Good afternoon, everyone, and welcome to the Arteris Second 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 Inc. 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 second quarter ended June 30, 2023. Nick will review the financial results for the second quarter, followed by the company's outlook for the third 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 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. 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 US GAAP. A reconciliation of these non-GAAP measures to the nearest GAAP measure can be found in the press release for the quarter ended June 30, 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 June 30, 2023. Listeners, who do not have a copy of the press release for the quarter ended June 30, 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.

Thank you, Erica, and thanks to everyone for joining us on the call this afternoon. We're excited to report a strong second quarter with annual contract value plus trailing 12-month royalties of $58.2 million, up 21% year-over-year when adjusted to exclude DJI as discussed in previous calls. Driving our growth in the second quarter was the addition of 12 new customers and 22 confirmed design starts with strong adoption of Arteris products by companies ranging from innovative startups to established market-leading system houses. In the second quarter, five of the top 10 largest technology companies engaged with Arteris. As we have stated previously, we believe as the volume of logic and IP cars continues to increase, so does the overall SoC complexity and the ability to effectively connect all of the underlying parts. Established companies, who today developed and licensed the bulk of IP, are increasingly looking to outsource system IP connectivity needs to commercial vendors such as Arteris. We are seeing an emerging confirmation of this trend in our customer base. In the second quarter, we closed deals with three of the top 10 global semiconductor companies, who have historically used internal system IP solutions. These wins demonstrate the willingness of major semiconductor companies to increasingly deploy commercial system IP products from commercial vendors such as Arteris. Deals in the second quarter were driven by strong demand across all our core market segments and particularly with design wins in enterprise computing automotive and consumer electronics, often driven by the addition of artificial intelligence and machine learning or AI/ML logic onto the chip. We also closed a Magillem SoC integration automation deal with a top 10 semiconductor company. AI/ML technology infusion into chips continues to significantly increase their size and complexity across all vertical markets and particularly in enterprise computing. This in turn is driving the increased adoption of Arteris products. As previously discussed, one of the major enterprise computing AI/ML design wins in the second quarter was Tenstorrent, who has licensed both Ncore Cache coherent interconnect and FlexNoC non-coherent interconnect based on superior performance power consumption and flexibility. Led by Jim Keller, Tenstorrent develops high-performance computing and data center RISC-V SoCs and chiplets. This is an example of Arteris' ability to support AI/ML high-end computing as well as the emerging RISC-V ecosystem. Another enterprise computing win driven by AI/ML use worth highlighting was in a major hyperscale system company in the top 10 of the largest global technology companies. AI/ML is also increasing the complexity of autonomous driving electronics, together with the functional safety needs and electrification driving Arteris' adoption for automotive electronics. Our continuing focus on the automotive supply chain and our strong relationship with many OEM manufacturers continue to pay off again in the quarter. We added 17 automotive deals across semiconductor companies Tier 1 suppliers and OEMs. Specific to automotive OEMs in the second quarter, we signed five contracts directly with OEMs, three of which were expansions of Arteris' technology use, and two were new customers. We also added a new Tier 1 customer. This level of automotive activity demonstrates the continued rapid adoption of Arteris' system IP by leading players in the automotive electronics industry. As an example, one of the new automotive semiconductor companies is BOS semiconductor, we selected Arteris FlexNoC network on chip IP, along with this automotive safety technology, to be the autonomous driving chips communication backbone, while also deploying our Magillem software to speed up and automate SoC integration. 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 a leading choice for innovative solutions in the automotive market. Another emerging opportunity in the AI/ML semiconductor space is generative AI. GPT-4 in particular, is quite expensive in terms of computation. One of the generative AI imperatives is to reduce the cost of queries, which can partially be accomplished through specific ASIC and accelerated hardware. As an example of a generative AI cost optimization approach, one major generative AI ASIC utilizes Arteris system IP and is ready for mass production this year. Generative AI and GPT-4 in particular require movements of very large amounts of data inside SoC semiconductors and represent another leap in complexity and value of system IP. Arteris is continuing to pursue additional generative AI ASIC opportunities in close collaboration with numerous companies, which we are trying to develop innovative SoCs that lower the cost per query. Turning to our product portfolio. Arteris delivered the production version of new FlexNoC 5 physically aware network on chip or NoC IP toward the end of the quarter. This new FlexNoC 5 NoC IP product addresses the problem that engineers designing SoCs to all 16-nanometer processes can design perfectly good, logic, data handling architectures that can be difficult to implement during physical design, potentially leading to numerous revision cycles and schedule delays. FlexNoC 5, with its physical awareness allows customers to analyze physical constraints during the development of logic architectures, and essentially turn over a physically verified design to placement in raw groups or physical layout contractor companies in order to accelerate physical design schedules and minimize change orders. In the first month of shipment of our new FlexNoC 5 IP, we signed several production and valuation license deals. Additionally, we are pursuing numerous FlexNoC 5 licensing opportunities and expect broader adoption to start in the second half of 2023. Additionally, during the quarter, we released a new version of Ncore Cache Coherent Interconnect IP, CodaCache Last-Level Cache IP in both Magillem CSR Compiler SoC integration and automation software, delivering on multiple customer-requested enhancements, which will be applicable both to our existing customer base and potentially new customers going forward. Certain macroeconomic headwinds including geopolitical uncertainties and global recessionary concerns remain in place, as discussed on the previous call. We also continue to be impacted by the US BIS restrictions with respect to China-US trade, as well as tightening credit conditions globally. We believe that Arteris is serving customers operating in areas of exciting and rapid innovation and growth including automotive, enterprise computing, communication consumer electronics, and industrial applications, leveraging innovations such as AI/ML including generative AI, autonomous vehicles and machines, electrification, and the emerging RISC-V ecosystem, which are driving the need for increased 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 second 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. In the second quarter, we implemented a change to our SoC integration automation software deals, formally known as IP deployment, which now allows Arteris to recognize revenue more quickly over the contract term, aligning this treatment with our network on chip IP deals. With this change, we now expect a significant majority of our revenue contracts to be recognized faster going forward, providing better visibility and reduced fluctuations from period to period. This model defers revenue recognition to future periods, resulting in significantly higher remaining performance obligations or RPO. As Charlie mentioned earlier, we signed a substantial multiyear SoC integration automation software deal late in the second quarter. Due to this change in timing of revenue recognition, the majority of the revenue from this deal will be recognized in future quarters, contributing to the $7.8 million increase in our RPO in the second quarter. Consequently, total revenue for the second quarter remained flat year-over-year at $14.7 million, but increased 12% sequentially, exceeding the top end of our guidance. At the end of the second quarter, annual contract value or ACV plus trailing 12-month royalties and other revenue stood at $52.8 million, a 21% increase year-over-year when adjusted to exclude DJI, and 6% higher sequentially. GAAP gross profit for the quarter was $13.5 million, representing a gross margin of 92%. Non-GAAP gross profit was $13.7 million, reflecting a gross margin of 93%. Total GAAP operating expense for the second quarter was $22.2 million compared to $19.7 million in the prior year. Non-GAAP operating expense was $17.9 million, compared to $15.7 million a year ago and $17.7 million in the first quarter, representing a sequential increase of $0.2 million. The year-over-year increase was primarily driven by ongoing R&D investment in next-generation NoC IP and SoC integration automation software products, along with continued sales and marketing investments to bolster customer engagement and strategic partnerships. Additionally, we achieved significant operating leverage in G&A expenses. GAAP operating loss for the second quarter was $8.7 million compared to a loss of $5.4 million in the prior year. The non-GAAP operating loss was $4.2 million, or 29%, compared to a loss of $1.9 million in the year ago period. The net loss for the quarter was $9.2 million, translating to a diluted net loss per share of $0.26. The non-GAAP net loss was $4.7 million, equating to a diluted net loss per share of $0.13 based on approximately 35.3 million weighted average diluted shares outstanding. Turning to the balance sheet and cash flow, we ended the quarter with $60.8 million in cash, cash equivalents, and investments. Cash flow used in operations was approximately $1.6 million in the quarter, benefiting from strong working capital thanks to early payments from certain customers. Free cash flow, including capital expenditures, was approximately negative $2.2 million. I would now like to provide our outlook for the third quarter and full year of 2023. For the third quarter, we expect ACV plus trailing 12-month royalties of $57 million to $61 million and revenue of $12.5 million, which is a decline between 10.6% and 35.6%. For the full year, we anticipate revenue between $54 million to $56 million, which is lower than our previous guidance due to the change in revenue recognition timing for our SoC integration automation software deals. ACV plus trailing 12-month royalties remains unchanged, with expectations to end 2023 at $60.4 million to $65.4 million. We expect non-GAAP operating loss margins of 34.5% to 49.5% and a non-GAAP free cash flow margin of negative 10.5% to negative 20.5%, reflecting the anticipated overall improvement in the second half of 2023. With that, I will turn the call over to the operator to open it up for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question comes from Matt Ramsay from TD Cowen. Please go ahead.

Yes. Thank you very much. Good afternoon, everyone. For my first question, Charlie, in your remarks, you mentioned some statistics regarding five of the top 10 largest tech companies that are working with Arteris on internal chip development, as well as three of the top 10 global semiconductor companies. Some of these companies you've worked with before, while others may be new partnerships. Could you elaborate on this? Is the focus mainly on AI and machine learning, where companies are aiming for more intricate ASIC designs? There seems to be significant activity around AI inference and similar areas. I would like to gain a better understanding of the scope of these collaborations and the specific application areas where you are partnering with these larger firms. Thank you.

Yes. Regarding the ten largest semiconductor companies, we are beginning to observe some changes. In previous calls, we mentioned that system IP is becoming significantly more complex, and this complexity will likely lead to some outsourcing to commercial vendors. We are starting to witness the initial stages of this trend. For instance, two of these companies, which were nearly 100% internal in previous years, are now collaborating with Arteris for some of their most intricate projects. The applications are quite diverse, including advanced automotive ADAS projects. Additionally, we have secured two deals involving Magillem, one with a new customer and another being a reorder. There is also a favorable uptake among large companies for machine learning initiatives, especially in generative AI, where the volume of data that needs to be processed within these chips is exceptionally high.

Got it. No that's helpful color. I guess as my follow-up question, Nick, the accounting change, and you mentioned a few times in your script maybe you could expand on it a little bit the reasons for the change what sort of percentage of deals or revenue or whatever metric makes the most sense that this change affects. And then you mentioned that the full year revenue guidance had come down due to that change. If you hadn't made the change with the revenue outlook be the same as it was before, up a little bit down a little bit. If you could give us that color that would be really helpful? Thanks, guys.

Hi, Matt. It's great to see you. I anticipated you would be the one to ask this question, so I'll do my best to answer it. Regarding our revenue recognition model, we've discussed before that we prefer not to have a mixed approach where about a third of our business is recognized at a point in time and the other 70% is recognized ratably. This setup is challenging for investors to grasp and for us to plan around, as the point-in-time revenue can be inconsistent and is heavily concentrated in Q2. We've been addressing this for some time, as there are numerous factors involved in reaching a resolution. We need to coordinate with our legal team, customers, auditors, and financial staff to enact a deal structure change that allows us to treat all of the SIA, which combines Magillem and Semifore, as largely ratable going forward. Our goal was to enhance predictability and visibility, aligning us more closely with a revenue model similar to Cadence or Synopsis. In terms of the Q2 figures, had we used the old model, we would have recorded an additional $2.5 million to $3 million in revenue, so Q2's 14.7% would have been about 2.5% to 3% higher if we had continued with the point-in-time method. Looking at 2023 overall, this transition is somewhat of a one-time situation; we won't delve into this detail at every earnings call, but we believe it’s important to provide some guidance now. The estimated impact for 2023 is between $4.5 million and $5 million due to the shift from point-in-time to ratable recognition, which contributes to our guidance being reduced by about 3%. If we compare apples to apples, the underlying business was actually 1.5% to 2% higher. As for your likely next question about 2024, we anticipate a similar decline of about $4 million to $5 million resulting from this change. However, it's important to note that one of the key benefits of this transition is the increase in RPO, which surged by $7.8 million in Q2. We expect this upward trend to continue, projecting an increase in RPO by $9 million to $10 million by the end of 2024.

That's really helpful, Nick. I just have one brief follow-up and then I'll jump back in the queue. The time duration on the ratability of these deals in this part of like you said about one-third of the business, could you walk through that and the shortest to longest and just what the typical length of the deal is now in the new ratable format? Thanks.

The shortest duration would be about a year. It's a bit of a bell curve, so there aren't many deals at that duration. The longest would be four to five years, but again, not many at that length. The sweet spot is around two to three years, with a median of approximately 2.5 years. Additionally, it's important to note that while we expect a rapid conversion, it won't be instant. There will be some customers who are grandfathered in on old terms or contract structures, but we believe this is a minority of deals.

Thank you. Our next question comes from Gus Richard of Northland. Please go ahead.

Yeah. Thanks for taking the question. Just to pound the ratable revenue recognition, when this happened with other companies that followed there's been a sharper falloff in revenue. Is there a bunch of renewals that you're expecting, or is it a smaller impact over the next 2.5 years?

Yeah. I mean it's a good question, Gus. And when you look at other comps who have done this when they've made the change the fall-off you're right is much sharper. I think the difference is for those companies they have been looking at a wholesale change to ratable from point in time. Had we done that, the impact would have been much more dramatic because we're only making the two-thirds to 70% of our business, perhaps as much as 71%, 73% when you count support and maintenance, which already was on a rational basis. It's less of a direct impact to us but it’s still material. It’s still $5-ish million in each of 2023 and 2024.

Got it. That's super helpful. And then Charlie, you mentioned you're working with five of the 10 largest tech companies. Can you put a little bit of arms and legs on where those companies are what they do?

Some of our new customers are large semiconductor companies that previously handled everything internally. We've also seen a significant reorder of our Magillem SoC integration automation software. The demand for our products is diverse and strong. What makes me particularly pleased is that several companies that used to keep everything in-house are now becoming more receptive to licensing external system IP solutions.

Okay, got it. And then just your royalty variable revenue was up nicely the last couple of quarters. Is that a trend we can expect? And do you see your after losing the cell phone guys Huawei and Qualcomm in the past? Do you expect to see that line grow with revenue going forward, or how are you thinking about that part of the business?

I've been discussing this extensively with the royalties team. If we exclude audit adjustments, which can be unpredictable, we had a significant audit benefit in Q2 and a decent one in Q1. If we leave those out, which is a reasonable portion of the total, and look back, particularly without considering HiSilicon, the trend has been strong. HiSilicon's royalty contributions diminished in Q1 of 2022. Removing those, royalties have been consistently increasing. Generally, we anticipate the growth rate of royalties to be about five percentage points higher than that of license growth, and that's approximately where we currently stand.

Sorry, say then about 5% higher than royalty growth?

Yes. So, five percentage points. Yes. So if you look at our guide for example for 2023 full year, overall, on sort of licenses is around 20% year-over-year. And that's probably a good long-term metric. We look at royalties CAGR as more like 25% to 30%.

Got it. Perfect. I’ll get back in the queue. Thanks.

Thank you. The next question comes from Brian Chen at Jefferies. Please go ahead.

Hi. Thanks for taking the question. Just wanted to revisit some of what we've been discussing over the past earnings calls. So, I've mentioned China headwinds, was the macro headwinds as it related to royalties around $5 million this year. If you could provide an update on where we are with that that would be great.

Yes, we are still seeing orders from China, although there are ongoing challenges with BIS. There is increased difficulty for Chinese startups to raise capital, which is likely to cause a slowdown in new venture formation. While the market remains very attractive, it is not as vibrant as it was a year or two ago. However, I wouldn’t say there has been any significant change in that trend.

Exactly. And I was looking at the data this morning, Charlie, in the data for China specifically and APAC generally remains very robust. We're still in the first and the second quarter. We're still seeing a good number of license wins and a good number of design starts, very healthy, no reduction at all. So, I think really it's indicative of the fact that the target markets for us in China in particular and APAC generally are not the type that are suffering from BIS or even from a lack of availability to capital. So think automotive and AML.

Got it. And just two other things. So RPO is up $8 million quarter-over-quarter. Could you help walk us through I guess the different drivers of that? Again, like I heard $2 million to $3 million was from the rev rec change and perhaps any commentary on what drove the remaining of that? And then on free cash flow, could you confirm breakeven just through the last three quarters this year again and some of the puts and takes around that?

Yes. Yes. Sure. I'll take those in order. So, in terms of the RPO, the $7.8 million as you say, say just call it, the let's say $3 million of that came from the change away from point of time to ratability. The rest of it was just a very strong quarter. RPO grows as you get bookings, it reduces as you recognize the revenue. We just had a very solid quarter and there was no one particular area that stood out in terms of either vertical or region, it was pretty much across the patch, a strong quarter. So the other so $4 million to $5 million of the RPO increase was out of the non-sort of ratable change impact.

Okay. And then free cash flow?

Regarding free cash flow, there are two key aspects to consider this quarter. It was a very strong quarter, as you may have noticed. We experienced a $3 million increase, similar to what we saw in December. A few major customers chose to pay us before the end of the quarter rather than when their payments were due, resulting in a $3 million boost to free cash flow for this quarter, which will reverse. We had anticipated a negative free cash flow of around $5 million for Q2, but it ended up being just over $2 million. Working capital is always variable; it doesn’t change the overall trend, just the timing between quarters. This means that the $3 million will reverse, which explains the guidance for Q3 of negative $3 million because of the advanced payments. Without those, Q3 would have been neutral. For the full year, we expect to be positive, as this is typically our strongest quarter for free cash flow due to higher bookings and relatively stable operating expenses throughout the year. Free cash flow is more influenced by the timing of bookings, which peak in Q4. We've seen a negative Q1, followed by a smaller negative in Q2. By year-end, we expect to offset the impacts of Q2, Q3, and Q4 to reach an overall figure close to $8.5 million, and we are maintaining that guidance.

Okay, perfect. Thank you for all the details. Nick and Charlie.

Welcome.

Thank you. Our next question comes from Kevin Garrigan at WestPark Capital. Please go ahead.

Hey Charlie and Nick, nice speaking with you guys again. Just a quick question. So, with FlexNoC five getting full production in Q2 would you say that the FlexNoC 5 helped at all with winning design starts with some of the top technology and semiconductor companies?

Yes. We sold a couple of licenses right away as soon as it became available and there is a very robust pipeline for the product because it solves a very valuable problem, which is that you now with some of these complex deep submicron SoCs you have to concern yourself with physical effects relatively early in the design cycle. And so this product has a lot of interest and it also raises the ASP, and we are expecting that this is going to be the main FlexNoC version and generate significant uptick in the second half. We predict that it was going to help and there's nothing that we see that would not make that prediction come true.

Okay, got it. That makes sense. And then just a quick follow-up. So I know you guys are really strong in automotive with radar vision cameras etc. But I think there still are a couple of kind of ADAS semiconductor companies that you don't have as customers right now. So you just won other large semiconductor and tech companies. So what do you guys kind of think it would take to get them over the hump and capture these ADAS semi companies as customers?

Yes, we’re not certain we’ll be able to reach all the potential customers we’re missing, as there are very few. I don’t want to mention the ones we don’t have. However, in the recent quarter, we did acquire two companies in the automotive sector that were not previously using Arteris, both in the ADAS area. Our penetration in automotive remains strong, but we’re not claiming we will capture every opportunity.

Yes, okay. Got it. That makes sense. Okay, thanks guys.

Thank you. There are no further questions. I will now turn the call back over to Charlie Janac for closing comments.

Yes. So we would like to thank you for your time and interest in Arteris and we look forward to meeting with you at the upcoming investor conferences that we are participating in during the next couple of months and we look forward to updating you on all of our business progress in the quarters to come. Thank you.

Ladies and gentlemen, this concludes the conference call for today. We thank you for participating and we ask you please disconnect your lines.