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Operator
Good afternoon, everyone, and welcome to the Arteris first 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 Incorporated with all rights reserved. For opening remarks and introductions, I will now turn the call over to Erica Mannion of Sapphire Investor Relations. Please go ahead.
Erica Mannion of Sapphire Investor Relations
Thank you, and good afternoon. With me today from Arteris 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 31, 2023. Nick will review the financial results for the first quarter, followed by the company's outlook for the second 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. These 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 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, 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 end of March 31, 2023. Listeners who do not have a copy of the press release for the quarter end of March 31, 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.
Charlie Janik
Thank you, Erica. And thanks to everyone joining us on the call this afternoon. We're excited to report a solid start to 2023 with annual contract value plus trailing 12-month royalties of $54.8 million, up 20% year-over-year when adjusted to exclude high silicon and DJI as discussed in previous calls, and up 5% sequentially. We continued our growth into 2023 with the addition of seven new customers and 22 confirmed design starts in the first quarter. Deals in the first quarter were driven by strong demand for Arteris products across our core market segments and led in particular by design wins in automotive and enterprise computing. Royalty revenue in the quarter was primarily driven by automotive followed by consumer electronic products. An element of Arteris strategy is to service both semiconductor and system companies. This is continuing to yield positive results. With the added focus on the broader automotive supply chain, including OEMs, and following last year's Arm Automotive Partnership, we are pleased to report that in the year to date, Arteris has secured four OEM design wins, including three new car companies across the US, Europe, and APAC. These new relationships demonstrate Arteris' ability to engage across the broader global automotive supply chain. This is important as establishing direct relationships with auto manufacturers can create additional opportunities for those car companies to encourage their own supply chains to leverage Arteris technology as well. 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 the leading choice for innovative solutions in the automotive SOC market. AI and machine learning also continue to be strong growth drivers for Arteris. New advanced AI electronics tend to require and benefit from network on chip IP and SOC integration automation. In the first quarter, Arteris closed numerous global AI and machine learning customer deals across various vertical markets driven by strong demand for Arteris technology. One of those notable AI wins in the Americas was 10th Storrent for enterprise computing applications. 10th Storrent develops AI high-performance computing and data center RISC-V SOCs and chiplets. The 10th Storrent team extensively evaluated Arcturus N-Core cache-coherent interconnect IP and selected it for the next generation products along with our FlexNoc non-coherent interconnect IP. This is an example of Arteris' ability to support AI high-end computing and the emerging RISC-V ecosystem. Another design win in the quarter was a selection of Arteris by ASIC Land, an APAC-based ASIC design house. Arteris system IP products will be deployed in ASIC Land's AI chips for automotive, enterprise computing, and edge computing applications for consumer and industrial markets. Another design win in the AI space was Accelera, AI, a European provider of advanced solutions for edge computing, with Arteris products used to accelerate computer vision at the edge. Arteris was chosen for its ability to enable Accelera AI engineers to meet performance, ultra-low power, and time to market objectives in its Metis AI platform. The emerging generative AI technology is opening another potential future application for Arteris products. While promising, generative AI is quite computationally expensive with query costs over 10 times higher than heuristic search algorithms. Arteris anticipates that there will be an increase in AI and machine learning hardware design activity in an effort to lower the computation costs of processing the large language models. With Arteris already designed in over 150 different machine learning chips, The generative AI ASIC and accelerator activity presents another exciting potential future opportunity for our company. Turning to our product portfolio, we are very excited about both our new FlexNOC 5 innovation and the SEMIFOR acquisition we discussed last quarter. Over the last several years, as semiconductor manufacturing process nodes have progressed, the associated Physical effects have begun to impact how engineers design SOCs, including causing multiple iterations of physical layout network-on-chip connectivity, which in turn impacts project schedules. To address this growing challenge for customers, in February, we announced FlexNOC 5 physically aware network-on-chip IP with unique and patented technology. We are happy to report that we have delivered a feature-complete early access version of FlexNOC 5 to multiple customers. We anticipate being able to ship a full production release in second quarter 23 with a positive impact on our revenue and ACV growth forecasted in second half of 2023. Expanding the Arteria's product portfolio in the first quarter, we announced the acquisition of Semifor, a leader in hardware software interface technology. The addition of semaphore complements our Magilem connectivity and register management technology, allowing Arteris to provide a more comprehensive SOC integration solution. Together with our NOC interconnect IPs, Arteris is now able to provide a complete solution, helping to increase chip design performance, power efficiency, and productivity, while improving the customer's overall SOC design economics from reducing product schedules to lowering the risk of costly redesigns. Macroeconomic uncertainties and global recessionary concerns continue to create headwinds. We also continue to be impacted by the U.S. BIS regulations with respect to China-U.S. trade, as well as tightening credit conditions in the USA, which may affect our smaller startup customers. However, we believe that Arteris is well-positioned to continue to make progress even in this challenging economic environment as our customers innovate in areas such as automotive, enterprise computing, consumer electronics, and AI across all applications, driving the needs for increased use of commercial system IP. 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. A reconciliation of GAAP to non-GAAP financials is included in today's earnings release, which is available on our website. Total revenue from the first quarter was $13.2 million, up 12% year-over-year and 17% sequentially. At the end of the first quarter, ACV plus trailing 12-month royalties and other revenue was $54.8 million, up 20% year-over-year when adjusted to exclude high silicon and DJI, as Charlie mentioned. Gross profit in the quarter was $12.0 million, representing a gross margin of 91%. Non-GAAP gross profit in the quarter was $12.1 million, representing a gross margin of 92%. Total operating expense for the first quarter was $20.8 million, compared to $17.4 million in the prior year period. Non-GAAP operating expense in the quarter was $17.7 million compared to $15.1 million in the prior year period. This increase was primarily driven by a combination of continued investment in next generation products together with increased investment in sales and marketing to drive product awareness and strong engagement with customers and strategic partners. Additionally, we have continued to achieve significant operating leverage in G&A expense. Operating loss for the first quarter was $8.8 million compared to an operating loss of $6.6 million in the prior year period. Non-GAAP operating loss was $5.6 million, or 42%, compared to a loss of $4.2 million in the prior year period. Net loss for the quarter was $9.0 million or diluted net loss per share of 26 cents. Non-GAAP net loss in the quarter was $5.8 million or diluted net loss per share of 17 cents based on approximately 34.6 million weighted average diluted shares outstanding. Turning to the balance sheet and cash flow, we ended the quarter with $63.4 million in cash, cash equivalents and investments. Cash flow used in operations was approximately $8.4 million in the quarter, driven predominantly by timing of payments from customers, which contributed to our stronger results in the fourth quarter of last year. Free cash flow, which includes capital expenditure, was approximately negative $8.5 million, in line with our prior guidance. As we discussed in our prior call, Our expectation is that free cash flow will normalize to break even over the remaining three quarters of 2023 taken as a whole. I would now like to turn to our outlook for the second quarter and full year 2023. For the second quarter, we expect ACV plus trailing 12-month royalties of $53.5 million to $57.5 million and revenue of $13 million to $14 million with non-GAAP operating loss margin of 37% to 57%, and non-GAAP free cash flow margin of negative 26.8% to negative 51.8%. For the full year, our guidance is unchanged. We expect revenue of $56 million to $60 million, ACV plus 12-month royalties to exit 2023 at $60.4 million to $65.4 million, Non-GAAP operating loss margin of 28.5% to 43.5%. Non-GAAP free cash flow margin of negative 9.7% to negative 19.7%, reflecting the anticipated improvement from the first quarter. Finally, I would draw your attention to the shelf registration statement that we filed with the SEC in November for a maximum aggregate offering price of $150 million, including a prospective supplement for an at-the-market or ATM offering of up to $50 million, pursuant to a sales agreement with Jefferies. Since, as mentioned in our last earnings call, we do not intend to sell any share pursuant to activate the ATM at this stage, we have decided to terminate the sales agreement related to the ATM. Following this termination, $150 million will remain available under our S3. We do not have any present intention to offer securities pursuant to this registration statement. With that, I will turn the call over to the operator and open it up for questions.
Operator
Thank you. We'll now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation time will indicate your line is in the question queue. You may press star two if you'd 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.
Nick
One moment, please, while we poll for questions. Thank you. Our first question is from Gus Richard with Northland.
Operator
Please proceed with your question. Yes, thanks for taking my question. Kelly, can you talk a little bit about the customers you see for FlexNoc 5 and sort of what uptake do you expect in the second half?
Charlie Janik
So the FlexNoc 5 has a number of interesting features, but The main feature is integrated physical awareness. And so the problem we're trying to solve is that for these sub 16 nanometer processes, you can now make a perfectly good sort of architecture that is very difficult to place in route. And that leads to a bunch of iterations in the back end and actually could even cause a customer to miss a market window. So what we're trying to do is allow people to measure the physical effects, uh, in the, uh, early part of the design cycle so that essentially they can, the customer can turn over a physically verified or physically estimated, um, design, uh, to their, to their place in route team. Right. And so, uh, this raises obviously the ASP of, of, of FlexNoc substantially. And, uh, and so we anticipate that, uh, it will increase the revenue in the second half in a meaningful way. The exact number I can't give you yet, but I think that we will see a significant uptick because of the FlexNoc average selling price increase. And this is basically useful for pretty much any customer doing a design below 60 nanometer, which happens to represent most of our customer base.
Erica
Hey guys, this is Nick. Great question, and as always, but just a little bit of color to add to Charlie's excellent commentary. The bigger impact on 2H for FlexNoc 5, because it is a ratable product, it's interconnect, and typical life is two and a half years on average for a license. the more pronounced impact will be on ACV plus TTMR. Uh, so we pick up the ACV, uh, the annualized, uh, um, value of the, of the contract, uh, immediately, but the revenue of course is spread over, uh, over time. So if we, if we land a new flex not five contract in November, for example, we'll only have one or two months worth of a two to three year term in the, in the revenue. Does that make sense?
Operator
Yes, it does. Absolutely. That was super helpful. And then just two quick questions, you know, given tightening credit standards and, you know, banks selling left and right and crazy things going on in China, I was wondering if you could just talk about, you know, startup slash China activity. And then I want to make sure I understand, you know, free cash flow, you know, by year end, is that still expected to be? break even or better.
Charlie Janik
I'll take the first one and I'll take the second piece of it. Basically, China is coming out of its COVID slumber. There's a headwind of the trade war issues But as we discussed earlier, we're kind of somewhat diversified against this because significant percentage of our products are French technology, which have different export restrictions than the U.S. restrictions. But China's coming out of the COVID slumber. So, you know, I think we'll see actually, you know, toward the end of the year, hopefully some improvement from the China business. The credit crunch, I think, is real. I think capital is getting tight. I think that causes problems for people who are short of capital. And so this will impact some of our startup customers who, if you don't have 18 months of cash, you're going to have to be very, very careful. And so there will be some headwinds with some of our smaller customers. On the other hand, as some of these larger companies are tightening up their budgets, outsourcing system IP development is actually more cost effective. And so we think that we might also see some tailwind from some large companies potentially going outside for some of their system IP solutions. So it's a mixed bag.
Erica
got it thanks and then the free cash flow and i'm that's it for me yeah and we are actually starting to see some some interesting developments and movements nothing that's uh sort of seriously in the pipe there but some some interesting movements on outsourcing uh to commercial markets which were obviously a leader in um but as far as the free cash flow the the um When we announced Q4 and guided for 2023, we guided at that time that Q1 would bear the brunt of the negative free cash flow for the whole of 2023. Part of that was because we have this flip of early cash from Q1 by a couple of big customers into Q4 of last year. So we got benefits of last year to the detriment of Q1. And part because Q1 is always sort of a hangover quarter. There's a few things that are non-linear in OPEX that I won't go into in detail, but it's similar for most companies. And so Q1 is often sort of a heavy OPEX and a lighter cash inflow from bookings quarter. So we forecast eight and a half million negative-ish for Q1. And that's exactly where we came in. So it was sort of on the money, so to speak. The full year, we're still actually forecasting just like we did for the last time we did for a year, again, $8.5 million, which means that Q2, Q3 and Q4 taken as a whole, we're expecting to be neutral. It won't be linear. It never is for us. Our Q4 is always our strongest cash flow quarter. because that's when the largest slice of our bookings fall. So Q2, we're still guiding five and change million negative or consumption free cash flow. Three will be neutral to slightly negative and Q4 will be strongly positive. It's a bit like a replay of 2021, those of you who can remember that. 2022 was a bit of an odd year from a cadence perspective. Q4 wasn't as strong, but there were reasons behind that. But yes, we're standing behind our folio guidance of neutral between April 1 and December 31.
Operator
Perfect. Thanks so much. That's it for me. I'll jump out of line. Thank you. Our next question is from Matt Ramsey with Callum. Please proceed with your question.
Matt Ramsey
Yeah, hi, everybody. Congrats on the results. This is actually Ethan Potasnik on for Matt. I just wanted to drill down into the full year guide. It was great to see you guys kind of reiterate it. On the prior call, there was some discussion about maybe a $4 or $5 million headwind on macro softness and then maybe another million or so in royalties. So I was wondering, A, how do you kind of see that dynamic playing out, and then if you could talk about trends over the remainder of the year across end markets, that would be really helpful.
Erica
Sure.
Charlie Janik
So let me just take the trends and then I'll let Nick answer about the guide. So one of the things that makes us pretty optimistic about the second half is that we should be able to ship FlexNOC 5 production in the second quarter. So that means that we'll have full second half of FlexNOC 5 revenue. So we think that's going to be helpful to the whole year guide. And then, you know, as I said, you have a sort of a mixed bag of tailwinds, headwinds, right? That I answered to Gus's question, right? Where you have China coming back online a little bit more, but there's more trade friction. You have credit crunch, which affects smaller customers, but perhaps more outsourcing pressure from the big customers. So we feel comfortable that we're well positioned to meet the guidance. And then with that, I'll turn it over to Nick to discuss the actual numbers.
Nick
Yeah, exactly, Charlie.
Erica
So Ethan, great to hear you again. So say hi to Matt when you see him. The So your question, you've got a great memory on the headwinds question that we talked about last time. And essentially, we were saying, hey, look, growth into 2023 would be somewhat stronger if we didn't have one China slash macro headwinds, most of which was China through BIS headwinds, which we were talking about a sort of a 7% to 8%. um, negative on the year. Uh, and that equates, that's your 4 million essentially, uh, that, that would have been there if, uh, if all things have been, um, unrestricted, so to speak. Uh, and the other is of course royalties, which is a direct, uh, directly attributable to, um, uh, anything which is impacted by, um, recession. And, you know, we all, we all know that we are, whether officially we're in a recession or unofficially we're in a recession, We all know that we actually are. And so that dampens demand for end products, whether they're in the consumer space, less so in the automotive space because the OEMs are desperately trying to manufacture as much as possible to deal with the general channel inventory shortage. So there's not really so much there, but generally across the batch there is demand temporary demand shortage so so that's the other million and with that that seems still about right we would have expected to get more like five this year we're looking at more like four from royalties which is a lot less than we would like you know we would rather have a guided five and gone to six but it's it's gone the other way around because of this this general sort of volume reduction so that the picture in other words in short, has not changed, but just to re-establish the color on the subject that you so rightly brought up again.
Matt Ramsey
Understood. Terrific. Thank you. Second question. It seems like auto, through this kind of earnings season and year to date, has continued its kind of streak of resiliency as compared to other end markets. And I know you can't talk about specific customer programs, but maybe if you guys could perhaps characterize how activity in automotive is doing. Are customers still kind of full steam ahead, or are there any kind of signs of a slowdown?
Charlie Janik
So one of the things that – we try to get across on the earnings call is that we're trying to engage with the entire supply chain of automotive, including the ride-sharing companies and the automotive OEMs. And it used to be maybe four or five years ago, you could never get a meeting with a car company because they would say, why are you talking to us? You're a semiconductor IP company. Well, that has completely changed. The car companies are trying to get control of their architectures. And so either they're designing chips themselves or they're working with partners to design architectures, silicon architectures that work for their fairly extensive software. And so we're sort of happy to announce that we've closed in year-to-date deals with four automotive companies. Now, we can't say who they are, but they're broadly spread across Europe, APAC, and the U.S., And so it just demonstrates our ability that essentially the entire automotive supply chain is going to be a customer for advanced automotive oriented system IP. And then as far as the car business, you know, it's going through a major disruption. The investments in sort of both offensive and defensive in that disruption are being maintained. And we see the automotive business as sort of one of the, along with the machine learning, artificial intelligence segment, as one of the shining stars of the current business.
Nick
Terrific. Thank you.
Operator
As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Kevin Garrigan with West Park Capital. Please proceed with your question.
Kevin Garrigan
Yeah. Hey, everyone. Let me echo my congrats on the strong results. Just a quick question. So I know you had noted that you're in a strong position to continue to gain market share and, you know, there's potential for large companies to outsource. Are you seeing any increase in competition from anyone? And can you kind of remind us who your competition is?
Charlie Janik
Yes. The competition situation continues to be favorable. The main competitors that we have are really the internal teams that build internal system IP. Those, you know, one of the effects of this recession is that, you know, some of the companies are going to have difficulty maintaining those investments. And so perhaps there'll be more outsourcing of system IP by large companies. by large semiconductor and hyperscaler companies. So that's kind of one of the trends. So that's pretty much what I have to say. And then of course the machine learning business is also, there's generative AI where you have a new killer app that has a major problem with cost of procreate cost. And so there's going to be, we think, a substantial amount of investment in specialized hardware and accelerators to lower the cost of the chat GPT generative AI type queries. So there's a lot of innovation going on, and so we think that we're well positioned to address that.
Kevin Garrigan
Okay, got it. Yeah, that makes total sense. And then just one quick follow-up. So, you know, you have one quarter of 2023 in the books. And, you know, as you look out to the rest of the year besides, you know, the macro, is there anything else that kind of keeps you up at night?
Charlie Janik
Yeah, lots of things. But I think, as I said, the sort of, for us at least, the kind of the headwinds and tailwinds balance out And so we feel, I think, comfortable with the guidance that Nick discussed.
Erica
Okay. I think the answer for me with my finance hat on is twofold. One is, can I deliver the income statement numbers, particularly the revenue? And that is sort of colored by the, uh, the amount of, um, uh, forward visibility we have. As you know, we have, we have a good amount of forward visibility. We typically talk around 70, 75%. We, we currently have around 75 to 80% visibility, uh, for, uh, hitting 2023 revenue numbers. Uh, so that's puts me in a reasonably comfortable position. It doesn't actually, uh, make me lose too much sleep because the amount of effective returns business that we have to get to fill that gap is relatively small. And we have a great sales team. And we have great products coming out as well in the H2, as Charlie mentioned, one of which is Flex.5, which is already out and is going to be delivering in the second half. The other thing, of course, is cash management. um we are uh as you know since we last uh chatted with you um we are laser focused on cash management uh and um very very careful on every penny we spend on on opex uh yeah we have a very simple model we don't have uh capex we have um cash influx from bookings and we have cash out to pay opex um and so Obviously, we always maximize the bookings because that's where we get our growth numbers from, but we're now very, very careful on OPEX, and we have very carefully dialed down since the end of the third quarter our OPEX, essentially our burn rate, our run rate, to keep it so that we can get good operating leverage from bookings growth from a cash flow perspective into this year, which is why we get some comfort. I get some comfort that we can achieve or exceed even our negative cash flow projection in the guidance.
Kevin Garrigan
Okay. Got it. That makes sense. Thanks for that.
Nick
That's all from me. Thanks, guys. Thank you. There are no further questions at this time.
Operator
I would like to turn the floor back over to Charlie Janik for any closing comments.
Charlie Janik
Okay, well, thank you for your time and interest in our terrace. We look forward to meeting with you at the upcoming investor conferences that we're participating in during the next couple of months, and we look forward to updating all of you on our business progress in the course to come. Thank you. This concludes today's conference. You may disconnect your lines at this time.
Operator
Thank you for your participation.
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