team had been assuming sort of free cash flow break-even second half of 2024 and maybe non-GAAP break-even second half of 2025. Things seem a little bit ahead of that schedule, if you're able to guide that for the full year on free cash flow. So maybe you could walk us through what's changed there. Is it lower OpEx? Is it more visibility on revenue? I'm just trying to figure out it because it seems at first look that things seem like things have been pulled in a little bit on free cash flow break-even, which is great to see. Thanks.

Nick Hawkins (CFO)

Yeah. Free cash flow is always going to a bit of a variable feast, Matt. I mean, the first and fourth quarters you probably saw in our commentary that we benefited again from a kind of a present from customers in fourth quarter of 2023 to the tune of a small number of millions of dollars, where they paid early, again. And I don't know why they do this, but they do. Nevertheless, we're still gunning for free cash flow neutral, slightly to slightly positive for FY 2024. You've obviously also noticed that we're guiding for free cash flow neutral in first quarter. Not all quarters are created equally. The second quarter and third quarter tend to be weaker from a free cash flow perspective. The fourth quarter and then sometimes the first quarter, depending on deals, tend to be positive.

Really, at the moment, we're at that stage where we might see a sawtooth of free cash flow over the quarters. But if you look at the overall trajectory over the year, we're looking at free cash flow neutral to positive.

Matt Ramsay (Managing Director and Senior Equity Research Analyst)

Got it. That's helpful. Just my last follow-up there and kind of piggybacks on that prior question is, second half of 2025, we're still thinking about non-GAAP break-even, then second half of 2026. The plan would still be for GAAP break-even. Is that still on track, or has that moved up maybe a hair as well?

Nick Hawkins (CFO)

So I think on the non-GAAP OpEx now that we're fully ratable, it's harder to shift the needle on revenue. We do expect to break the seal on non-GAAP profitability as we exit 2025 and enter 2026. So the full-year 2025, we don't think at this stage, although we're not guiding it clearly, we don't think that is feasible to be non-GAAP operating profit positive. But we'd expect to see the exit of that year as being the pivot point as to where we go into non-GAAP profitability, and then we enjoy the benefits of that through 2026. Does that make any sense or answer your question?

Matt Ramsay (Managing Director and Senior Equity Research Analyst)

No, Nick, obviously, we're looking at decent ways out here given the macro. So I appreciate that color. And yes, it does answer the question. But thank you very much, guys. Congrats. And I'll jump back in the queue.

Nick Hawkins (CFO)

Thanks, Matt.

Operator (participant)

Thank you. Your next question comes from the line of Hans Mosesmann from Rosenblatt. Please go ahead.

Hans Mosesmann (Managing Director)

Hey, thanks. Hey, guys. Good evening and congrats on the execution. Hey, Charlie or Nick, ASPs for licensing, what is that trend? How's that looking as we go into 2024?

Charlie Janac (CEO)

So we've announced FlexNoC 5 or started shipping it in the beginning of June of 2023. So we have a whole year of delivering it. FlexNoC 5 is now over half of FlexNoC sales. So the ASP of that is about 33% higher because of the second-generation physical awareness. So the ASP is tracking kind of to our projections. It's going up every year. And we said on the IPO that we're going to be at something like $1 million average project deal size by 2026. And I think we're tracking to that. So the ASPs are rising well, driven by essentially new functionality that we're delivering into the marketplace to address the complexity of some of these generative AI and automotive SoCs.

Hans Mosesmann (Managing Director)

Great. And you may have mentioned this. I apologize. I've been traveling. What were royalties as a percentage of revenues?

Nick Hawkins (CFO)

Yeah. Let me tell you that one.

Charlie Janac (CEO)

That's the next question.

Nick Hawkins (CFO)

Yeah. Let me tell you that one, Matt. So if I give you the numbers, it's probably easier. I mean, royalties come in at around sort of 10% of total. But if you look at 2022, for example, we had total royalties and other of $4.3 million. But if you strip out the other, which is really just it's nothing to do with royalties. It's things like training, SOWs, and various other things that can't be recognized as license revenue. If you just look at the variable royalties that we report, it was $3.1 million in 2022. If you look at 2023, it was $5.1 million. So that's obviously a pretty big increase. But bear in mind that, to be fair, there's some audit stuff in there. There's some audit we had some really successful audits thanks to our audit guru. So we have, say, a big tailwind from royalty audits.

If you strip out those and you just get back to pure, pure variable royalties, then we're up around 45%-50% year-over-year. And in our guidance we don't actually guide royalties, but you can look for a similar kind of growth on royalties into 2024. And there's no reason why that shouldn't continue into we don't actually project any sort of other revenue. We don't project or include, in our guidance, any audit benefits, any audit pickups, even though they may well happen. So we're seeing at least maintaining the same rate of growth royalties and maybe increasing. So look at $5.3 million total, total versus $53 million. So it's about 10% of total revenue. It's a very roundabout way of answering the question and with getting some color in the middle of it. I hope you don't mind.

Hans Mosesmann (Managing Director)

Right. And so to kind of summarize that, so this year, it would probably grow as a percentage of total revenues by a few points. Is that right, kind of all-parking it?

Nick Hawkins (CFO)

Yeah. Yeah. You'd expect it to be growing this year, albeit we will not have the audit. So the audit benefits that we had this year, we will not get next year. Or sorry, in 2024, we're not expecting we're not predicting or forecasting that we'll get them in our guidance. But in reality, yeah, we may well get those again.

Hans Mosesmann (Managing Director)

Great. Then the last question.

Nick Hawkins (CFO)

So the total should be increasing.

Hans Mosesmann (Managing Director)

Okay. Perfect. And then the last question, and I'll let somebody else ask a question. You guys have been kind of sharing with investors that in the automotive space, SoCs per vehicle could be over 20 over, say, 2026-2027 timeframe. Is that still kind of a good number to kind of talk about with investors, number of SoCs per vehicle?

Charlie Janac (CEO)

Yes. The number's still good. But for example, this is public information. If you were to pay attention to, for example, the Mobileye booth at CES in January, they were showing basically automated driving control boards that not only had two SoCs in there, but also three and four, right? So we feel pretty comfortable with the projected 23 SoCs per car number, but it could be more. And on the other hand, there's some SoC consolidation where people are trying to consolidate driver management, dashboard control, and things like this. So I think the low- to mid-20s number, it remains to be good.

Hans Mosesmann (Managing Director)

Excellent. Thank you very much.

Operator (participant)

Thank you. Once again, should you have a question, please press the star followed by the one on your telephone keypad. And your next question comes from the line of Kevin Garrigan from WestPark Capital. Please go ahead.

Kevin Garrigan (Equity Research Analyst)

Yeah. Hey, good afternoon, all. Thanks for letting me ask a question. So just kind of going off of Hans's question, Charlie, in your script, you know that you're seeing an acceleration in AI and automotive. And then you just kind of mentioned Mobileye going ahead with adding multiple SoCs to their chip designs. Are automotive OEMs and automotive-related companies still continuing with new chip designs? Are you seeing any push-outs there? And then just kind of wondering how you're viewing the automotive market in 2024?

Charlie Janac (CEO)

Yeah. So there's an increasing number of car OEMs building chips. So I think out of 35 OEMs, I think we have nine as customers. Ultimately, it's not clear to me that all those projects are going to go to production because I think all the car companies need to understand architectures and the cost structures of automated driving. But at the end, some of the people like Mobileye have just a huge momentum and huge critical mass in actually getting a mission-critical solution like that into the market. But clearly, all the car OEMs, in order to be competitive, are doing some electronic design work, which provides an opportunity for Arteris. And yes, so our design win rate in automotive continues to be quite positive.

Kevin Garrigan (Equity Research Analyst)

Okay. Perfect. Perfect. And then just as a quick follow-up, just a clarification. The four active customers in the quarter, were these all new customers and customers that were using internal solutions that shifted to using Arteris?

Charlie Janac (CEO)

So there's actually two numbers. They just happen to be the same. So in the fourth quarter, we added four net new customers, right? And some of those were startups. Some were big companies. We also added in the year we have a list of basically top 20 semiconductor companies and top 20 system houses. And all of those were mainly internally focused. So they made their own internal system IP. And four of those companies have decided to go with Arteris. So the whole thesis of this system IP market is that you have maybe 30% of the market to be commercial and two-thirds being internal. And the thesis is that over the next four orfive5 years, the market will go two-thirds commercial and one-third internal. And that provides a major opportunity for people like Arteris. But a lot of these companies are starting slowly, right?

We're getting sort of beachhead deals. We're getting to know those large customers. We're getting to negotiate contracts with them. And then we're wanting to do a good job so that they feel comfortable ordering more based on the success of the initial projects.

Kevin Garrigan (Equity Research Analyst)

Okay. Perfect. I appreciate that. Thanks, guys.

Operator (participant)

Thank you. That concludes our question-and-answer session. I will now turn the call over to Charlie Janac for closing comments.

Charlie Janac (CEO)

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

Operator (participant)

Thank you. That does conclude our conference for today. Thank you all for participating. You may all disconnect.