Arteris, Inc. (NASDAQ:AIP) Q1 2023 Earnings Call Transcript May 7, 2023

Operator: Good afternoon, everyone. And welcome to the Arteris First Quarter 2023 Earnings Call. Please note this call is being recorded and simultaneously webcast. All material contained in the webcast is sole property and copyright of Arteris Incorporated with all rights reserved. For opening remarks and introductions, I will now turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead.

Erica Mannion: Thank you and good afternoon. With me today from Arteris are Charlie Janac, Chief Executive Officer; and Nick Hawkins, Chief Financial Officer. Charlie will begin with a brief review of the business results for the first quarter ended March 31, 2023. Nick will review the financial results for the first quarter, followed by the company’s outlook for the second quarter and full year of 2023. We will then open the call for questions. Before we begin, I’d like to remind you that management will make statements during this call that are forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties that could cause actual results or events to differ materially from those anticipated and you should not place undue reliance on forward-looking statements.

Additional information regarding these risks, uncertainties and factors that could cause actual results to differ appear in the press release Arteris issued today and in the documents and reports filed by Arteris from time-to-time with the Securities and Exchange Commission. Please note, during this call, we will see 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 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, 2023. In addition, for a definition of certain of the key performance indicators used in this presentation, such as annual contract value, confirmed design starts, active customers and remaining performance obligations, please see the press release for the quarter ended March 31, 2023. Listeners who do not have a copy of the press release for the quarter ended March 31, 2023, may obtain a copy by visiting the Investor Relations section of the company’s website. Now I will turn the call over to Charlie.

Charlie Janac: Thank you, Erica, and thanks to everyone joining us on the call this afternoon. We are excited to report a solid start to 2023 with annual contract value plus trailing 12-month royalties of $54.8 million, up 20% year-over-year when adjusted to exclude HiSilicon and DJI, as discussed in previous calls and up 5% sequentially. We continued our growth into 2023 with the addition of seven new customers and 22 confirmed design starts in the first quarter. Deals in the first quarter were driven by strong demand for Arteris products across our core market segments and led in particular by design wins in automotive and enterprise computing. Royalty revenue in the quarter was primarily driven by automotive, followed by consumer electronic products.

An element of Arteris strategy is to service both semiconductor and system companies. This is continuing to yield positive results. With the added focus on the broader automotive supply chain including OEMs and following last year’s ARM automotive partnership, we are pleased to report that in the year-to-date, Arteris has secured four OEM design wins, including three new car companies across the U.S., Europe and APAC. These new relationships demonstrate Arteris ability to engage across the broader global automotive supply chain. This is important as establishing direct relationships with auto manufacturers can create additional opportunities for those car companies to encourage their own supply chains to leverage Arteris technology as well.

Advanced SoCs require best-in-class network-on-chip technology for low power and safe connectivity. So we remain excited that Arteris products continue to be the leading choice for innovative solutions in the automotive SoC market. AI and machine learning also continue to be strong growth drivers for Arteris. New advanced AI electronics tend to require and benefit from network-on-chip IP and SoC integration automation. In the first quarter, Arteris closed numerous global AI and machine learning customer deals across various vertical markets driven by strong demand for Arteris technology. One of those notable AI wins in the Americas was Tenstorrent for enterprise computing applications. Tenstorrent develops our AI high performance computing and data center RISC-V SoCs and chiplets.

The Tenstorrent team extensively evaluated Arteris Ncore cache coherent interconnect IP and select it for the next-generation products, along with our FlexNoC non-coherent interconnect IP. This is an example of Arteris ability to support AI high end computing and the emerging RISC-V ecosystem. Another design win in the quarter was a selection of Arteris by ASICLAND, an APAC-based ASIC design house. Arteris system IP products will be deployed in ASICLAND’s AI chips for automotive, enterprise computing and edge computing applications for consumer and industrial markets. Another design win in the AI space was Axelera AI, a European provider of advanced solutions for edge computing, with Arteris products used to accelerate Computer Vision at the Edge.

Arteris was chosen for its ability to enable Axelera AI engineers to meet performance, ultralow power and time-to-market objectives in its Metis AI Platform. The emerging generative AI technology is opening another potential future application for Arteris products. While promising, generative AI is quite computationally expensive with query cost over 10 times higher than heuristic search algorithms. Arteris anticipates that there will be an increase in AI and machine learning hardware design activity in an effort to lower the computation costs of processing the large language models. With Arteris already designed in over 150 different machine learning chips, the generative AI ASIC and accelerator activity presents another exciting potential future opportunity for our company.

Turning to our product portfolio. We are very excited about both our new FlexNoC 5 innovation and the Semifore acquisition that we discussed last quarter. Over the last several years, as semiconductor manufacturing process nodes have progressed, the associated physical effects have begun to impact how engineers design SoCs, including causing multiple iterations of physical layout network-on-chip connectivity, which in turn impacts project schedules. To address this growing challenge for customers, in February, we announced FlexNoC 5 Physically Aware Network-on-Chip IP with unique and patented technology. We are happy to report that we have delivered a feature-complete early access version of FlexNOC 5 to multiple customers. We anticipate being able to ship a full production release in second quarter 2023 with a positive impact on our revenue and ACV growth forecasted in the second half of 2023.

Expanding the Arteris product portfolio in the first quarter, we announced the acquisition of Semifore, a leader in hardware/software interface technology. The addition of Semifore complements our Magillem Connectivity and Register Management technology, allowing Arteris to provide a more comprehensive SoC integration solution. Together with our NOC interconnect IPs, Arteris is now able to provide a complete solution, helping to increase chip design performance, power efficiency and productivity, while improving the customer’s overall SoC design economics from reducing product schedules to lowering the risk of costly redesigns. Macroeconomic uncertainties and global recessionary concerns continue to create headwinds. We also continue to be impacted by the U.S. BIS regulations with respect to China U.S. trade, as well as tightening credit conditions in the U.S.A., which may affect our smaller start-up customers.

However, we believe that Arteris is well positioned to continue to make progress even in this challenging economic environment, as our customers innovate in areas such as automotive, enterprise computing, consumer electronics and AI across all applications, driving the needs for increased use of commercial system IP. 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 $13.2 million, up 12% year-over-year and 17% sequentially. At the end of the first quarter, ACV plus trailing 12-month royalties and other revenue was $54.8 million, up 20% year-over-year when adjusted to exclude HiSilicon and DJI, as Charlie mentioned. Gross profit in the quarter was $12.0 million, representing gross margin of 91%. Non-GAAP gross profit in the quarter was $12.1 million, representing gross margin of 92%.

Total operating expense for the first quarter was $20.8 million, compared to $17.4 million in the prior year period. Non-GAAP operating expense in the quarter was $17.7 million, compared to $15.1 million in the prior year period. This increase was primarily driven by a combination of continued investment in next-generation products, together with increased investment in sales and marketing to drive product awareness and strong engagement with customers and strategic partners. Additionally, we have continued to achieve significant operating leverage in G&A expense. Operating loss for the first quarter was $8.8 million, compared to an operating loss of $6.6 million in the prior year period. Non-GAAP operating loss was $5.6 million or 42%, compared to a loss of $4.2 million in the prior year period.

Net loss for the quarter was $9.0 million or diluted net loss per share of $0.26. Non-GAAP net loss in the quarter was $5.8 million or diluted net loss per share of $0.17 based on approximately 34.6 million weighted average diluted shares outstanding. Turning to the balance sheet and cash flow. We ended the quarter with $63.4 million in cash, cash equivalents and investments. Cash flow used in operations was approximately $8.4 million in the quarter, driven predominantly by timing of payments from customers, which contributed to our stronger results in the fourth quarter of last year. Free cash flow, which includes capital expenditure was approximately negative $8.5 million, in line with our prior guidance. As we discussed in our prior call, our expectation is that free cash flow will normalize to break even over the remaining three quarters of 2023 taken as a whole.

I would now like to turn to our outlook for the second quarter and full year 2023. For the second quarter, we expect ACV plus trailing 12-month royalties of $53.5 million to $57.5 million and revenue of $13 million to $14 million with a non-GAAP operating loss margin of 37% to 57% and non-GAAP free cash flow margin of negative 26.8% to negative 51.8%. For the full year, our guidance is unchanged. We expect revenue of $56 million to $60 million, ACV plus trailing 12-month royalties to exit 2023 at $60.4 million to $65.4 million, non-GAAP operating loss margin of 28.5% to 43.5%, non-GAAP free cash flow margin of negative 9.7% to negative 19.7%, reflecting the anticipated improvement from the first quarter. Finally, I would draw your attention to the shelf registration statement that we filed with the SEC in November for a maximum aggregate offering price of $150 million, including a prospectus supplement or an at-the-market or ATM offering of up to $50 million pursuant to a sales agreement with Jefferies.

Since as mentioned in our last earnings call we do not intend to sell any share pursuant to activate the ATM at this stage, we have decided to terminate the sales agreement related to the ATM. Following this termination, $150 million will remain available under our S3. We do not have any present intention to offer securities pursuant to this registration statement. With that, I will turn the call over to the Operator and open it up for questions.

Q&A Session

Operator: Thank you. Thank you. Our first question is from Gus Richard with Northland. Please proceed with your question.

Gus Richard: Yes. Thanks for taking my question. Charlie, can you talk a little bit about the customers you see for FlexNoC 5 and sort of what uptick do you expect in the second half?

Charlie Janac: So the FlexNoC 5 has a number of interesting features, but the main feature is integrated physical awareness. And so the problem we are trying to solve is that, for these sub-16-nanometer processes, you can now make a perfectly good architecture that is very difficult to place in route and that leads to a bunch of iterations in the back end and actually could even cause a customer to miss a market window. So what we are trying to do is, allow people to measure the physical effects in the early part of the design cycle, so that essentially they can — the customer can turn over a physically verified or physically estimated design to their place and route team, right? And so this raises obviously the ASP of FlexNoC substantially and so we anticipate that it will increase the revenue in the second half in a meaningful way.

The exact number, I can’t give you yet. But I think that we will see a significant uptick, because of the FlexNoC average selling price increase. And this is basically useful for pretty much any customer doing a design below 16-nanometer, which happens to represent most of our customer base.

Nick Hawkins: Hey, Gus. This is Nick. It’s a great question and as always. But just a little bit of color to add to Charlie’s excellent commentary. The bigger impact on 2H for FlexNoC 5, because it is a ratable product, it’s interconnect and typical life is two and a half years on average for a license. The more pronounced impact will be on ACV plus TTMR. So we pick up the ACV, the annualized value of the contract immediately, but the revenue, of course, is spread over time. So if we land a new FlexNoC 5 contract in November, for example, we will only have one month or two months’ worth of a two-year to three-year term in the revenue. Does that make sense?

Gus Richard: Yes. It does. Absolutely. That was super helpful. And then just two quick questions, given timing, credit standards and banks selling left and right, and everything that’s going on in China, I was wondering if you could just talk about start-up/China activity. And then I want to make sure I understand free cash flow by year end, is that still expected to be breakeven or better?

Nick Hawkins: Charles…

Charlie Janac: So I will take the first one and I will let Nick answer…

Nick Hawkins: Can you take — yeah.

Charlie Janac: … the second piece of it.

Nick Hawkins: Sure.

Charlie Janac: So, basically, China is coming out of its COVID sort of slumber, right? So there’s a headwind of the sort of the trade war issues. But as we discussed earlier, we are kind of somewhat diversified against this, because significant percentage of our products are French technology, which have different export restrictions than the U.S. restrictions. But China is coming out of the COVID slumber. So I think we will see actually toward the end of the year, hopefully, some improvement from the China business. The credit contract I think is real. I think capital is getting tight. I think that doesn’t — that causes problems for people who are short of capital and so this will impact some of our start-up customers who if you don’t have 18 months of cash, you are going to have to be very, very careful and so there will be some headwinds with some of our smaller customers.

On the other hand, as some of these larger companies are tightening up their budgets, outsourcing system IP development is actually more, is sort of more cost effective and so we think that we might also see some tailwind from some large companies potentially going outside for some of their system IP solutions. So it’s a mixed bag.

Gus Richard: Got it. Thanks. And then the free cash flow…

Nick Hawkins: Hi.

Gus Richard: … and that’s it for me. Yeah.

Nick Hawkins: And we are actually starting to see some interesting developments and movements. Nothing that’s sort of seriously in the pipe, but some interesting movements on outsourcing to commercial market, which we are obviously a leader in. But as far as the free cash flow, the — when we announced Q4 and guided for 2023, we guided at that time that Q1 would bear the brunt of the negative free cash flow for the whole of 2023. Part of that was because we have this flip of early cash from Q1 by a couple of big customers into Q4 of last year. So we got benefited last year to the detriment of Q1 in part, because Q1 is always sort of a hangover quarter as a few things that are nonlinear in OpEx. But I won’t go into it in detail, but it’s similar for most companies and so Q1 is often a sort of a heavy OpEx and a lighter cash inflow from bookings quarter.

So we forecast $8.5 million negative-ish for Q1 and that’s exactly where we came in. So it was sort of on the money, so to speak. The full year, we are still actually forecasting just like we did for the last time we guided full year by, again, $8.5 million, which means that Qs 2, 3 and 4 taken as a whole, we are expecting to be neutral. It won’t be linear. It never is for us. We — our Q4 is always our strongest cash flow quarter, because that’s when the largest slice of our bookings fall. So Q2 we are still guiding $5-and-change million negative consumption free cash flow. Three will be neutral to slightly negative and Q4 will be strongly positive. It’s a bit like a replay of 2021 those of you who can remember that, 2022 was a bit of an odd year from a cadence perspective, Q4 wasn’t as strong, but there are reasons behind that.

But, yes, we are standing behind our full year guidance…

Gus Richard: Okay.

Nick Hawkins: … of neutral between April 1 and December 31.

Gus Richard: Okay. Thanks so much, guys. That’s it for me. I will jump out of line.

Operator: Thank you. Our next question is from Matt Ramsay with Cowen. Please proceed with your question.

Ethan Potasnick: Yeah. Hi, everybody. Congrats on the results. This is actually Ethan Potasnick on for Matt. I just — I wanted to drill down into the full year guide. It was great to see you guys kind of reiterate it. On the prior call, there was some discussion about maybe a $4 million, $5 million headwind on macro softness and then maybe another $1 million or so in royalties. So I was wondering, A, how do you kind of see that dynamic playing out, and then if you could talk about trends over the remainder of the year across end markets, that would be really helpful?

Nick Hawkins: Sure. And…

Charlie Janac: So let me just take the trends and then I will let Nick answer about the guide. So…

Nick Hawkins: Yeah.

Charlie Janac: … one of those things that makes us pretty optimistic about the second half is that we should be able to ship FlexNoC 5 production in the second quarter. So that means that we will have full second half of FlexNoC 5 revenue. So do you think that’s going to be helpful to the whole year guide? And then, as I said, you just have a sort of a mixed bag of tailwinds/headwinds, right? I answered to Gus’ question, right, where you have China coming back online a little bit more, but there’s more trade friction. You have credit crunch, which affects smaller customers, but perhaps more outsourcing pressure from the big customers. So we feel comfortable that we are well positioned to meet the guidance. And then with that, I will turn it over to Nick to discuss the actual numbers.

Nick Hawkins: Yeah. Exactly, Charlie. And so, Ethan, great to hear you again, and so say hi to Matt, when you see him. The — so your question — you got a great memory on the headwinds question that we talked about last time and essentially we were saying, hey, look, growth into 2023 would be somewhat stronger if we didn’t have, one, China/macro headwinds, most of which was China through BIS headwind, which we were talking about sort of 7% to 8% negative on the year and that equates — that’s your $4 million essentially that would have been there if all things have been unrestricted, so to speak. And the other is, of course, royalties, which is a direct — directly attributable to anything which is impacted by recession and we all know that we are, whether officially we are in a recession or unofficially we are in a recession, we all know that we actually are.

And so that dampens demand for end products, whether they are in the consumer space, less so in the automotive space, because the automotive, the OEMs, are desperately trying to manufacture as much as possible to deal with the general channel inventory shortage. So there’s not really so much there, but generally, across the batch, there is demand — temporary demand shortage. So that’s the other $1 million, which — that seems still about right. We would have expected to get more like $5 million this year, but we are looking at more like $4 million from royalties, which is a lot less than we would like. We would rather have guided $5 million and gone to $6 million, but it’s going the other way around because of this general sort of volume reduction.

So the picture in other words, in short, has not changed, but just to reestablish the color on the subject that you so rightly brought up again.

Ethan Potasnick: Understood. Terrific. Thank you. Second question, it seems like auto through this kind of earnings season and year-to-date has continued its kind of streak of resiliency as compared to other end markets. And I know you can’t talk about specific customer programs, but maybe if you guys could perhaps characterize how activity in automotive is doing. Are customers still kind of full steam ahead or are there any kind of signs of a slowdown?

Charlie Janac: So the — one of the things that we try to get across on the earnings call is that, we are trying to engage with the entire supply chain of automotive, including the ridesharing companies and the automotive OEMs. And it used to be, maybe four years or five years ago, you could never get a meeting with a car company, because they would say, why are you talking to us. You are a semiconductor IP company. Well, that has completely changed. The tire companies are trying to get control of their architectures and so either they are designing chips themselves or they are working with partners to design architectures — silicon architectures that work for their fairly extensive software. And so we are sort of happy to announce that we have closed in — year-to-date deals with four automotive companies.

Now we can’t say who they are. But they are broadly spread across Europe, APAC and the U.S. And so it just demonstrates our ability that essentially the entire automotive supply chain is going to be a customer for advanced automotive-oriented system IP. And then as far as the car business, it’s going through a major disruption. The investments in sort of both offensive and defensive in that disruption are being maintained and we see the automotive business as sort of one of the along with the machine learning, artificial intelligence segment as one of the shining stars of the current business.

Ethan Potasnick: Terrific. Thank you.

Operator: Our next question is from Kevin Garrigan with Westpark Capital. Please proceed with your question.

Kevin Garrigan: Yeah. Hey, everyone. Let me echo my congrats on the strong results. Just a quick question. So I know you had noted that you are in a strong position to continue to gain market share and potential for large companies to outsource. Are you seeing any increase in competition from anyone and can you kind of remind us who your competition is?

Charlie Janac: Yes. So the competition situation continues to be favorable. The main competitor that we have are really the internal teams that build internal system IP. Those — one of the effects of this recession is that some of the companies are going to have difficulty maintaining those investments and so perhaps there will be more outsourcing of system IP by large semiconductor and hyperscaler companies. So that’s kind of one of the trends. So — yeah, so that’s pretty much what I have to say. And then, of course, the machine learning business is also there’s generative AI, where you have a new killer app that has a major problem with cost per query cost and so there’s going to be we think a substantial amount of investment in specialized hardware and accelerators to lower the cost of the ChatGPT generative AI type queries. So there’s a lot of innovation going on and so we think that we are well positioned to address that.

Kevin Garrigan: Okay. Got it. Yeah. That makes total sense. And then just one quick follow-up. So you have one quarter of 2023 in the books and as you look out to the rest of the year besides the macro, is there anything else that kind of keeps you up at night?

Charlie Janac: Yeah. Lots of things. But, I think, as I said, the sort of for us at least, the kind of the headwinds and tailwinds balance out and so we feel, I think, comfortable with the guidance that Nick discussed.

Kevin Garrigan: Okay. Thanks.

Nick Hawkins: I think the answer from me from the — with my comments at on is some two-fold. One is, can I deliver the income statement numbers, particularly the revenue and that is sort of colored by the amount of forward visibility we have. We have a good amount of forward visibility. We typically talk around 70%, 75%. We currently have around 75% to 80% visibility for hitting 2023 revenue numbers. So that puts me in a reasonably comfortable position. It doesn’t actually make me lose too much sleep because the amount of kind of effective returns business that we have to get to for that gap is relatively small and we have a great sales team. So we — and we have great products coming out as well in H2, as Charlie mentioned, one of which is FlexNoC 5, which is already out and is going to be delivering in the second half.

The other thing, of course, is cash management. We are — as you know, since we last chatted with you, we are laser focused on cash management and very, very careful on every penny we spend on OpEx. We have a very simple model. We don’t have CapEx. We have cash in from bookings and we have cash out to pay OpEx. And so, obviously, we always maximize bookings because that’s where we get our growth numbers from, but we are now very, very careful on OpEx. And we have very carefully dialed down since the end of the third quarter our OpEx, essentially our burn rate and run rate, to keep it so that we can comfortably — we can get good operating leverage from bookings growth from a cash flow perspective into this year, which is why we get some comfort, I guess, some comfort that we can achieve our — achieve or exceed even our negative cash flow projection in the guidance.

Kevin Garrigan: Okay. Got it. That makes sense. Thanks for that. That’s all for me. Thanks, guys.

Operator: Thank you. There are no further questions at this time. I would like to turn the floor back over to Charlie Janac for any closing comments.

Charlie Janac: Okay. Well, thank you for your time and interest in Arteris. We look forward to meeting with you at the upcoming investor conferences and we are — that we are participating in during the next couple of months and we look forward to updating all of you on our business progress in the quarters to come. Thank you.

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