Title

Presentation

Arteris, Inc. misses on earnings expectations. Reported EPS is $-0.18 EPS, expectations were $-0.17. Arteris, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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 sole property and copyright of our 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 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 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: 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 also trialing 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, 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 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, 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 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 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 our 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 five base device that offers a scalable architecture, high throughput and low power consumption, effectively shrinking an entire base station onto a single SoC.

SCALINX is another innovator in communications infrastructure, which is 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 rectification, 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 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 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 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 general AI and autonomous driving. With that, I’ll turn it over to Nick to discuss our financial results in more detail.

Nicholas Hawkins: 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?

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Operator: Thank you. [Operator Instructions] Your first question comes from the line of Matt Ramsay from TD Cowen. Please go ahead.

Matthew Ramsay: 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. 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? Thanks.

Karel Janac: 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 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 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: Hi 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 nothing gets better, it also seems something gets worse, obviously, that impact would be approximately double that at $4 million headwind.

Matthew Ramsay: Thank you both for that, and thanks, Nick, for the numbers. 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 to first look, to things seem like things have been pulled in a little bit on free cash flow breakeven, which is great to see? Thanks.

Nicholas Hawkins: Yes. It’s always – free cash flow is always going to a bit of a variable fees, 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 going 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 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.

Matthew Ramsay: Got it. That’s helpful. Just my last follow-up there, and 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: So, I think on the non-GAAP OpEx that was fully ratable. It’s harder to change – to shift the needle on 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: No, that does. 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. Thank you very much, guys. Congrats. I will jump back in queue.

Karel Janac: Thanks, Matt.

Operator: Thank you. And your next question comes from the line of Hans Mosesmann from Rosenblatt. Please go ahead.

Hans Mosesmann: Hi, thanks. Hi guys. Good evening. And congrats on the execution. Hi. Charlie, or Nick, ASPs for licensing? What is that trend? How is that looking as we go into 2024?

Karel Janac: 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: Great. And you may have mentioned this, and I apologize. I’ve been traveling. What were royalties as a percentage of revenues?

Nicholas Hawkins: Yes. Let me take that…

Karel Janac: The next question.

Nicholas Hawkins: Yes. Let me take that one, that. 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. Its 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 group.

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 – included in our guidance any audit benefits, any audit pickups, even though they may well happen. So, we’re seeing at least maintain the same rate of growth 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: 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 parting [ph]?

Nicholas Hawkins: 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 – oh 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: 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: 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 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 [ph] and Dashboard control and things like this. So I think, the low to mid-20s number is – it remains to be good.

Hans Mosesmann: Excellent. Thank you very much.

Operator: Thank you. [Operator Instructions] And your next question comes from the line of Kevin Garrigan from WestPark Capital. Please go ahead.

Kevin Garrigan: Yes. Hi, good afternoon all. And thanks for letting me ask a question. 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 doing the automotive market in 2024?

Karel Janac: Yes. So there’s an increasing number of car OEMs are 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 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: 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?

Karel Janac: So there’s actually two numbers. They just happen to be the same. So in the fourth quarter, we added four new 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 – 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 or five 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? 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.

Kevin Garrigan: Okay, perfect. I appreciate that. Thanks, guys.

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: 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 all 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.