Rambus Inc (RMBS) Q3 2020 Earnings Call Transcript

Welcome to the Rambus Third Quarter and Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Rahul Mathur, Chief Financial Officer. You may begin your conference.

Thank you, operator, and welcome to the Rambus third quarter 2020 results conference call. I'm Rahul Mathur, CFO; and on the call with me today is Luc Seraphin, our CEO. The press release for the results that we will be discussing today has been furnished to the SEC on Form 8-K. A replay of this call will be available for the next week at 855-859-2056. You can hear the replay by dialing the toll-free number and then entering ID number 2281104 when you hear the prompt. In addition, we are simultaneously webcasting this call. Along with the audio, we're webcasting slides that we will reference during portions of today's call. So, even if you're joining us via conference call, you may want to access the webcast with the slide presentation. A replay of this call can be accessed on our website beginning today at 5:00 P.M. Pacific Time. Our discussion today will contain forward-looking statements including our financial guidance for future periods; product and investment strategies; timing of expected product launches; demand for existing and newly acquired technologies; the growth opportunities of the various markets we serve; the expected benefits of our merger, acquisition and divestiture activity including the success of our integration efforts; risks and the potential adverse impacts related to or arising from the novel Coronavirus or COVID-19 and the effects of ASC 606 on reported revenue, amongst other things. These statements are subject to risks and uncertainties that are discussed during this call and may be more fully described in the documents we file with the SEC, including our 8-Ks, 10-Qs and 10-Ks. These forward-looking statements may differ materially from our actual results and we're under no obligation to update these statements. In an effort to provide greater clarity in our financials, we're using both GAAP and non-GAAP financial presentations in both our press release and on this call. A reconciliation of these non-GAAP financials to the most directly comparable GAAP measures has been included in our press release in our slide presentation and on our website at rambus.com on the Investor Relations page under Financial Releases. The order of our call today will be as follows: Luc will start with an overview of the business; I will discuss our financial results, including our guidance for future periods, and then we will end with Q&A. I'll now turn the call over to Luc to provide an overview of the quarter.

Thanks, Rahul, and good afternoon, everyone. The company had another very solid performance this quarter, as our excellent product growth continues. We delivered on revenue of $56.9 million and exceeded expectations for profitability with continued discipline on the bottom line. It was another very strong quarter of cash generation with $44.1 million in cash from operations. This brings the total for the year to over $143 million, which already significantly exceeds our total for the entirety of last year. As our proven track record of cash generation and progress on strategic product initiatives continue, we are poised for healthy top-line growth in 2021. Data center remains the key growth market across all of our businesses. Cloud demand skyrocketed in the first half, driven by the significant increase in online activity from corporations and consumers, and has returned to more normal growth rates in the third quarter. We continued to see sustained investment from our customers in products and solutions that will help improve the performance and security of the global data infrastructure. Memory and interface chips delivered a solid quarter, with quarterly revenue up 39% year-over-year. We are on track to have another record year, with over 50% growth in our product business versus 2019. While we continue to gain DDR4 market share, the third quarter saw the beginning of the short-term data center inventory digestion we cautioned about in previous calls. We expect the bulk of this adjustment to occur in the fourth quarter and a return to normal consumption levels early next year. We still anticipate ending 2020 significantly above the full-year guidance we provided in 2019. Looking forward to 2021, we have a larger qualification footprint in the upcoming DDR4 server platform transition, which should drive further market share gains. For DDR5, we are in a leading position for qualification with our memory customers and CPU partners. DRAM suppliers are now sampling DDR5 modules with our chips to system companies. Looking forward, we are investing in the development of additional chips for DDR5 platforms, as well as new architectures and IP for novel memory subsystems. This will further strengthen our memory leadership position in the years to come. Turning to Silicon IP, we had a strong quarter with increasing design win momentum across data center, 5G and edge. This was supported by excellent execution from last year's acquisitions, with the former Verimatrix and Northwest Logic teams, both hitting the targeted run rate for revenue. I'm delighted with this performance as the successful integration of these teams gives us confidence in our ability to create greater value from future acquisitions. Our solutions continued to lead the industry, with the latest example being our silicon demonstration of the world's fastest HBM2E memory interface, running at up to 4 gigabits per second. At this speed, our comprehensive solution delivers the highest bandwidth for the most demanding data center applications, including AI, machine learning training, and high-end graphics. Lastly, we are very pleased Micron extended their license agreement for an additional four years under the existing financial terms. This extends their license agreement beyond the next renewal dates for Samsung and SK Hynix and is a great testament to the ongoing strength and relevance of our patent portfolio, as well as our growing partnership with Micron. With this extension, we have solidified a sustained foundation of cash generation from our licensing program that allows us to return value to our stockholders and build our growing product businesses. With that, this afternoon, we announced a new stock repurchase program, which Rahul will discuss in more detail later on in the call. The program demonstrates the Board's confidence in our strategic direction and underscores our ongoing commitment to investors. Strong cash generation also gives us the flexibility to invest and expand our technology roadmap to address most data-centric applications. Through our ongoing focus on execution, we have multiple revenue streams across the company, and with our structural step-downs behind us after Q4, we will be well-positioned for significant absolute growth in 2021. With that, I'll turn the call back to Rahul to discuss the quarterly financial results.

Thanks, Luc. I'd like to begin with our financial results for the third quarter. Let me start with some highlights on slide five. As Luc mentioned, we delivered a solid quarter. We delivered financial results in line with our revenue expectations and at the high end of our earnings expectations, while continuing to strengthen our balance sheet and make progress on a number of business initiatives, as well as our long-term growth strategy. We've adopted ASC 606 in 2018 using the modified retrospective method, which did not restate prior periods, but rather runs the cumulative effect of the adoption through retained earnings as a beginning balance sheet adjustment. Any comparison between our results under ASC 606 and prior results under ASC 605 is not an accurate way to track our company's progress. We will continue to provide operational metrics, such as licensing billings, to give our investors better insight into our operational performance. We delivered revenue of $56.9 million and licensing billings of $53.1 million in line with our expectations. The strength of our model reflects our proven record of generating strong cash flows. We have a very strong balance sheet and ended the quarter with cash, cash equivalents, and marketable securities of $520.2 million, up nicely from the previous quarter, primarily due to cash from operations of $44.1 million. This brings year-to-date cash from operations for the nine months to $143.4 million, well above last year's full year total of $128.5 million, with another quarter remaining in the current year. Our continued execution on our strategy and our operational discipline have yielded solid financial results and a strong balance sheet that afford us flexibility to support our strategic initiatives. Over the past years, growth in our product businesses has enabled us to offset the known step-downs in patent licensing. We are well-positioned for next year with our final significant licensing step-down scheduled for Q4. Our products will drive overall company growth in 2021, improving both our top and bottom line. Now let me talk you through some revenue details on slide six. Revenue for the third quarter was $56.9 million in line with our expected range. Royalty revenue for the third quarter was $16.6 million, while licensing billings was $63.1 million. The difference between licensing billings and royalty revenue primarily relates to timing, as we don't always recognize revenue in the same quarter as we bill our customers. Going into additional detail, our product revenue was $29.8 million, consisting primarily of our buffer chip business. Our contract and other revenue was $10.5 million, consisting primarily of our Silicon IP business. For the year, there's roughly $40 million of our Silicon IP business that's being reflected in our licensing billings. This is almost twice what we expected at our Analyst Day a year ago. Strength in our security IP business in particular enabled us to meet our revenue expectations in Q3. These results represent excellent growth year-over-year. Let me now walk you through our non-GAAP income statement on slide seven. Along with our revenue performance in Q3, we again exceeded our profitability targets as we have done consistently over the past many years. Total operating expenses, including COGS for the quarter came in at $56.7 million. Operating expenses of $45.8 million were lower than in the prior quarter due to lower expenses related to our headquarter facility and other variable expenses. Multiple revenue streams enabled us to offset quarterly variances in any particular business. We ended the quarter with headcount of 679, slightly higher than 670 in the previous quarter as we continue to invest in our product program. Under ASC 606, we recorded $3.3 million of interest income related to the financing component of our fixed fee licensing arrangement for which we have recognized revenue, but not yet received payment. We incurred $0.8 million of interest expense primarily associated with our convertible notes. This was offset by incremental interest income related to the return on our cash and investment portfolio. After adjusting for non-cash interest expense on a convertible note, this resulted in non-GAAP interest and other income for the quarter of $2.7 million. Excluding the interest income related to the significant financing component related to ASC 606, this would have been $0.6 million of interest and other expense. Assuming a flat rate of 24% for non-GAAP pretax income, non-GAAP net income for the quarter was $2.2 million. With continued focus on cost and disciplined execution, we delivered profit that was nicely above our expectations. Now let me turn to the balance sheet details on slide eight. Over the past several years, we've built a very strong balance sheet. Cash, cash equivalents and marketable securities totaled $520.2 million, up significantly from the previous quarter, primarily through cash from operations of $44.1 million. As I mentioned previously, year-to-date cash from operations for the nine months was $143.4 million, well above last year's total of $128.5 million with another quarter remaining in the current year. As we continue to deliver on the top line and execute on operational efficiency, we expect to continue to deliver strong cash from operations into the future. At the end of Q3, we had contract assets worth $401.7 million, which reflects the net present value of unbilled AR related to licensing arrangements for which the company has no future performance obligations. I expect this number to continue to trend down as we bill and collect for these contracts. It's important to note that this metric doesn't represent the entire value of our existing licensing agreements, as several customers have royalty-based agreements that allow us to recognize revenue each quarter under ASC 606. As we announced previously, we were pleased to extend our existing licensing agreement with Micron in September at our existing financial terms, demonstrating the strength and relevance of our patent portfolio. When this extension comes into effect in Q4, we expect to account for this agreement to be recognized as a variable contract. We do not expect one-time impact to revenue nor the corresponding addition to our unbilled contract assets. Instead, we expect to recognize ASC 606 revenue on a quarterly basis starting in the first quarter of 2021. Between this extension and buffer chip growth, our ASC 606 revenue is poised for strong growth next year. From a licensing billings perspective, as negotiated in the original agreement, the Micron contract will step down to $4.5 million in Q4 and then step back up to $10 million in the quarter from Q1 2021 through Q4 of 2024. It's also worth noting, we renewed our agreement for four years longer than the extension period initially specified. We have a strong partnership with Micron and this bodes well for our upcoming renewals and extensions with our other partners. Over time, we endeavor to transition renewals and extensions to variable agreements that could allow us to take revenue over time as opposed to upfront under ASC 606. Third quarter CapEx was $10.6 million and depreciation was $4.8 million. We delivered $33.5 million of free cash flow in the quarter. Looking forward, I expect roughly $14 million of CapEx for the fourth quarter. This represents roughly $35 million for the full year of 2020, 80% of which is related to the relocation of our headquarters facility. I also expect depreciation of roughly $5 million for the fourth quarter and roughly $19 million for the full year of 2020. Now, let me turn to our guidance for the fourth quarter on slide nine. As a reminder, our forward-looking guidance reflects our current best estimates that our actual results could differ materially from what I'm about to review. In addition to the financial outlook under ASC 606, we've also been providing information on licensing billings, which is an operational metric that reflects amounts invoiced to our licensing customers during the period adjusted for certain differences. As you've see in the supplemental information we provided on slide 13 of our earnings deck, licensing billings closely correlate with what we had historically reported as royalty revenue under ASC 605. Under ASC 606, we expect revenue in the fourth quarter between $45 million and $51 million. We expect royalty revenue between $12 million and $18 million. We also expect licensing billings between $61 million and $67 million. We've been making steady progress on our business and financial initiatives. Similarly, we're very pleased with the execution on the acquisitions we made last year. The teams have integrated well into our company and on a trajectory nearing our expectations at the time of each acquisition. Our guidance reflects the contract terms of the patent licensing potential with Micron I mentioned previously, as well as the inventory digestion impacting our buffer chip business. As we've been discussing, we've been monitoring the inventory build we saw at the beginning of the year, and we're confident this pause doesn't reflect any change in our competitive position or market share. As Luc mentioned, we expect to be through this in early 2021. Our Q4 guidance on buffer chip reflects annual growth of over 50% year-over-year and is almost 30% better than what we anticipated at last year's Analyst Day. In total, our Q4 guidance reflects financial results for 2020 that are substantially better than what we expected at last year's Analyst Day on both the top and bottom line, despite the unprecedented challenges presented by COVID-19. We expect Q4 non-GAAP total operating costs and expenses, which include COGS, to be between $59 million and $55 million as we continue to invest in programs. Under ASC 606, non-GAAP operating results for the fourth quarter are expected to be between $4 million and a $14 million loss. For non-GAAP interest and other income and expense, which excludes interest income related to ASC 606, we expect this to be approximately $1 million of expense, which includes $0.6 million of interest expense related to the notes due in 2023. We expect our pro forma tax rate in 2020 to remain consistent with our 2019 pro forma tax rate of roughly 24%. The 24% is higher than the statutory rate of 21%, primarily due to higher tax rates in our foreign jurisdictions. As a reminder, we paid roughly $20 million of cash taxes each year, driven primarily by our licensing agreements with our partners in Korea. We expect non-GAAP taxes to be between a benefit of $1 million and $4 million in Q4. We expect our Q4 share count to be roughly 117 million basic and diluted shares outstanding. This leads you to between a non-GAAP loss per share of $0.03 and $0.10 for the quarter. We have gone through a successful transformation over the past several years and our strong product growth has offset structural step-downs in patent licensing, the divestiture of payments and ticketing, and the shutdown of our lighting business. This has resulted in roughly flat top line, as we transition back to our core semiconductor focus. Through this transition, however, our operational discipline resulted in fantastic growth in cash from operations. As we look forward, the scheduled step-down of patent licensing will be behind us. In the coming years, we expect patent licensing to stabilize at the same level we expect to see in 2020. As I mentioned earlier, our product growth will translate into profitable growth in 2021. With that said, while we don't provide guidance beyond Q4, we're comfortable with the analyst consensus estimates at the top line and bottom line for each quarter of 2021. While the near-term macroeconomic conditions are difficult for any of us to predict, consensus estimates are currently in line with our long-term strategy reflecting product growth that continues to be significantly better than the broader semiconductor industry. Our confidence in our long-term prospects is reflected in the new $20 million share repurchase authorization from our Board that we announced earlier today. Let me finish with a summary on slide 10. We are proud of the excellent performance by our team in this unpredictable macroeconomic environment and the progress we continue to make against strategic initiatives to drive long-term profitable growth. While we understand that ASC 606 added a level of complexity to our financial reporting, it's important to reiterate that the underlying financial strength of our business remains strong. We have a predictable base of revenue and a demonstrated ability to generate cash. We have refocused our product portfolio around Rambus' core strength in the semiconductor industry and are well-positioned with a predictable licensing base and multiple product revenue streams across our company. We have continued to execute and our operational discipline has yielded solid cash from operations. We continue to leverage our strong balance sheet to support our strategic initiatives. Before I open up the call to Q&A, I would once again like to thank our employees for their continued teamwork and execution resilience during these uncertain times. Everyone, please stay safe and take care of yourself and your families. With that, I'll turn the call back to our operator to begin Q&A. Could we please have our first question?

Thank you, Rahul. Your first question comes from Suji Desilva with ROTH Capital. You may now ask your question.

Hi, Luc and Rahul. Congratulations on a very strong cash generation and a good sign of the turnaround here. Rahul, I model out ASC 605. I just wanted to check. The 3Q revenue affected my numbers, it seems to be $103 million and $0.30 of EPS. Does that sound like what the ASC 605 might look like?

So, Suji, I think what you're doing is substituting what we report for licensing billings for what is royalty revenue. So, you're kind of making some apples and oranges there, but I understand that's how a lot of our investors and analysts look at our company. Generally, that's how we look at it ourselves. But I think if you were to do that math, yes, I get it the same numbers that you have.

Okay. And just to check on the guidance to 4Q, I think with the step-down or the drop in the product revenue, it seems like it's more like $97 million and $0.25. Does that sound reasonable as well?

Yeah. Again, you are doing math that we can't publish because it's company-specific non-GAAP results. But if I were to do that math, I'd get the same numbers that you do.

Okay. Good. And a couple of questions, quick on financial perhaps and starting. You said early, I think the 4Q 2020 the license step-down is the last one you see in the near future quarter-wise. Is that correct? 2021 the more normal year without any expected step-downs, is that what you were saying?

Yes. That's right. So, this is something that we've been talking about for not just quarters, but I think for a year. Just the agreements that we signed over the past several years, 2016, 2017, 2018, were structured in a way that allowed our partners to take advantage of a very positive time in our industry, with some more payments upfront and then fewer billings. But what we said fairly consistently is that we think for the full year 2020, that should be roughly the rate we'll be at for the next several years. We were very excited to extend the Micron agreement for four years instead of what was contractually three. So that extension then comes back up at the end of 2024 and as you know, we have Samsung coming up in the middle of 2023 and then Hynix also in 2024. So, what we said is we expect licensing billings to be roughly flat now for the next several years, with the basis we had in 2020. The one caveat is that we also have our Silicon IP businesses. And in some cases, there are billings associated with that business that also show up in our licensing billings. And I think, as I mentioned in our prepared remarks, there's probably about $40 million of licensing billings in 2020 that’s really related to the Silicon IP business. But that base associated with just our patent licensing business, I expect to be roughly flat for the next several years, because we don't have large extensions and rolls with the big three DRAM partners until 2023 and 2024.

Okay. And then maybe one more question for Rahul and perhaps Luc. With the burgeoning cash amount, I appreciate the buyback confidence in place. But with the success of the recent acquisitions, can you talk about the target areas for further acquisitions similarly to beef up memory and security? And what size of acquisition are you perhaps willing to go to now, or similar as before?

Hi, Suji. This is Luc. Yeah. Thanks. Yeah. We continue to generate cash every quarter and we're pleased with this buyback. We confidently look at acquisitions. We would like to continue to grow. So, the larger the acquisition, the better. But we're looking at anything that would complement our offering in the data infrastructure to grow our business through acquisitions. We look at this very regularly. We say no to a lot of acquisitions that we think are not going to be good for us strategically or financially, but that's centered to our strategy going forward.

Okay. And maybe a few more perhaps for Luc. On the data center side, the memory buffer opportunity in calendar 2021, is the visibility driven by a resumption of Intel platforms that brings the data center spending back or data center cycles? Or is it your share gains? Perhaps you can talk about what your ending calendar 2020 shares versus 2021 share opportunity?

We continue to gain market share in 2020. We expect approximately 50% growth compared to last year, in a market that only grew about 5%. This growth was primarily in the first half of the year due to increased orders related to COVID-19, but now those orders are winding down as inventory gets digested. Overall, the growth was strong in the first half but less so in the second half. Looking ahead to 2021, we see a few favorable factors. We anticipate that inventory digestion will be complete early next year, and Intel will launch its next-generation processes, which will benefit us since we are process independent. Regardless of the market share split between AMD and Intel, as long as the market grows, we will grow with it. In the long term, we expect upside from DDR5 as all our DRAM customers have placed sample orders. This should ramp up at the end of next year, and we are investing in the companion chips needed for DDR5 platforms, as well as emerging architectures from cloud companies. This segment shows promising growth potential and share gains for us. We just need to navigate through Q4, where we expect to see inventory digestion, but after that, we anticipate favorable conditions.

Okay. Last quick question, Luc, I'll pass it along. Any thoughts on the Intel NAND divestiture to Hynix and the implication for Rambus?

It really doesn't have any implications for us. I think this is part of the industry consolidation. I think what's happening in the industry is that we see a lot of consolidations. I think people are going to start to develop domain-specific platforms, because they have to deal with an exponential growth of data workloads coming from the new applications like video, work-from-home, AI and so on and so forth. We see some of that consolidation happening now in the industry. For us, it's all benefits, because what it means is that everyone is going to need to have access to more data faster, and that's where we spend our investment money. I think it's going to be requiring more security as well. And if you look at the track record of security design wins, we see this being translated in that track record. So all of this is good for us. But SK Hynix is going to increase, doesn't have a direct impact.

Your next question comes from the line of Gary Mobley with Wells Fargo Securities. You may ask your question.

Hey, guys. Congrats on a strong finish to the year. Thanks for taking my question. I wanted to ask about product cycles for the buffer chip business as we look into next year. First, when you get your opinion on who will be the first to adopt DDR5 will be the hyperscalers? And then with respect to Intel's 10-nanometer Ice Lake, moving from 6 memory channels to 8. I wonder if you can give me sort of a take on how that might relate to your average selling prices and your content in these memory modules.

Yes. Thanks, Gary. These are really good questions. So, first of all, the move to 6 to 8 channels is going to happen before DDR5 in the next version of the DDR4 processor from Intel. And that will give their customers the ability to populate more memory per processor. So that's a potential growth in the market. And that's going to be up to their customers to decide whether they realize that growth or not because all of their customers have moved from 6 to 8 memory channels. When we move from Ice Lake with 8 channels in DDR4 to DDR5 platforms, we're going to stay on an 8 channel platform. So that capacity of potentially more memory processor will continue. For us, we see a couple of triggers for next year. One is the move to Ice Lake. And the fact that every time you have a new platform, there's an opportunity for us to have a better design and footprint. And we know that our footprint for Ice Lake is better than what it was for Comet Lake. So that's the first thing that is happening. For DDR5, it will really ramp when the whole ecosystem is ready. They are at different stages of development. When I say there is the processor guys and the memory guys as well. But the good news for us is we do have some ample purchase orders down from all of them. We are shipping into modules and these modular shipping into the very early centers in system companies. So, all of these are good signs. I think when everyone is ready, we're going to be in a very strong position to enjoy a nice share on these swaps.

Thanks for that, Luc. To you, Rahul, I wanted to ask about your buyback and your timeframe for the buyback. In the past, you've done accelerated share repurchases. And so, I'm just wondering if you can go at this time with a more, I guess, methodical approach or slower approach? And am I doing the math right, given sort of the offsetting lower share count offset by lower interest income? This could be potentially $0.20 accretive on an annual basis.

So, Gary, thanks for the question. To put a little bit of context, the last time we did a share repurchase authorization was in 2015, and that was also for 20 million shares. And then from an actual activity perspective, we did about $100 million of accelerated share repurchase in 2015. We did another, I think, $50 million in 2017 and another $50 million in 2018. So that's how you get to the $3.6 million that was on the previous authorization, which we canceled with the new one. The reason I provide that history is that this is something we look at for several years in the future. I think it's a very strong signal from our company and from our Board that we believe in the long-term value of our company. Now that said, we have done accelerated share repurchase in the past because I think it's a very positive signal. It also gives us the surety of taking shares out of the market. But then we're opportunistic in terms of when we actually act. Now of course, we can't be in any possession of material non-public information whenever we choose to be in the market. So, we have to look at some of those guidelines as well. But if you look at what we've done in the past, what that typically refers to is about 40% to 50% of our expected free cash flow over the next three or four years. So, I think that's how we look at how we size that amount. Hopefully, that's helpful to you.

Sure. I appreciate the commentary with respect to your comfort level with current consensus for fiscal year 2021, which I believe, currently from a revenue perspective sits at $437.2 million which of course, is an adjusted revenue number. But I was wondering if you can give us any sort of preliminary view into sort of your OpEx trend against that backdrop?

Sure. Sure. So, just from an OpEx trend, I think what we look at is we're going to continue to look at investing in our business. We have done a fantastic job over the past couple of years of taking cost out of our company. So, what you would see from a total OpEx perspective is that it would be a little bit larger than we have in this year 2020, because we will continue to invest in our programs. I think I'd expect to see our gross margins on the product side continue to be very strong, kind of in the 60% to 65% range. And then you also have high margins in the Silicon IP business as well. So, I think that's what adds up to our comfort on the consensus, both on the top line as well as the bottom line for each quarter of 2021.

Your next question comes from the line of Sydney Ho with Deutsche Bank. You may now ask your question.

This is Jeff Rand on for Sydney. Congrats on the nice quarter. Earlier in the year, you announced a patent agreement with the Chinese company building DRAM. Have the recent escalations in trade tensions had any impact on this? And how do you think about the China market going forward?

Hi, Jeff. This is Luc. We are monitoring the situation in China like everyone else. However, the tensions do not have a direct effect on our agreement. This is solely a patent licensing agreement, which legally permits our partners in China to manufacture DRAM devices under a royalty arrangement. Our revenue will increase as they ramp up their products. So, the effect could be indirect, depending on how quickly they enhance their production for various reasons, but there will be no direct impact. This is strictly a legal agreement for them to produce DRAM for us.

And Jeff, I just can add a little. What we talked about is that we don't expect it to be a significant impact from a dollar perspective in the near term, just as the partner is ramping. And as Luc mentioned, there's no technology transfer in the places. It's just a legal agreement that allows them to ship. I think one of the benefits of the license from my view is that our license agreements are usually five years or longer. And so that extended beyond the existing renewal and extension timeframe for the big three DRAM manufacturers and it just talks to the strength and relevance of our portfolio.

Great. And then just following up. Commentary from earnings so far point to on-premise IT spending still being pretty weak. Can you talk about how on-premise spending risk cloud spending impacts your business?

You mean on-premise spending compared to what, sorry?

Yeah, Compared to cloud spending.

Cloud spending? Well, it's difficult for us to track that. Our buffer chip business mostly goes into data center types of applications. We see a shift from cloud demand from enterprise to cloud demand, but that is not a sector because you need memory modules to either in enterprise or cloud. And just by the same token because we are almost done, anything different to relative share of Intel or AMD, it’s kind of indifferent to share of enterprise and cloud. We focus on market growth and we continue to gain share in terms of design and footprint, we should see alike continuation of our share gain in that space. We don't ship any products into the client space in terms of buffers.

Your next question comes from John Pitzer with Credit Suisse. You may now ask your question.

Yeah. Guys, congratulations on the solid results, especially the free cash flow. And thanks for letting me ask the question. I guess, my first question is on the data center digestion you see in the calendar fourth quarter, is there any way to quantify kind of the hit that you're expecting to see in the fourth quarter because of that? And is this because customers have too much CPUs they bought too much early in the year? Or is it because they actually have too much memory? And I guess, importantly, because as you think about visibility as to data center coming back, why are you confident that it's only a one quarter phenomenon?

Sure, John. It's Rahul. Thanks very much for your commentary. Let me start, and I'll see if Luc would like to add. If you look at the guidance that we gave for Q4, we had our buffer chip business dropping from roughly $30 million in Q3 to about $21 million in Q4. And what we said is that all of our channel checks and conversations with our partners indicate that this should come back sometime early next year in terms of what's there. I think it really is the best phase to use is inventory digestion. I think our partners and you see that downstream in China are just being very cautious in terms of how much inventory they have in hand. It’s really something we have been talking about all year, right? We saw great demand in the first half of the year. And I think really that was because of the uncertainty of what was going to happen from a supply chain perspective under COVID. And I think now, as Luc mentioned earlier, people have better visibility and have more face in the resilience of the supply chain; then what they're trying to do is just to manage their inventories. So, I'll pause there and see if there's anything Luc want to add.

Earlier this year, the system company began building up inventory due to concerns about potential disruptions in the supply chain. However, these inventory increases were mainly upstream from us at the system level. Now that those concerns have been alleviated, people are starting to reduce their inventory at that level. You raised a good point about memory being indiscernible; that’s because memory is on a different cycle. They can fill their systems later in the process, building the systems first and then adding memory at the end. This is beneficial for us because it allows us to monitor our memory-related opportunities. Additionally, since memory is added later, it provides flexibility based on who gains market share during the transition, with those memory modules ultimately being allocated to other platforms once things stabilize. Our outlook for Q1 is influenced by the challenges within the ecosystem, which is quite evident with various players involved. In Q4, we expect to see inventory digestion, and early next year, we anticipate a resumption in demand.

That's good color. And then just as my follow-up, Rahul, you kind of impressively answered this when you commented that you feel confirmable with street consensus estimates for the quarters next year in 2021. But I am just kind of curious on the OpEx front, how do we think about kind of COVID as an OpEx driver, how much more expense was this year because of COVID and conversely were there any cuts that you were able to take out this year's OpEx that come into next year's OpEx. So, I'm just kind of curious how we should be thinking about that dynamic?

Yeah. John, that's a great question. And I think as I mentioned earlier, we have done a fantastic job over the past several years seeking cost out of our company. You see it in our guidance on operating expenses and you see it in overall come down particularly in terms of SG&A. I think from a COVID impact, we actually had fewer expenses this year, particularly related to travel. And that's something I think that helped us. One of the things that I think we've done very well as a company is use the opportunity with COVID to kind of re-imagine how we want to go run our company. So, things like hybrid work in our facilities with them, for example, right? So, I think there are definitely things that we can do to continue to take cost out of our company next year. And what we're going to do is then take that cost that we might have otherwise had on the infrastructure and invest it back in the programs. I think I've been delighted with the growth in our product program. So, it's something where we're using the learnings that we've seen over the course of this year with COVID to become more efficient next year as our employees come back to work. I hope that helps to answer your question. Again, to give back a little earlier just in terms of a range of our OpEx. I think I'd see a little bit of increase, specifically on the R&D side year-over-year, but you should have flatter SG&A coming down.

Perfect. Thanks, guys. I appreciate it.

Thank you, John.

Thank you.

Your next question comes from Mark Lipacis with Jefferies. You may now ask your question.

Hi. Thanks for taking my questions. I just want to confirm my understanding. For the renewed Micron contract, is it true that the terms remain the same as before and there is no change in revenue recognition from an ASC 606 perspective?

Let me clarify this for you, Mark. It might sound confusing, and it is somewhat complicated. When we adopted ASC 606 in 2018, due to the nature of our agreement with Micron, we had essentially earned everything related to that contract, effective through the end of this year. Consequently, when we adopted ASC 606, we adjusted the entire balance as part of retained earnings. With the renewal we signed in Q3, the new terms will not take effect until next quarter in Q4. As a result, contractually, that contract will decrease by $5.5 million for us in Q4, which is why you see a difference in our expected results from Q3 to Q4. However, it will rebound to $10 million a quarter starting in Q1 of 2021 and will continue at that rate for the next four years, through Q4 of 2024. From a billing perspective, we will see $10 million quarterly for the next 16 quarters. Following ASC 606, since we signed an extension, I anticipate we can treat the agreement as a variable contract and recognize revenue under ASC 606 on a quarterly basis starting in Q1 of 2021. As I mentioned earlier, I do not expect a significant one-time revenue entry in Q4 when the license becomes active, nor do I foresee a large increase in our contract asset or unbilled contract asset. Instead, I expect to recognize that revenue evenly from 2021 through 2024. I hope that clarifies your question.

Got it. I think I understand. So, previously, when you adopted 606, you recognized one-time revenues. Then, on a billings basis, you had billings, but we wouldn't have ASC 606 revenues recognized. On this...

Actually, because the contract was signed before our adoption of ASC 606, we were never able to recognize revenue. It was a one-time adjustment to retained earnings to reflect that time, so it’s one of the agreements of 606.

So, you are going to recognize revenues quarterly now according to ASC 606?

Starting in Q1 of 2021.

Gotcha. Okay. That's great. And do you think this is what you would expect to happen with future contracts as they come up for renewal?

So, Mark, that's exactly what we've been trying to do. As we sign new agreements or as we sign renewals or extensions is to have contracts that are more friendly from a 606 perspective. So we've also been very straightforward that we're not going to give up economic value in order to get slightly better accounting. But yes, in our rules and extensions, that's what we have been trying to do.

Thanks for going over that with me again. Regarding the share repurchase, should I understand that you generate a significant amount of cash and seek out opportunities, including inorganic ones? If those opportunities don't arise, you accumulate cash and decide that the best course of action is to return it to shareholders. Is that the correct way to think about your resources?

We have maintained a consistent approach to capital allocation, focusing on organic investments and returns to shareholders. At the end of the quarter, we had approximately $520 million in cash, which allows us to invest in growth areas, as reflected in our product expansion. We're also actively pursuing inorganic growth and I'm happy with the progress on the two acquisitions we completed last year. Our cash position allows us to continue investing organically while also partaking in industry consolidation. Additionally, we have been opportunistic in returning capital to shareholders, targeting a return of 40% to 50% of free cash flow. We have been effective in this area over the past few years. It's important to note that our share repurchase program does not prevent us from pursuing suitable mergers and acquisitions. We're consistently scouting for opportunities in data centers, memory, and security, similar to our successful endeavors last year. For a company of our size, we hold relatively little debt, with only one convertible issue maturing in early 2023, which isn't dilutive until we reach $23.30 per share. This gives us considerable financial flexibility, positioning us well for continued organic and inorganic growth.

Very helpful. Thank you, Rahul. Appreciate that.

Most welcome, Mark. Thank you.

At this time, there are no further questions. This concludes the question-and-answer session. I would now like to turn the conference back over to Luc Seraphin.

Thank you to everyone who has joined us today for your continued interest and for your time. We hope each of you stay safe and healthy, and look forward to speaking with you again soon. Have a great day. Thank you.

Thank you. This now concludes today's conference.