Arteris, Inc. Q4 FY2022 Earnings Call

Good afternoon everybody, and welcome to Arteris Fourth Quarter and Full Year 2022 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.

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 fourth quarter and full year ended December 31, 2022. Nick will review the financial results for the fourth quarter and full year followed by the company's outlook for the first 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 the 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 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 cite certain non-GAAP measures, including non-GAAP net loss, non-GAAP net loss per share and free cash flow, which are not measures prepared in accordance with U.S. GAAP. The non-GAAP measures are presented as we believe that they provide investors with the means of evaluating and understanding how the company's management evaluates the company's operating performance. These non-GAAP measures should not be considered in isolation from, as substitutes for or superior to financial measures prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the nearest GAAP measure can be found in the press release for the quarter ended December 31, 2022. 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 December 31, 2022. Listeners who do not have a copy of the press release for the quarter ended December 31, 2022 may obtain a copy by visiting the Investor Relations section of the company's website. Now, I will turn the call over to Charlie.

Thank you, Erica, and thanks to everyone for joining us on the call this afternoon. We're excited to report a strong finish to 2022 with annual contract value plus trailing 12-month royalties of $52.4 million, up 22% year-over-year when adjusted to exclude HiSilicon and DJI as discussed in previous calls. We continue our growth in 2022, illustrated by adding 38 active customers and reaching 82 design stars during the year and over 3 billion systems shipped with SoCs connected by our Terra system IP since inception. We continued our progress in automotive semiconductor electronics by closing 8 automotive customer licenses in 2022. Demonstrating the continued demand for our solutions, we had a total of 24 confirmed SoC project design starts in the fourth quarter. We also added 40 new customers in the quarter, contributing to the 20% year-to-year increase in customers deploying Arteris IP. 2022 deals were driven by strong demand for our products across all of our core markets and led in particular by automotive and consumer electronics, followed by enterprise computing, industrial, and communication applications. In Q4, we also continued to see Arteris technology sales to automotive OEMs, including in China, where our IP was licensed for next-generation electric vehicle designs. Besides OEMs, we also saw strong automotive momentum with Tier 1s and numerous semiconductor companies. For example, Telechips licensed Arteris IP in the fourth quarter for advanced automotive solutions. These solutions help to ensure security requirements are met when designing Telechips' new business area solutions such as advanced driver assistance systems, ADAS, and microcontroller units, MCUs. Advanced SoCs require best-in-class network-on-chip technology for low power and safe connectivity, and we're excited that the Arteris products continue to be the leading choice for high-performance innovative solutions in the advanced SoC automotive markets. Besides automotive, other applications are also getting more sophisticated with growing AI and machine learning electronics, including smart edge devices. The advanced SoCs that power them typically use ARM or risk processor IP and tend to increasingly require Arteris network on-chip interconnect IP for SoC connectivity. To that end, Arteris and SiFive announced a partnership to accelerate risk 5 SoC designs for edge applications to speed up electronics product innovation for consumer electronics and industrial markets. Turning to our product portfolio. We are very excited about our new FlexNoC 5 innovations and the Semifore acquisition. Over the last several years, semiconductor manufacturing process technology has gone beyond 17-nanometer, with many new SoC designs starting at 5-nanometer and increased 3-nanometer ramp-up, the associated physical effects have started to impact how engineers design SoCs by causing physical layout driven network-on-chip connectivity iterations, which have a growing impact on project schedules. To address this growing challenge our customers face, we announced FlexNoC5 physically aware network-on-chip IP with unique and patented technology. The fifth generation of our core interconnect technology provides customers with up to 5x faster physical convergence over manually driven physical iterations for new and derivative designs across automotive, communications, consumer electronics, enterprise computing, and industrial applications. Continuing our efforts to expand the scope of IP and SoC solutions in the fourth quarter, we acquired Semifore, a leader in hardware software interface automation, providing registered management technology. Semifore is used by customers to effectively design, verify document, and helping the validation of the hardware, software integration that is essential to every SoC and is used by leading semiconductor and system companies across automotive, consumer electronics, communication, enterprise computing, and other applications. The addition of Semifore complements both our Magillem IP deployment automation and our network on chip IP and expands our SoC solutions by providing a critical SoC integration layer, which in turn allows customers to accelerate hardware, software development, and convergence. With the new FlexNoC5 innovation and Semifore acquisition, we expect our customers to be able to accelerate their SoC designs. We are physically aware IP connectivity and to better integrate SoC hardware and software layers, improving the overall SoC economics while reducing project schedules and risks of costly redesign. As previously discussed, we are seeing short-term macroeconomic uncertainties and global recessionary impacts, particularly in the first half of 2023. We're also seeing headwinds from the tightening U.S. BIS regulations with respect to U.S.-China trade. 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, consumer electronics, and machine learning across all applications driving the need for the use of commercial system IP. With that, I'll turn it over to Nick to discuss our financial results in more detail.

Thank you, Charlie, and good afternoon, everyone. As I review our 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. I will start by summarizing our key results for the fourth quarter. Total revenue for the fourth quarter was $11.2 million. At the end of the fourth quarter, ACV plus trailing 12-month royalties and other revenue was $52.4 million, up 22% year-over-year when adjusted to exclude HiSilicon and DJI as Charlie mentioned. Gross profit was $10.1 million, representing a gross margin of 90%. Non-GAAP gross profit for the quarter was $10.2 million, representing a gross margin of 91%. Total operating expense for the fourth quarter was $19.2 million compared to $17.6 million in the prior year period. Non-GAAP operating expense for the quarter was $16.7 million compared to $13.3 million in the prior year period. The increase was primarily driven by a combination of investment in sales and marketing to drive product awareness and strong engagement with customers and strategic partners. Additionally, we continue to invest in certain next-generation products while significantly driving operating leverage in G&A expense. Operating loss for the fourth quarter was $9.1 million compared to a loss of $7.3 million in the year-ago period. Non-GAAP operating loss was $5.8 million or 51.8% compared to a loss of $2.8 million in the year-ago period. Net loss for the quarter was $7.2 million or diluted net loss per share of $0.21. Non-GAAP net loss for the quarter was $4 million or diluted net loss per share of $0.12 based on approximately 33.6 million weighted average diluted shares outstanding. Turning to the balance sheet and cash flow. We ended the quarter with $72.6 million in cash, cash equivalents, and investments. Cash flow used in operations was approximately $400,000 for the quarter, while free cash flow, which includes capital expenditure, was approximately negative $800,000 or 7.1%. Moving on to our annual results. Total revenue for 2022 was $50.4 million, up 33% year-over-year, reflecting strong growth across IP licensing and royalty revenue. Gross profit for 2022 was $46.1 million, representing gross margin of 92%. Total operating expenses were $75 million compared to $55.9 million in the year-ago period. Non-GAAP operating expenses were $62.8 million compared to $49.9 million in the year-ago period. The increase was primarily due to the incremental costs expected of a public company. Operating loss was $28.9 million, increasing from a loss of $21.8 million in the year-ago period. Non-GAAP operating loss was $16.2 million or 32.1%, increasing from a loss of $15.5 million in the year-ago period. Our operating losses are partly derived from our subscription-based ratable revenue recognition, which defers a portion of revenue. We define RPO or remaining performance obligations as the amount of contracted future revenue. RPO was $57.7 million as of December 31, 2022. Net loss in 2022 was $27.4 million or net loss per share basic and diluted of $0.84. Non-GAAP net loss was $14.7 million or net loss per share basic and diluted of $0.45 based on approximately 32.6 million weighted average shares outstanding. Cash flow used in operations was $6.8 million in 2022, while free cash flow, which includes capital expenditure, was negative $7.8 million or 15.5%, which was better than previously guided, partly as a result of a $2.5 million favorable timing of cash received earlier from customers. I'd now like to turn to our outlook for the first quarter and the full year 2023. For the first quarter, we expect ACV plus trailing 12-month royalties of $51.5 million to $55.5 million and revenue of $11 million to $13 million with non-GAAP operating loss margin of 55% to 75% and non-GAAP free cash flow margin of negative 56.7% to negative 81.7%, partly resulting from the $2.5 million early payment from customers in the fourth quarter of 2022 that I mentioned earlier. For the full year, 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% and non-GAAP free cash flow margin of negative 9.7% to negative 19.7%, reflecting the concentration of negative free cash flow into the first quarter. Finally, I would draw your attention to a self-registration statement that we filed with the SEC in November for a maximum aggregate operating price of $150 million, including a prospectus supplement from an ATM or aftermarket offering of up to $50 million. We have not activated the ATM at this stage, and I have no intention to do so at the current stock price levels. With that, I will turn the call over to the operator and open up for questions.

We filed a self-registration statement with the SEC in November for a maximum operating price of $150 million, which includes a prospectus supplement for an aftermarket offering of up to $50 million. We have not activated the ATM at this time, and I do not plan to do so given the current stock price levels. I will now turn the call over to the operator to open the floor for questions.

So thank you for your interest and time in Arteris. We look forward to meeting with some of you at the upcoming investor conferences that we are participating in the next couple of months, and we look forward to updating all of you on our business progress in the quarters to come. Please, looking forward to your questions.

Our first question is from Hans Mosesmann with Rosenblatt Securities.

This is Mack Clain on for Hans. Could you please provide the mix of licensing engagements in the quarter between automotive, communications, machine learning, etc.? And I have a follow-up as well.

Nick, do you want to take this one? Or do you want me to take it?

Yes. So automotive is about 20% roughly. Consumer roughly 25%. Enterprise is probably something like 15%. And then the rest of it and then royalties are somewhere around 8%.

Okay. That's very helpful. And then just lastly, if you could just expand on the general trend for the deal overall, that would be helpful.

Yes. So automotive continues to be a strength. We've added a number of automotive customers for the quarter and for the year. The automotive royalties are growing nicely. But we are also very excited about our progress in machine learning. There are some new exciting applications for machine learning ASICs that are coming up, including ASICs for the chat GPT large language models. And we also continue to be excited about the unforeseen space applications. So there seems to be a lot of work going on in both terrestrial and orbital space applications.

Our next question is from Auguste Richard with Northland.

Charlie, I was wondering if you could talk a little bit about Semifore, and how that fits into your product portfolio? Is it just a separate stand-alone product? Or will there be some integration with the existing product suite?

Yes, Semifore is a high-performance, high-capacity register management product that is very fast. We also have bridges to management capabilities within our product line. Initially, we will sell them separately, but our long-term plan is to integrate Semifore register management into the next-generation Magillem products. It will be a stand-alone solution in the short term and integrated in the medium term.

And then on the FlexNoC5, is there an ASP uplift for this new product? And how far along are you in filling that or selling that to customers?

Right. So the FlexNoC5 has essentially integrated physical awareness in it, and that capability has a significant ASP uplift compared to the FlexNoC4 without physical awareness. So we do anticipate a revenue uplift from that, and it is a product that we have so far delivered to several early access customers who are providing us with feedback on as they test the product in their projects. So we're in the early access stage with the FlexNoC5, but we have customer installations.

And if I can just add some color to that excellent answer. The impact, I mean, you talked about where it's at in terms of customer adoption. There are some early access customers, and we expect to see sort of revenue accretion in the second half from that through the ASP uplift.

Got it. And then the last one for me. In your prepared comments, you talked a little bit about the impact of the macro and headwinds from China and some of the trade issues and I was just wondering if you could expand on that a little bit and just kind of give us a sense of how much of a headwind that's creating for you in the short term?

Yes. So yes, I mean, there are some definite macro headwinds. There's also some macro tailwinds, but we continue to see the strength in our business, and we see continued investment by customers in developing new applications for automated driving, car electrification, edge and data center machine learning and machine-to-machine communications based on 5G. So we're seeing a relatively steady number of design starts. And in general, our customers are investing in designing their way of recession. So while there might be some tailwind on royalties based on unit volumes that could be somewhat reduced. The design starts seem to be just fine as our customers turn to engineering new products.

I can provide some numerical insight regarding the challenges mentioned. The headwinds you've identified are accurate and significant, and we've addressed them previously. As we noted during the Q3 earnings call, we anticipated BIS-related headwinds from China in FY '23, estimating a 7% impact on our overall revenue for that year due to this. We stand by that estimation, although we have yet to fully assess the total impact, which is certain to exist. This translates to a $4 million to $5 million effect on our results for '23. Additionally, we are facing a negative royalty impact of around $1 million due to our customers' inability to meet shipping volumes. Together, these factors suggest a total impact of approximately $5 million to $6 million, which shouldn't come as a surprise, as it is a short-term issue. The royalties will bounce back as volume increases, and the situation in China is also expected to improve.

And our final question is from Ambrish Srivastava with BMO.

This is Jamison on for Ambrish. So I just have just a couple of brief ones. So I'm just kind of curious; you are talking about these macro headwinds. It seems like they're taking place or expecting at least the first half more so than the back half. So should we expect looking at the first half of 2023, should we expect a relatively flat growth versus 2022 and then an acceleration in the back half in terms of revenue?

Yes, that's exactly what we're saying. So it's not out of line with what other people in the semi-space broadly have been headlining recently. And we don't know exactly when these things are going to improve, but you hit the nail on the head.

Okay, perfect. I just want to clarify something about the gross margin. I believe you mentioned previously that there is some seasonality in gross margins, particularly in the first quarter where we anticipate a decline followed by a gradual increase throughout the year, and then another decline in the first quarter. Is this still something we should expect, or might it not apply anymore as you continue to grow your revenues?

Yes, that's a great question. The answer is primarily mathematical. Most of our cost of revenue is associated with our field application engineers, and we don't hire or manage those in direct proportion to revenue. When revenue is lower, the same cost of FAEs is distributed over a smaller revenue base, and the opposite is true for higher revenue. Typically, you'll observe higher gross margins during high revenue quarters and lower gross margins during low revenue quarters. As you mentioned, the first quarter is usually a low revenue period, so the margins are generally a bit lower than usual. The variation from quarter to quarter is about 1%.

Our next question is from Ethan Potasnick with Cowen.

This is Ethan Potasnick on for Matt Ramsay. I had a question on how we should think about, I guess, use of cash and OpEx throughout the year we have heard. We've seen a lot of companies kind of, I guess, tighten the belt. But how are you balancing kind of staying prudent versus some of the kind of growth initiatives that are currently underway?

Let me provide some insights on operating expenses and free cash flow. Throughout 2022, we continued to increase our operating expenses, particularly in engineering, while general and administrative costs have remained stable for about a year. Sales has also been relatively stable. We did increase our marketing efforts in the fourth quarter, but we don't expect that to grow going forward. The primary growth in operating expenses for 2023 will come from next-generation products in research and development, such as NoC5, which you noted won't impact revenue until the second half of the year and will increase sequentially quarter-over-quarter as higher average selling prices take effect. We incurred operating expenses throughout the year and invested heavily in digital marketing, product marketing, and customer positioning marketing aimed at strengthening our relationships with customers. This effort contributed to the OEM engagement and partnership we announced earlier, which we anticipate will yield benefits, particularly in the automotive sector, although not immediately. Regarding cash flow, you might wonder how we maintain a guide from a negative 8% to another negative 8% in free cash flow. Part of this is due to an unexpected advanced payment from customers at the end of 2022, totaling around $2.5 million. The reported negative $7.8 million for 2022 was actually an underlying negative 10.3%, which aligns with our Q3 full-year guidance. If we adjust that for 2023, instead of a negative 8.5%, we would be at a negative 6%. This indicates an improvement from negative 10.5% to negative 6%. Most of the negative cash flow for 2023 will occur in the first quarter, which we expect to be around negative $8 million, while we anticipate the remainder of 2023 to remain relatively flat in terms of free cash flow. This positions us well to be cash flow neutral in 2024, followed by cash flow positivity thereafter.

Okay. Got it. I admittedly I may have missed this in the beginning of the Q&A. But I was wondering if you could discuss the full year outlook a little bit more in detail. Obviously, I'm aware that the team has a significant visibility. But maybe kind of parse out areas you're seeing, I guess, downward pressure or if there are areas where maybe there's accelerated interest in terms of shipments and royalties. So I would be curious to hear that fleshed out a little bit more.

Yes. I mean, as Nick pointed out, we're seeing a bit of a headwind from China, right? So sort of a modest impact on our growth rate there. On the other hand, continued strength in automotive. There are some new exciting machine learning applications that are coming up that is creating excitement both in our customer base and that requires new silicon to be designed. So I think there's offsetting tailwinds and headwinds. And so you have impact on consumer, strength in automotive, strength in machine learning.

Regarding your question on royalties, certain royalties in 2022 and early 2023 have indeed been affected by recessionary influences, as these factors have a direct impact on volumes across the semiconductor industry, leading to lower unit shipments. As a result, our royalties have been impacted. However, the strength of our model enables us to recover, and as the recessionary effects ease, we anticipate an increase in royalties. We expect to see some acceleration in the second half of the year and significantly into 2024 and beyond. It is important to note that our automotive royalties continue to perform exceptionally well, having more than doubled in the past two years, and we are consistently adding new deals and design-ins.

There are no more questions at this time. We can conclude today's conference. Thank you, everyone, for your participation. Please disconnect your lines, and have a great day.