Earnings Call Transcript - AIP Q3 2024

Operator, Operator

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 the webcast is the sole 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, Investor Relations

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 third quarter ended September 30, 2024. Nick will review the financial results for the third quarter, followed by the company's outlook for the fourth quarter 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 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 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 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.

Charles Janac, CEO

Thank you, Erica, and thanks to everyone for joining us on our call today. In the 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 the third quarter was primarily driven by increasing adoption of our technology by our current customer base. As an example, a top 5 global technology company increased their deployment of Arteris products to enable the development of their high-end AI chiplets and SoCs. This expanded engagement provides our customers with wider 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 scheduling. This is yet another example of our continued success in accelerating automotive electrification and autonomous driving with over 9 car manufacturers 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 SoCs, then starting for the next generation of chiplet-based AI solutions and VeriSilicon for HPC data center SoCs. The majority of the new designs in the 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 license deals in dollar terms this 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 and 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 our Arteris Ncore IP extensions for our customers. Additionally, we announced a partnership with Andes Technologies to accelerate RISC-V SoC adoption and are pleased to have been named by them as a 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 with large customers appears to be paying off. In dollar terms, the majority of our license 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 with 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 often produce large volumes. As microcontrollers are used to control the operational 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 remains 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 are 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 0 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 4 of the presentation, total revenue for the third quarter was $14.7 million, up 11% year-over-year and at the midpoint of our guidance range. At the end of the third quarter, annual contract value or ACV plus 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 5, 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 was $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 6 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 7. For the fourth quarter of 2024, we expect ACV plus royalties of $63 million to $67 million; revenue of $14.7 million to $15.7 million with non-GAAP operating loss of $5 million to $4 million and non-GAAP free cash flow of negative $0.9 million to a positive $1.1 million. For the full year 2024, our guidance is as follows: ACV plus royalties to exit 2024 at $63 million to $67 million, up over 16% year-over-year at the midpoint, unchanged from the prior guidance. Revenue of $56.9 million to $57.9 million, increasing the midpoint of our guidance by $0.4 million. Non-GAAP operating loss of between $17.1 million to $16.1 million, improving the midpoint of our guidance by $3.4 million. And non-GAAP free cash flow of positive $0.7 million to positive $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, resulting 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

Our first question comes from Joshua Buchalter at TD Cowen.

Joshua Buchalter, Analyst

Congratulations on your solid results amidst a challenging environment. This earnings season has been quite intriguing, with positive developments in the Chinese auto market while the rest of the world shows weakness. Could you take a few minutes to discuss how, in a situation where China continues to gain market share globally, this affects you? Is it a positive development or does it pose challenges for your business? Mobileye, one of your main customers, seems to be losing share in that market, and there are also many local competitors enhancing their semiconductor offerings where you've established partnerships. I would be interested in your perspective on this situation and its implications for your business.

Charles Janac, CEO

So, yes, I mean, this sort of automotive disruption is kind of difficult to predict, right? And so our strategy has been to be in as many projects as we can capture. We are in start-ups, automotive car manufacturers, and Tier 1s. Regardless of market share shifts, our efforts should benefit. But 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 are a number of others. From Arteris' perspective, it doesn't make a whole lot of difference. However, the Chinese have put a significant effort into 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 likely to impose some protective barriers, right? I don't know how much the market share is going to shift, but the electric car in China is going to be, eventually, the predominant technology.

Nick Hawkins, CFO

Can I add a bit more detail to Charlie's insightful comments, Josh? As you mentioned, we have a very limited number of Chinese auto OEMs whose names we can use, but you recognized most of the ones we could disclose. Some of the ones we can mention are Black Sesame, Horizon, and SemiDrive; all of which are significant players in that sector. Unfortunately, there are many others we cannot name. Regarding Mobileye, that's a great question. Mobileye is encountering some challenges, particularly in China, but remains a strong contender in the market with an impressive range of products. We have experienced some negative impacts on our royalties due to Mobileye's lower shipments in the first and second quarters, although this began to improve in the third quarter. Nevertheless, the decline in royalties from Mobileye in comparison to our earlier expectations has had less than a 1% effect on our overall revenue for the year, so it is not as severe as it may seem.

Charles Janac, CEO

If I may add, in terms of Mobileye, Mobileye is not going anywhere. They are designed into several very impressive vehicles and are going to continue to be the leader despite short-term headwinds or those kinds of things. We believe Mobileye will do well in this market because of their superior software technology.

Joshua Buchalter, Analyst

Thank you both for all the color there. To follow up and move away from the auto space, 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 the contribution today? And maybe what that funnel can look like over the next year or so as you diversify the revenue base?

Charles Janac, CEO

Yes. 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 we discussed on the earnings call is that we are also moving into the microcontroller market. Microcontrollers have become sophisticated enough that at least the mid-range to upper range of the microcontroller market can benefit from our system IP technology. This opens up an additional segment, so we're quite excited about that. We are also excited about our strong product pipeline for next year. Therefore, we continue to be prudent but optimistic.

Nick Hawkins, CFO

Yes. One thing I would just add to that, Charlie, is that as you can see 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 30s percent of total revenue and is growing quite nicely. A lot of this is driven by 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 horizontal. That contributes to about 40% of total revenue but that goes across all our verticals, as you probably know; so some interesting dynamics are going on there.

Operator, Operator

Your next question is from Kevin Garrigan from Rosenblatt Securities.

Kevin Garrigan, Analyst

Let me add 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? I think you guys had mentioned the average time from licensing to production for automotive is about 2.5 to 3 years. Are you seeing these Chinese customers looking to accelerate that timeline?

Charles Janac, CEO

Yes. We are seeing design activity throughout the world, right? People are building chips for the 2030 automotive model year, right? People typically try to design their way out of recessions. Even when there's shipment volume impact, the impact on the design activity from our perspective, at least doesn't seem to be great. Certainly, the Chinese design activity is robust, but there are also a number of designs that are being done in the U.S. and in Europe.

Kevin Garrigan, Analyst

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

Charles 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. 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. This would 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. However, if you bundle everything together, then essentially things will improve.

Kevin Garrigan, Analyst

Yes. Okay. Yes, that makes sense. And then just last one, if I could. And congrats on the announcement of the NoC Tiling. How is customer feedback been for this product?

Charles Janac, CEO

Well, that particular product is just coming out. People have been asking for that for a long time. We are finally starting deliveries. We have a significant number of customers waiting for it because what it does is the AI sections are complicated. Customers want to design a certain section, get it verified, and then replicate it across the chip to build larger clusters out of these tiles—that's why it's called Tiling. This is built at the request of our AI customers, and we think the reception is going to be very good. We've had many requests for it, but the orders and revenue impact will probably not start until next year.

Nick Hawkins, CFO

Kevin, this is Nick. Just a little bit of extra color. I didn't want to interrupt Charlie midstream. But regarding the MCUs question, it is definitely a new incremental product area for us to an extent. However, we have had some history in MCUs in the past. While I can't name the customer, it's a very large U.S. top semiconductor company, and the volumes we have, this is actually for a Bluetooth application, were very significant. The royalties also out of that were substantial, which gives you an understanding that we have visited this space before but are emphasizing it much more now.

Operator, Operator

Your next question is from Gus Richard from Northland.

Gus Richard, Analyst

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 ASPs you're involved with now or how many of the top 30 tech companies that design chips you're involved with?

Charles Janac, CEO

Yes. We've created our own Top 10 index, the Top 30 index by market cap, right, of technology companies. Out of those 30, about 15 are designing chips, about half of them at the moment. Basically, 10 out of the 30 are using Arteris for something.

Gus Richard, Analyst

Got it. You had a large deal with one of the top 5 tech companies to expand the use of your products, correct?

Charles Janac, CEO

Correct. This would be one of the large hyperscalers, yes.

Gus Richard, Analyst

And Nick, for you, I calculate your bookings from cash flow are on the order of $23 million to $24 million. Am I in the right ballpark?

Nick Hawkins, CFO

Close. I think that's a good blended average between the 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 a reasonable third quarter and a weaker fourth quarter in terms of bookings. This year, it's back to normal, a decent third quarter but a much stronger fourth quarter. So the number you quoted there is kind of an average between the two.

Gus Richard, Analyst

Between Q3 and Q4?

Nick Hawkins, CFO

Yes, exactly—Q3 and Q4.

Gus Richard, Analyst

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

Charles 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, Analyst

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

Nick Hawkins, CFO

Not yet, no. It's more of an early access, so revenue will follow in due course.

Operator, Operator

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

Charles Janac, CEO

Well, thank you, everyone, 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 months, and we look forward to updating you on all of our business progress in the quarters to come. So thank you.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.