Earnings Call Transcript - RMBS Q3 2021

Operator, Operator

Welcome to the Rambus Third Quarter and Fiscal Year 2021 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 Desmond Lynch, Vice President of Finance and Investor Relations. You may begin your conference.

Desmond Lynch, VP of Finance and Investor Relations

Thank you, operator, and welcome to the Rambus third quarter 2021 results conference call. I am Desmond Lynch, VP of Finance and Investor Relations. And on the call with me today is Luc Seraphin, our CEO; Rahul Mathur, our CFO; and Keith Jones, Chief Accounting Officer. The press release for the results that we will be discussing today has been filed with 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 the ID number, 953-7075 when you hear the prompt. In addition, we are simultaneously webcasting this call, and along with the audio, we are 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 PM Pacific Time. Our discussions today will contain forward-looking statements, including our expectations regarding business opportunities, products 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, the company’s ability to deliver ongoing profitable growth, the company’s outlook and financial guidance for the fourth quarter of 2021 and related drivers, risks and the potential adverse impact related to or arising from COVID-19 and the effects of ASC 606 on reported revenue, among 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 and 10-Qs and 10-Ks. These forward-looking statements may differ materially from our actual results, and we are under no obligation to update these statements. In an effort to provide greater clarity in the financials, we are 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 a press release, in our slide presentation and on our website at rambus.com on the Investor Relations’ page under Financial Releases. We adopted ASC 606 in 2018, using the modified retrospective method, which did not restate prior periods, but rather ran 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 the company's progress. We will continue to provide operational metrics such as license billings to give our investors better insight into operational performance. The order of our call today will be as follows. Luc will start with an overview of the business; Rahul will discuss the financial results; Keith will discuss our guidance for future periods, and then we will end with Q&A. I will now turn the call over to Luc to provide an overview of the quarter.

Luc Seraphin, CEO

Thank you, Des, and good afternoon, everyone. Q3 was another strong quarter for Rambus. We delivered revenue in line with expectations at $81.3 million, generated $46 million in cash from operations, and hit our targets for profitability. This performance was driven by great execution from the entire global team. Memory Interface Chips delivered record revenue of roughly $37 million, which is up 18% quarter-over-quarter and 23% year-over-year. There's high demand for Server Memory, and with that, we expect further growth and another record quarter in Q4. All of this growth and momentum is happening in the context of a very challenging supply chain environment across the entire semiconductor industry. As we mentioned last quarter, we've seen the same shortages and cycle time challenges experienced by our peers. We are proactively managing our supply chain and working closely with our partners to ensure our ability to satisfy the growing customer demand for our products and support the aggressive Memory Interface Chip revenue targets we set at the beginning of the year. Despite these challenges, as I stated earlier, we delivered 18% quarter-over-quarter growth in Q3 and will continue to grow in Q4. In addition to this solid financial performance, we also achieved some very exciting product milestones. Our first-generation DDR5 RCD is in production and shipping in volume to customers. In anticipation of the ever-rising needs of future data centers, we are also the first to sample a second generation of DDR5 RCD. This is an important achievement as we raised the bar on performance and maintain our leadership position in DDR5 Memory Interface Chips. Turning to our CXL Interconnect initiative, we're seeing high engagements across the entire ecosystem, including DRAM, OEM and cloud players, and we are getting great feedback on the needs of both the markets and our customers for our future roadmap. We launched our industry-leading CXL 2.0 Controller IT, including integrated security functionality that protects data with no performance overhead. This IP was developed by the team that recently joined from PLDA and will be a key ingredient for future datacenter architectures. This brings me to broader progress across the Silicon IP business, where we are growing in size and scale with new products and design wins. We are leading the charge for critical technologies in our focus areas, including CXL, HBM, and Security IP. Through our continued internal development efforts, and the additions of Northwest Logic, the Security IP team from Verimatrix, AnalogX, and PLDA, our total Silicon IP business is now on a run rate of over $100 million in bookings annually. In support of our company’s performance, we are increasing our attention on environmental and social matters. We are focusing on opportunities to drive responsible, inclusive, and sustainable practices across our own operations as well as our supply chain. This has led to continued improvements in our ESG structure and disclosures. Overall, the team is executing very well. We brought in record product revenue and achieved industry-leading technology milestones across multiple businesses. We see a growing number of opportunities to address the critical challenges facing the industry and remain at the forefront of next-generation data-intensive architectures. As we continue our journey as a leading product and technology company, I am very excited about what the Rambus team can accomplish. Before I turn the call over to Rahul, I would like to take a moment to thank him for his contributions over the past five years and wish him well for the next chapter of his career. As we announced last month, Rahul will be leaving Rambus to pursue an opportunity outside of the semiconductor industry. We have appointed Keith Jones, our current Vice President, Chief Accounting Officer, and Corporate Controller as the Interim CFO. Keith brings a wealth of experience and expertise, and I am confident he will help lead the team through a successful transition. With that, I'll turn the call over to Rahul to discuss the quarterly financial results.

Rahul Mathur, CFO

Thanks, Luc. I'd like to begin with a summary of financial results for the third quarter on Slide 5. Once again, we delivered a solid quarter with product revenues growing 19% and generated $46 million in cash from operations. We have consistently executed on our profitable growth over the past many years. This has enabled us to invest in strategic initiatives, return capital to investors and improve cash from operations and free cash flow. We've built a strong foundation for our future growth. Let me walk you through our non-GAAP income statement on Slide 6. Revenue for the third quarter was $81.3 million, in line with expectations. Royalty revenue was $33.1 million, while licensing billings were $66.1 million. The difference between licensing billings and royalty revenue primarily relates to timing, as we don't always recognize revenue in the same quarter we bill our customers. The licensing billings for the quarter included $1.7 million related to PLDA, which closed in the quarter. Including our products and Silicon IP business, we were delighted to report record billings for the company in Q3. Product revenue was $36.7 million, consisting primarily of our Memory Interface business. Memory Interface Chip revenue was at an all-time high for the company, despite the supply chain challenges seen in our industry, and we're delighted to see such strong demand from our customers. Contract and other revenue was $11.5 million, consisting primarily of the Silicon IP business. We were pleased to report another quarterly record for our Security IP business. Total operating costs, including cost of goods sold for the quarter, came in at $62.8 million. Operating expenses of $48.2 million were in line with our expectations as lower variable R&D expense was offset by higher expenses associated with the acquisition of PLDA, which closed after we had provided guidance for the quarter. We expect to continue to grow investments in our product roadmap in the coming quarters to drive long-term growth. We ended the quarter with a total headcount of 694; this was over 100 times higher than the previous quarter as we integrate the strong engineering talent from both AnalogX and PLDA. Under ASC 606, we recorded $2.2 million of interest income related to the financing component, a fixed fee licensing arrangement for which we had recognized revenue but had not yet received payment. We incurred $0.7 million of interest expense primarily associated with our convertible note. This was offset by incremental interest income with our cash and investment portfolio. After adjusting for non-cash interest expense on the convertible note, this resulted in a non-GAAP interest and other expense for the third quarter of $2 million. Excluding the financing interest income related to ASC 606, this would have been $0.2 million of interest and other expense. Using an assumed flat rate of 24% for non-GAAP pre-tax income, non-GAAP net income for the quarter was $15.6 million. With continued focus on cost and disciplined execution, we again delivered a profit that was above expectations. Now, let me turn to the balance sheet details on Slide 7. Our ability to generate cash has helped us both invest in growth drivers and consistently return capital to shareholders. At the end of the quarter, cash, cash equivalents, and marketable securities totaled $419.7 million, down from the previous quarter as cash from operations of $46 million was offset by net payments for the acquisitions of AnalogX and PLDA of approximately $97.1 million. As we deliver on the top line and execute on operational efficiency, we expect to continue to deliver strong cash from operations in the future. At the end of Q3, we had contract assets worth $289.7 million, which reflects the net present value of unbilled accounts receivable related to licensing arrangements for which the company has no future performance obligations. We 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 we've consistently renewed our royalty-based agreements in a manner that allows us to recognize revenue each quarter. Third quarter CapEx was $4.9 million, while depreciation was $5.4 million. We delivered $41.1 million of free cash flow in the quarter. Looking forward, we expect CapEx for the fourth quarter to be roughly $5 million. We continue to expect depreciation of roughly $21 million for the full year of 2021. Now, let me hand the call over to Keith, who will go through our guidance for the fourth quarter.

Keith Jones, Chief Accounting Officer

Thanks, Rahul. Let me turn to our guidance for the fourth quarter on Slide 8. As a reminder, the forward-looking guidance reflects our current best estimates at this time. 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 we have reported historically, licensing billings closely correlates with what we had historically reported as royalty revenue under ASC 605. Under ASC 606, we expect revenue in the fourth quarter between $84 million and $90 million. We expect royalty revenue between $26 million and $32 million and licensing billings between $62 million and $68 million. As Luc mentioned, this outlook represents another record revenue for the buffer chip business at record billings for the total company. We continue to actively manage through the supply chain challenges in our industry. We expect Q4 non-GAAP total operating costs, which include COGS, to be between $68 million and $64 million as we increase the investment in our strategic initiatives and include a full quarter of the impact of PLDA expense. Under ASC 606, non-GAAP operating results for the fourth quarter are expected between a profit of $16 million and $26 million. For non-GAAP interest and other income and expense, which excludes interest income related to ASC 606, we expect approximately $1 million of expense, which includes $600,000 of interest expense related to convertible notes during 2023. We expect the pro forma tax rate to remain consistent at roughly 24%. The 24% is higher than the statutory tax rate of 21% primarily due to higher tax rates in our foreign jurisdictions. As a reminder, we pay roughly $20 million of cash taxes each year, driven primarily by licensing agreements with our partners in Korea. We expect non-GAAP taxes to be between an expense of $4 million and $6 million in Q4. We expect Q4 share count to be roughly 115 million basic and diluted shares outstanding as we have completed the repurchase program we announced in the second quarter. Overall, we anticipate a non-GAAP profit per share range between $0.10 and $0.16 for the quarter. Let me finish with a summary on Slide 9. Over the past several years, we have made substantial progress strategically, operationally, and financially. We have realigned our portfolio to address the opportunities in the datacenter and to support long-term growth. Our product businesses are well positioned in the market and anticipate long-term growth in each segment. We continue to invest organically in products like DDR5 and the CXL initiatives, make inorganic investments, such as our acquisitions of AnalogX and PLDA, and return value to our shareholders through share repurchases. Before I open the call up to Q&A, I would like to thank our employees for the continued teamwork, execution, and resilience during these uncertain times. Everyone, please stay safe and take care of yourself and your loved ones. With that, I'll turn the call back to our operator to begin the Q&A. Can we have our first question?

Operator, Operator

Thank you, Keith. Your first question comes from Sidney Ho with Deutsche Bank. Your line is open.

Sidney Ho, Analyst

Thank you for taking my questions. First of all, Rahul, thank you for the help over the years, and good luck with the next adventure. But my first question is on the supply chain. You guys have done a pretty good job managing supply chain last quarter. It seems like the quarter before as well. Have you seen any customers holding back on purchases of your products because they can't get all the parts from other suppliers? And conversely, have you seen customers ordering more than they need, because they worry about getting the parts from you? What are the indications you're looking at?

Luc Seraphin, CEO

Hi, Sidney, this is Luc. Thanks for the question. On the supply chain, we do not see customers holding back purchases because of the constraints they have with potentially the other components. So we don't see any significant issues happening to us. With respect to customers over-ordering, what we see in the current environment is that lead times are a bit longer, cycles are a bit longer, and there's a lack of visibility. We are also in the middle of a transition between DDR4 and DDR5. So customers are managing their RAM into DDR5 in a correct way. We don't see any worrying behaviors from our customers, but they are managing the transition from DDR4 to DDR5, and we're supporting them through that transition.

Sidney Ho, Analyst

Great, that's helpful. Maybe my follow-up question is on the licensing billings side. I'm surprised to see you expect your Q4 licensing billing coming down a little bit on a sequential basis and up only slightly over a year, given Q4 is typically seasonally stronger plus you have the Silicon IP business going very nicely in past few quarters and you also have the acquisition coming in. Can you talk about the dynamics a little bit here for Q4? Thanks.

Keith Jones, Chief Accounting Officer

Sure, Sidney. What we see in our licensing billings, we have a little bit of a mix in how our revenue gets recorded. So that's our Silicon IP business. Some of that ends up in the contract and other line items. Then some amounts end up in the royalties and the licensing billings. In large part, it has to do with any pieces that we have associated with those agreements that will impact reporting. But in any event, we do see strong momentum in both businesses. So if you take it in aggregate, you do see growth.

Sidney Ho, Analyst

Okay, thank you very much.

Keith Jones, Chief Accounting Officer

Thank you, Sidney.

Operator, Operator

Your next question comes from Mehdi Hosseini with SIG. Your line is open.

Mehdi Hosseini, Analyst

Yeah, excuse me. Thanks for taking my question. A couple of follow-ups. When I take your guide details, especially looking at your licensing billing, contract, and product revenue, it seems to me that there is a little bit of an upside to expectation, given what you have guided for calendar year '21. Now you also have the PLD cost that is dialed into your cost, but still your pro forma EPS is growing despite the lack of the revenue contribution from PLD. So my question is, given the trend that I try to highlight upside to your core business, that's enough to absorb the incremental costs from the acquisition, that will take a little bit of time to generate revenue. Is that the right way to think about the core business versus what you have acquired? And I have a follow-up.

Keith Jones, Chief Accounting Officer

Thanks, Mehdi. The core business is really strong. You can see the guidance that we put forth for our chip business, and what you're seeing is just growth there. There's really steep demand for Server Memory. That is a strong business. Our patent licensing billings business is solid. It's pretty stable, and we don't see a lot of fluctuation as we are doing a good job at renewals. Lastly, Luc and I mentioned the Silicon IP business, and that has been a great story. As Luc mentioned, we are exiting the year at a $100 million run rate for revenue. When we take a look at PLDA and AnalogX, we do see them contributing. So in the current quarter and Q3, they contributed about $1.7 million of revenue. Looking out to Q4, we're looking at a range of about $3 million to $4 million. We expect a similar amount of costs. Overall, they will be relatively breakeven in 2021. As we talked about before, we're looking at revenues increasing for those acquisitions to be about $20 million in 2022, and then they will start contributing to the bottom line as well.

Mehdi Hosseini, Analyst

Got it, clear. Thank you for the details. And then I'm just looking at the trend with DDR5. How should I think about the introduction of DDR5 with all the mixed signals out there with the server bills and new CPU? How do you see DDR5 traction from your end drive and associate the revenue contribution?

Luc Seraphin, CEO

Hi, Mehdi, that's a great question. As we talked about almost a year ago, we do see the volume ramp of DDR5 price happening this coming quarter, Q4. We had production orders shipping in Q3. We continue to see growth in Q4. This is a confirmation that DDR5 is starting to ramp in the market as expected. We also see better pricing of DDR5, which seems to be the case when the industry moves from generation to generation. And finally, what's really exciting for us is that, when we look at our design footprints on DDR5, they continue to be better than what we had in the successive generations of DDR4. As DDR5 ramps into the market, we expect to continue to grow our share. You probably saw as well that we announced the introduction of a faster DDR5 chip at 5.6 and 34.8. This is in anticipation of the future needs of processors. We are continuing to lead in terms of introducing the latest product to the market so that we can continue to grow share.

Operator, Operator

Your next question comes from Gary Mobley with Wells Fargo Securities. Your line is open.

Gary Mobley, Analyst

Hey, guys, thanks for taking my question. I guess I feel somewhat obligated to say some nice things about Rahul. I'm just kidding. No, it's been great working with you over the last five years, Rahul, and you will be missed. I'd like to ask about the outlook for product revenue in fiscal year '22, maybe not so much in actual dollar amounts, but maybe help us level set how the year may trend in terms of the key determinants of demand, the uniformity of the quarter-to-quarter demand. In other words, are some customers perhaps prepping their supply chain in anticipation of shipping servers that spend DDR5? Can you fill the demand based on the wafer supply you have lined up with TSMC? And perhaps if there's any inventory at later considerations and as well perhaps some of the supply chain constraints that some of your competitors may be dealing with that allow you to take some market share? Thank you, I know it's a lot.

Luc Seraphin, CEO

Thanks, Gary. Yes, that's a lot, but as you know, it's all great questions. I would start by saying that we continue to gain share in the DDR space. In 2020, we were among the highest in this market share. This year, we'll be above 20% market share, so we continue to gain share. As we said earlier in the call, in the third quarter of this year, we grew 18% quarter-over-quarter and 23% year-over-year, which is a much higher growth than the market growth, which is still low single-digit. We continue to gain share in that market and have no concerns whatsoever about the demand. Regarding the supply, we're facing what the whole industry is facing in terms of supply. This is something we're working on with our suppliers and the support of our suppliers almost on a daily basis. We managed to work with our supply chain partners to get record revenue in Q3. As we said, we will continue to grow in Q4. But I think what we're facing, as we said in the early call, is lack of visibility. We plan week after week with our partners, and it's difficult to have visibility. Deep inside, the fundamentals remain very sound. We expect to continue to grow share as we move into 2022. You would watch this transition between DDR4 and DDR5 as people transition their products to DDR5. We see longer lead times as we've said earlier, as people want to ensure they have what they need to manage this transition. In terms of filling the demand, as I said, we're working with our suppliers daily, and we're working with our customers on the mix of our products, and so far it's been working for us. As I said, we had a record quarter in Q3, and we see growth in Q4. I think Q1 and Q2 are going to continue to be tight, but we expect to start seeing some leveling in the second half of the year.

Gary Mobley, Analyst

Appreciate the color, Luc. Either for Rahul or Keith, I wanted to ask about the operating margin in the fourth quarter. I think all your different guidance might point to adjusted operating margin somewhere in the mid to upper 40% range, substituting license billings for the royalties or the other way around. So I'm wondering if that mid to high 40% operating margin is sort of a new benchmark as we think about 2022?

Keith Jones, Chief Accounting Officer

That's a great question, Gary. The math you did is accurate. As we look into 2022, one of the impacts that we do have is that our overall mix will change. We will have more products being a part of a percentage of the revenue, which has a 60% to 65% margin compared to the licensing which has a 100% margin. So overall, it could be in that range. We do expect overall growth with profitability as our revenue grows, and our profit margins overall should be relatively stable.

Operator, Operator

Your next question comes from John Pitzer with Credit Suisse. Your line is open.

John Pitzer, Analyst

Yeah. Good afternoon, guys. Congratulations on the solid results. Thanks for letting me ask questions. Luc, I’m curious just to apologize if you gave out a number, I didn't hear one. I know there are a lot of sort of indirect constraints on your business. Did you see any direct constraints on your product revenue business in the quarter either on wafer or back-end testing, packaging or logistics?

Luc Seraphin, CEO

Yes, of course. As I said, we do experience what our competitors and partners are experiencing. Depending on the week, we do see wafer constraints, and we do see substrate constraints. We work with our partners on a weekly basis. We replan our shipments on a weekly basis, and that's how we manage our supply to our customers. We do see pockets of constraints across the supply chain that can potentially impact us directly, but for the last couple of months or three months, we've been working closely with our partners to minimize the impacts on our customers and our growth.

John Pitzer, Analyst

That's helpful. At the midpoint of your guidance, the product revenue is going to be up about 25% plus or minus this year. And I know that in the buffer business at the end of last year you had some customer inventory that needed to be resolved. But when you think about the 25% growth this year, do you feel that that's keeping up with the market that implies share gains? And more importantly, as you continue this transformation to more of a product revenue company, how should we think about the three to five year CAGR kind of in product revenue, especially with things like DDR5 on the cusp?

Luc Seraphin, CEO

Sure. We do see continued growth and share gain. As we said earlier, it's mostly coming from the increased footprints of design wins from generation to generation. In 2020, we were among the highest in market share. This year, we will be above 20% market share, continuing to gain share. As we said earlier in the call, in Q3 of this year, we grew 18% quarter-over-quarter and 23% year-over-year, which is much higher than the market growth. We do continue to gain share in that market and have no concerns about demand. Regarding the supply, we're facing what the whole industry is facing in terms of supply. We are working with our suppliers daily to manage these constraints. We see a record revenue in Q3 and expect continued growth in Q4. I think Q1 and Q2 will remain tight, but the second half of the year should see some leveling.

John Pitzer, Analyst

And if I can sneak one quick one in here for Keith. Keith, you mentioned in the answer to the last question, product gross margin sort of in that 60% to 65% range. Is that where they are today? How should we think about the DDR transition? And before you answer, I should have started this but I wanted to also thank Rahul publicly for all the help over the years.

Keith Jones, Chief Accounting Officer

So if you take a look at our gross margins today, what we have and what we see is that for DDR5, it’s a new product introduction, so those gross margins are a little bit higher. Conversely, given where DDR4 is at in its cycle, those margins are being slightly compressed as we see some ASP pricing pressure. However, our teams are doing a great job from a manufacturing standpoint to reduce standard costs. But at the end of the day, you see on a net-net basis the blended gross margin for our products remains in that 60% to 65% range.

John Pitzer, Analyst

Perfect. Thanks, guys. Appreciate it.

Operator, Operator

Thank you, John.

Kevin Cassidy, Analyst

Thanks for letting me ask the question, and congratulations. And sorry, I didn't get to work with you much, Rahul. On the CXL, can you say what the adoption rate is for your dev visibility into the next-generation of server processors? Do you have an idea of how much the adoption is of motherboards designing with that are going to use the CXL standard?

Luc Seraphin, CEO

Hi, Kevin, great question. I think every generation of processors for the future, AMD or others, will offer our CXL interface capability as part of their processor interfaces. That's why we brought about CXL. There are several use cases for CXL, one of special interest to us is memory extension. As you know, whatever processor you use, you will need access to more memory. The first product that we're going to develop is the CXL memory expander, and this will be compliant with CXL 2.0. It will be able to be used on any platform in datacenters.

Kevin Cassidy, Analyst

Okay, great. You had mentioned on the DDR5 modules that there are other components that you might be going after. Can you give us maybe a high-level picture of what we would expect the increase in your TAM would be per module?

Luc Seraphin, CEO

Sure. First of all, on the timing of the three companion products on the offline module, given our development schedule and qualification schedule, they will hit the market in the second half of next year. This is where it's going to increase our potential revenue. I would say that, that will probably add at least 50% of our content compared to the DDR5 product itself. But again, we're monitoring that, and we are introducing those products to the market now. I think this is going to be something that will be relevant to our revenue growth in the second half of next year. Thank you. Well, thank you, Rahul, for all your help over the last few years. Thank you to everyone for joining today for your continued interest and time. We hope each of you stays safe and healthy. We look forward to speaking with you again soon. Have a great day. Thank you.

Operator, Operator

Thank you. This now concludes today's conference. You may now disconnect.