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 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…

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, formerly referred to as IP deployment, but now enables Arteris to recognize revenue rapidly over the contract term aligning this treatment with that for our network and chip IP deals. With this change, we now expect a significant majority of our revenue, contracts to be recognized rapidly going forward, providing better visibility and reduced period-to-period fluctuations. This model defers the recognition of revenue 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. As a result of this change in timing of revenue recognition, the substantial majority of revenue derived from this deal will be recognized in future quarters in part driving the $7.8 million increase in our RPO in the second quarter. Consequently, total revenue for the second quarter was flat year-over-year at $14.7 million, but up 12% sequentially. This exceeded 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 was $52.8 million, up 21% year-over-year when adjusted to exclude DJI as Charlie mentioned earlier, and 6% higher sequentially. GAAP gross profit in the quarter was $13.5 million representing a gross margin of 92%. Non-GAAP gross profit for the quarter was $13.7 million, representing a gross margin of 93%. Total GAAP operating expense for the second quarter was $22.2 million compared to $19.7 million…

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

Yes. Thank you very much. Good afternoon, guys. For my first question, Charlie, you -- in your script, you read off some stats around five of the top 10 largest tech companies engaged with Arteris for sort of internal chip development and three of the top 10 global semi's companies. And I mean, some of those you've had relationships in the past and it seems like some of them might be new. So maybe you could expand upon that a little bit. Is this primarily in the AI/ML space where folks are looking to do more complex ASIC designs? There's a lot of work being done on inference for AI and the like. I'm just trying to understand the scope of those engagements and the application areas that you're working with some of those larger companies on. Thanks.

Yes. In terms of the 10 largest semiconductor companies we're starting to see -- I think we discussed on prior calls that some of the system IP is becoming much more complex and that is eventually going to be outsourced to the commercial vendors right at least to a certain extent. And we're starting to see some of that, right? So two of those companies have been in prior years almost 100% internal and they are essentially going with Arteris for some of their most complex projects. So we're starting to see a beginning of that trend. In terms of applications, it's kind of fairly broad. Some of those are automotive advanced automotive ADAS projects. Some are -- one of those deals or two of those deals were Magillem. One was a new Magillem customer one was a reorder. And we're also seeing fairly good adoption in the large companies also for machine learning projects particularly for generative AI where the amount of data that has to be moved inside those types of chips is very, very large.

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. Nice [indiscernible] Yes I know that you were going to be the first person to ask that question. So I hope I can answer it properly. So in terms of why I think you know that we've talked about it many times in the past that we don't really like the idea of having a mixed revenue recognition model where about a third 30% of our business was a point in time and the other 70% was ratable because it's very hard for investors to understand and it's very hard even for us to plan for because the point in time tends to be a little bit lumpy and very, very focused on to Q2. So we've been working with this for a while. There are a lot of moving pieces to get to the endpoint. So we have to align legal the customers, our auditors our financial people and so on to get to a point where we could get a change in deal structure that was sufficient to have all of the SIA, which is our new acronym for and Magillem and Semifore combined treated ratable going forward or largely ratable going forward. So that was the goal was to give predictability and more visibility on the -- so we're much more like a cadence or a synopsis now in terms of our revenue model. So that's the why. The how much question so to give you a rough feel the 20 -- sort of Q2 number would have had about another $2.5 million to $3 million of revenue in it under the old model which is now in RPO. Just to give you a sense for how Q2 was actually the 14.7% would have been another 2.5% to 3% higher if we had stayed on…

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.

Sure, yeah. So shortest would be somewhere around a year. But those are -- it's a bit of a bell curve as you can imagine. So there aren't many that duration. The longest would be four to five years, but again not many at that duration. The sweet spot is around two to three with a midpoint of around -- our median is about 2.5 years. What I would say is also Matt just a little bit of extra color, it's not going to be an instant conversion. We think it's going to be a rapid conversion but not -- there will be some customers there are some customers who are grandfathered in on old terms or old contract structures. But we think that's the not majority that's the minority of deals.

Thank you very much, Nick for all the detail, and thanks guys. I’ll jump back in the queue.

Thank you. [Operator Instructions] Our next question comes from Gus Richard of Northland. Please go ahead.

Yeah. Thanks for taking the question. Just to pound the ratable revenue rec, 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 shorter. I think the difference is for those people 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 is already ratable, maybe 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. Is it -- can you put a little bit of arms and legs on where those companies are what they do?

Yeah. I mean, some of them are very large semiconductor companies that previously were 100% internal. So those will be new customers. There was a very large -- a fairly large reorder for Magillem SoC integration automation software. So yeah it's kind of all over the place but it just shows the strong demand for our products. But the thing that makes me most glad is that we're starting to see several companies that have previously been internal are starting to be a little bit more open to licensing outside 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 you're 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?

Yeah. I've been chatting at length with the royalties team about that as you can imagine. Really if you look at -- we have if you take out audit upticks, so the compliance based, which you can't guarantee they happen from time-to-time. And they're nice when they come but there's nothing -- and we have a large audit actually in benefit in Q2 and we have a relatively decent one in Q1. If you exclude those, which is reasonable amount of the total, you still -- if you go back to the -- I mean you scrub out HiSilicon the trend has been great. HiSilicon really died from a royalty perspective in Q1 of 2022. And so, if you take those out royalties has been steadily growing throughout. And so, in general, we would expect the rate of royalties growth to be some five percentage points higher than that license growth. And that's roughly what it's trending to be at the moment.

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 at 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. I mean, we're continuing to see orders out of China. So -- but you essentially have the continued headwinds with BIS. We're seeing that out there is increased difficulty in Chinese startups raising capital. So you would expect a bit of a slowdown in new venture formation. And so, it continues to be a very attractive market, but it's not as gangbusters as it was a year or a couple of years ago. But nothing -- no inflection change I would say.

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 and not the type that are suffering from BIS or even from a lack of availability to capital. So think automotive and AML. And then you've got an idea.

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?

And on free cash flow, thank you for reminding. So, yes, we -- there's two kind of aspects to free cash flow this quarter. One is -- and so it was a very healthy quarter as I'm sure you saw. In essence, the -- we had a $3 million pickup a bit like we did in December if you remember back to the December quarter. We had a couple of customers, major customers who decided to pay us before the end of the quarter instead of when they were due. So, we had a sort of a $3 million tailwind on free cash flow in the quarter and so that will reverse. We have actually forecast some $5 million and change for free cash flow negative in Q2 ended up being $2 million and change. Working capital as you know is always a flux. It always -- it doesn't change the direction. It just changes the cadence between two quarters. So that $3 million will reverse. And that's why you're seeing a guide for the 3Q of negative $3 million which is that $3 million that was advanced paid absent that therefore 3Q would have been neutral. Full year should be positive. It's always our strongest free cash flow quarter because that's when we have the majority of bookings and OpEx for us is relatively flat in terms of cash OpEx is relatively flat over the year. Free cash flow is therefore driven more by the bookings cadence and bookings are strongest in 4Q. So, we've had a sort of a negative Q1 as you know we have had a negative in Q2 but a much smaller one. And then by the time we get to the end of the year we'll have sort of an offset to of Q2, Q3 and Q4 to zero we expect so that the overall for the year will still end up somewhere around the $8.5 million that made good. That's how we're sticking to that guidance.

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

Welcome.

Thank you. [Operator Instructions.] 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. So, we're not sure we're going to get all the people that we don't have because there's you can count them on a finger of one hand. So we're yes I don't even want to name the ones we do not have. But in the quarter we did get two companies for automotive that were not previously Arteris users and both of those were essentially in the ADAS area. So I would say that our automotive penetration continues I would say unabated. But we're not saying we're going to get everyone.

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.