UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended March 31, 2023
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from to
Commission file number 001-40960
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
( | ||
| (Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices) | ||
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
| Large accelerated filer | o | Accelerated filer | o | ||||||||
x | Smaller reporting company | ||||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
As of April 27, 2023, there were 35,368,825 shares of the registrant’s common stock outstanding.
TABLE OF CONTENTS | ||
| Page | ||||||||
2
Part I - Financial Information
Item 1. Financial Statements
Arteris, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
(Unaudited)
| As of | |||||||||||
| March 31, 2023 | December 31, 2022 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Short-term investments | |||||||||||
Accounts receivable, net of allowance of $ | |||||||||||
| Prepaid expenses and other current assets | |||||||||||
| Total current assets | |||||||||||
| Property and equipment, net | |||||||||||
| Long-term investments | |||||||||||
| Equity method investment | |||||||||||
| Operating lease right-of-use assets | |||||||||||
| Intangibles, net | |||||||||||
| Goodwill | |||||||||||
| Other assets | |||||||||||
| TOTAL ASSETS | $ | $ | |||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued expenses and other current liabilities | |||||||||||
| Operating lease liabilities, current | |||||||||||
| Deferred revenue, current | |||||||||||
| Vendor financing arrangements, current | |||||||||||
| Total current liabilities | |||||||||||
| Deferred revenue, noncurrent | |||||||||||
| Operating lease liabilities, noncurrent | |||||||||||
| Vendor financing arrangements, noncurrent | |||||||||||
| Deferred income, noncurrent | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 11) | |||||||||||
| Stockholders' equity: | |||||||||||
Preferred stock, par value of $ | |||||||||||
Common stock, par value of $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated other comprehensive income | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Total stockholders' equity | |||||||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | $ | |||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
3
Arteris, Inc.
Condensed Consolidated Statements of Loss
(In thousands, except share and per share data)
(Unaudited)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Revenue | |||||||||||
| Licensing, support and maintenance | $ | $ | |||||||||
| Variable royalties and other | |||||||||||
| Total revenue | |||||||||||
| Cost of revenue | |||||||||||
| Gross profit | |||||||||||
| Operating expenses: | |||||||||||
| Research and development | |||||||||||
| Sales and marketing | |||||||||||
| General and administrative | |||||||||||
| Total operating expenses | |||||||||||
| Loss from operations | ( | ( | |||||||||
| Interest expense | ( | ( | |||||||||
| Interest and other income (expense), net | ( | ||||||||||
| Loss before provision for income taxes and loss from equity method investment | ( | ( | |||||||||
| Loss from equity method investment, net of tax | ( | ||||||||||
| Provision for income taxes | |||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | ( | $ | ( | |||||||
| Weighted average shares used in computing per share amounts, basic and diluted | |||||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
4
Arteris, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Other comprehensive income: | |||||||||||
| Unrealized gains on available-for-sale securities, net of tax | |||||||||||
| Comprehensive loss | $ | ( | $ | ( | |||||||
See accompanying notes to unaudited condensed consolidated financial statements.
5
Arteris, Inc.
Condensed Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
(Unaudited)
| Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||||
| Additional | Accumulated Other | |||||||||||||||||||||||||||||||||||||
| Common Stock | Paid-In | Comprehensive | Accumulated | |||||||||||||||||||||||||||||||||||
| Shares | Amount | Capital | Income | Deficit | Total | |||||||||||||||||||||||||||||||||
| BALANCE—December 31, 2022 | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||
| Issuance of common stock for cash upon exercise of stock options | — | — | ||||||||||||||||||||||||||||||||||||
| Issuance of common stock for settlement of restricted stock units | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Tax withholding on RSUs settlement | ( | — | ( | — | — | ( | ||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Unrealized gains on available-for-sale securities, net of tax | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||
BALANCE—March 31, 2023 | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||
| Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||||
| Additional | Accumulated Other | |||||||||||||||||||||||||||||||||||||
| Common Stock | Paid-In | Comprehensive | Accumulated | |||||||||||||||||||||||||||||||||||
| Shares | Amount | Capital | Loss | Deficit | Total | |||||||||||||||||||||||||||||||||
| BALANCE—December 31, 2021 | $ | $ | $ | ( | $ | ( | $ | |||||||||||||||||||||||||||||||
| Issuance of common stock for cash upon exercise of stock options | — | — | — | |||||||||||||||||||||||||||||||||||
| Issuance of common stock for settlement of restricted stock units | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Tax withholding on RSUs settlement | ( | — | ( | — | — | ( | ||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||
BALANCE—March 31, 2022 | $ | $ | $ | ( | $ | ( | $ | |||||||||||||||||||||||||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
6
Arteris, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Adjustments to reconcile net loss to net cash used in operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Stock-based compensation | |||||||||||
| Operating non-cash lease expense | |||||||||||
| Amortization of deferred income | ( | ||||||||||
| Loss from equity method investment | |||||||||||
| Net accretion of discounts on available-for-sale securities | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Accounts receivable, net | ( | ||||||||||
| Prepaid expenses and other assets | ( | ||||||||||
| Accounts payable | ( | ||||||||||
| Accrued expenses and other liabilities | ( | ( | |||||||||
| Deferred revenue | ( | ||||||||||
| Net cash used in operating activities | ( | ( | |||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
| Purchases of property and equipment | ( | ( | |||||||||
| Purchases of available-for-sale securities | ( | ||||||||||
| Proceeds from maturities of available-for-sale securities | |||||||||||
| Payments of deferred transaction costs relating to investment in Transchip | ( | ||||||||||
| Net cash provided by (used in) investing activities | ( | ||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||||||
| Payments of contingent consideration for business combination | ( | ( | |||||||||
| Principal payments under vendor financing arrangements | ( | ( | |||||||||
| Proceeds from exercise of stock options | |||||||||||
| Payments to tax authorities for shares withheld from employees | ( | ||||||||||
| Payments of deferred offering costs | ( | ||||||||||
| Net cash used in financing activities | ( | ( | |||||||||
| NET DECREASE IN CASH AND CASH EQUIVALENTS | ( | ( | |||||||||
| CASH AND CASH EQUIVALENTS, beginning of period | |||||||||||
| CASH AND CASH EQUIVALENTS, end of period | $ | $ | |||||||||
| Noncash investing and financing activities: | |||||||||||
| Operating lease right-of-use assets, exchanged for lease obligations | $ | $ | |||||||||
| Purchase of property and equipment through vendor financing | $ | $ | |||||||||
| Unpaid deferred transaction costs relating to investment in Transchip | $ | $ | |||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
7
ARTERIS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and do not include all disclosures normally required in annual consolidated financial statements prepared in accordance with GAAP. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2022 and the related notes included in the Company’s Form 10-K filed on February 28, 2023 (2022 Form 10-K) with the U.S. Securities and Exchange Commission (SEC). The December 31, 2022 condensed consolidated balance sheet was derived from the audited consolidated financial statements as of that date. In management’s opinion, the unaudited interim consolidated financial statements have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments necessary for the fair statement of the unaudited condensed consolidated financial statements.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of Arteris, Inc. and its wholly-owned subsidiaries. All intercompany transactions and accounts have been eliminated.
Use of Estimates
The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates relate to, among others, revenue recognition, the useful lives of assets, assessment of recoverability of property, plant and equipment, fair value of investments, impairment of the equity method investment, fair values of goodwill and other intangible assets, including impairments, leases, allowances for doubtful accounts, deferred tax assets and related valuation allowance, stock-based compensation, potential reserves relating to litigation and tax matters, collectability of certain receivables, fair value and amortization of deferred income, as well as other accruals or reserves. Actual results could differ from those estimates and such differences may be material to the unaudited condensed consolidated financial statements.
8
Concentrations of Credit Risk
Financial instruments that potentially subject us to concentration of credit risk consist of cash and cash equivalents, investments and accounts receivable. Cash is currently held in three financial institutions that the Company believes are creditworthy. Cash held at these financial institutions generally exceed federally insured limits. The Company is exposed to credit risk in the event of default by the financial institution holding its cash, cash equivalents, and investments to the extent recorded in the balance sheet. The Company has not experienced any losses to date related to these concentrations.
The Company’s accounts receivable are derived principally from revenue earned from customers located in Americas, Europe, Middle East and Asia Pacific regions.
Accounts receivable from the Company’s major customers representing 10% or more of total accounts receivable was as follows:
| As of | |||||||||||
| March 31, 2023 | December 31, 2022 | ||||||||||
| Customer A | % | % | |||||||||
| Customer B | % | % | |||||||||
| Customer C | % | % | |||||||||
Revenue from the Company’s major customers representing 10% or more of total revenue was as follows:
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Customer D | % | % | |||||||||
| Customer C | % | % | |||||||||
Significant Accounting Policies
There have been no significant changes to the Company’s significant accounting policies during the three months ended March 31, 2023 from those disclosed in the annual consolidated financial statements for the year ended December 31, 2022.
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and in May 2019 issued ASU No. 2019-05, Credit Losses (Topic 326): Targeted Transition Relief (collectively referred to as Topic 326), which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. Topic 326 replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. Topic 326 is effective for the Company for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements and related disclosures.
9
3. REVENUE
Disaggregated Revenue
The following table shows revenue by product and services groups (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Licensing, support and maintenance | $ | $ | |||||||||
| Variable royalties | |||||||||||
| Other | |||||||||||
| Total | $ | $ | |||||||||
Contract Balances
The following table provides information about accounts receivable, net, contract assets and deferred revenue (in thousands):
| As of | |||||||||||
| March 31, 2023 | December 31, 2022 | ||||||||||
| Accounts receivable, net | $ | $ | |||||||||
| Contract assets | $ | $ | |||||||||
| Deferred revenue | $ | $ | |||||||||
The Company recognized revenue of $8.6 million and $7.4 million for the three months ended March 31, 2023 and 2022, respectively, that was included in the deferred revenue balance at the beginning of the respective periods. Contract assets are included in prepaid expenses and other current assets and other assets on the condensed consolidated balance sheets.
As of March 31, 2023, non-cancelable contracted but unsatisfied or partially satisfied performance obligations that have not yet been recognized, which includes deferred revenue and amounts that will be invoiced and recognized as revenues in future periods is $56.4 million, of which $29.7 million is expected to be recognized over the next 12 months and the remainder thereafter. The Company has elected to exclude the potential future royalty receipts from this amount.
10
Costs of Obtaining a Contract with a Customer
Incremental costs of obtaining a contract with a customer consist primarily of direct sales commissions incurred upon execution of the contract. These costs are required to be capitalized under ASC 340-40, Other Assets and Deferred Costs — Contracts With Customers, and amortized over the license term. As direct sales commissions paid for term extensions are commensurate with the amounts paid for initial contracts, the deferred incremental costs for initial contracts and for term extensions are recognized over the respective contract terms. Total capitalized direct commission costs were as follows (in thousands):
| As of | |||||||||||
| March 31, 2023 | December 31, 2022 | ||||||||||
| Short-term commission capitalized in prepaid expenses and other current assets | $ | $ | |||||||||
| Long-term commission capitalized in other assets | |||||||||||
| Total | $ | $ | |||||||||
Amortization of capitalized sales commissions was $0.9 million and $0.7 million for the three months ended March 31, 2023 and 2022, respectively and are included in sales and marketing expense in the condensed consolidated statements of loss.
4. NET LOSS PER SHARE
The following table presents the calculation of basic and diluted net loss per share attributable to common stockholders (in thousands, except share and per share data):
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Numerator: | |||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Denominator: | |||||||||||
| Weighted-average shares outstanding - basic and diluted | |||||||||||
| Net loss per share, basic and diluted | $ | ( | $ | ( | |||||||
Since the Company was in a loss position for all periods presented, the diluted earnings per share is equal to the basic earnings per share as the effect of potentially dilutive securities would have been antidilutive.
The following table summarizes the potentially dilutive securities that were excluded from the calculation of diluted earnings per share because they would be anti-dilutive:
| As of | |||||||||||
| March 31, 2023 | March 31, 2022 | ||||||||||
| Stock options | |||||||||||
| Restricted stock units | |||||||||||
| Restricted common shares issued for business combination (see Note 12) | |||||||||||
| Total | |||||||||||
11
5. INVESTMENTS
The following tables summarize the fair value and amortized cost of the Company’s cash equivalents and available-for-sale securities by major security type (in thousands):
| As of March 31, 2023 | |||||||||||||||||
| Amortized Cost | Unrealized Gains/(Losses) | Aggregate Fair Value | |||||||||||||||
Assets: | |||||||||||||||||
Money market funds | $ | $ | — | $ | |||||||||||||
Commercial paper | ( | ||||||||||||||||
| Corporate bonds | ( | ||||||||||||||||
| U.S. government agency securities | ( | ||||||||||||||||
| U.S. treasury securities | |||||||||||||||||
Total financial assets | $ | $ | ( | $ | |||||||||||||
| As of December 31, 2022 | |||||||||||||||||
| Amortized Cost | Unrealized Losses | Aggregate Fair Value | |||||||||||||||
Assets: | |||||||||||||||||
Money market funds | $ | $ | — | $ | |||||||||||||
Commercial paper | ( | ||||||||||||||||
| Corporate bonds | ( | ||||||||||||||||
| U.S. government agency securities | ( | ||||||||||||||||
| U.S. treasury securities | ( | ||||||||||||||||
Total financial assets | $ | $ | ( | $ | |||||||||||||
The maturity dates of the Company’s investments are as follows (in thousands):
| March 31, 2023 | |||||
| Less than one year | $ | ||||
| 1-2 years | |||||
| Total | $ | ||||
| December 31, 2022 | |||||
| Less than one year | $ | ||||
| 1-2 years | |||||
| Total | $ | ||||
All unrealized losses on available-for-sale securities have been in such position for less than one year as of March 31, 2023 and December 31, 2022. There were no credit losses of available-for-sale securities during the three months ended March 31, 2023.
6. FAIR VALUE MEASUREMENTS
Assets Measured and Recorded at Fair Value on a Non-Recurring Basis
Equity method investments, and certain non-financial assets, such as intangible assets are remeasured at fair value only if an impairment or observable price adjustment is recognized in the current period.
12
Financial Instruments Not Recorded at Fair Value on a Recurring Basis
Financial instruments not recorded at fair value on a recurring basis include vendor financing arrangements. The carrying value of the vendor financing agreements was $1.4 million and $1.7 million as of March 31, 2023 and December 31, 2022, respectively. The Company’s vendor financing arrangements are classified within Level 2 because these borrowings are not actively traded and have a variable interest rate structure based upon the Company’s incremental borrowing rate. The estimated fair values of these financial instruments approximate their carrying values.
Financial Instruments Recorded at Fair Value on a Recurring Basis
The following tables summarize the Company’s financial assets measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):
| As of | |||||||||||||||||||||||
| March 31, 2023 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Fair Value | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Cash equivalents: | |||||||||||||||||||||||
| Money market funds | $ | $ | $ | $ | |||||||||||||||||||
| Total cash equivalents | |||||||||||||||||||||||
| Short-term investments: | |||||||||||||||||||||||
| Commercial paper | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| U.S. government agency securities | |||||||||||||||||||||||
| U.S. treasury securities | |||||||||||||||||||||||
| Total short-term investments | |||||||||||||||||||||||
| Long-term investments: | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| U.S. government agency securities | |||||||||||||||||||||||
| Total long-term investments | |||||||||||||||||||||||
Total financial assets | $ | $ | $ | $ | |||||||||||||||||||
| As of | |||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Fair Value | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| Cash equivalents: | |||||||||||||||||||||||
| Money market funds | $ | $ | $ | $ | |||||||||||||||||||
| Total cash equivalents | |||||||||||||||||||||||
| Short-term investments: | |||||||||||||||||||||||
| Commercial paper | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| U.S. government agency securities | |||||||||||||||||||||||
| U.S. treasury securities | |||||||||||||||||||||||
| Total short-term investments | |||||||||||||||||||||||
| Long-term investments: | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| U.S. government agency securities | |||||||||||||||||||||||
| Total long-term investments | |||||||||||||||||||||||
| Total financial assets | $ | $ | $ | $ | |||||||||||||||||||
13
7. INTANGIBLE ASSETS AND GOODWILL
Intangible assets, net
Intangible assets, net consisted of the following as of March 31, 2023 (in thousands):
| Gross Fair Value | Accumulated Amortization | Net Book Value | |||||||||||||||
Developed technology | $ | $ | ( | $ | |||||||||||||
Customer relationships | ( | ||||||||||||||||
IPR&D | — | ||||||||||||||||
Trade name and other | — | ||||||||||||||||
Total intangibles | $ | $ | ( | $ | |||||||||||||
Intangible assets, net consisted of the following as of December 31, 2022 (in thousands):
| Gross Fair Value | Accumulated Amortization | Net Book Value | |||||||||||||||
Developed technology | $ | $ | ( | $ | |||||||||||||
Customer relationships | ( | ||||||||||||||||
IPR&D | — | ||||||||||||||||
Trade name and other | — | ||||||||||||||||
Total intangibles | $ | $ | ( | $ | |||||||||||||
Amortization expense of intangible assets was $0.2 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively.
The expected future amortization expense of these intangible assets as of March 31, 2023 is as follows (in thousands):
Fiscal year ending December 31, | |||||
Remainder of 2023 | $ | ||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| Thereafter | |||||
| Total future amortization expense | $ | ||||
Goodwill
As of March 31, 2023 and December 31, 2022, goodwill was $4.2 No
14
8. ACQUISITION
Semifore Acquisition
On December 27, 2022, the Company acquired 100 % of the issued and outstanding equity securities (the Acquisition) of Semifore, Inc. (Semifore), provider of hardware software interface (HSI) technology. Semifore technologies are used to effectively design, verify, document, and help in the validation of the hardware-software integration that is used in the SoC complex chip market. The addition of Semifore technologies and team expertise augments Arteris System IP and IP deployment automation to further enhance software control of the IP and SoC hardware. The Acquisition closed on December 27, 2022 and has been accounted for in accordance with the acquisition method of accounting for business combinations with the Company as the accounting acquirer.
The consideration transferred for the acquisition was $3.1 million. The Company recorded $1.4 million for developed technology intangible assets with an estimated useful life of years and $0.7 million for customer relationships intangible assets with an estimated useful life of years.
In connection with the acquisition, key employees and former owners of Semifore were issued a total of 663,143 shares of the Company’s common stock and obtained the right to additional cash payment totaling $1.8 million. Out of the 663,143 shares issued, 331,569 shares of common stock vested as of the closing date and the remaining 331,574 shares and $1.8 million cash payment will vest on the first and third anniversary of the closing date if certain key employees continue to be employed by the Company. These contingent cash payments and equity awards have been accounted for separately from the business combination and will be recognized by the Company as compensation costs in the subsequent periods as related services are provided. The Company recognized $0.3 million as compensation expense during the three months ended March 31, 2023.
Under the acquisition method of accounting, the purchase price is allocated to identifiable assets acquired and liabilities assumed based on their fair values on the acquisition date. The following table provides the estimated fair values of the identifiable assets acquired and liabilities assumed as of the acquisition date (in thousands):
| FAIR VALUE | |||||
| Cash | $ | ||||
| Accounts receivable | |||||
| Prepaid expenses and other current assets | |||||
| Contract assets | |||||
| Intangibles | |||||
| Accounts payable | ( | ||||
| Deferred revenue | ( | ||||
| Deferred tax liability | ( | ||||
Total identifiable net assets | |||||
Goodwill | |||||
Total purchase price | $ | ||||
Goodwill generated from this business combination is attributed to synergies between the Company’s and Semifore’s respective products and services and is housed within the Company’s single operating segment. The Company does not have any tax basis in the total goodwill of $1.5 million and the goodwill is non-deductible for income tax purposes.
The Company incurred $0.5 million acquisition-related expenses, which were recorded as general and administrative expenses in the consolidated statements of income (loss) for the year ended December 31, 2022.
The Acquisition did not have a material impact on the Company’s condensed consolidated financial statements; therefore, historical and proforma disclosures have not been presented.
15
9. LEASES
The Company leases its offices at various locations under noncancelable operating lease agreements expiring at various dates through 2032. Under the terms of these agreements, the Company also bears the costs for certain insurance, property tax, and maintenance. The terms of certain lease agreements provide for increasing rental payments at fixed intervals.
Total operating lease related costs were as follows (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Operating lease cost | $ | $ | |||||||||
| Short-term lease cost | |||||||||||
| Total lease cost | $ | $ | |||||||||
The weighted-average remaining term of the Company’s operating leases was 3.9 years and 3.1 years as of March 31, 2023 and December 31, 2022, respectively, and the weighted-average discount rate used to measure the present value of the operating lease liabilities was 10.0 % and 7.5 % as of March 31, 2023 and December 31, 2022, respectively. Cash payments made related to operating lease liabilities were $0.3
Maturities of operating lease liabilities as of March 31, 2023 were as follows (in thousands):
Fiscal year ending December 31, | |||||
Remainder of 2023 | $ | ||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| Thereafter | |||||
| Total undiscounted cash flows | $ | ||||
| Less: imputed interest | ( | ||||
| Present value of lease liabilities | $ | ||||
| Operating lease liabilities, current | $ | ||||
| Operating lease liabilities, non-current | |||||
| Total lease liabilities | $ | ||||
10. BORROWINGS
Vendor financing arrangements—The Company has various vendor financing arrangements with extended payment terms on the purchase of software licenses and equipment. In order to determine the present value of the commitments, the Company used an imputed interest rate of 10.0 %, which is an estimate based on the Company’s collateralized borrowing rate.
Vendor financing arrangements as of March 31, 2023 were as follows (in thousands):
Fiscal year ending December 31, | Amount | ||||
Remainder of 2023 | $ | ||||
| 2024 | |||||
| Total undiscounted cash flows | $ | ||||
| Less: Imputed interest | ( | ||||
| Present value of vendor financing arrangements | $ | ||||
| Vendor financing arrangements, current | $ | ||||
| Vendor financing arrangements, noncurrent | |||||
| $ | |||||
16
11. COMMITMENTS AND CONTINGENCIES
Indemnifications—The Company often enters into limited indemnification provisions in license agreements in the ordinary course of the Company’s licensing business. Pursuant to these provisions, which are often inserted into license agreements in the semiconductor IP and software licensing industries, the Company agrees to indemnify, hold harmless, and reimburse the indemnified parties up to a capped amount for losses suffered or incurred by such indemnified parties due to third party claims if such claims are determined to be caused by the Company. The term of these indemnification provisions is generally either for a term of years or perpetual, in each case beginning on the execution date of the agreement. The Company has also agreed to indemnify under indemnity agreements with its directors and officers, to the extent legally permissible, against liabilities incurred in connection with any action in which such individual may be involved by reason of such individual being or having been a director or officer, other than certain liabilities arising from willful misconduct of the individual.
The Company has incurred no actual payment obligations from these above-noted indemnification provisions and director and officer indemnity agreements for three months ended March 31, 2023 and 2022 and the condensed consolidated financial statements do not include liabilities for any potential indemnity-related obligations as of March 31, 2023 and December 31, 2022.
Legal—The Company has been and will continue to be subject to legal proceedings and claims.
In the normal course of business, the Company may receive inquiries or become involved in legal disputes regarding such litigation matters. Pursuant to ASC 450, Contingencies, the Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred, and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter.
In December 2022, the Company received notice of a complaint filed against the Company and two other defendants that are entities in the semiconductor industry by Network System Technologies, LLC in the United States District Court for the Western District of Texas, and two additional complaints were filed in the Eastern District of Texas against certain companies, including some customers of the Company, asserting among other things patent infringement relating to the Company’s technology and seeking damages and injunctive relief. The Company intends to vigorously defend itself in respect to these complaints and anticipates an increase in legal expenses to do so.
Due to the inherent uncertainties and complex technical issues arising from such intellectual property litigation, the Company cannot predict or guarantee any result of such intellectual property litigation. As with any such litigation at its initial stages, the Company cannot comment on the possible final litigation results of ongoing litigation or the risk whether the Company may not prevail in such intellectual property litigation. In addition, such litigation may make it necessary to support or defend the Company or the Company’s customers relating to the claims in the litigation.
Further, the ultimate outcome of the litigation, like any litigation, is uncertain and, regardless of outcome, litigation can have an adverse impact on the Company because of defense costs, potential negative publicity, diversion of management resources and other factors, which in turn may have a material adverse impact on the Company’s business, consolidated financial position, results of operations, or cash flows. As intellectual property claims are inherently unpredictable, the Company is currently evaluating whether such matters may have a material adverse effect on the Company’s financial position, results of operations, or cash flows.
In addition, significant judgement is required in both the determination of probability and determination as to whether a loss is reasonably estimable. Future revisions to such estimates could materially impact the Company’s results. Accordingly, there can be no assurance that existing or any future legal proceedings for liability estimates arising in the ordinary course of business or otherwise will not have a material adverse effect on the Company’s business, consolidated financial position, results of operations or cash flows.
17
12. STOCK-BASED COMPENSATION
2016 Stock Plan
On October 10, 2016, the Company amended and restated the 2013 Equity Incentive Plan and changed the name of the plan to Arteris, Inc. 2016 Incentive Plan (the 2016 Plan). Adoption of the 2016 Plan provides for participation by foreign nationals or those employed outside of the United States.
The 2016 Plan provides for the granting of the following types of stock awards: incentive stock options, non-statutory stock options, stock appreciation rights (SARs), restricted stock awards, restricted stock unit awards (RSUs) and other stock awards. The number of shares authorized for award was 20,803,838 . The Company granted awards of common stock in the form of 14,142,208 shares as of December 31, 2021. Following the Company’s IPO in October 2021, all future grants will be made under the 2021 Plan (as defined below), with none remaining available for future grant under the 2016 Plan.
2021 Stock Plan
The Company adopted the 2021 Incentive Award Plan (the 2021 Plan) effective October 26, 2021. The 2021 Plan provides for a variety of stock-based compensation awards, including stock options, SARs, restricted stock awards, RSUs, performance bonus awards, performance stock unit awards, dividend equivalents, or other stock or cash based awards.
Following the effectiveness of the 2021 Plan, the Company will not make any further grants under the 2016 Plan. However, the 2016 Plan will continue to govern the terms and conditions of the outstanding awards granted under this plan. Shares of common stock subject to awards granted under the 2016 Plan that are forfeited or lapse unexercised and withheld to cover taxes which following the effective date of the 2021 Plan are not issued under the 2016 Plan will be available for issuance under the 2021 Plan.
2021 Employee stock purchase plan
The Company adopted the 2021 Employee Stock Purchase Plan (the 2021 ESPP) effective on October 26, 2021. The 2021 ESPP would enable eligible employees of the Company to purchase shares of common stock at a discount to fair market value. As of March 31, 2023, there had been no offering period under the ESPP.
2022 Employment Inducement Incentive Plan
The Company adopted the 2022 Employment Inducement Incentive Plan (the 2022 Inducement Plan) effective November 3, 2022, pursuant to which it reserved 2,000,000 shares of its common stock. The 2022 Inducement Plan provides for a variety of stock-based compensation awards, including stock options, SARs, restricted stock awards, restricted stock unit awards, performance bonus awards, performance stock unit awards, dividend equivalents, or other stock or cash based awards. Awards under the 2022 Inducement Plan can only be made to newly hired employees.
Shares Available for Future Grant
Shares available for future grant consisted of the following:
| As of | |||||
| March 31, 2023 | |||||
| Shares available for future grant under the 2021 Plan | |||||
| Shares available for future grant under the 2021 ESPP | |||||
| Shares available for future grant under the 2022 Inducement Plan | |||||
The Company issues new shares upon a share option exercise or release of restricted stock units.
18
Stock Options
The following table summarizes the stock option activities under the Company’s 2016 Plan:
| Options Outstanding | |||||||||||||||||||||||
| Number of Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value ($'000s) | ||||||||||||||||||||
BALANCE—December 31, 2022 | $ | $ | |||||||||||||||||||||
| Exercised | ( | $ | |||||||||||||||||||||
| Canceled | ( | $ | |||||||||||||||||||||
BALANCE—March 31, 2023 | $ | $ | |||||||||||||||||||||
Options vested and exercisable—March 31, 2023 | $ | $ | |||||||||||||||||||||
The aggregate intrinsic value of the options exercised for the three months ended March 31, 2023 and 2022 was $2.0 million and $1.6 million, respectively. The total grant-date fair value of options vested was $0.1
As of March 31, 2023, there was $0.3 million of unamortized stock-based compensation cost related to unvested stock options, which is expected to be recognized over a weighted-average period of 1.6 years.
The Company had no stock option grants during the three months ended March 31, 2023.
Restricted Stock Units and Awards
The following table summarizes the restricted stock unit activities under the Company’s 2016 and 2021 Plan and the 2022 Inducement Plan:
| Restricted Stock Units | |||||||||||
| Number of Shares | Weighted-Average Grant Date Fair Value | ||||||||||
Unvested—December 31, 2022 | $ | ||||||||||
| Granted | $ | ||||||||||
| Vested | ( | $ | |||||||||
| Canceled | ( | $ | |||||||||
Unvested—March 31, 2023 | $ | ||||||||||
The total grant-date fair value of restricted stock units vested was $2.2 million and $1.1 million during the three months ended March 31, 2023 and 2022, respectively.
As of March 31, 2023, there was $40.6 million of unamortized stock-based compensation cost related to unvested restricted stock units, which is expected to be recognized over a weighted-average period of 3.1 years.
Restricted Common Stock
In connection with the Semifore Acquisition (see Note 8), the Company issued 331,574 shares of common stock that will vest on the first and third anniversary of the closing of the Acquisition contingent on the continued employment of certain key employees. As of March 31, 2023, 331,574 shares of common stock remain unvested. These shares had a grant date fair value of $1.3 million based on the closing stock price on the acquisition date. The Company will recognize total compensation cost of $1.3 million to be amortized on a straight-line basis over the total vesting period of three years . As of March 31, 2023, the total unamortized compensation cost was $1.2 million.
19
Stock-based Compensation
Stock-based compensation expense is recorded on a departmental basis, based on the classification of the award holder. The following table presents the amount of stock-based compensation related to stock-based awards to employees on the Company’s condensed consolidated statements of loss (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Cost of revenue | $ | $ | |||||||||
| Research and development | |||||||||||
| Sales and marketing | |||||||||||
| General and administrative | |||||||||||
| Total stock-based compensation | $ | $ | |||||||||
During the three months ended March 31, 2023, the Company recognized $0.1 million as stock-based compensation expense for common stock issued as part of the Semifore Acquisition.
13. EQUITY METHOD INVESTMENT
On February 21, 2022, Arteris IP (Hong Kong) Ltd. (AHK), a wholly-owned subsidiary of the Company, entered into a Share Purchase and Shareholders Agreement (the SPA) with certain investors and Ningbo Transchip Information Consulting Partnership (Limited Partnership) (Management Co). The transaction closed on June 20, 2022.
The Company, the investors and Management Co, pursuant to the SPA, subscribed to the registered capital of Transchip Technology (Nanjing) Co., Ltd. (Transchip), a formerly wholly-owned subsidiary of the Company. As a result, the registered capital of Transchip increased to $29.4 million. The Company subscribed for the registered capital of approximately $11.9 million, of which $11.6 million of the contribution was contributed in-kind by way of an interconnect solutions technology license by the Company pursuant to a -year technology license and services agreement which can be extended automatically for another -year term, and the remaining was paid in cash.
The license agreement provides Transchip the right to software licenses, services, software updates and technical support. On the closing date, the license agreement including the support and maintenance services to be provided to Transchip was valued to be $11.6 million, which was recorded as deferred income and will be recognized as interest and other income (expense), net over a period of years on a straight line basis after delivery of the license. The license was delivered to Transchip on September 2, 2022. For the three months ended March 31, 2023, the Company recognized income of $0.3 million for the license agreement.
The Company’s ownership interest of Transchip’s common stock was 35.0 % on a fully diluted basis as of March 31, 2023. The Company accounts for its common stock investment in Transchip as an equity method investment as it does not control but has significant influence over operating and financing policies of Transchip. Transchip is the Company’s only equity method investment.
As of March 31, 2023, the carrying value of the investment in Transchip was $11.1 million. There was no significant difference between the Company’s carrying value of the investment in Transchip and its share of underlying equity in net assets of Transchip. The Company’s loss from its proportionate share of its equity method investment in Transchip was $0.8 million for the three months ended March 31, 2023. The Company concluded that there were no indicators of impairment related to the Company’s equity method investment in Transchip as of March 31, 2023.
20
14. INCOME TAXES
The Company’s effective tax rate was (3.4 )% and (1.8 )% for the three months ended March 31, 2023 and 2022, respectively. The Company’s income tax provision was $0.3 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively. The change in forecasted foreign withholding tax, changes in the geographic mix of worldwide earnings which are taxed at different rates, and the impact of losses in jurisdictions with full valuation allowances, has resulted in an increase in the income tax provision for the period ended March 31, 2023 compared to the period ended March 31, 2022.
The Company’s management continuously evaluates the need for a valuation allowance and, as of March 31, 2023, concluded that a full valuation allowance on its federal, state, and certain foreign jurisdictions deferred tax assets was still appropriate.
15. RELATED PARTY TRANSACTIONS
The Company defines related parties as directors, executive officers, nominees for director, stockholders that have significant influence over the Company, or are a greater than 10% beneficial owner of the Company’s capital and their affiliates or immediate family members.
In November 2020, the Company entered into a lease agreement with Isabelle Geday, a member of the Board of Directors. The lease payments were less than $0.1 three-year term and is eligible to receive $26,445 per month for the first 12 months of the consulting term and $19,445 per month for the remaining 24 months of the consulting term. For the three months ended March 31, 2023, the Company paid Ms. Geday $0.1 million for consulting services. Lastly, the 455,000 stock options and 62,200 RSUs granted in connection with Ms. Geday’s prior employment continue to vest.
In December 2022, the Company entered into a three-month non-exclusive evaluation license agreement with Transchip. Under the agreement, the Company licensed certain technology products for no licensing fee. In March 2023, the Company entered into an amendment to extend the non-exclusive license agreement by three months for no licensing fee. See Note 13 for additional discussion on the Company’s transactions with Transchip.
21
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included under Part I, Item 1 in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes and the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the fiscal year ended December 31, 2022 included in the 2022 Form 10-K. This discussion and analysis contains forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under the heading “Risk Factors” in this Quarterly Report on Form 10-Q. Please also see the section under the heading “Cautionary Note Regarding Forward-Looking Statements” in the 2022 Form 10-K.
Unless the context otherwise requires, all references in this report to “we,” “us,” “our,” the “Company,” and “Arteris” refer to Arteris, Inc. and its subsidiaries.
Overview
We are a leading provider of System IP, including interconnect and other intellectual property, (collectively, IP) technology that connects client IP blocks such as processors, memories, artificial intelligence/machine learning (AI/ML) accelerators, graphics subsystems, safety and security and other input/output (I/Os) subsystems via multiple Network-on-Chips (NoCs) in order for our customers to create System-on-Chips (NoC) (SoCs) semiconductors faster, better, and at a lower cost. Our products enable our customers to deliver increasingly complex SoCs that not only process data but are also able to make decisions. Growth in the total addressable market for our solutions is being driven by the addition of more processors, channels of memory access, machine learning sections, chiplets, additional I/O interface standards and other subsystems within SoCs. The growth in the numbers of these connected on-chip subsystems place an increasing premium on the interconnect IP capability to move data inside complex SoCs. We believe this increase in SoC complexity is creating a significant opportunity for sophisticated System IP solutions which incorporate NoC interconnect IP, IP deployment software and NoC interface IP (consisting of peripheral data transport IP and control plane networks connected to NoC interconnect IPs).
Our IP deployment solutions, which were significantly enhanced by our acquisition of Magillem Design Services S.A. (Magillem) in 2020, complement our interconnect IP solutions by helping to automate not only the customer configuration of its NoC interconnect but also the process of integrating and assembling all of the customer’s IP blocks into an SoC. Products incorporating our IP are used to carry most of the important data inside complex SoCs for sophisticated applications, including automotive, enterprise computing, communications, consumer electronics, and industrial markets.
As of March 31, 2023, we had 243 full-time employees and offices in eight locations in the United States, France, China, South Korea and Japan. For the three months ended March 31, 2023, we generated revenue of $13.2 million, net loss of $9.0 million, and net loss per share, basic and diluted of $0.26. As of March 31, 2023, we had Annual Contract Value (as defined below) of $51.4 million. During the three months ended March 31, 2023, we added six net new Active Customers (as defined below) and our customers had 22 Confirmed Design Starts (as defined below).
Factors Affecting Our Business
We believe that the growth of our business and our future success are dependent upon many factors including those described under “Risk Factors” and elsewhere in this report, in addition to those described below. While each of these factors presents significant opportunities for us, these factors also pose challenges that we must successfully address in order to sustain the growth of our business and enhance our results of operations.
22
License Agreements with New and Existing Customers
Our ability to generate revenue from new license agreements, and the timing of such revenue, is subject to a number of factors, risks and contingencies. For new products, the time from initial development until we generate license revenue can be lengthy, typically between one and three years. In addition, because the selection process by our customers is typically lengthy and market requirements and alternative solutions available to customers for IP-based products change rapidly, we may be required to incur significant research and development expenditures in pursuit of new products over extended, multiyear periods of time with no assurance that our solutions will be successfully developed or ultimately selected by our customers. While we make efforts to observe market demand and market need trends, we cannot be certain that our investment in developing and testing new products will generate an adequate rate of return in the form of fees, royalties or other revenues, or any revenues. Moreover, the customer acquisition process has a typical duration of six to nine months; following this, a customer’s chip design cycle is typically between one to three years and may be delayed due to factors beyond our control, which may result in our customer’s product not reaching the market until long after we entered into a contract with such customer. Customers typically start shipping their products using our interconnect IP solutions between one to five years following completion of their product design, known as mass production, at which point we start to receive royalties; this lasts for up to seven years depending on the market segment. Any significant delay in the ramp-up of volume production of the customer’s products into which our product is designed could adversely affect our business due to delayed or significantly reduced revenues. Further, because the average selling prices (ASPs) of our products may decline over time, we consider new license agreements and new product launches to be critical to our future success and anticipate that for our newer products, we are and will remain highly dependent on market demand timing and revenue from new license agreements.
End Customer Product Demand and Market Conditions
Demand for our interconnect IP solutions and associated royalty revenue is highly dependent on market conditions in the end markets in which our customers operate. These end markets, which include the automotive, enterprise computing, communications, consumer electronics, and industrial markets, are subject to a number of factors including end-product acceptance and sales, competitive pressures, supply chain issues and general market conditions. For example, our revenue has been supported by the increased need for more complex SoCs to enable sophisticated automated driving. If the demand in this market continues to grow, we anticipate it will continue to have a positive impact on our revenue. In contrast, if general market conditions deteriorate or other factors occur such as supply chain issues resulting in fewer semiconductors utilizing our IP solutions being available for sale, our revenue would be adversely affected.
Terms of our Agreements with Customers
Our revenue from period to period can be impacted by the terms of the agreements we enter into with our customers. For example, in recent periods we have structured certain agreements with customers that include substantial up-front licensing payments. As a result of how these contracts are structured and the revenue is recognized, our revenue in the three months ended March 31, 2023 may not be comparable to future periods if we do not enter into similar contractual agreements. Further, a meaningful percentage of our revenue is generated through royalty payments. Because the time between a new license agreement win and the customer’s end product being sold can be substantial, with sales of the end product being subject to a number of factors outside our control, our revenue from royalties is difficult to predict. As a result of the foregoing, revenue may fluctuate significantly from period to period and any increase or decrease in such revenue may not be indicative of future period-to-period increases or decreases.
Technological Development and Market Growth
We believe our growth has been and will continue to be driven by technology trends in our end markets. For example, the requirements of smaller die size, lower power consumption, a higher frequency of operation and management of critical net latency in a timely and cost-effective manner for on-chip processing in the automotive, enterprise computing, communications, consumer electronics, and industrial markets has resulted in increased SoC design complexity for chips used in these markets. This trend in turn has created increased demand for in-licensing commercial semiconductor design IP, which in turn has positively impacted our revenue and growth.
23
In order to address technological developments such as the above and expand our offerings, we have invested significantly in our research and development efforts. These investments, which included growth in engineering headcount, have resulted in substantially increased research and development expenses in recent periods. As we continue to invest in our technology and new product design efforts, we anticipate research and development expense will increase on an absolute basis and as a percentage of revenue in the near term. In the medium to longer term, however, while we expect to increase our research and development expense on an absolute basis, we expect this expense to reduce as a percentage of revenue.
We will continue to evaluate growth opportunities through acquisitions of other businesses.
Impact of Operating Globally
We believe our products’ global footprint provides us with the opportunity to enter new markets and accelerate our growth. For three months ended March 31, 2023, 65.3% of our revenue was derived from sales to customers outside of the United States and 29.0% of our revenue was derived from customers located in China. For 2022, 59.3% of our revenue was derived from sales to customers outside of the United States and 28.8% of our revenue was derived from customers located in China. While we believe operating internationally has beneficially impacted our results of operations, we are subject to inherent risks attributed to operating in a global economy. Further, our international operations have been, and may in the future continue to be, subject to restrictive government regulations. For example, U.S. export regulations, including regulations announced October 7, 2022 that impose broad end-use and other restrictions on doing business with certain customers and facilities in China that develop or produce semiconductor chips or manufacturing equipment, may limit or adversely impact our ability to license or support our products to entities in or doing business with certain advanced AI or “supercomputer” design companies, foundries and manufacturers of assemblies and components in China. As a result of these restrictions, we may face challenges to maintain our revenue and our revenue may decrease.
Cyclical Nature of the Semiconductor Industry
The semiconductor industry in which our customers operate is highly cyclical and is characterized by increasingly rapid technological change, product obsolescence, competitive pricing pressures, evolving standards, short product life cycles and fluctuations in product supply and demand. New technology may result in sudden changes in system designs or platform changes that may render some of our IP solutions obsolete and require us to devote significant research and development resources to compete effectively. Periods of rapid growth and capacity expansion are occasionally followed by significant market corrections in which our customers’ sales decline, inventories accumulate, and facilities go underutilized. During an expansion cycle, we may increase research and development hiring to add to our product offerings or spend more on sales and marketing to acquire new customers, such as during the recent cycle of expansion in which we increased the number of our engineers significantly. During periods of slower growth or industry contractions, our sales generally suffer due to a decrease in customers’ Confirmed Design Starts or in sales of our customers’ products.
COVID-19 Impact
The duration and extent of the COVID-19 pandemic already had an adverse effect on the global economy and the lasting effects of the pandemic continue to be unknown. In response to the COVID-19 pandemic, the measures implemented by various authorities have caused us to change our business practices, including those related to where employees work, the distance between employees in our facilities, limitations on in-person meetings between employees and with customers, suppliers, service providers and stakeholders, as well as restrictions on business travel to domestic and international locations and to attend trade shows, technical conferences and other events. Although we have experienced, and may continue to experience, some impact on certain parts of our business as a result of governmental restrictions and other measures to mitigate the spread of COVID-19, our results of operations, cash flows and financial condition were not materially adversely impacted the three months ended March 31, 2023.
24
We are unable to accurately predict the full impact that COVID-19 will have on our future results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of any future pandemics and containment measures. Although we expect most of our employees to return to physical offices, the nature and extent of that return is uncertain and differs among jurisdictions. For additional details, see the section titled “Risk Factors—Our business has been, and may continue to be, adversely affected by health epidemics, pandemics and other outbreaks of infectious disease, including the current COVID-19 pandemic.”
Key Performance Indicators
We use the following key performance indicators to analyze our business performance and financial forecasts and to develop strategic plans, which we believe provide useful information to investors and others in understanding and evaluating our results of operations in the same manner as our management team. These key performance indicators are presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with generally accepted accounting principles in the United States (GAAP), and may differ from similarly titled metrics or measures used by other companies, securities analysts, or investors.
Annual Contract Value
We define Annual Contract Value (ACV) for an individual customer agreement as the total fixed fees under the agreement divided by the number of years in the agreement term. Our total ACV is the aggregate ACVs for all our customers as measured at a given point in time. Total fixed fees include licensing, support and maintenance and other fixed fees under IP licensing or software licensing agreements but exclude variable revenue derived from licensing agreements with customers, particularly royalties. ACV was $51.4 million and $49.6 million as of March 31, 2023 and 2022, respectively. In addition, total ACV and trailing-twelve-months royalties and other revenue was $54.8 million and $52.8 million as of March 31, 2023 and 2022, respectively. We monitor ACV to measure our success and believe the increase in the number shows our progress in expanding our customers’ adoption of our platform.
Active Customers and Customer Retention
We define Active Customers as customers who have entered into a license agreement with us that remains in effect. The retention and expansion of our relationships with existing customers are key indicators of our revenue potential. We added six and seven net new Active Customers during the three months ended March 31, 2023 and 2022, respectively. Our annual average customer retention rate was 98% from March 31, 2022 to March 31, 2023. ACV fluctuates due to a number of factors, including the timing, duration and dollar amount of customer contracts.
Confirmed Design Starts
We define Confirmed Design Starts as when customers confirm their commencement of new semiconductor designs using our interconnect IP and notify us. Confirmed Design Starts is a metric management uses to assess the activity level of our customers in terms of the number of new semiconductor designs that are started using our interconnect IP in a given period. Our interconnect IP and NoC interface IP customer base started a total of 22 and 19 designs during the three months ended March 31, 2023 and 2022, respectively. We believe that the number of Confirmed Design Starts is an important indicator of the growth of our business and future royalty revenue trends.