Arteris, Inc. (AIP) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to the Arteris IP First Quarter 2022 Earnings Call. All material contained in the webcast is the sole property and copy of Arteris IP with all rights resolved. For opening remarks and introductions, I will now turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead.

Thank you, and good afternoon. With me today from Arteris IP 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 first quarter ended March 31, 2022. Nick will then review the financial results for the first quarter, followed by the company's outlook for the second quarter and full year of 2022. 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 the 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 and uncertainties and factors that could cause actual results to differ appear in the press release, Arteris IP issued today and in the documents and reports filed by Arteris IP 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. These non-GAAP measures are presented as we believe that 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 March 31, 2022. In addition, for a definition of certain key performance indicators used in this presentation such as annual contract value, design starts, active customers and remaining performance obligations, please see the press release for the quarter ended March 31, 2022. Listeners who do not have a copy of the press release for the quarter ended March 31, 2022 may obtain a copy by visiting the Investor Relations section of the company's website. Now I'd like to turn the call over to Charlie.

Thank you, Erica, and thanks to everyone for joining us on the call this afternoon. We're excited to report a strong first quarter to start 2022 with annual contract value plus trailing 12-month royalties of $52.8 million, up 26% year-over-year. Demonstrating our continuing momentum, our active customers increased by 7 new system IP customers in the quarter. Total customer design starts in the quarter were 19 SoC projects. Major new customer deals, including IP licenses to Cambricon, Rapid Silicon and Socionext. Cambricon selected our Arteris IP NoC interconnect solution based on our strong technology track record for automotive machine learning applications. We also signed a key new deal with a major ridesharing company in the quarter and announced that BMW licensed Arteris IP for a neural network accelerator project. Additionally, Sondrel deployed Arteris IP for their next-generation automotive AI/ML SoCs. We believe these relationships underline that SoC creation is occurring at all stages of the automotive supply chain from semiconductor companies to Tier 1 vendors, automotive OEMs and ridesharing companies as electrification, automated driving and ECU consolidation revolutionize the industry. Besides the progress in automotive, we also continued the strong momentum in AI/ML, consumer electronics, enterprise and 5G communication market segments. We continue to close new deals addressing AI/ML technology during the first quarter across numerous verticals. The market for machine learning at the edge continues to be promising with continued addition of new customers and a broad range of applications. On the product front, in the first quarter, we continued our strong investment in engineering new system IP products and are confident that we will continue our multiyear track record of delivering at least 1 new major system IP product in 2022. Democratization of SoC design as well as disintermediation of the semiconductor supply chain, we believe, is driving a strong need for automation of system IP solutions in order to compensate for a shortage of SoC architects and skilled interconnect IP engineers. While we are seeing strong demand for our products, we're also seeing worldwide inflationary pressures in terms of employee compensation and service provider pricing. As we discussed in our prior conference call, we are seeing the regionalization of the semiconductor industry. However, the troubling events in Ukraine are driving the United States and Europe together into a more cohesive block than previously predicted. I should mention that Arteris IP has no current exposure to either Ukraine or Russia. We believe that it is important, however, for Arteris IP to continue to expand its multiregional presence in order to be a global system IP provider. Lastly, in the first quarter, we continued to strengthen our management team by adding Michal Siwinski as our Chief Marketing Officer. Michal joins us following a 22-year career at Cadence Design Systems, including leadership roles in product strategy, solutions and customer engagement, culminating as a Corporate Vice President, Marketing and Business Development. With Michal's addition, we now have a complete top management team with significant public company experience for our next stage of growth. With that, I'll turn it over to Nick to discuss our financial results in more detail.

Thank you, Charlie, and good afternoon, everyone. As I review our first quarter 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 first quarter was $11.8 million, up 77% year-over-year. As a reminder, those of you who are new to the Arteris IP story, our revenue is derived from licensing intellectual property, licensing software, software and maintenance services, providing professional services, training services and royalties. Given the variation in revenue recognition methodologies between our product offerings, as a management team, we focus on annual contract value, or ACV, as a leading indicator of financial performance. We define ACV for an individual customer agreement as the total fixed fees under the agreement also referred to as the TCV, or total contract value, divided by the number of years in the agreement term. As this calculation does not include the contribution from royalty payments, we also referred to ACV plus trailing 12-month royalties as a metric, which provides a more complete picture of our total revenues. We monitor this metric to measure our success and believe that the historical increase shows our progress in expanding our customers' adoption of our solutions. At the end of the first quarter, ACV plus trailing 12-month royalties and other revenue was $52.8 million, up 26% year-over-year driven in particular by growth in automotive, AI/ML, consumer electronics, enterprise and 5G communication market segments and up 5% quarter-over-quarter. Remaining performance obligations, or RPO, was $60.5 million, up 28% year-over-year as of March 31, 2022. We define RPO as the amount of contracted future revenue. Gross profit in the quarter was $10.9 million, representing a gross margin of 92% and compared to $5.8 million or 87% in the prior year period. R&D expense for the first quarter was $8.2 million or 70% of revenue compared to $6.3 million in the prior year period. The increase was primarily driven by additional head count in our 4 R&D centers and payroll expense as we continue to invest in developing new and improved product offerings. Sales and marketing expense for the first quarter was $3.6 million or 31% of revenue compared to $2.4 million in the year ago period. We continue to invest in sales and marketing as we work to continue to drive awareness of the benefits of our solution in the market and expand our sales and application engineering force and marketing efforts to harness the significant potential in front of us. G&A expense for the first quarter was $3.2 million or 27% of revenue compared to $3.0 million in the year ago period. G&A reflects an increase in people and infrastructure-related expenses associated with our transition to being a public company. Operating loss for the first quarter was $6.6 million or 56% of revenue compared to a loss of $6.4 million in the year ago period. Non-GAAP operating loss was $4.2 million or 36% of revenue compared to a loss of $5.8 million in the year ago period. Net loss for the quarter was $6.8 million or net loss per share, basic and diluted, of $0.22. Non-GAAP net loss for the quarter was $4.4 million or net loss per share, basic and diluted, of $0.14 based on approximately 31.6 million weighted average diluted shares outstanding. As a reminder, our IPO lockup expired on April 25, 2022. When the lockup expired, former employees, current employees and other stockholders held approximately 9.8 million shares, which are no longer subject to the lockup and can be freely sold subject to normal restrictions, such as having material nonpublic information, or MNPI. Additionally, current and former employees and directors held approximately 8.3 million shares when the lockup expired that are either subject to outstanding options or reserve for future issuance pursuant to restricted stock unit grants as part of our employee incentive programs. These shares, assuming they satisfy the various vesting conditions can also be sold subject to normal restrictions. Turning to the balance sheet and cash flow. We ended the quarter with $82.2 million in cash. Cash flow used in operations was $1.4 million in the quarter while free cash flow, which includes capital expenditure was negative $1.5 million. I would now like to turn to the outlook for the second quarter and the full year 2022. For the second quarter, we expect ACV plus trailing 12-month royalties of $49.5 million to $51.5 million and revenue of $11.5 million to $14.5 million with non-GAAP operating loss margin of 19.4% to 34.4% and non-GAAP free cash flow margin of negative 29.4% to negative 44.4%. For the full year, we expect ACV plus trailing 12-month royalties of $51.6 million to $55.6 million and revenue of $48 million to $52 million, representing an increase from the prior guidance of $47 million to $51 million. Non-GAAP operating loss margin of 24.9% to 39.9% similar to prior guidance of non-GAAP operating loss margin of 25.6% to 40.6%, reflecting the impact of wage inflation on our operating expenses, and non-GAAP free cash flow margin of negative 10.5% to negative 25.5%, similar to prior guidance of negative 10.9% to negative 25.9%. With that, we'll open up the call for questions. Over to you, operator.

[Operator Instructions] Our first question is from Matt Ramsay with Cowen.

This is Josh Buchalter on behalf of Matt. Congrats on the results. First thing I wanted to ask about was the guidance. It calls for a sequential decline of ACV plus trailing 12 months royalty revenue. Obviously saw that you maintained the full year guidance, but I was wondering what would normal seasonality look like. And was there any impact in the short term related to China shutdowns, whether a contract signed at customers or royalty shipments?

Yes. Let me take that one. This Nick here. It's a great question. I mean you already know because we've spoken to you many times that we have a headwind in Q2, which is already sort of built into our prior guidance. But just so everybody else knows who's not familiar with this, but there was a very substantial deal with HiSilicon in May of 2019, the end dates in this month. That creates a sort of a headwind of around $3.3 million in Q2. That's not something new, but it is a headwind, nevertheless. The other point you make, which is the -- a slight decline in ACV guidance for Q2 plus royalties is 2 things really. One is, as you know, we do have a little bit of seasonality with our IPD business. And generally, our sort of bookings as well. And sometimes, we can end up with a big deal falling into the end of 1 quarter or the beginning of another quarter. We are seeing a few Chinese deals, for example, falling out of the end of June into the beginning of July, and that creates sort of an instant ACV hit, which then picks back up again the next quarter, which is why you're seeing the full year not moving. The second issue is the royalties, the TTMR, part of ACV plus TTMR. We are seeing supply chain constraints hitting our customers no less. Obviously, it's hitting our customers. And this is everything from sort of fab capacity, generally foundry capacity, and things like noble gases, which are constrained by Russia. And that's reducing our customers' ability to ship volumes and that then puts a dent in near-term royalties that won't impact longer-term royalties, but it does impact the near term. Does that sort of give a fulsome answer to the question?

Yes, that was perfect. I appreciate all the color there. And then for my follow-up, all throughout this earnings season and frankly, the past several, we've heard about supply constraints impacting auto units. That said, there's clearly an improving mix of premium in [ SUVs ], which come with the associated increase in semiconductor content. I was wondering if you could help us parse out this net exposure from both the mix shift to higher semis content versus lower overall unit and how this result -- how this impacts your overall near-term results, but more importantly, long term, given the increased complexity of SoCs that are going into vehicles?

Yes. I mean -- this is Charlie. I'll take that one. So the automotive business continues to be robust. We're not seeing any slowdowns in design cycles. There are more members of the -- or more participating companies of the automotive ecosystem that are designing SoCs and those -- these are increasingly complex. So that all favors our tariffs as far as we can see. The only sort of headwind that could arise is that the semiconductor manufacturing capacity constraints could impact royalties. But people are building fabs at pretty robust rate. And we think that the constraints in the semiconductor manufacturing are going to be over at some point. We don't know exactly when, but could be second half of this year, could be early next year. But there's just a lot of very interesting design activity that's taking place and the automotive chain is one of the -- one of the things that looks particularly promising. I should also add that we're going to see an increase in military spending, and that may also translate into additional SoC design starts.

Yes. Just one additional comment, this is Nick, on the automotive side on the kind of more of the longer term. You may remember that we published some data, some third-party data, that talk exactly about the issue you're referencing there, which is the number of SoCs per vehicle is growing from around sort of 3% to 4% in 2020 up to the low 20s, something around 23 per vehicle and this is for sort of L2 plus by 2026. And that is exactly the issue that you're referencing there, but that's more of a longer-term trend. It doesn't really make a massive difference from sort of quarter-to-quarter.

Our next question is from Mark Lipacis with Jefferies.

I don't know for Charlie or Nick. You referenced higher compensation expenses. Is that just in new product development? And I guess, can you talk about how that -- if it's manifesting also in your customers' willingness or eagerness to reach to you guys to help potentially offset that same challenge that they may be having.

So let me take the first half of that. I was going to -- let me take the first half, and then I'll pass over to Charlie for the sort of the more commercial and industrial sort of part of -- the second part of your question, Mark. So I mean, in general, you won't be surprised to hear that we're seeing primary and secondary inflation across, which is 75% of our OpEx roughly is people. And another significant portion is services and services is basically people. And that's happening in U.S., Europe and Asia Pacific, particularly China, and you know what the wage inflation rates are running out, they're pretty high. So we're trying to contain them as much as possible. But there is, without question, sort of upward pressure, which we're seeing. As far as the -- and by the way, it's not just R&D, it's the -- accountants pay more, lawyers have paid more, marketing people have paid more. And it's more difficult, you have to compete harder to get good people. As far as the willingness of our customers, a great question. Willingness of customers to do business with us and whether they want us to share the pain by some sort of cost reduction, I would guess that really as a straight down the wheelhouse. So Charlie?

Yes. Yes, we're not seeing any -- I wouldn't say that we're seeing particular margin pressures on our product. Our products generate a lot of value. They save customers a lot of money. And so we're not seeing price pressure or margin pressure on our products at this time.

And I guess I was tackling this from the standpoint of -- it seemed to me like if your customers are seeing similar wage pressures than given the prices of your licenses that it actually may make it easier for your customers to make a decision, if they're in a make-or-buy decision, that they're seeing the wage pressures and labor shortages they may reach a few more often. And I was wondering if that was manifesting in your pipeline or not.

Yes. I think that's absolutely correct. The fact that our customers are also having difficulty finding some [indiscernible] labor and that labor is expensive for them as well. It basically means that automation is something that is going to get very good reception both near term, medium term and long term, so that it does expand the opportunity for Arteris IP product adoption versus internal solutions.

Our next question is from Hans Mosesmann with Rosenblatt Securities.

Congratulations guys. Good execution. Just a question on the royalty, the headwind. What end market is driving that? Is that wireless, if there is a headwind?

So yes, I mean, I don't know, Nick, if you want to take this or if you want me to take it. But basically, the smartphone royalties have been declining and the automotive royalties have been rising, right? So as sort of the automotive adoption takes place and more of the existing designs make it into cars and get shipped in volume, that will lead the rise of additional royalty revenues. So we think on a long-term basis, we feel pretty confident in our royalty stream as the automotive royalties takeover from the smartphone royalties. And ultimately, there will be some of the machine learning designs, which are quite numerous recently, will actually reach production and start generating volume.

Yes. I mean exactly, you said it right. There are other actually big rising stars in our royalty stream. One is consumer, interestingly. And the other is more sort of industrial, and those are sort of growing very nicely. The HiSilicon that we can actually put a name to it. On the mobility side, has still not declined to 0, but it's getting close, but it is a decline quarter-over-quarter over time. But for sure, automotive remains the mainstay and we're in 35-plus customers, 60-plus designs. And so we have a good spread there across all the different players, different layers, whether it be semiconductor or Tier 1s or OEMs. We have a good spread across all of the [indiscernible] class, all the subverticals as well. So it's a nice position to be in, but we do have broad brush or broad-based royalty streams coming in from other sectors as well.

That's very helpful. And just as a follow-up question, on the BMW win, on the neural network accelerator project, can you comment on who was the competition in that project or projects that are similar to that? Are those in-house efforts? Or are there other players that are kind of coming out there that are challenging you guys with this IT?

Yes. I mean the -- we kind of have 2 classes of competitors. Obviously, one is [ Arm ] and I don't know if there is a competitor on this particular situation. And the other one is internal, right? But I think internal interconnect is becoming increasingly expensive and difficult to develop because of the shortage of interconnect engineers, right? So I think that our main challenge in these kinds of sales cycles is to prove out that we're suitable for the customers acquisition -- for applications for what they're really trying to do. And so that's really the main hurdle that we have to get over for these kinds of designs, but I don't think the competitive situation of Arteris, whether it's on the BMW deal or some other places is it's pretty favorable.

Our next question is from Ambrish Srivastava with BMO.

I had a question on -- Nick, you mentioned seasonality for ACV and TTM royalties. Could you just explain how we should be thinking about it on a go-forward basis? And then the second kind of related question. You talked about China deals moving from end of quarter to the other, is that largely because of the shutdowns, that very well-publicized shutdowns in China? Or is there something else going on there? And then I had a very quick follow-up after that, Nick, sorry.

Well, Ambrish, great to speak with you again. I hope you well. But yes, in terms of the China situation -- or I'll take the -- I'll take them in order. So the seasonality question first. Generally speaking, as you -- as I think you know, the ACV plus TTMR is kind of designed to be something which is relatively steady. It doesn't move around such as sort of point-in-time revenue does and that's part of the reason we adopted it as one of our metrics. It does, however, it can suffer from deals -- large licenses shifting from being signed and actually the software delivered by the end of -- like the last week of a quarter or the first week of the second quarter. And that's usually outside of our control, in fact, it's totally outside of our control because it's -- we're customer-driven. They ask for it on day X, then we provide on day X. If they ask it on a day Y, then it goes on day Y. So the seasonality is still fairly steady. It's always ACV plus TTMR. It always gets a bit of a boost in Q4 because it's a quarter when we have a particularly strong set of bookings. But of course, they get spread over the subsequent years, depending on the contract. The China question is slightly unique. And yes, it is totally a COVID issue because the epicenter of our customers. There's also the epicenter of the COVID shutdown and that has been quite severe. The reaction by the Chinese authorities to this is they really want to stamp it out, and you probably know it's quite difficult for people to get to work and collaborate and what have you. So we have no doubt that those deals have not gone away. They're just maybe taking -- there are literally situations where people cannot get to offices to put their chop on our license. It's as basic as that because in China, the chop is everything you should probably know if you follow of the Arm situation. So anyway, that's what's really moving China around. And the other to just sort of to add a lot -- some color to the color. The revenue, of course, is much more smooth. The GAAP revenue is much more smooth when it's an interconnect sale because that's spread evenly over the number of days in the license. So if it's 3 years, it'd be 3 times 365 days spread. So you automatically get that. So it doesn't have the same sort of lumps unless it's a point-in-time revenue, which is more of an IPD software deal. Sorry, you have another question.

Yes. Actually, just -- and I'm glad you answered that because the seasonality comment did surprise me because the whole reason which made sense to not focus on bookings and go to ACV and TTMR because bookings do tend to be lumpy. But your explanation makes sense. We should be thinking of it more as a 4Q seasonality then through the course of the year, correct? Is that [indiscernible]?

Correct. It's exactly right. Exactly right.

Got it. Okay. And then my quick follow-up was the royalty revenues would be -- are being impacted by the supply chain being gummed up. But do you feel pretty comfortable with the annual guide that it should be -- I mean it's a small number, but do feel pretty comfortable that, that situation should be alleviated by then?

Yes. I mean we're not putting ourselves out of experts on the silicon supply chain. There are much, much smarter people than me to give that sort of analysis. But the general sense, we do follow what's going on and we speak to our customers and the foundries. And our sense, generally, is it's probably a 2023 solution to get that completely ungummed. But we are still -- we're still signing contracts. All the interconnect contracts still have royalties. The royalty rates are generally sort of strong to increasing. So there's nothing changing in our model from that perspective. The only variable right now is the units out from our customers, which is -- I mean, actually, if you look at the first quarter, it was pretty strong. But we're a little cautious on how that's going to play out in the next couple of quarters for those [indiscernible].

[Operator Instructions] Our next question is from Auguste Richard with Northland.

Yes. I'm seeing Qualcomm make good progress in getting in the automotive market, and I know they have their own network on a chip IP. And I'm just wondering is Qualcomm displacing any of the OEM designs that you would expect or having any other impact on any of the design activity that you're working on?

Yes. I mean Qualcomm is a very nimble organization with their internal network on chip technology. So they're definitely a worthy competitor in the automotive market. But as Nick mentioned, our projections is that there's going to be 20, 23 SoCs in every car as the electrification and the automated driving and these 2 consolidation unfold. And so Qualcomm is going to capture some of those, but the existing players such as Mobileye, NXP, Bosch and others will be able to defend their turf. And so Qualcomm will take their share, but they're unlikely to drive other players out of the market at least in the foreseeable future, right? So they'll get their share. But I think the impact on our tariffs is probably not going to be major given how many SoCs there are per vehicle.

Got it. That's very helpful. And then turning to China, there's the Arm situation, which I'm curious if that's impacting potential customers in China in terms of their choice of interconnect. And also as China pulls away from the U.S. and going to self-sufficiency, are there any EDA players rising there that could be a challenge and/or it's too early to know about sanctions, but any thoughts along sort of those dynamics?

Yes. So I mean, -- we're not -- I would not classify our tariffs as the EDA company. I mean, we're a semiconductor IP company. The technology that we have is quite complex, and we're not seeing any alternatives in the market that would be indigenously coming from the China market. So we're continuing to see a robust activity in China with the caveat that Nick mentioned, which is customers, particularly in Shanghai, can get access to their chops to validate some contracts. But that's a temporary effect. So we're not seeing anything right now that will be coming from China that will be threatening the Arteris IP position in the system IP space.

Got it. Helpful. And sorry for mischaracterizing your business.

Oh, yes. Yes. I mean -- we're -- we have lots of software that allow people to make our IP work. But the value over their get is actually from us helping them get the chip out and actually being in the chip and being the communication part or IP being a communication part of the chip.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Charlie Janac for closing remarks.

Yes. So this is an exciting time to be at Arteris IP, and we look forward to continuing our momentum in the years ahead, and updating all of you in the quarters to come. Thank you for joining our call today and for your interest in our Arteris IP. Thank you very much.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.