Q2 2022 Arteris Inc Earnings Call

introductions, I will now like to turn the call over to Erica Manion at Sapphire Investor Relations. Please go ahead.

Thank you and good afternoon. With me today from our terrorist IP are Charlie Janick, Chief Executive Officer, and Nick Hawkins, Chief Financial Officer.

Charlie will begin with a brief review of the business results for the second quarter end of June 30, 2022. Nick will then review the financial results for the second quarter, followed by the company's outlook for the third quarter and full year of 2022. We will then open the call for questions. Before we begin, I'd like to remind you that management will make statements during this call that are forward-looking statements within the meaning of 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 our Terrace IP issued today and in the documents and reports filed by our Terrace IP from time to time with the Securities and Exchange Commission. For more information, visit Terrace.org

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 measured prepared in accordance with US GAAP. These non-GAAP measures are presented as we believe they provide investors with a 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 end of June 30, 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 end of June 30, 2022.

Listeners who do not have a copy of the press release of the quarter ended June 30, 2022, may obtain one by visiting the investor relations section of the company's website. Now I'd like to turn the caller to Charlie.

Thank you, Erica, and thanks to everyone for joining us on the call this afternoon.

We're excited to report our continuing momentum in 2022 with annual contract value plus trailing 12-month royalties of $51.7 million in the second quarter, up 18% year-over-year, despite high silicon contract ending in Q2, which removed $3.3 million of annual contract value.

Demonstrating the strength in market demand, our active customers increased by 9.25, while total confirmed design starts were 18 SOC projects.

Major new customer wins including Telechips in automotive, Pleops in consumer, and Sunrise memory in enterprise, as well as a leading automotive OEM.

leading enterprise hyperscaler and leading

machine learning artificial intelligence semiconductor company.

Deals in the second quarter were driven by strong demand for our Terrace IP across our core markets, including multiple transactions in automotive, consumer electronics, enterprise around data center applications, and AI ML. These were broadly distributed geographically across APAC, EMEA, and the U.S.

With the EMEA, there was an increase in innovative Israeli startup wins, including an innovative for development of next generation of vision processing for edge devices, for robotics, drones, and other

Augmenting reality, virtual reality, and mobile products.

On the product front, we continue to invest heavily in development of innovative system IP products.

In the second quarter, we made a major release of our NCORE Cash Coherent product to multiple automotive and enterprise customers.

With respect to the IP deployment software product line, we partnered with major customers to implement continuous IP block integration flows for new designs and incremental changes which accelerate their delivery of new SoC platforms and derivative chips.

We also delivered a framework for automatic SOC assembly scripting, which lowers the difficulty and cost of integration for internal design automation groups.

While there are macroeconomic uncertainties, we believe that our Terrace IP is well positioned to make progress even in challenging economic environments.

We are seeing increased silicon content of electronic systems as they are engineered to be smarter and in some cases autonomous.

One of these markets is the automotive market.

where vehicles are becoming endpoints of a vast transportation network.

Furthermore, we see ever higher levels of silicon integration to the point where electronic systems are made up of complex semiconductors on relatively few circuit boards.

This is driving system houses to become involved in silicon design at some level, either by themselves or together with partners.

Before turning over the call to Nick, I'd like to mention in the second quarter we announced the addition of Claudia Fan-Munchi to the Arterios IP's board of directors.

Claudia contributes a wealth of experience.

which includes a distinguished 30-year career at IBM, where she held various positions, including executive roles in engineering, IP licensing, and IBM Ventures.

She is also a Stanford University lecturer and sits on the board of directors of major public companies.

With that, I will 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 that I will be referring to non-GAAP metrics.

A reconciliation of gapped and non-gapped financials is included in today's earnings release which is available on our website.

Total revenue for the second quarter was $14.8 million, up 37% year over year, benefiting from higher than expected concentration of point-in-time IP deployment revenue.

As a reminder, IP deployment deals are largely recognized as point-in-time revenue as opposed to our Interconnect license agreements which are generally recognized rapidly.

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 contract 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 also refer to ACV plus trailing 12-month Royalties as a metric which provides a more complete picture of our total revenue.

At the end of the second quarter ACV plus trailing 12-month royalties and other revenue was $51.7 million.

up 18% year-over-year in particular driven by growth in automotive consumer electronics

AI, ML, enterprise and 5G communication market segments.

and down 2% quarter over quarter, reflecting the removal of the $3.3 million ACV associated with the 2019 High Silicon License Agreement, which ended in May 2022.

Remaining performance obligations or RPO were $55.7 million, up 11% year-over-year as compared to June 30, 2022.

We define RPO as the amount of contracted future revenue.

Gross profit in the quarter was $13.8 million, representing a gross margin of 93%, compared to $10.0 million, or 92%, in the prior year period.

R&D expense for the second quarter was $8.8 million or 59% of revenue compared to $6.1 million in the prior year period.

The increase was driven by continued investment in new and improved product offerings in our five R&D centers.

across our full product portfolio.

Sales marketing expense for the second quarter was $3.7 million or 25% of revenue compared to $2.2 million in the year-ago period.

We intend to continue to invest in sales and marketing as we work to continue to drive awareness of the benefits of our solutions in the market and expand our sales and application engineering force.

and marketing efforts to harness the significant potential opportunity in front of us.

G&A expense for the second quarter was $3.2 million or 22% of revenue, compared to $4.6 million in the year-to-year period.

G&A expense reflects a decrease in professional services associated with our transition to being a public company in 2021.

Operating loss for the second quarter was $5.4 million or 37% of revenue compared to a loss of $3.5 million in the year-ago period.

non-GAAP operating loss was $1.9 million or 13% of revenue compared to a loss of $3.0 million in the year-ago period.

Net loss in the quarter was $5.7 million or diluted net loss per share of 18 cents.

non-GAAP net loss in the quarter was $2.2 million or diluted net loss per share of 7 cents, based on approximately 32.3 million weighted average diluted shares outstanding.

Turning now to the balance sheet in cash flow, we ended up the culture with $81.3 million cash flow.

Cash flow from operations was approximately $0.2 million in the quarter, while free cash flow, which includes capital expenditure, was positive $0.1 million, reflecting the benefit of both the previously mentioned IP deployment deals and also the earlier than expected collection from a major customer.

I would now like to turn to the outlook for the third call from the full year 2022.

For the third quarter we expect ACB plus training 12-month royalties of $51.0 million to $53.0 million and revenue of $10.5 million to $12.5 million.

with non-GAAP operating loss margin of 41.2% to 56.2% and non-GAAP free cash flow margin of negative 41.2% to negative 56.2%

For the full year we expect revenue of $49.5 million to $52.5 million.

representing a $1.0 million increase at the midpoint compared to prior revenue guidance.

ACV plus 12 months royalties to exit 2022 at $48.0 million to $52.0 million.

representing a $3.6 million decrease at the midpoint compared to prior ACV plus TTMR guidance.

reflecting the removal of the $3.7 million ACB associated with the 2020 DJI license agreement which ends in December 2022.

and some caution on the timing of fourth quarter deals as a result of the current economic concernancies.

Non-GAP operating loss margin of 24.3% to 39.3% representing an improvement of 60 basis points at the midpoint compared to prior guidance.

inclusive of the increased revenue guidance.

partial offset by the impact of wage inflation on our operating expenses.

and non-GAAP free cash flow margin of negative 10.1% to negative 25.1%

representing an improvement of 40 basis points at the midpoint compared to prior guidance.

With that, I will turn the call over to the operator and open it up for questions. Operator

Thank you. Ladies and gentlemen, at this time we will be conducting a question and answer session. If you'd like to ask a question, you may press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue.

For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key.

Our first question comes from the line of Matt Ramsey with Callan. Please proceed with your question.

Yeah, thank you very much. Good afternoon, guys, and thanks for taking the questions.

I guess for my first one, congratulations on the results. Nick, it sounds like the software deployment and stuff that's getting recognized point in time is what drove the upside to the revenue. If I look forward into the third quarter and maybe even the implied fourth quarter revenue from the full year, how much of that sort of turns business are you assuming in the revenue guide for the back half of the year, or is that...

fairly de-risk and would represent potential upside if the terms business actually comes through as it did in the second quarter. Thanks.

Yeah, hi Matt. Nice to speak to you again. These things come around so quick. But yeah, you're absolutely right. We kind of indicated a large part, even though we have all the business, i.e. the interconnect and the IP deployment software. And in fact, even some of the royalties were really strong in Q2. The big sort of outperform was really the cadence of IP deployment deals.

And there was a set amount of rebalancing by customers in terms of when they want to place their orders, whether it was Q1, Q2, Q3. And particularly there was a rebalancing between Q2 and Q3. So yeah, big outperforming Q2. And the reason for the slightly lower guidance in Q3 is because some of those deals were previously slated for Q3 and they came forward a little bit. So there's an element of that.

quite a big element further out for the rest of the year.

Again, you've got the same, actually the revenue we're guiding is slightly up. That's really just general strength across the board.

we're not expecting as much IP deployment software revenue, which is mainly point in time in Q3, but for the full year it's still wasting.

Does that give you a sort of a good sense for where we're at?

No, it does. Thank you for that. It sounds like much less of the sort of turns business in the back half of the year implied in the guidance, and we'll just kind of see how things go is kind of how I read that. Is that fair?

Yeah, as you know we have a huge repeat rate. We have around about a 90%. Right now we have a 90% visibility of revenue for the year in terms of gap revenue, which is very sort of comforting. So there's still sort of a 10% terms, but the dependency is much lower. The dependency of course in ACB terms is more significant on terms business.

and to the extent that we are being a little bit cautious because of the economic uncertainties around the world on how Q4 might end up, that has much more of a direct impact on ACV as we exit the year as it does revenue which is mostly rattleable. Certainly all the end connectors is rattleable so it has any deals that flow from Q4 and Q1 for example doesn't really impact revenue at all.

just ACVs, which is why we're being a little cautious on.

on the Q4 ACV exit point.

Thank you for that, Nikta. As my follow-up, I wanted to kind of pick back up on that.

in the macro environment that we're in and in the market that we're in, investors definitely have their radars up for commentary. Like you mentioned the sentence there about maybe a little bit more caution on license activity and deal activity in the fourth quarter. I don't know Charlie. Do you have any?

just commentary generally, are we talking about business in China, are we talking about maybe what end market and what geography, have you seen things maybe push out a tiny bit, is it broad, is it one deal, just any kind of context there would be really helpful. Thanks guys.

Yeah.

So, you know.

Certainly you want to be conservative, but we're kind of seeing the headwinds and the tailwinds balance, particularly for licensed revenue, right? On the tailwind side, we're seeing some inflationary pressures across the globe. You've got strict logdowns in China that may have slowed down some activity there, although generally our China business remains strong, right? But you also have a number of headwinds. The automotive, you know, the car is.

That comes from the line of Ambrish Srivastava with BMO. Please proceed with your question.

Hi, thank you. Good talking to you guys again. I had a couple of questions. Actually, we'll start off with the inflationary part first. How do you balance the negative impact to your P&L versus the ability to pass along costs because most of your contracts are set in pricing earlier? So can you just help us understand that part? And then I had a quick follow-up clarification. Yes, thank you.

Charlie, do you want to take that one?

Yeah, yeah.

We have some subscription contracts that are multi-year, but we are able to pass some costs along. I think we've increased our prices, I think, about 10% in the last few months. So we have some ability to pass along inflationary costs, but we are definitely seeing inflationary pressure, particularly with salaries and...

and personnel or retention costs and those kinds of things.

you know, again, you know, you just manage that as best as you can. And you're also trying to make sure that the customers are happy and that they understand how you're dealing with the situation.

a couple of bits of color that might help you there in terms of unpacking that and sort of modeling it. The first is that we are largely seeing the wage inflation pressures in the rearview mirror. It was a big pressure in the first half, particularly in the first quarter.

As you know, wage inflation was right. We're seeing that less of an issue now. It's not gone away, but it's not as bad, not as extreme. Second point is just for sort of mathematically, around 70% of our OPEX is people-based. And so this gives you an idea of how wage inflation can impact our long-term OPEX.

That said, we are keeping a lid on OpEx and it's actually increasing at a fairly slow rate.

Got it. That is helpful. That is helpful. And then my quick follow-up is on the ACV side. You mentioned two factors to the Delta. The DJI versus macro. Can you just please help clarify how much of it is the impact from DJI versus the factoring in macro? Thank you.

Sure thing, yeah. So if you look at the whole year with the exit point of 22 versus exit point of 21, which is really the way that it should be sort of characterized because it's an actual annual measure, the headwind between High Silicon, don't forget them, who ended in May and DJI which ends future in December , the headwind between those two is $7 million on ACV. The second piece is kind of the unknown.

ACB right now is growing nicely as you've seen. The unknown is how Q4 might turn out. And there are enough things going on in the world which I don't need to tell you about. There's a lot of newsworthy things going on including economic performance.

inflation, GDP, now two centers of geopolitical tensions and so on. So we just feel like it's wise to be a little cautious in the way that we think of Q4 in terms of the cadence of deals. We do have a large, a small number of large value deals that can impact how ACV turns out for the year if they end up ending.

In Q1 for example instead of Q4 and we don't know till we get there, frankly. Got it. Basically for new biz, repeat biz, the repeat biz we're very confident on.

because customers have to continue to buy our products, be it the Blunt software or be it Interconnect, to continue designing and making chips complex.

complex SOC chips.

Whereas new customers...

maybe there could be some delay, we just don't know, and we're just exercising a degree of caution on how we guide people.

Thank you.

Thanks, Ambush.

Our next question comes from the line of Mark Lapatius with Jefferies. Please proceed with your question.

Hi, thanks for taking my question. Carly, maybe for you, um,

You know, putting aside like disruptions that are associated with COVID and inability for teams to meet together.