Arteris, Inc. (NASDAQ:AIP) Q1 2022 Earnings Conference Call May 10, 2022 4:30 PM ET

Company Participants

Erica Mannion - Sapphire Investor Relations
Charlie Janac - Chief Executive Officer
Nick Hawkins - Chief Financial Officer

Conference Call Participants

Josh Buchalter - Cowen
Mark Lipacis - Jefferies
Hans Mosesmann - Rosenblatt Securities
Ambrish Srivastava - BMO
Gus Richard - Northland

Operator

Good afternoon, everyone. And welcome to the Arteris IP First Quarter 2022 Earnings Call. All materials contained in the webcast is the sole property and copy of Arteris IP with all rights reserved.

For opening remarks and introductions, I will now turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead.

Erica Mannion

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 US 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 measures 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.

Charlie Janac

Thank you, Erica. And thanks to everyone for joining us on the call this afternoon. We are 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 continued momentum, our active customers increased by seven 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 Arteris IP SoC 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 license 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 an ECU consolidation to revolutionize the industry. Besides the progress in automotive, we also continue a 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 one 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 are also seeing worldwide inflationary pressures in terms of employee compensation and service provider pricing.

As we discussed in our prior conference calls, 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 our Arteris IP to continue to expand its multi-regional 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 will turn it over to Nick to discuss our financial results in more detail.

Nick Hawkins

Thank you, Charlie, and good afternoon, everyone. As I review our first quarter results today, please note, I will 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 of those of you who are new to the Arteris IP story, our revenue is derived from licensing intellectual property, licensing software, software 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 customer’s 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 were $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 in 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 headcount in our four 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 $3.7 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 lock up expired on April 23, 2022. While the lockup expired, former employees, current employees and other stockholders held approximately 9.8 million shares, which are no longer subject for lock-up and can be freely sold subject to normal restrictions such as having material non-public information or MNPI.

Additionally, current and former employees and directors held approximately 8.3 million shares when the lock-up expired, but rather subject to outstanding options or reserved for future issuance pursuant to restricted stock unit grant as part of our employee incentive programs. These shares assuming they satisfy the various best in 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 will open up the call for questions. Over to the Operator.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Matt Ramsay with Cowen. Please go ahead.

Josh Buchalter

Hey, guys. This is Josh Buchalter on behalf of Matt. Thank you for taking my questions and 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-month royalty revenue, obviously, saw that you maintain 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 with that customers or royalty shipments? Thank you.

Nick Hawkins

Yeah. Hi, Josh. Let me take. I want to sneak here and it’s great question. I mean, you already know because we have 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 is not familiar with this, because there was a very substantial deal with HiSilicon in May of 2019 end dates in this month that creates sort of a headwind of around frequent $3 million in Q2. That’s not something new, but it is a headwind.

Nevertheless, the other point you make which is the slightly decline in ACV guidance for Q2 and plus royalties is two things really. But 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 one 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 instant ACV hit, which then picks back up again in the next quarter, which is why you are 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 by loss, obviously, it’s hitting our customers and this is everything from sort of fab capacity, generally a fab capacity and things like novel gases [ph], which are constrained by Russia and that’s reducing our customers’ ability to ship volumes on that then puts a dent in mid-term royalties looking to impact longer term royalties, but it doesn’t in near-term. So that sort of give a fulsome answer to the question.

Josh Buchalter

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

Charlie Janac

Yeah. I mean -- this is Charlie. I will take that one. So the automotive business continues to be robust. If we are not seeing any slowdowns in design cycles, there are more members of the -- or more participating companies of the automotive ecosystem, there are designing associates and these are increasingly complex. So that all favors our tariffs as far as we can see.

The only sort of headwinds 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 it could be second half of this year, it could be early next year.

But there is just a lot of a very interesting design activity is taking place and the automotive chain is one of the things that it looks particularly promising. I should also add that you are going to see an increase in military spending and that may also translate into additional SoC design starts.

Nick Hawkins

Yeah. Just one additional comment -- this is Nick, on the automotive side more of the longer term. You may remember that the, we published some data, some third-party data, that talk exactly about if you are referencing there, which is the number of SoCs per vehicle is growing from around sort of three to four in 2020 up to the low 20s, something around 23 per vehicle and those is force of L2 [ph] plus by 2026 and that is exactly the issue that you are referencing there, but that’s more of a longer-term trend. It doesn’t really make a massive a difference from sort of across the quarter.

Josh Buchalter

Understood. Thank you. I will hop back in the queue.

Operator

Thank you. Our next question is from Mark Lipacis with Jefferies. Please go ahead.

Mark Lipacis

Hey. Thanks for taking my question. I don’t know it’s for Charlie or Nick, you referenced higher compensation expenses. Is that just in new product development and I guess can you can you talk about how that -- if it’s manifesting also in your customer’s willingness or eagerness to reach to you guys to help potentially offset that same challenge that they may had -- be having? Thank you.

Nick Hawkins

Well, let me take this…

Charlie Janac

So we are…

Nick Hawkins

Oh! I was going to -- I am going to -- let me take the first half and then I will pass over to Charlie for the more commercial, industrial sort of part that the second part of your question, Mark. So, I mean, in general, you won’t be surprised to hear that with that we are 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 what the wage inflation rates running out that pretty highs. So we are trying to contain them as much as possible, but there is without question sort of upward pressure which we are seeing.

As far as the, and by the way, it’s not just R&D, it’s that you have accountants paid more, lawyers have paid more, marketing people paid more, that is more difficult. You have to compete harder to get good people.

So, as far as the willingness of our customers, great question, willing to the customers to do business with us and whether they want us to share the paint by sort of -- some sort of cost reduction, I would guess that’s a really as a split down the wheelhouse. So Charlie?

Charlie Janac

Yeah. Yeah. We are not seeing any, I wouldn’t say that, we are seeing particular margin pressures in our product. Our products generate a lot of value, they saved customers a lot of money and so we are not seeing price pressure or margin pressure on our products at this time.

Mark Lipacis

So, thanks for that. And I guess I was tackling this from the standpoint of, it seems 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 that they are in a make or buy decision that they are seeing the wage pressures and labor shortages.

Nick Hawkins

Yeah.

Mark Lipacis

And they may reach do more often and I was wondering if that was manifesting in your pipeline or not?

Nick Hawkins

Yeah. I think, that’s absolutely correct. The fact that our customers are also having difficulty finding some -- it’s going to be 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 this does expand the opportunity for Arteris IP product adoption versus internal solutions.

Mark Lipacis

Got it. Thank you.

Operator

Thank you. Our next question is from Hans Mosesmann with Rosenblatt Securities. Please go ahead.

Hans Mosesmann

Yeah. Thank you. Congratulations guys. Good execution. Just a question on the royalty, the headwinds, what end market is driving that, is that wireless if there is a headwind?

Charlie Janac

So, yeah, I mean, I don’t know, Nick, if you want to take this or probably you 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 to rise of a additional royalty revenue.

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 mixed-use learning designs, which are quite numerous recently will actually reach production is start generating volume.

Nick Hawkins

Yeah. I mean, exactly, you said it right. There are 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, we can actually put a name to it, on the e-mobility side has still not decline to zero, but it is getting close, but it is a decline quarter-over-quarter over time. But for sure automotive remains the mainstay and we are in 35-plus customers, 60-plus designs and so we have a good spreads there across all the different players -- different layers whether it would be semiconductor or Tier 1s or OEMs.

We have a good spread across all of them and across all the sub verticals as well. So it’s is a nice position to be in, but we do have broad-brush or broad based royalty streams coming in from other side such as well.

Hans Mosesmann

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 is the competition in that project or projects that are similar to that? Are those in-house efforts or are there other players that are going to coming out there that are challenging you guys with this IP?

Charlie Janac

Yeah. I mean, we can have two classes of competitors, obviously, one is arm and I don’t know if there was 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 what suitable for the customers acquisition of application for the 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 our Arteris whether it’s on the BMW deal or some other places is -- it’s pretty favorable.

Hans Mosesmann

Okay. Great. Thanks.

Operator

Thank you. Our next question is from Ambrish Srivastava with BMO. Please go ahead.

Ambrish Srivastava

Hi. Thank you very much. I had a question on like 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 yes, I had a very quick follow-up after that, Nick, sorry.

Nick Hawkins

Well, hi, Ambrish. Great to speak with you again. I hope you are well. But, yeah, in terms of the China situation or Baltic, see, I will 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. If those doesn’t move around such as sort of point in time revenue does unless probably recently we adopted it as one of our metrics.

It does, however, it can suffer from deals, should large licenses shifting from being signed, and actually, the software delivered by the end of -- like the last week of the quarter or the first week of the second quarter and that’s usually outside of our control, that is totally outside of our control, because it’s customer driven, they ask on day X then we provide on day X, if they ask on day Y, then it goes on day Y.

So the seasonality is still fairly steady. There -- it’s always ACV plus TTMR 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, I guess, spread over the subsequent years depending on the contract.

But the China question is slightly unique, and yes, it is totally a COVID issue, because the epicenter of our customers is 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 is quite difficult people get to work and collaborate and what have you.

So, we have no doubt, those deals have not gone away, but it just may be taking, the literally situations, where people cannot get to offices to put that chop on our license, it’s just basic as that, because in China, the chop is everything if you probably know, if we follow the arm situation. So anyway but that’s what…

Ambrish Srivastava

Yes. Yes.

Nick Hawkins

What really get moving in China around.

Ambrish Srivastava

Go it. And the other thing…

Nick Hawkins

The other thing…

Ambrish Srivastava

Sorry, go ahead.

Nick Hawkins

…just to sort of add some color to the color. The revenue of course is much more smooth, the GAAP revenue is much more smooth when it’s [inaudible] an interconnect sale, because that spreads evenly over the number of days in the license, so if it’s three years, if we have done 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 build, so you have another question.

Ambrish Srivastava

Yeah. Actually I am just and I am glad you answer 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 correct…

Nick Hawkins

Correct. Exactly, right.

Ambrish Srivastava

Got it.

Nick Hawkins

Exactly, right.

Ambrish Srivastava

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 you feel pretty comfortable that situation should be alleviated by then?

Nick Hawkins

Yeah. I mean, we are not putting ourselves out as experts on the silicon supply chain.

Ambrish Srivastava

Yeah.

Nick Hawkins

There are much, much smarter people to me to give that sort of analysis. But the general sense we do follow what’s going on that we speak to our customers and out in the foundries. And our sense, generally it’s probably a 2023 solution to get that completely on government. But we are still signing contracts, all the interconnect contracts still have royalties, the royalty rates are generally sort of the strong increasing.

So there is nothing changing in our model from that perspective. The only variable right now is the units out from our customers, which is I am actually if you look at the Q -- first quarter it was pretty strong. But we are a little cautious on how that’s going to play out in the next couple of quarters. That helps…

Ambrish Srivastava

Prudent -- yeah prudently so. Nick, thank you.

Nick Hawkins

Yeah. You know me.

Operator

Thank you. [Operator Instructions] Our next question is from Gus Richard with Northland. Please go ahead.

Gus Richard

Yes. Thanks for taking the question. I am seeing Qualcomm made good progress in getting in the automotive market and I know they have their own network on a chip IP. And I am 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 are working on?

Charlie Janac

Yeah. I mean, Qualcomm is a very nimble organization with their internal network on chip technology. So they are definitely a worthy competitor in the automotive market. But as Nick mentioned, our projections is that there is going to be 2023 SoCs in every car as the electrification and the automated driving and industry 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 curve and so Qualcomm will take their share. But they are not -- they are unlikely to drive other players out of the market at least in the foreseeable future, right? So, they will 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.

Gus Richard

Got it. That’s very helpful. And then turning to China, so there is the arm situation, which I am curious if that’s impacting potential customers in China in terms of their choice of, well, 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 you sort of those dynamics?

Charlie Janac

Yeah. So, I mean, we are not -- I would not classify Arteris as the EDA company. I mean we are semiconductor IP company. The technology that we have is quite complex and we are not seeing any alternatives in the market, there would be indigenously coming from the China market.

So, we are 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 temporary effect. So we are not seeing anything right now that will be coming from China that will be threatening the Arteris IP position in the system IP space.

Gus Richard

Got it. Helpful and sorry for miss characterizing your business.

Charlie Janac

Oh! Yeah. I mean, we are -- we have lots of software that allow people to make our IP work, but the value of their get is actually from us helping them get the chip out and actually be in the chip and being the communication part -- our IP being a communication part of the chip.

Gus Richard

Right. Totally understood. That’s it from me. Thanks.

Operator

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.

Charlie Janac

Yes. So this is an exciting time to be at Arteris IP and we look forward to continue 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 Arteris IP. Thank you very much.

Operator

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