Arteris Inc

NASDAQ:AIP

Earnings Call Analysis

Revenue Growth and Future Financial Outlook

In 2023, revenue rose by 7% to $53.7 million, with a non-GAAP net loss of $21.6 million. Cash, cash equivalents, and investments ended at $53 million. Cash flow from operations was negative at $15.7 million, with a free cash flow of negative $17.2 million. Looking ahead, 2024 revenue is projected to range from $54.5 to $57.5 million, an up to 16% increase from 2023. The company anticipates free cash flow neutral to positive and becoming cash flow positive in 2024 with non-GAAP cash flow margins between negative 5% and positive 5%. The situation in China is expected to stabilize with a $2 million impact from 2023 headwinds. Long-term, non-GAAP profitability is expected as the company exits 2025 and moves into 2026.

Finishing 2023 Strong: Record Customer Activity and Expanded Reach

The company wrapped up the year with a distinct upward trajectory in key areas of business. They attained an annual contract value of $56.1 million after a year-end boost from trailing 12-month variable royalties. Customer acquisition remained strong with 23 new customers integrated over the year, bolstered by an addition of 4 during the last quarter. This growth spanned critical sectors such as Automotive, Enterprise, Consumer, and Communications. The company's SoC (System on Chip) design complexity has heightened, pushing its customer base to increasingly rely on the company's commercial system IP solutions. This demand was evidenced by a record number of license deals and 95 new chip-design starts throughout the year, demonstrating a commitment to innovation and resilience amidst complex macroeconomic challenges.

Robust Portfolio and Diverse Revenues: A Shift Towards Broader Applications

Loyalties from past design wins have solidified into an ascending revenue stream for the company, with royalties growing by 32% from the previous year. Now, their royalty base has diversified beyond consumer applications into a broader range involving Automotive, Consumer Electronics, and Enterprise Computing, thereby reducing reliance on any single industry. Over half of the license deals in the quarter were related to AI/ML (Artificial Intelligence/Machine Learning), testifying to the company's steady push into burgeoning tech spaces. Successful engagements, such as with Rain AI for edge AI accelerators, HQ for a 5G base station chip, and Eyenix for modem SoCs, further underscore the company's pivotal role in tech innovation.

Commitment to Safety and Quality: Recognitions and Certifications

Strategic focus areas like Automotive, recognizing the value of integration with AI-enabled systems, have spurred the company to obtain key certifications. The ISO-2626 certification for their interconnect IP and the ISO-26262 TCL1 certification for their integration automation software cement the company's devotion to mission-critical safety applications. To top it off, recognition such as the Autonomous Vehicle Technology of the Year Award by AutoTech breakthrough and ISO 9001 Quality and Management System Certification consolidated its reputation for product and process excellence.

Financial Vigor and Strategic Optimism Amid Headwinds

Financially, the company showed resilience with fourth-quarter revenue reaching $12.5 million, a year-over-year uptick of 12%, and RPO (Remaining Performance Obligations) surging to a record $72.7 million, denoting a substantial 26% growth. Margins remained strong with GAAP and non-GAAP gross profit at 88% and 90% respectively. Nonetheless, the company remained watchful of macroeconomic uncertainties and the impacts of geopolitical issues on businesses, especially in China. Despite these concerns, there’s a strong belief in the robustness of the long-term opportunity backed by a steadfast product pipeline and collaborations with leading electronics companies.

A Forward-Looking Approach: Financial Outlook and Free Cash Flow

Looking ahead, the company has its sights set on performance milestones. For the first quarter of 2024, they anticipate ACV plus trailing 12-month variable royalties between $55 million and $59 million and non-GAAP operating loss margins to be in the range of 41% to 61%. The full-year outlook is even more promising, with expected annual growth of 16% at the midpoint for ACV and variable royalties. Revenue is projected to be between $54.5 million and $57.5 million, with non-GAAP operating loss margins improving to 33% to 43%, and non-GAAP free cash flow margins estimated to be between -5% to +5%. The company's strategic measures in 2023 are driving towards a future of free cash flow positivity in 2024.

Earnings Call Transcript 2023-Q4

[Operator]

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 sold property and corporate of Arteris, Inc. 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]

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 are tariffs issued today and in the documents and reports filed by our tariffs from time to time with the Securities and Exchange Commission. Please note, during this call, we will state 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. Our non-GAAP measures are presented as we believe they provide investors with the 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.

[Karel Janac, executive]

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 post Trailing 12-month variable royalties of $56.1 million. We added 4 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 towards 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 4 new major semiconductor and system house companies, as customers during the year. Not only are we seeing growth in a number of our customers, 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 version 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 loyalty base for our tariffs, 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 the 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 to 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, heard 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, HQ, a leading innovator in 5G and AI technologies has licensed Arteris FlexNoC for use in its comprehensive, multi-mode 4G, 5G base station chip. It is a risk [indiscernible] based device that offers a scalable architecture, high throughput and low power consumption, effectively shrinking an entire base station onto a single SoC.

Eyenix is another innovator in communications infrastructure, which is licensed both our ENCORE and FlexNoC interconnect IPs for use in their next-generation modem SoC, with the aims to provide [indiscernible] 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 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 Encore Cash Coherent interconnect IP has achieved ISO-2626 certification.

A key milestone to ensure safe technology is incorporated into modern vehicles and other autonomous systems. Similarly, our Magillem SoC integration Automation Software also received its ISO-26262 TCL1 functional safety certification, further expanding upon Arteris's ongoing commitment, to support mission-critical safety applications.

The 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 and Management System Certification, further supporting customer confidence in our commitment to product and process quality. Currently, certain macroeconomic dynamics, including geopolitical uncertainties and the US 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 general AI and autonomous driving. With that, I'll turn it over to Nick to discuss our financial results in more detail.

[Nicholas Hawkins, executive]

Thank you, Charlie, and good afternoon, everyone. As I review our fourth quarter and full year results today, please note that 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 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 now to 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 negative $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 basically 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 to $59 million and revenue of $12.1 million to $13.1 million, with non-GAAP operating loss margin of 41% to 61%. And non-GAAP free cash flow margin of negative 9% to positive 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 to $68 million, up 16% year-over-year at the midpoint. Revenue of $54.5 million to $57.5 million, non-GAAP operating loss margin of 33% to 43%. And non-GAAP free cash flow margin of negative 5% to positive 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 the 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 for questions. Operator?

[Operator]

[Operator Instructions] Your first question comes from the line of Matt Ramsay from TD Cowen.

[Matthew Ramsay, analyst]

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. And I'm just trying to get an idea of -- if the environment has improved at all, the headwind it 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?

[Karel Janac, executive]

Yes, Matt. So yes, 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 and 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 they are designing SoCs. And so we anticipate that we'll -- the situation in China will be stable going forward. It might get better planning -- we're planning on stability.

[Nicholas Hawkins, executive]

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 piece, 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 nothing gets better, it also seems like something gets worse, obviously, that impact would be approximately double that at $4 million headwind.

[Matthew Ramsay, analyst]

I guess as 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 breakeven. I think our team had been assuming sort of free cash flow breakeven, second half of '24 and maybe non-GAAP breakeven second half of '25, 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 seems at first look to things seem like things have been pulled in a little bit on free cash flow breakeven, which is great to see.

[Nicholas Hawkins, executive]

Yes. It's always -- free cash flow is always going to a bit of a variable piece, 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 '23, with -- to the tune of a few small number of millions of dollars. Where they're paid early, again, and I don't know why they do this, but they do. .

The -- nevertheless, we're still gunning for free cash flow neutral, slightly to slightly positive for FY '24. You've obviously also noticed that we're gunning for -- or we're guiding for free cash flow neutral in the first quarter. But not all quarters are created equally. The second quarter and the 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. So really, at the moment, we're at that stage where we might see a sort 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.

[Matthew Ramsay, analyst]

Got it. That's helpful. Just my last follow-up there and it kind of piggybacks on that prior question is second half of '25, we're still thinking about non-GAAP breakeven and second half of '26, the plan would still be for GAAP breakeven. Is that still on track? Or has that moved up maybe a hair as well?

[Nicholas Hawkins, executive]

So I think on the non-GAAP OpEx, that was fully ratable. It's harder to change -- to shift the needle on the revenue. We do expect to break the seal on non-GAAP profitability. As we exit '25 and enter '26. So the full year '25, 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 positive -- 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 see -- we enjoy the benefits of that through 2026. Does that make any sense to answer your question?

[Matthew Ramsay, analyst]

No, Nick, that's -- obviously, we're looking at decent ways out here, given the macro. So I appreciate that color. And yes, it does answer the question.

[Operator]

And your next question comes from the line of Hans Mosesmann from Rosenblatt.

[Hans Mosesmann, analyst]

Congrats on the execution. Charlie, or Nick, ASPs for licensing? What is that trend? How is that looking as we go into 2024?

[Karel Janac, executive]

So in -- we've announced FlexNoC 5 in -- started shipping 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 to 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 still -- we're tracking to that. So the ASPs are rising well, driven by essentially new functionality that we're delivering to the marketplace, to address the complexity of some of these generative AI and Automotive SoCs.

[Hans Mosesmann, analyst]

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

[Nicholas Hawkins, executive]

Yes. Let me take that ...

[Karel Janac, executive]

The next question.

[Nicholas Hawkins, executive]

Yes. Let me take that one [indiscernible]. So if I can give you the numbers, it's probably easier. I mean, royalties come in at around sort of 10%, but the -- of total -- but if you look at '22, for example, we had total royalties and other of 4.3%. But if you strip out the other, which is really just -- it has 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 reported, it was $3.1 million in 2022. If you look at '23, 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 a big tailwind from loyalty audits. If you strip out those and you just get back to pure, pure available 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 '24. And there's no reason why that shouldn't continue into -- we don't actually project any sort of other royalty -- other revenue. We don't project or guide -- include in our guidance any audit benefits, any audit pickups, even though they may well happen. So we're seeing at least maintain the same rates of both royalties and may be increasing. So look at $5 million, $5.3 million total versus $53 million. So it's about 10% of total revenue. So very round about where I'm answering the question. And we're getting some color in the middle of, I hope you don't mind.

[Hans Mosesmann, analyst]

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 -- Is that right kind of [indiscernible] ?

[Nicholas Hawkins, executive]

Yes. You'd expect it to be growing this year, albeit we won't have the audit. The audit benefits that we had this year, we will not get next year -- sorry, we made in '24, we're not expecting -- we're not predicting or forecasting that we'll get them in our guidance. But in reality, yes, we may well get those again.

[Hans Mosesmann, analyst]

Okay. Great. Perfect. And then 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, you say, like 2026 to 2027 time frame. Is that still kind of like a good number to kind of talk about with investors, a number of SoCs were per vehicle?

[Karel Janac, executive]

Yes. The number is 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 2 SoCs in there, but also 3 and 4, 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 [indiscernible] Dashboard control and things like this. So I think the low to mid-20s number is -- it remains to be good.

[Operator]

[Operator Instructions] And your next question comes from the line of Kevin Garrigan from WestPark Capital.

[Kevin Garrigan, analyst]

So just kind of going off of Hans' question, Charlie, in your script, you know that you're seeing an acceleration in AI and Automotive. I know you just kind of mentioned Mobileye going ahead with adding multiple SoCs to their chip designs. Our Automotive OEMs and Automotive-related companies still continuing with new chip designs? Are you seeing any pushouts there? And then just kind of wondering how you're viewing the Automotive market in 2024?

[Karel Janac, executive]

Yes. So there's an increasing number of car OEMs are building chips. So I think out of 35 OEMs, I think we have 9 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 just 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, our -- so our design win rate in Automotive continues to be quite positive.

[Kevin Garrigan, analyst]

Okay. Perfect. Perfect. And then just as a quick follow-up, just a clarification. The 4 active customers in the quarter, were these all new customers and customers that were using internal solutions that shifted to using Arteris?

[Karel Janac, executive]

So there's actually 2 numbers. They just happen to be the same. So in the fourth quarter, we added 4 net new customers, right? And those -- some of those were start-ups, 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 4 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 be commercial and 2/3 being internal. And the thesis is that over the next 4 or 5 years, the market will go 2/3 commercial and 1/3 internal, and that provides a major opportunity for people like Arteris. But A lot of these companies are starting slowly, right? So 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.

[Operator]

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

[Karel Janac, executive]

Yes. So thank you for your time and interest in Arteris. We look forward to meet with you at the upcoming investor conferences, that we are participating in, during the next couple of weeks and months. And we look forward to updating you on a lot of our business progress in the quarters to come. So thank you very much for your attention.

[Operator]

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