eMemory Technology Inc. (3529) Earnings Call Transcript & Summary

Good afternoon, and welcome to eMemory's Second Quarter 2022 Webcast Investor Conference. Present today, we have our Chairman, Dr. Charles Hsu; President, Mr. Michael Ho; Head of IR, Ms. Lijing Chen; and the Director of the Finance Department, Ms. Teresa Kuo. The format of today's event will be as follows: first, eMemory's Chairman, Dr. Charles Hsu will give an opening remark. Afterwards, President, Mr. Michael Ho, will summarize our operations in the second quarter of 2022, followed by the outlook of our business. Next, Dr. Charles Hsu will introduce the topic titled: Why Is Random Number Generation Important In Gaming. Then we will go into the Q&A session where our management team will be ready to answer your questions. Please feel free to submit your questions in the input box on the webcast window throughout the conference. As a reminder, this conference is being recorded, and a webcast replay will be available within 3 hours after the conference is finished. Please visit the company's website at www.ememory.com.tw under the Investor Relations section. As usual, before we begin, we would like to remind everyone that today's presentation may contain forward-looking statements that are subject to the risk factors associated with the semiconductor and IP business. Please refer to the cautionary statement as shown on Page 3 of today's presentation. Now I would like to give the floor over to eMemory's Chairman, Dr. Charles Hsu.

Okay. Good afternoon, everyone, and thank you for attending our conference call today. Our second quarter operating results hit a record high, reflecting our continuous efforts to invent new technologies and develop new application areas. Although the semiconductor industry has entered several quarters of inventory adjustment, we remain confident in our long-term growth. The reasons are as follows: The first is because over the past 2 years, we have accumulated over 1,000 tape-outs with more than 200 new applications in 28-nanometer and below. These new products will enter mass production to drive the growth of our royalties. First of all, our technology development has reached 4- and the 5-nanometer with customers' production in 6- and 7-nanometer. This new process performed a new market for our future growth. And the second reason is the customers are accelerating their product development, no matter high-performance computing AIoT, autonomous driving, our industrial automation, security will be a must. We are seeing this trend from our PUF-based licensing revenue, which has grown more than 10x compared to the previous year. All in all, we remain confident in the company growth in the future. Next, I would like to invite our President, Michael Ho to share our second quarter performance and the future outlook.

Thank you, Charles. Good afternoon, everyone. Now let's begin with our 2022 second quarter financial results. The second quarter revenue was TWD 796 million, up 9.5% sequentially and up 47.1% year-over-year. Operating expenses were TWD 336 million, up 7.1% sequentially and up 30% year-over-year, mainly attributable to the increase in salary and other related human resources expenses such as increase in bonuses and rewards. Operating income is TWD 460 million with an increase of 11.3% sequentially and 62.7% year-over-year. The operating margin increased by 1 percentage point sequentially and increased by 5.6 percentage points year-over-year to 57.8%. EPS for the quarter was TWD 5.48 and ROE was 69.5%. Next, let's move on to revenue contributions by licensing and royalty. Licensing in the second quarter accounted for 25.2% of the total revenue, up 4.8% sequentially and up 15% year-over-year. In U.S. dollars the licensing was the same as last quarter and up 10.6% year-over-year. Royalties in the second quarter contributed 74.8% of the total revenue increasing 11.2% sequentially and increasing 62.3% year-over-year or up 5.4% sequentially and up 57% year-over-year in U.S. dollars. Total revenue in the first half of 2022 grew 33.8% as compared to the previous year. In terms of U.S. dollars, the total revenue increased 33% compared to previous year. With that, I will comment more specifically on our revenue contribution by specific IPs. For NeoBit accounted for 22% of the total licensing revenue in the second quarter, increasing 26.4% sequentially, but decreasing 11.4% year-over-year. Its royalty accounted for 40% of the total royalty, up 14.6% sequentially and up 38.2% year-over-year. For NeoFuse, accounted for the 46.9% of the total licensing revenue in the second quarter, down 24.2% sequentially and down 8% year-over-year. The main reason is that many of our customers who originally only used the NeoFuse have adopted our new PUF-based security solutions such as root of trust to improve their security application levels. In addition to the existing NeoFuse royalty, PUF-based royalty will double the total royalties driving the growth of our future royalty revenue. In terms of total royalty revenue, NeoFuse royalties increased 9.7% sequentially and 84.5% year-over-year, accounting for 56.4% of total royalties. For PUF-based security IPs contributed to 23.4% of licensing revenue, increasing 576.4% sequentially, up 2,163% year-over-year as the result of strong demand for our security IPs. Its royalty accounted for 0.1% of the total royalties, which is up 47.6% compared to the previous quarter and up 100% compared to the previous year. We anticipate PUF-based security IPs to continue its growth momentum in H2 and beyond. For MTP technology, accounted for 7.7% of total licensing revenue decreasing 39.3% sequentially and decreasing 23.7% year-over-year. Royalty from MTP decreased 1.1% sequentially, but increased 67.7% year-over-year. In the first half of 2022, the licensing and revenues are as belows: NeoBit licensing revenue increased 2.6% year-over-year and royalty increased 15.7% accounting for 34.5% of the total revenue. NeoFuse licensing and royalty revenue grew 13.1% and 69.8% year-over-year, respectively, contributing to 56.5% of the total revenue. PUF-based security IP licensing revenue increased 609.9% year-over-year, while royalty revenue increased 100%, accounting for 3.6% of the total revenue. MTP Technology licensing revenue decreased 44.6% year-over-year, but royalty revenue increased 82.1%, accounting for 5.4% of the total revenue. Now let's look at the royalties for 8-inch and 12-inch wafers. For 8-inch wafers, which accounted for 51.1% of royalties, increased 12.1% sequentially and 56.3% year-over-year due to the growth in wafer shipment and ASP from the increasing penetration rate for our various applications. For 12-inch wafers contributed to 48.9% of royalties increasing 10.3% sequentially and 69.1% year-over-year due to the increasing penetration rate for 28-nanometer and below. In total, 177 product tape-outs were completed in the second quarter with 7/6 (sic) [ 6/7nm ] increasing significantly. We will provide more information in the management report. In the next section, I will address our future outlook. We expect the growth of revenue to continue in the third quarter. For licensing revenue, licensing revenue will grow due to the continued strong demand for our IPs, especially NeoFuse and PUF-based security solutions. For royalty revenues, 8-inch and 12-inch royalties will continue their growth momentum from the increasing penetration rate in various applications, increasing new tape-out from 6- and 7-nanometer will also drive higher ASP and royalty growth further. Moving on to the new business development. PUFrt, root of trust IP and PUFcc security coprocessor IP continue to be adopted by applications in IoT, industrial IoT, FPGA, data processor unit, DPU, CPU, Setup Box, mobile storage, UFS and Automotive. Our collaboration with ARM is progressing very successfully, and we anticipate more joint marketing activities before the end of this year. For new IP technology development, 22-nanometer ReRAM IP is adopted by wearable and IoT applications. For NeoFuse (sic) [ NeoFlash ], it's being licensed to multiple foundries as Embedded Flash solutions in security in -- in specialty processes, targeting Smart Power and Smart MCU related applications. PUF-based IPs have taped-out in N5 and developing in N4 and N3. We successfully developed PUF-based Embedded Flash solutions to protect digital assets. This concludes my comments. Next, I will pass the time to Charles. Thank you.

The next section I'm going to talk about why is random number generation important in gaming. Actually, when the number of generation is also very important in security, but today, I was specifically talking about the application in gaming. You might recall that in my last talk, I talked about metaverse security and I gave a brief overview of the 7 layers of the metaverse to refresh your brains, the conceptual framework of the metaverse consists of 7 layers. The first layer is what the consumer will be experiencing and goes all the way to the backbone of the metaverse such as service and equipment providers. Today, I will be diving deeper into how PUF-based technology can apply to the experience layer of the metaverse in particular, the role of random number generation in gaming. Okay. Please turn to Page 14. Random number generator abbreviation is RNG, are algorithms or hardware components that create random values. In gaming, random numbers determine random events such as your chances of picking up a rare item or even which shape of a block you get on Tetris. We again obtained their variables from naturally changing local values. For example, a game console's internal clock or the sequence of buttons you pressed. Sometimes, these numbers are easy to hack, especially for seasoned gamers. Please turn to Page 15. And using role-playing games previsions, RPG. As an example, players typically complete missions by slaying Monsters, challenging bosses and acquiring powerful items. As you pay -- as you play so the game, the monsters you kill will randomly drop new equipment, where it can be then -- it can then be loaded. Every item has a quality level for simplification purposes. We will talk about the common items and the legendary items when the monster drops and item, the game randomly determines its quality with chances for a legendary item being extremely low. In mobile RPGs, while the game is free to play, micro transaction option allows gamers to buy in-game items that supposedly guarantees certain weapon drops. The drive to acquire better items get people addicted to games and spending a lot of money. Please turn to Page 16. About the software versus hardware random numbers. So in software random numbers, when developing computer games, programmer usually use seeded software-based random numbers, which use a seed number to create their numbers through a mathematical algorithm. Each time a new number is generated, it is built upon the seed number and the PUF values, resulting in a sequence of random numbers. However, the seemingly random output sequence is deterministic because the seed is a fixed number. So the sequence is reproducible. A good real-life example is programmers who use a certain logic or patterns to determine random numbers. Typically, software-based random numbers are good enough for -- and often used in games to offset players' chances and keep the game exciting. In the role playing game example's case the random number will determine the weapon revealed given a drop or micro transaction purchase. And about how we base random number generator, I previously mentioned that computers need the physical world's randomness to generate a true random number. A good real-life example is leaves that fall from a tree, the location where the leaf will land will be truly random and unpredictable. Similarly, silicon devices themselves generate noises that are random in nature. While those noises are smaller we can design a circuit to amplify or accumulate these noises, then we can digitize the analog noise signal into digital random numbers. Please turn to Page 17. So while software based random numbers keep a game unpredictable and fresh, they are criticized for their lack of true randomness. The computer cannot just put out a random number as easily as rolling a dice, which is why today's gaming world often uses software based random number generators because not all system platforms have entropy harvested from the physical world. Moreover, if the random numbers are generated with a specific platform, they could potentially be controlled, compromising the fairness of the random numbers. Because of this, many question if in-game purchases guarantee anything. Many players spend thousands of dollars on in-game purchases and certain micro transactions have been compared to a gambling simulator leading to controversies in the gaming industry. Some countries have even banned certain games since it violates anti-gaming -- anti gambling law as seen in these articles. In fact, Taiwan's Ministry of Economic Affairs recently announced that they will require game companies to disclose their odds of winning in the face of these unfair game practices. Thus replacing software based random number with true hardware random number is an inevitable trend to create a gaming ecosystem with better fairness. Please turn to Page 18. Who does the true random numbers affect the -- affect the game industry? First of all, let's look at the -- about the players. From the player perspective, where, it's an RPG or speed game or gambling game, et cetera, credibility is important. Players want assurance that there is some form of fairness in their games. Many people go so far as to look at the data and the percentages around games to determine if the results they are getting and the money they are spending will have a fair outcome. And for the game providers, it is vital to have a verifiable, quantifiable RNG that provides necessary transparency to players. And about the digital asset, perhaps an overlooked aspect is the potential item purchased in these games. As the world transforms, items used and purchased in games, such as the weapon we mentioned in RPG games, can evolve to NFT with the involvement of the vertical -- with the involvement of the virtual assets, the credibility of NFTs have become more important than ever. Assets need to be traceable from their origin to determine their authenticity. Furthermore, NFTs also require security protections. So please turn to Page 19. So how do you generate those random numbers? And how do you protect the assets with our PUF-based TRNG. This becomes possible because it uses an on-chip physical entropy source to produce secure and systematical numbers. Generating random numbers on the blockchain, decentralizes the process of generating random numbers from the providers to the third party, bringing more transparency, fairness, verifiability and temporal resistance to the random number generation process. Since Game Player requires massive data and is played by numerous players worldwide, many random numbers are needed. Implementing PUFtrng on blockchain needs -- on Blockchain nodes, we will produce enough random numbers on the chain to accommodate the volume of random numbers required. The game servers will request a random number from the blockchain nodes, which operate in games. Once produced, the random number will be uploaded to the blockchain. Since blockchain is an open database, it maintains a public record of the random number used in gaming. Given this record, everyone can check the random number used in each micro transaction to verify whether the random result is fair or not. So the application of our PUFtrng can further extend to creating secure private keys that encrypt online data. And the PUF-based OTP can even store these secret keys as a result every time a transaction takes place, such as sending cryptocurrency, the key payer can be used to secure your transactions. Security is critical in the future when game-based transactions promote the exchange of NFTs and other valuable assets. Our PUF-based security solution can be easily and widely used in gaming applications, which is an important part in the experience there of the Metaverse. And this concludes my presentation on these random number generations. Thank you.

[Operator Instructions] This quarter, we have prepared a Q&A brief opening statement. P. Jing will first begin the statement in Chinese before I translate it to English.

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Thank you, Michael. I will now do the statement in English, and this will be the format of our Q&A session. So in our Q&A session of the previous quarter, we spent a lot of time explaining the impact on the company during the semiconductor down cycle. Since our company operations do not involve manufacturing processes and finished products, we faced no inventory and depreciation costs. In fact, the downturn is accelerating our customers' R&D which is the best time for us to license our IPs to these customers. Since the last quarter, the industries have begun inventory digestion and the impact on chip and foundry customers has emerged. According to the information disclosed during our customers' earnings calls, the inventory adjustments will last for several quarters. Investors have a lot of questions related to this. More than 500 products embedded with our IPs are manufactured in more than 20 foundries and hundreds of process platforms every year. Because of this, it's very difficult to analyze it in a very simple way. In addition, there are more than 1,000 new tape-outs accumulating over the past 2 years in the pipeline ready for production. These new tape-out products have no inventory issues. To begin our Q&A session, let's invite Michael to explain this further, and hopefully, we can provide a rough picture for you.

Please turn your attention towards the slide. The table is the status of our revenue since 2009 in U.S. dollars. The NTO in this table refers to the number of new tape-outs each year. In other words, the number of chip products that have adopted our IPs. The revenue includes both licensing and royalties with royalty accounting for more than 70% of our total revenue. Tape-out will include design licensing fee for that year. We typically receive royalties at least 1 to 2 years when these new tape-outs move to production. Then we can receive royalty based on the wafer volume and wafer ASP. So primary business contribution for each year is the result of customer tape-outs from 1 to 2 years ago or before. Let's take our first technology, NeoBit, for example. Many used in 8-inch and some 12-inch 90 and 55-nanometer for DDI application. In the past, customers have migrated to more advanced process and switched to NeoFuse. At the same time, there are still more than 200 new products adopting our IP each year. NeoBit actually took about 10 years from the first customer adoption to achieving a penetration rate of 20% for 8-inch at the major foundries and the country continuing to perform steadily. NeoBit is our highest ROE technology as most of the IBs adopted by customers are from existing library, requiring less R&D maintenance. Let's look at the NeoFuse which kicked off in 2013 and reached 1 million wafer shipment in 2019. NeoFuse is mainly used in 12-inch and DRAM. We believe that the potential market is at least 10x that of NeoBit. The technology development for NeoFuse have already reached 4- and 5-nanometer and the customers have started mass production in 6- and 7-nanometer, still with very big potential for growth. In addition, our third growth driver, PUF-based related technologies also saw a sharp increase in licensing fees during the second quarter and the growth momentum is just at the beginning. MTB has also been introduced to large volume applications like PMIC, an SPD for DDR5 modules. In addition, Customers' inventory correction will not change our fundamental and core competence. Our design-in activities still remain very strong. All in all, we remain confident in our long-term growth despite of the current industry headwinds. Thank you.

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So the question is second-tier foundries may start to reduce their wafer price. What impact does this have on eMemory?

Average ASP increased by 4.9% last year when the second-tier foundries increased their wafer price the most. Part of the reason behind last year's ASP growth was driven by more contributions from 28-nanometer and below. During the first half of this year, our ASP royalty per wafer increased 9.5%. Part of the reason was due to the wafer price increase from our largest foundry customers, in addition to continuous increase of more leading edge contribution. Therefore, the price increase -- decrease of the second-tier foundries have less effect on our average royalty per wafer. Our view on the growth of our royalties per wafer has not changed as we will see increasing contribution from more advanced processes. Furthermore, increasing adoption of MTP technology and path-based solutions will also enhance our ASP since the royalty rate or royalty per wafer are much higher for those technologies compared to OTP.

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So this question was, can eMemory IPs work for 2 and 3 nanometers? Why is the progress for advanced process adoption slower? Why haven't customers started adopting it? What do the most advanced processes customers currently use?

A foundry usually begins its development for the most leading process with its own foundation IP typically with its own OTP solution coded eFuse. Most advanced process in the past have used the eFuse for perimeter setting, ID or other functions that require OTP. For our IPs to be provided to customers we need to pass order verifications foundries require, which typically take 1 to 2 years. Once our IPs are qualified, it's usually already to late for the most leading-edge customers. For example, our design activities just significantly increased in 6 and 7-nanometer after our IPs were qualified with customer production records. Most customers' applications we engage now, migrate from 12- and 16-nanometer and the most used, eFuse, in their previous generations. The reason customers replace eFuse with our IPs is to meet their density or security requirements because eFuse can only write 4K bits at the most where our IPs can accommodate density of 100x or higher. Even worse, eFuse can be easily -- be hacked by reverse engineering. Due to the increasing demand for security and much higher storage density requirement, customers are constantly requesting our IP solution in the most leading-edge processes. Moreover, our cooperation with ARM's Confidential Compute Architecture can be adopted by the most leading-edge customers. We are working with customers and the foundries to accelerate our qualification progress and hope we can catch up in the future.

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So the question that was asked was, what are eMemory's automotive-related applications? What is the room for growth?

Many of our existing customers are developing or already in automotive, such as driver MCU, CIS, ISP, networking and PMIC which bring our IPs into automotive applications. For example, Dialog is our first DNI house customers. They started adopting our IP in 2003. Now almost all their products have our IPs. After being acquired by Renesas last year, their target is to extensively expand into the automotive field, taking all our IPs along with their expansion. Our first NeoFuse customer, Riotech also adopt our IPs in older automotive solutions. Riotech also started to adopt our PUF Route of Trust to upgrade their security function. Besides existing customers and applications, we have 7-nanometer ADAS customer already in mass production. We believe the penetration rate in automotive-related applications have a big potential for growth as our IP provide chip customers with better yield, higher functionality and counterfeit protection and receptacle for car connections.

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So the question was TSMC mentioned that they would expand their capacity for specialty processes, especially for 28 nanometers. What is the impact to eMemory IPs?

Foundry specialty process are MEMS, CMOS image sensor, embedded nonvolatile memory, our RF analog, high-voltage and BCD process. All are related to our IPs, like a high [indiscernible] driver, BCD for PMIC and the MEMS CIS, RF analog and embedded emerging memory. This will speed our penetration rate in foundries. Thank you.

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So the question was, in times of downturn, customers will cost down and ask suppliers to reduce prices. Since eMemory's gross profit is 100%, are you facing the pressure from your customers?

A 100% gross profit because we don't have the cost of a good store, that is our business nature and it has nothing to do with the pricing. Our business model charges a relatively low design license fee from chip customers. Many large customers are annual fee-based. As long as they pay a small amount of annual fee, they can tap out as many as they can by using our existing and developed IP library. Only customized IPs require extra payment, but it's still very low compared to other IP vendors. Our main business relies on royalty, which only occurs when customers successfully design win and move into production stage. This business model is very attractive for chip customers, especially during the downturn when they need to speed up R&D and control expenses at the same time. For foundry customers, we work even more closely with them to provide our R&D support to provide -- to help develop specialty process for add-on value when utilization rates are relatively low and still with a relatively low license fee.

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The question was, Does eMemory have any plans for M&A or raising capital?

The deal was the incident in Taiwan involving some fraud company using eMemory's name to raise capital. This company defrauded individual investors by asking for a money transfer. We are formally answering this question and clarifying that we do not have any fundraising activities. Since 2000, eMemory has relied on organic growth by inventing new technologies one after another. Since turning profitable in 2005, we have maintained a more than 90% dividend payout policy, which is different from most of the large international IP companies by our growth strategy to increase their IP portfolios. Our technology development strategies are all based on our core confidence related to our existing technology and platform. There is still considerable room for future growth. So we don't consider any mergers and acquisitions.

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So the question that was asked was, in the cooperation with ARM, is NeoPUF or PUF-based IP, a reference design or a recommendation? And Charles will answer this question.

Currently, our cooperation with ARM is still at the verification stage, which is considered as a reference design. When joint promotion starts with ARM, they will directly recommend customers to adopt our solution because the PUF and the OTP belong to HMAC and they need to be qualified on foundry processes in advance. So only eMemory solutions are available.

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So the question was, to pass ARM's PSA certification, does each core need to be recertified. For example, does Cortex-M3 and A9 need to be certified 3 times separately?" Charles will answer this question.

Okay. Let me remind everybody, PSA means platform for security architecture. So basically, this is -- this certification is basically for the security functions. Again, so there's no need to recertify. Our PUFcc -- PUF Crypto Coprocessor process IPS has all certification required. We are cooperating with ARM by combining PUF Crypto Coprocessor with ARM's Corstone and the Mbed ecosystem and that will help customers quickly pass Level 3 device certifications.

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