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Operator
Good afternoon, everyone, and welcome to the Atris IP first quarter 2022 earnings call. All material contained in the webcast is the sole property and copy of Atris IP with all rights reserved. For opening remarks and introductions, I will now turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead.
Erica Mannion at
Thank you, and good afternoon. With me today from Atris IP are Charlie Janik, Chief Executive Officer, and Nick Hawkins, Chief Financial Officer. Charlie will begin with a brief review of the business results for the first quarter ended March 31st, 2022. Nick will then review the financial results for the first quarter followed by the company's outlook for the second 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 the 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 and uncertainties and factors that could cause actual results to differ appear in the press release, our Taras IP issue today, and in the documents and reports filed by our terrorist IP 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. These non-GAAP measures are presented as we believe that 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 U.S. GAAP. A reconciliation of these non-GAAP measures to the nearest GAAP measure can be found in the press release for the quarter ended March 31, 2022. In addition, for a definition of certain key performance indicators used in this presentation, such as annual contract value, design starts, active customers and remaining performance obligations, please see the press release for the quarter ended March 31st, 2022. Listeners who do not have a copy of the press release for the quarter ended March 31st, 2022 may obtain a copy by visiting the investor relations section of the company's website. Now I'd like to turn the call over to Charlie.
Charlie Janik
Thank you, Erica. And thanks to everyone for joining us on the call this afternoon. We're excited to report a strong first quarter to start 2022 with annual contract value plus trailing 12-month royalties of $52.8 million, up 26% year-over-year. Demonstrating our continuing momentum are active customers increased by seven new system IP customers in the quarter. Total customer design starts in the quarter were 19 SOC projects. Major new customer deals, including IP licenses to Cambricon, Rapid Silicon, and SocioNext. Cambricon selected Arteris IP knock interconnect solution based on our strong technology track record for automotive machine learning applications. We also signed a key new deal with a major ride sharing company in a quarter and announced that BMW licensed Arteris IP for a neural network accelerator project. Additionally, Sondrell deployed Arteris IP for their next-generation automotive AI ML SOCs. We believe these relationships underline that SOC creation is occurring at all stages of the automotive supply chain, from semiconductor companies to Tier 1 vendors, automotive OEMs, and ride-sharing companies, as electrification, automated driving, and ECU consolidation revolutionize the industry. Besides the progress in automotive, we also continued a strong momentum in AI ML, consumer electronics, enterprise, and 5G communication market segments. We continue to close new deals addressing AI ML technology during the first quarter across numerous verticals. The market for machine learning at the edge continues to be promising with continued addition of new customers and a broad range of applications. On the product front in the first quarter, We continued our strong investment in engineering new system IP products and are confident that we will continue our multi-year track record of delivering at least one new major system IP product in 2022. Democratization of SOC design, as well as disintermediation of the semiconductor supply chain, we believe is driving a strong need for automation of system IP solutions in order to compensate for a shortage of SOC architects and skilled interconnect IP engineers. While we are seeing strong demand for our products, we're also seeing worldwide inflationary pressures in terms of employee compensation and service provider pricing. As we discussed in our prior conference calls, we are seeing the regionalization of the semiconductor industry. However, the troubling events in Ukraine are driving the United States and Europe together into a more cohesive block than previously predicted. I should mention that Arteris IP has no current exposure to either Ukraine or Russia. We believe that it is important, however, for Arteris IP to continue to expand its multi-regional presence in order to be a global system IP provider. Lastly, in the first quarter, we continued to strengthen our management team by adding Michal Savinsky as our Chief Marketing Officer. Michal joins us following a 22-year career at Cadence Design Systems, including leadership roles in product strategy, solutions, and customer engagement, culminating as a corporate vice president, marketing, and business development. With Michal's addition, we now have a complete top management team with significant public company experience for our next stage of growth. With that, I'll turn it over to Nick to discuss our financial results in more detail.
Erica
Thank you, Charlie, and good afternoon, everyone. As I review our first quarter results today, please note I'll be referring to non-GAAP metrics.
Charlie
A reconciliation of GAAP to non-GAAP financials is included in today's earnings release, which is available on our website. Total revenue for the first quarter was $11.8 million, up 77% year over year. As a reminder of those of you who are new to the Arteris IP story, our revenue is derived from licensing intellectual property, licensing software, software and maintenance services, providing professional services, training services, and royalties. 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 fixed fees under the agreement, also referred to as the TCV or total contract value, 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 revenues. We monitor this metric to measure our success and believe that the historical increase shows our progress in expanding our customers' adoption of our solutions. At the end of the first quarter, ACV plus trailing 12-month royalties and other revenue was $52.8 million, up 26% year over year, driven in particular by growth in automotive, AI and L, consumer electronics, enterprise, and 5G communication market segments, and up 5% quarter over quarter. Remaining performance obligations, or RPO, were $60.5 million, up 28% year over year as of March 31st, 2022. We define RPO as the amount of contracted future revenue. Gross profit in the quarter was $10.9 million, representing a gross margin of 92%, and compared to $5.8 million, or 87% in the prior year period. R&D expense in the first quarter was $8.2 million, or 70% of revenue, compared to $6.3 million in the prior year period, The increase was primarily driven by additional headcount in our four R&D centers and payroll expense as we continued to invest in developing new and improved product offerings. Sales and marketing expense for the first quarter was $3.6 million or 31% of revenue compared to $2.4 million in the year-ago period. We continue to invest in sales and marketing as we work to continue to drive awareness of the benefits of our solution in the market and expand our sales and application engineering force and marketing efforts to harness the significant potential in front of us. G&A expense for the first quarter was $3.2 million, or 27% of revenue, compared to $3.0 million in the year-ago period. G&A reflects an increase in people and infrastructure-related expenses associated with our transition to being a public company. Operating loss for the first quarter was $6.6 million or 56% of revenue compared to a loss of $6.4 million in the year-ago period. Non-GAAP operating loss was $4.2 million or 36% of revenue compared to a loss of $5.8 million in the year-ago period. Net loss for the quarter was $6.8 million, or net loss per share basic and diluted of 22 cents. Non-GAAP net loss for the quarter was $4.4 million, or net loss per share basic and diluted of 14 cents, based on approximately 31.6 million weighted average diluted shares outstanding. As a reminder, our IPO lockup expired on April 25, 2022. When the lockup expired, former employees, current employees, and other stockholders held approximately 9.8 million shares, which are no longer subject to the lockup and can be freely sold subject to normal restrictions, such as having material non-public information or MNPI. Additionally, current and former employees and directors held approximately 8.3 million shares when the lockup expired that are either subject to outstanding options or reserved for future issuance. pursuant to restricted stock unit grants as part of our employee incentive programs. These shares, assuming they satisfy the various vesting conditions, can also be sold subject to normal restrictions. Turning to the balance sheet and cash flow, we ended the quarter with $82.2 million in cash. Cash flow used in operations was $1.4 million in the quarter, while free cash flow, which includes capital expenditure, was negative $1.5 million. I would now like to turn to the outlook for the second quarter and the full year 2022. For the second quarter, we expect ACV plus trailing 12-month royalties of $49.5 to $51.5 million and revenue of $11.5 to $14.5 million with non-GAAP operating loss margin of 19.4% to 34.4% and non-GAAP free cash flow margin of negative 29.4% to negative 44.4%. For the full year, we expect ACV plus trailing 12-month royalties of $51.6 to $55.6 million and revenue of $48 to $52 million, representing an increase from the prior guidance of $47 to $51 million. Non-GAAP operating loss margin of 24.9% to 39.9%. similar to prior guidance of non-GAAP operating loss margin of 25.6% to 40.6%, reflecting the impact of wage inflation on our operating expenses, and non-GAAP free cash flow margin of negative 10.5% to negative 25.5%, similar to prior guidance of negative 10.9% to negative 25.9%. With that, we'll open up the call for questions. Over to the operator.
Operator
Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 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 keys. One moment, please, while we poll for questions. Our first question is from Matt Ramsey with Corwin. Please go ahead.
Matt Ramsey
Hey, guys. This is Josh Buckhalter on behalf of Matt. Thank you for taking my questions, and congrats on the results. The first thing I wanted to ask about was the guidance. It calls for a sequential decline of ACV plus trying to solve much royalty revenue. I obviously saw that you maintained the full-year guidance, but I was wondering what would normal seasonality look like, and was there any impact in the short term related to China shutdowns, whether with contract signs at customers or royalty shipments? Thank you.
Charlie
Yeah, hi, Josh. Let me tell you honestly, Nick, here. It's a great question. I mean, you already know because we've spoken to you many times that we have a headwind in Q2, which is already sort of built into our prior guidance. But just so everybody else knows who's not familiar with this, there was a very substantial deal with HiSilicon in May of 2019, the end dates in this month. That creates a sort of a headwind of around $3.3 million in Q2. That's not something new, but it is a headwind nevertheless. The other point you make, which is the slight decline in ACV guidance for Q2 plus royalties, is two things, really. One is, as you know, we do have a little bit of seasonality with our IPD business and generally our bookings as well. And sometimes we can end up with a big deal falling into the end of one quarter or the beginning quarter. of another quarter, we are seeing a few Chinese deals, for example, falling out of the end of June into the beginning of July. And that creates sort of an instant ACV hit, which then picks back up again the next quarter, which is why you're seeing the full year not moving. The second issue is that royalties, the TTMR part of ACV plus TTMR, we are seeing supply chain constraints hitting our customers. Obviously, it's hitting our customers, and this is everything from sort of fab capacity, generally, family capacity, and things like noble gases, which are constrained by Russia, and that's reducing our customers' ability to ship volumes, and that then puts a dent in near-term royalties doesn't impact longer-term royalties, but it does impact the near-term. Does that sort of give a fulsome answer to the question?
Matt Ramsey
No, that was perfect. Thank you. I appreciate all the color there. And then for my follow-up, all throughout the current season and, frankly, the past several, we've heard about supply constraints impacting auto units. That said, there's clearly an improving mix of premium and SEVs, which come with an associated increase in semiconductor content. I was wondering if you could help us parse out this net exposure from both the mixed shift to higher semis content versus lower overall units and how this impacts your overall near-term results, but more importantly, long-term, given the increased complexity of SOCs that are going into vehicles. Thank you.
Charlie Janik
Yeah, I mean, this is Charlie. I'll take that one. So the automotive business continues to be robust, right? We're not seeing any slowdowns in design cycles. There are more members of the, or more participating companies of the automotive ecosystem that are designing SOCs, and those SOCs are increasingly complex, so that all favors Arteris, as far as we can see. The only sort of headwind that could arise is that the semiconductor manufacturing capacity constraints could impact, uh, royalties, but, uh, people are building fabs at, uh, you know, pretty, pretty robust rate. And, uh, uh, you know, we think that, uh, you know, the, uh, the constraints in semiconductor manufacturing are going to be over, uh, at some point, we don't know exactly when, but, uh, uh, could be second half of this year, uh, could be early next year. Uh, but, uh, there's just a lot of, a lot of very interesting design activity that's taking place. And the automotive chain is, uh, is one of the, you know, one of the things that looks particularly promising. I should also add that, you know, we're going to see an increase in military spending, and that may also translate into additional SOC design starts.
Charlie
Yeah, just one additional comment, for instance, Nick, on the automotive side, more of the longer term. You may remember that the – We published some data, some third-party data, that talk exactly about the issue you're referencing there, which is the number of SOCs per vehicle is growing from around sort of three to four in 2020 up to the low 20s, something around 23 per vehicle. And this is for sort of L2 plus by 2026. And that is exactly the issue that you're referencing there. But that's more of a longer-term trend. It doesn't really make a massive difference from sort of quarter to quarter.
Matt Ramsey
Understood. Thank you. I'll hop back in the queue.
Operator
Thank you. Our next question is from Mark the Packers with Jefferies. Please go ahead.
Mark
Hey, thanks for taking my question. I don't know if we're Charlie or Nick. You referenced higher compensation expenses. Is that just in new product development? And I guess, can you talk about how that, if it's manifesting also in your customers' willingness or eagerness to reach to you guys to help potentially offset that same challenge that they may be having. Thank you.
Charlie
Let me take the first half of that. Let me take the first half, and then I'll pass over to Charlie for the more commercial industrial part of that, the second part of your question, Mark. So, I mean, in general, you won't be surprised to hear that we're seeing primary and secondary inflation across, which is 75% of our OPEX, roughly, is people. And another significant portion is services, and services is basically people. And that's happening in US, Europe, and Asia Pacific, particularly China, and even you know what the wage inflation rates are running out there they're pretty uh they're pretty high so we're trying to contain them as much as possible but there is uh without question sort of upward pressure which we're seeing um as far as the um and by the way it's not just r d it's um that you know accountants are paid more lawyers are paid more marketing people are paid more um and it's more more difficult you have to compete harder to get good people um As far as the willingness of our customers, great question, willingness of customers to do business with us and whether they want us to share the pain by some sort of cost reduction, I would guess that's really straight down the wheelhouse of Charlie.
Charlie Janik
Yeah. Yeah, we're not seeing any – I wouldn't say that we're seeing particular margin pressures on our product. Our products generate a lot of value. They save customers a lot of money. And so we're not seeing price pressure or margin pressure on our products at this time.
Mark
So thanks for that. And I guess I was tackling this from the standpoint of it seemed to me like if your customers are seeing similar wage pressures, then given the prices of your products, licenses that it actually may make it easier for your customers to make a decision if they're in a make or buy decision that they're seeing the wage pressures and labor shortages and they may reach you more often. And I just wondered if that was manifesting in your pipeline or not.
Charlie Janik
Yeah, I think that's absolutely correct. The fact that our customers are also having difficulty finding some labor and that labor is expensive for them as well, it basically means that automation is something that is going to get very good reception, both near-term, medium-term, and long-term, so that it does expand the opportunity for Arcturus IP product adoption versus internal solutions.
Mark
Gotcha. Thank you.
Operator
Thank you. Our next question is from Hans Mosesman with Rosenblatt Securities. Please go ahead.
Hans Mosesman
Yeah, thank you. Congratulations, guys. Good execution. Just a question on the royalty, the headwind. What end market is driving that? Is that wireless, if there is a headwind?
Charlie Janik
So... Yeah, I mean, I don't know, Nick, if you want to take this or if you want me to take it, but basically the smartphone royalties have been declining and the automotive royalties have been rising, right? So as the automotive adoption takes place and more of the existing designs make it into cars and get shipped in volume, that will lead to rise of additional royalty revenue. So we think on a long-term basis, we feel pretty confident in our royalty stream as the automotive royalties take over from the smartphone royalties. And ultimately, there will be some of the machine learning designs, which are quite numerous recently, will actually reach production and start generating volume.
Erica
Yeah, I mean, exactly.
Charlie
You said it right. There are other actually big rising stars in our royalty stream. One is consumer, interestingly, and the other is more sort of industrial. And those are sort of growing very nicely. The high silicon, we can actually put a name to it, on the mobility side, has still not declined to zero, but it's getting close. But it is a decline quarter over quarter all the time. But for sure, automotive remains the mainstay, and we're in 35-plus customers, 60-plus designs. And so we have a good spread there across all the different players, the different layers, whether it be semiconductor or or tier ones or OEMs, we have a good spread across all of them and across all the sub-verticals as well. So it's a nice position to be in, but we do have broad-based royalty streams coming in from other sectors as well.
Hans Mosesman
That's very helpful. And just as a follow-up question, on the BMW platform, win on the neural network accelerator project. Can you comment on who was the competition in that project or projects that are similar to that? Are those in-house efforts or are there other players that are coming out there that are challenging you guys with this IT?
Charlie Janik
Yeah, I mean, the, you know, we kind of have two classes of competitors, obviously, one is harm. And I don't know if there's a competitor on this particular, particular situation. And the other one is internal, right. But I think, you know, integral internal interconnect is becoming increasingly, you know, expensive and difficult to develop because of the shortage of, of interconnect engineers, right. So I think that, you know, our main challenge in these kinds of sales cycles is to prove out that we're suitable for the customer's acquisition of application for what they're really trying to do. And so that's really the main hurdle that we have to get over for these kinds of designs. But I don't think, you know, the competitive situation of Arteris, whether it's on the you know, it's pretty favorable.
Hans Mosesman
Okay, great. Thanks.
Operator
Thank you. Our next question is from Amrish Srivastava with BMO. Please go ahead.
Amrish Srivastava
Hi. Thank you very much. I have a question on, Nick, you mentioned seasonality for ACV and TTM royalties. Could you just explain how we should be thinking about it on a go-forward basis? And then the second kind of related question, you talked about China deals moving from end of quarter to the other. Is that largely because of the shutdowns that very well publicized shutdowns in China, or is there something else going on there? And I had a very quick follow-up after that next article.
Charlie
Well, hi, Ambrish. Great to speak with you again. Hope you're well. But, yeah, in terms of the China situation, I'll take them in order. The seasonality question first. Generally speaking, as I think you know, the ACV plus TTMR is kind of designed to be something which is relatively steady. It doesn't move around such as... sort of point-in-time revenue does and that's part of the reason we adopted it as one of our metrics. It does, however, it can suffer from deals, large licenses shifting from being signed and actually the software delivered by the end of like the last week of a quarter or the first week of the second quarter and that's usually outside of our control. In fact, it's totally outside of our control because we're customer driven and If they ask for it on day X, then we provide it on day X. If they ask for it on day Y, then it goes on day Y. So the seasonality is still fairly steady. It's always ACB plus TKMR, it always gets a bit of a boost in Q4 because it's a quarter when we have a particularly strong set of bookings. But of course, they get spread over the subsequent years depending on the length of the contract. The China question is slightly unique, and yet it is totally a COVID issue because the epicenter of our customers is also the epicenter of the COVID shutdown, and that has been quite severe. The reaction by the Chinese authorities to this is they really want to stamp it out, and you probably know it's quite difficult for people to get to work and collaborate and and what have you. So we have no doubt that those fields have not gone away. They're just maybe taking, they're literally situations where people cannot get to offices to put their chop on a license. It's as basic as that because in China the chop is everything as you probably know if you follow the arm situation. So anyway, that's what's really moving China around.
Amrish Srivastava
Got it. And the other thing
Charlie
The other thing, just to add some color to the color, the revenue, of course, is much more smooth. The gap revenue is much more smooth when it's an interconnect sale because that spreads evenly over the number of days in the license. So if it's three years, it'd be three times 365 days spread. So you automatically get that. So it doesn't have the same sort of lumps unless it's a point-in-time revenue, which is more of an IPV software deal. Sorry, you had another question.
Amrish Srivastava
Yeah, actually, and I'm glad you answered that because the seasonality comment did surprise me because the whole reason, which made sense, to not focus on bookings and go to ACV and TTMR because bookings do tend to be lumpy. But your explanation makes sense. We should be thinking of it more as a 4Q approach. than through the course of the year, correct? Correct. Exactly right. Got it. Exactly right. Okay. And then my quick follow-up was the royalty revenues are being impacted by the supply chain being gummed up, but do you feel pretty comfortable with the annual guide that it should be? I mean, it's a small number, but do you feel pretty comfortable that that situation should be alleviated by then?
Charlie
Yeah, I mean, we're not putting ourselves out as experts on the silicon supply chain. There are much, much smarter people than me to give that sort of analysis. But the general sense, we do follow what's going on and we speak to our customers and our foundries. And our sense generally is it's probably a 2023 solution to get that completely ungummed. But we are still... We're still signing contracts. All the interconnect contracts still have royalties. The royalty rates are generally sort of strong to increasing. So there's nothing changing in our model from that perspective. The only variable right now is the unit out from our customers, which is Actually, if you look at the first quarter, it was pretty strong. But we're a little cautious on how that's going to play out in the next couple of quarters.
Amrish Srivastava
Prudently so, Nick. Thank you.
Charlie
Yep. You know me.
Operator
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Gus Richard with Northland. Please go ahead.
Gus Richard
Yes, thanks for taking the question. I'm seeing Qualcomm make good progress in getting in the automotive market, and I know they have their own network on a chip IP. And I'm just wondering, is, you know, Qualcomm displacing any of the OEM designs that you would expect or, you know, having any other impact on any of the design activity that you're working on?
Charlie Janik
Yeah, I mean, Qualcomm is a very nimble organization with their internal network on chip technology. So they're definitely a worthy competitor in the automotive market. But as Nick mentioned, our projections is that there's going to be 2023 SOCs in every car as the electrification and the automated driving and ECU consolidation unfolds. And so Qualcomm is going to capture some of those, but the existing players such as Mobileye, NXP, Bosch, and others will be able to defend their turf. And so Qualcomm will take their share, but they're not, they're unlikely to drive other players out of the market, at least in the foreseeable future. Right. So yeah, You know, they'll get their share, but I think the impact on our tariffs is probably not going to be major, given how many SOCs there are per vehicle.
Gus Richard
Got it. That's very helpful. And then, you know, turning to China, there's the arms situation, which I'm curious if that's impacting potential customers in China in terms of their choice of, you know, you know, interconnect. And, you know, also as China pulls away from the U.S. and going to self-sufficiency, you know, are there any EDA players rising there that could be a challenge? And or, you know, it's too early to know about sanctions, but, you know, any thoughts along just sort of those dynamics?
Charlie Janik
Yeah, so, I mean, we're not, I would not classify Arteris as an EDA company. I mean, we're a semiconductor IP company. The technology that we have is quite complex, and we're not seeing any alternatives in the market that would be indigenously coming from the China market. So we're continuing to see a robust activity in China with the caveat that Nick mentioned, which is customers particularly in Shanghai can get access to their chops to, uh, to, uh, validate some, some contracts. Uh, but that's, uh, you know, a temporary, uh, temporary effect. So we're not seeing anything right now that, uh, would be coming from China. There will be threatening the, uh, various IP position in, uh, in the system IP space.
Gus Richard
Got it. Um, helpful and sorry for mischaracterizing your business.
Charlie Janik
Oh, yeah, yeah, yeah. I mean, we're, you know, we have lots of software that allow people to make our IP work. But the value of their GET is actually from us helping them get the chip out and actually being in the chip and being the communication part, our IP being a communication part of the chip.
Gus Richard
Right, totally understood. That's it for me, thanks.
Operator
Thank you. Ladies and gentlemen, we have reached the end of the question and answer session, and I would like to turn the call back to Charlie Janik for closing remarks.
Charlie Janik
Yes. So, you know, this is an exciting time to be at Arcturus IP, and we look forward to continuing our momentum in the years ahead and updating all of you in the quarters to come. Thank you for joining our call today and for your interest in ArcGIS IP. Thank you very much.
Operator
Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
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