Arteris, Inc. (NASDAQ:AIP) Q4 2021 Earnings Conference Call March 3, 2022 4:30 PM ET

Company Participants

Erica Mannion - Sapphire IR
Charlie Janac - CEO
Nick Hawkins - CFO

Conference Call Participants

Matt Ramsay - Cowen
Jamison Phillips-Crone - BMO Capital Markets
Kevin Garrigan - Rosenblatt Securities

Operator

Good afternoon, everyone, and welcome to the Arteris IP Fourth Quarter and Full Year 2021 Earnings Call. All materials contained in the webcast is the sole property and copyright of Arteris IP with all rights reserved.

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

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 fourth quarter ended December 31, 2021. Nick will then review the financial results for the fourth quarter and full year 2021 followed by the company's outlook for the first quarter and full year of 2022. We will then open the call for questions.

Before we begin, I would like to remind you that management will make statements during this call that are forward-looking statements within the means of Federal Securities laws. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated and you should not place undue reliance on forward-looking statements. Additional information regarding these risks, uncertainties and factors that could cause 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 site certain non-GAAP measures, including non-GAAP net loss and non-GAAP net loss per share, which are not measures prepared in accordance with US GAAP.

The non-GAAP measures are prepared 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 US GAAP. Listeners who do not have a copy of the press release for the quarter ended December 31, 2021 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 everyone for joining us on the call this afternoon.

We are excited to report a strong fourth quarter, our second quarter as a public company with annual contract value plus trailing 12 month royalties of $50 million, up 19% year-over-year. Demonstrating our continued momentum in 2021, our active customers increased by 42 new system IP customers including 36 for NoC interconnect IP and six for IP deployment software. This marks the highest number of new active customer addition in a 12-month period in the company's history.

In the fourth quarter alone the total number of active customers increased from 179 to 192. Total customer design starts increased from 57 in 2020 to 86 in 2021. Machine learning applications continue to account for the largest number of new licenses, followed by automotive and 5G infrastructure.

Machine learning design wins included Cornami, SY5 and six other as of yet unannounced machine learning companies. The edge machine learning market continues to be promising with large number of new customers and broad range of applications.

Customers in the automotive market continued adoption of Arteris IP technology in the fourth quarter, illustrated by both solid license revenue and increasing automotive royalties, as EVs and automated driving vehicles begin commercialization in increasing numbers. Automotive orders continued to be strong across the entire supply chain including semiconductor companies, such as Mobileye, NXP, Tier-1 vendors, such as Bosch, automotive OEMs such as BMW and several ride-sharing companies as well as several unannounced customers. Demonstrating the breadth of activity throughout the automotive supply chain in the fourth quarter, we won a key design win with a major automotive OEM who is making the transition to designing their own SoCs together with their semiconductor company partners.

The reason this OEM selected Arteris IP was their desire to control their SoC architectures allowing this OEM to better support their extensive automated driving software development programs. In addition, Arteris IP track record in supporting functional safety requirements, with our resilience features was another factor in the selection process. With a successful track record of our existing automotive customers in getting their SoC to market, we believe Arteris IP is increasingly being viewed as an innovative technology partner in the automotive sector.

Another major development in the quarter was the increasing adoption of both Arteris IP network on chip NoC interconnect products and IP deployment software by customers at the same time in an attempt to shorten SoC design cycles and make the use of their IP block library assets more effective. Design win customers licensing both products include, Sondrel a UK based design house, and [Mobileland] an emerging machine learning company, as well as four other unannounced customers licensing both solutions together in the quarter.

As we discussed last quarter, we announced the launch of Arteris' Harmony Trace Design Data Intelligence Solution to help ease compliance with semiconductor industry functional safety and quality standards.

The development of Harmony Trace was driven by our customers' needs to establish an automated traceability flow and implement change, management best practices between their existing requirements, specification, electronic designed automation tools, software code depository and documentation tools. Harmony Trace allows our customers to use their existing tools and automatically link data between them, due to Harmony Trace's unique semiconductor industry-specific semantic computing technology.

We believe Harmony Trace is a revolutionary product that is best adopted by multiple companies at different levels of an industry supply chain. The initial feedback from customers has been positive as Harmony Trace helps them verify and close gaps between product specifications and actual implementation of those requirements. We are now at a stage where we are working with multiple early adopters to fit Harmony Trace into their product development flows.

We expect Harmony Trace will take time for wide customer adoption, but we believe it will ultimately be a valuable product for mission-critical segments of the semiconductor industry. As we look ahead, the move towards system IP being of greater complexity and therefore greater value continues. Decision making SoCs, which incorporate machine learning functions are and will continue to be more complex than data processing semiconductors and we believe this provides Arteris IP the opportunity to deliver ever-increasing value.

Since 2003 the industry developed for one processor, a few IOs and one or two memory channels to hundreds of IP blocks, multiple processors, cash coherency used outside of the processor subsystem and up to eight channels of memory access. More recently, we have also viewed the emergence of machine learning technology and chiplets which require a further increase in system IP complexity.

The semiconductor industry is also going through regionalization, where fab investment and the three major economic blocks of the world is increasing dramatically. Democratization of SoC design with system houses being able to build their own custom semiconductor - and semi-custom Socs profitably as well as, disintermediation of the semiconductor supply chain toward a fabless model, were only a few critical IP blocks are being designed internally by major system companies we believe is a further expanding our potential customer base.

All of these trends support greater design activity with more companies engaging in semiconductor design and more outsourcing of non-core IP block technology, which in turn favors the development and growth of Arteris IP. We do not currently anticipate a slowdown in SoC design starts. More and more companies are designing SoCs or are partnering with SoC design partners to get the silicon they need to support their business models. Some of these software-driven business models require large investments and benefit from running on customized silicon.

For example, we believe that automotive OEMs, who do not move to at least understand their SoC hardware architectures will be at a significant disadvantage versus those which have access to customized silicon technologies. Moreover, our customers' design starts are increasingly complex. We believe this increase in SoC complexity makes it increasingly difficult to develop system IP solutions in-house though some of the largest semiconductor companies continue to do so.

As an added benefit for Arteris IP, the increasing number of IP blocks and SoCs designs also increases the value of IP deployment software solutions given their ability to accelerate the use of all types of IP blocks and facilitate SoC assembly. As the result, we're seeing a trend towards SoC system IP solutions being increasingly licensed from commercial vendors such as Arteris IP. Specific to Arteris IP, we plan to introduce at least one new IP deployment and our NoC interconnect product in 2022.

Before I turn the call over to Nick to review the financials, I would also like to mention we have strengthened our management team with the addition of Pankaj Mayor as our new Executive Vice President of Global Sales providing our executive team with additional public company experience. We also plan to continue to invest in engineering, customer support, sales and technical marketing headcount to enhance the support of our customers and continue growing our business to capitalize on our system IP opportunity.

With that, I'd like to 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 fourth quarter and full year results today, please note that 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. As a reminder for those who are new to the Arteris IP story, our revenue is derived from licensing intellectual property, licensing software, support and maintenance services, 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 Total Contract Value or TCV divided by the number of years in the agreement term.

As this calculation does not include the contribution from royalty payments, we've also referred to ACV plus trailing 12 months royalties as a metric which provides a more complete picture of our total revenue proxy. We monitor this metric to measure our success and believe the historical increase shows our progress in expanding our customer's adoption of our solutions.

By the end of the fourth quarter, ACV plus trailing 12 month royalties and other revenue was $50.0 million, up 19% year-over-year driven in particular by growth in automotive and machine learning applications and up 10% quarter-over-quarter. Total revenue in the fourth quarter was $11.4 million down year-over-year due to a $7.4 million point in time IP licensing revenue recognized in the fourth quarter of 2020 relating to DJI.

The gross profit associated with this point in time revenue also benefited the fourth quarter and annual non-GAAP operating income, net income, earnings per share and free cash flow in 2020. Remaining performance obligations or RPO were $60.5 million, up 26% year-over-year as of December 31, 2021. We define RPO as the amount of contracted future revenues.

Gross profit for the quarter was $10.3 million, representing a gross margin of 19% and compared to $14.1 million in the year ago period. And the expense for the fourth quarter was $7.3 million or 64% of revenue, compared to $5.0 million in the year-ago period. The increase was driven by additional development cost and additional headcount including cost due to the additional headcount resulting from the Magillem acquisition and payroll expenses, as we continue to invest in new and improved product offerings.

Sales and marketing expense for the fourth quarter was $3.0 million or 27% of revenue compared to $3.4 million in the year ago period. We intend to continue to invest in sales and marketing as we continue to drive awareness of the market and expand our sales and application engineering force and marketing efforts to capture the significant opportunity in front of us. G&A expense for the fourth quarter was $2.8 million or 24% of revenue compared to $0.9 million in the year-ago period. G&A reflects an increase in people and infrastructure-related expenses associated with our public ready efforts.

Operating loss for the fourth quarter was $7.3 million or 64% of revenue, decreasing from profit of $3.2 million in the year-ago period. Non-GAAP operating loss was $2.8 million or 24% of revenue decreasing from a profit of $4.8 million in the year-ago period. Net loss in the quarter was $7.8 million or net loss per share basic and diluted of $0.27. Non-GAAP net loss in the quarter was $3.3 million or net loss per share basic and diluted of $0.12 based on approximately 28.5 million weighted average shares outstanding.

Turning now to the balance sheet and cash flow. We ended the quarter with $85.8 million in cash, cash flow provided by operations was $3.2 million in the quarter, while free cash flow which includes capital expenditure was positive $2.9 million. Moving to our annual results, total revenue for 2021 was $37.9 million, up 19% year-over-year, due to an increase in 27% in license revenue driven by continued expansion of our active customer base and the successful integration of the IP Deployment

Solutions acquired from Magillem offset by $1.3 million decline in royalty and other revenue, from supply chain constraints on our customer shipment volumes and the decline in royalties from HiSilicon that has been directly impacted by US government export controls.

Gross profit in 2021 was $34.1 million representing a gross margin of 90% compared to 95% in the year-ago period, reflecting the inclusion of the higher field application engineering support expenses inherent in the newly acquired IP Deployment solutions. Total operating expenses were $49.7 million compared to $32.2 million in the year-ago period. Operating loss was $21.8 million or 57% of revenue increasing from a loss of $3.8 million in the year-ago period.

Non-GAAP operating loss was $15.5 million or 41% of revenue increasing from a loss of $1.8 million in the year-ago period. Net loss in 2021 was $23.4 million or net loss per share basic and diluted of a $1.06. Non-GAAP net loss was $17.2 million or net loss per share basic and diluted of $0.78 based on approximately 22 million weighted average shares outstanding. Cash flow used in operations was $0.8 million in 2021, while free cash flow which includes capital expenditure was negative $1.6 million.

I would now like to turn to our outlook for the first quarter and the full-year 2022. For the first quarter, we expect ACV plus trailing 12-month royalties of $50.5 million to $52.5 million and revenue of $10 million to $12 million with non-GAAP operating loss margin of 41.1% to 56.1% and non-GAAP free cash flow margin of negative 23% to negative 38%.

For the full year, we expect ACV plus trailing 12 month royalties of $51.6 million to $55.6 million and revenue of $47.0 million to $51.0 million with non-GAAP operating loss margin of 25.6% to 40.6% and non-GAAP free cash flow margin of negative 10.9% to 25.9%.

With that, we'll open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Matt Ramsay with Cowen. You may proceed with your question.

Matt Ramsay

Thank you very much, guys. Good afternoon, everybody. Charlie, I wanted to ask a couple of questions about the automotive business for you guys. I guess there is two separate topics here. One is, you announced a new win in the fourth quarter, just now with an OEM that's going to be building their own silicon, maybe you could expand on that a little bit, if you're able to? And I guess what the pipeline looks like there for companies in the auto space doing their own silicon rather than relying on sort of merchant products?

And then the second question, we've talked a lot in the past about the stickiness and the durability of Arteris IP, the interconnect being really thick you once you win customers. And I noticed, no secret mobilize is going to be pre-IPO incremental and maybe that's the reason that they've been a little bit more open about multiple years of their road map going forward rather than even the cards are little closer to the best. But I noticed in there, the chip gets the furthest in the future for them is now switching from MIT to [risk-five] for the DPU architecture. But it seems like your IP is very sticky across that transition. But maybe you could talk a little bit about the stickiness of the IP? Thanks.

Charlie Janac

Okay. So to address the first question, so I actually - we expected that the car companies are going to be also building their silicon, but that's actually may happen in a few cases. But what seems to be happening more is that they are working with silicon partners that and they're maybe building or architecting one or two IPs themselves and then they're working with silicon partners to basically build customized silicon that supports the very large investments that they're making in their software infrastructure for automated driving and infotainment and those kinds of things.

So we think that - one of the reasons we highlighted this design win is we think this is a part of a greater trend and we think that those car companies that don't at least understand their silicon architectures and with their software runs are going to be at a big competitive advantage. So we think that at least architectural IP design is going to be pervasive across the entire automotive supply chain.

Now, the second question was about Mobileye, right. So yes it is a very sticky technology, particularly in automotive, if you are changing your interconnect in the middle of the project or you basically have to requalify the silicon, right. So the network on chip is actually stickier - even stickier in automotive than it is in other less mission critical segments. So as long as you're doing a good job and as long as you're supporting the customer, and you're delivering the technology that can keep the pace with the evolution of their architectures, you generally get the repeat business on the next set of projects. So very sticky.

Matt Ramsay

Thank you for the color on both of those topics Charlie. As my second topic, Nick, I wanted to ask a bit about visibility of the business going forward. There's obviously a lot going on in the world at the moment and from a supply chain point of view, geopolitical point of view and a number of things.

But one of the attractive features of the business model that you guys have is a lot of visibility on forward revenue and I wonder if you might remind us some of those metrics and give a little commentary on visibility for the upcoming calendar year given all the things we're seeing going on in the world. Thanks very much, guys.

Nick Hawkins

Sure. Yes, some great questions. So let me parse it up into sort of some bite-size piece. As far as the easiest one to I think to handle is the geopolitical military conflict out in Eastern Europe and Russia. We have no direct customers or business in Ukraine or Russia. And we have no intention of changing that either in the foreseeable future. So there is an almost zero impact, whether a secondary or tertiary impact on economies around the world whose values drive, that's a much bigger question that I can answer.

The supply chain was a very interesting one, because we see this time and time again, pretty much everybody out there who is in the semis or the IP businesses related to semis is commenting on the same issue which is silicon shortage, some of the supply chain shortages tend to called.

And all the foundries are completely tapped out as you know which means that volumes from our customers are seriously constrained. And so we've seen an impact on royalties for sure, for very successful chip products from our customers that are constrained in terms of volume and we see that playing out for probably the rest of 2022 and starting to moderate in 2023, that's generally what we're hearing in the industry.

But as far as the last question which I guess is the real key is we go into each quarter with about 80%, 85% visibility of the following quarter's revenue and pretty much ACV as well of [indiscernible]. So that's actually very helpful to us, helped me in terms of guiding the Street. We start - if you look at the 12 months out picture we are somewhere in the 60% to 70% if you include the renewals that we have enjoyed over the years some 90% plus renewal rate from our big customers.

So we have very, very strong visibility over revenue. And the flip side or the other side is of course, OpEx and OpEx we can control to the best to the of our abilities anyway. And definitely some inflationary issues around OpEx as you know, wage inflation is creeping up, especially engineering people, but we are staying on top of it, and we're mindful of how we've guided the Street and our commitments we've made to the Analyst community, the investor community to deliver on results. Does that answered your question, Matt?

Matt Ramsay

Yes it does. I understand there's a lot of it is variability on right now with sort of supply chain in semis versus demand-side geopolitically. So I appreciate the color and the visibility definitely helps. Congrats on the results, guys. I'll jump back in the queue.

Operator

Our next question comes from the line of Ambrish Srivastava with BMO Capital Markets. You may proceed with your question.

Jamison Phillips-Crone

Hello, this is Jamison Phillips calling in for Ambrish, Thanks for the question. I think the first thing I want to touch on was, I think consensus said that you're looking for some pretty big downward sequential declines in 1Q, you guys are guiding only down 4%.

So I was wondering if you could maybe remind us if there is any seasonality to this 1Q revenue because at least we are modeling another big downturn in 1Q. And if there is any seasonality maybe just a little bit explanation on how to think about revenues going forward?

Charlie Janac

Sure. Yes, let me take that one. So the - and hi, thanks for the question, again. And actually, I said hi, Matt as well as hi Phillips, [indiscernible] and thanks for your question. But yes to the question, one of the less known features of our business, because we've only owned it for a year is the IP deployment software business that we acquired from Magillem and as you probably know from Ambrish that's a mainly point in time revenue recognition model.

And so some deals and that's sort of side of the business can swing revenue a little bit more than the ratable revenue recognition model of the SIP business as we go, which is the Interconnect. In Q1, we did actually have - we have actually been having a conscious effort to normalize more quarter-to-quarter. The IP deployment business, which used to be very much Q2 and Q4 centric before we acquired it and that was the mentality that certainly carried through into a lot of 2021 and we spent a lot of time working with the salesforce and working with the application of engineering force to balance that out a little bit more between the quarters.

We were successful doing that. And part of the success of that was to normalize more into Q1 and so, therefore, we're not seeing the seasonality that we originally thought of when we first acquired was that we would have a very heavy Q4 because of the predominance of big IP deployment contracts. Unless so in Q1, it's now looking to be more less seasonally fluctuating than we had originally thought. So you kind of more like normal, that's why we're not changing the annual guidance by much, even though it was an outperform in Q1 simply because it's just becoming more balanced across the year.

Jamison Phillips-Crone

Okay. That's helpful, thanks. And looking at the second half versus the first half, I think we've been modeling back half up maybe 60%, 50% compared to the first half. When you're talking about those balancing of revenues or we should be looking for as kind of a steady low single-digit growth during the rest of the year given the maintained annual guidance, is that correct?

Charlie Janac

Yes, exactly. So we're guiding $10.5 million for Q1 of revenue as I'm sure you've seen and we're guiding $49 million for the year and obviously four times $10.5 million is 42. And so there is definitely a pickup anticipated in Q4. Q4 for us historically has always been the strongest quarter.

It's a quarter where our customer base in many cases and this is not a new thing I'm sure you've heard it before, in many cases where customers will seek to use their budget and some of that budget goes to us and so we have a lot of activity in the fourth quarter. This year actually we were successful in skewing that as much towards October, November as December which was actually a really positive thing, because it helps our cash flow in Q4 and that was a positive effort by us to change the MO of the business.

But yes, there is definitely an uptick and if not just that there is a seasonality issue, it is also because the business is still growing. So naturally, you would hope that the second half is going to be bigger than the first half. Thank you very much

Operator

[Operator Instructions] Our next question comes from the line of Kevin Garrigan with Rosenblatt Securities. You may proceed with your question.

Kevin Garrigan

Good afternoon, everyone. This is Kevin on for Hans. Just a couple of quick ones. The first one in terms of ASP per license, how you kind of look at your expansion opportunities. Can you give us a sense of what the trends are there and how they compare to maybe three or six months ago and kind of at a high level are these opportunities or expansions in line with what you've been thinking?

Charlie Janac

Yes, so there is a couple of tailwinds here. So, one of them is that the chips are getting much more complex and so they just use more system IP, right. You have non-cash coherency that's going outside the - in some cases outside of the CPU subsystem, you have multiple layers of cash, you have more channels of memory.

So, the ASP is going up because there is just more of our products that are necessary to build these complex chips. The other positive development is that some of our customers, and I think we covered on the call is that, some of our customers are now starting to buy not only the Interconnect but also the IP Deployment Software right off the bat, initially and so that also rises ASP.

So we've seen some very positive trends in that aspect, right. And so a couple of years ago where all we had was a non-coherent Interconnect you basically wind up with just maybe a 300,000 kind of the ASP whereas now you may be - if everybody buys everything from us, it's over $1 million, right and the average is probably now more like 450 or 500. So the ASP has been going up and we think that it's going to keep going up. So obviously, we're trying to provide good value to our customers in terms of what we deliver. But the ASP, I think is going to continue to increase for the next several years.

Kevin Garrigan

Got it. Thank you very much. That's very helpful. And then just as a quick follow-up regarding your design starts. I know you guys said in your press release that all major verticals can increase. But was there kind of one standout vertical that you'd point out?

Charlie Janac

Yes, in terms of design wins, there is just a lot of activity in machine learning, right. So we are getting one machine learning order after another, particularly, for the edge machine learning applications. On the royalty side, the automotive royalties are starting to kick in, right, so that's also very, very positive. But on the license side, I would say the biggest driver - the biggest segment is machine learning because ultimately machine learning is not going to be its own segment, it's going to be everywhere. And so those features are going to be necessary for a very large number of chips.

Kevin Garrigan

Perfect. Thank you. And congrats on the results.

Charlie Janac

Okay. Thanks, Kevin.

Operator

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Charlie Janac for closing remarks.

Charlie Janac

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

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.

Nick Hawkins

Thanks, everybody.

Charlie Janac

Thank you.