Earnings Call Transcript - RMBS Q3 2022

Desmond Lynch, CFO

Thank you, operator and welcome to the Rambus third quarter 2022 results conference call. I am Desmond Lynch, Chief Financial Officer at Rambus 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 filed with the SEC on Form 8-K. A replay of this call will be available for the next week at 866-813-9403. 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. A replay of this call can be accessed on our website beginning today at 5:00 p.m. Pacific Time. Our discussions today will contain forward-looking statements, including our expectations regarding projected financial results, financial prospects, market growth, demand for our solutions, the company's ability to effectively manage any supply chain shortages and the effects of ASC 606 on reported revenue amongst other items. These statements are subject to risks and uncertainties that may be discussed during this call and are 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 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 our 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 a modified retrospective method which did not restate prior periods but rather than 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 licensing billings to give our investors better insight into our operational performance. 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 and then we will end with Q&A. I'll now turn the call over to Luc to provide an overview of the quarter.

Luc Seraphin, CEO

Thank you, Des. The company delivered an excellent performance in Q3. We exceeded our guidance for both revenue and earnings and delivered a record $80 million in cash from operations. These strong results were achieved in the context of a challenging macroeconomic environment. Our strategic focus in data center, strength of execution and diverse portfolio of offerings are driving the continued profitable growth of the company and give us confidence in our outlook for a strong Q4. In addition, we are able to consistently return value to our stockholders most recently with the initiation of a $100 million accelerated share repurchase program and further debt retirement. And just this morning, we announced that we have extended our comprehensive patent license agreement with Samsung for an additional 10 years. With this extension, we have solidified a sustained foundation of cash generation from our licensing program that allows us to continue to return value to our stockholders and build our growing product businesses. Samsung has been a trusted partner for many years and we are very pleased to strengthen our strategic relationship. This extension enables deeper collaboration on the products and is a testament to the continued value of our innovations for the ongoing advancement of the industry. Turning to our detailed results, memory interface chips drove another record quarter of product revenue at $58.6 million, up 10% sequentially and 60% year-over-year. This was a great performance from the team but we remain vigilant as we navigate through dynamic macroeconomic conditions. We continue to focus on execution and are actively managing through a rapidly evolving supply-demand environment. Visibility is improving the supply chain and we expect continued growth in Q4. Demand for our DDR4 RCD remains strong and DDR5 continues to ship as our customers prepare for the ramp of the next-generation computing platforms. We are in the midst of simultaneous platform and DRAM transitions. And as such, we continue to expect the demand ramp for DDR5 to be somewhat lumpy in nature. With that, our memory interface chip product mix may shift as we march toward the projected DDR4, DDR5 server memory crossover which we now project to be in the first half of '24. In addition, as we mentioned in last quarter's call, we expanded our chipset offering with the introduction of our new DDR5 SPD Hub and temperature sensor. These companionships along with the RCD, are integrated into server memory modules. We expect production of these parts to ramp in '23, in line with market demand. As we look to the longer-term evolution of the data center, industry momentum around CXL is accelerating. Multiple applications for CXL attached memory are emerging enabling new tiers in the memory architecture. CXL enabled architectures promise to deliver higher performance and improved total cost of ownership in server generations to come. We continue to work in close collaboration with the ecosystem to develop CXL solutions for memory expansion and cooling. We're seeing strong engagement from cloud, OEM and DRAM makers alike and are well aligned with the market needs and timing. Turning now to silicon IP. We delivered another strong performance with sustained momentum across multiple markets. We remain on track to deliver $120 million to $130 million in revenue and over 20% growth year-over-year. Data center and AI are driving robust demand for our high-performing silicon IP solutions and we have growing traction in government and automotive. Rambus continues to demonstrate leadership in our areas of focus with major PHY, controller and security IP wins. In closing, this was an excellent quarter for the company. We delivered results above guidance and expect an even stronger Q4. We are confident in the long-term growth of the company but remain vigilant given the challenging macro environment. We are continuing to invest in the right programs for the data center market to drive continued growth and we are leveraging our strong balance sheet to return value to our stockholders. I am extremely proud of the team and I want to thank our customers and partners for their ongoing support. With that, I turn the call over to Des to discuss the quarterly financial results.

Desmond Lynch, CFO

Thank you, Luc. I'd like to begin with a summary of our financial results for the third quarter. Once again, we delivered a strong quarter with our financial results above the high end of both our revenue and earnings expectations and generated a quarterly record cash from operations of $80 million. Our ability to consistently generate strong cash flows has enabled us to invest in our strategic initiatives and consistently return capital to shareholders. During the quarter, we initiated a $100 million accelerated share repurchase program which immediately retired 3.1 million shares. In addition, we paid a net amount of $54 million to repurchase $39 million aggregated principal amount of our convertible notes. Let me walk you through our non-GAAP income statement. We continue to execute and revenue for the third quarter was $112.2 million, above the high end of our expectations. Royalty revenue was $29.9 million, in line with our expectations. It was down from the prior quarter due to upfront revenue for several license arrangements being included in Q2. Licensing billings was $62.2 million. The difference between licensing billings and royalty revenue primarily relates to timing as we do not always recognize revenue in the same quarter as we bill our customers. Product revenue was $58.6 million, consisting primarily of memory interface chips. Memory interface chip revenue was a record for the company and we are delighted to see such strong demand from our customers. Contract and other revenue was $23.7 million consisting primarily of silicon IP. As a reminder, only a portion of our silicon IP revenue is reflected in contract and other revenue and the remaining portion is reported in royalty revenue as well as in licensing billings. Total operating costs, including cost of goods sold for the quarter was $77.9 million. Operating expenses of $54.6 million were in line with our expectations and we ended the quarter with a total head count of 763 employees. Under ASC 606, we recorded $1.2 million of interest income related to the financing component of fixed fee licensing arrangements for which we have recognized revenue but not yet received payment. Additionally, we benefited from approximately $1.7 million in favorable foreign currency exchanges during the period. We incurred approximately $100,000 of interest expense associated with our convertible notes. This was offset by incremental interest income associated with our cash and investment portfolio. And adjusting for noncash interest expense on the convertible notes, this resulted in non-GAAP interest and other income for the third quarter of $2.9 million. Excluding the financing interest income related to ASC 606, this would have been $1.6 million of interest and other income. Using an assumed flat tax rate of 24%, non-GAAP pretax income for the quarter was $28.3 million. With disciplined execution and focus, we delivered earnings that were above the high end of our expectations. Now, let me turn to the balance sheet details. We ended the quarter with cash, cash equivalents and marketable securities totaling $264.8 million down from the previous quarter as record cash from operations of $80 million was offset by the $100 million accelerated share repurchase program we initiated in the quarter and $54 million net payment to repurchase the convertible notes. At the end of Q3, we now have approximately $10 million in aggregated principal amount remaining of our convertible notes which are due to mature in February 2023. As we continue to execute, we expect to deliver strong cash from operations in the future. At the end of Q3, we had contract assets worth $180 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 is important to note that this metric does not represent the entire value of our existing licensing agreements as with each renewal opportunity, we restructure our patent agreements in a manner that allows us to recognize revenue each quarter. Third quarter CapEx was $9.3 million, while depreciation expense was $6.7 million. We delivered $70.7 million of free cash flow in the quarter. Looking forward, we expect CapEx for the fourth quarter to be approximately $8 million. As a reminder, the forward-looking guidance reflects our current best estimates at this time and our actual results could differ materially from what I'm about to review. In addition to the financial outlook, we've also been providing information on licensing billings which 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. Now, let me turn to our guidance for the fourth quarter. Under ASC 606, we expect revenue in the fourth quarter between $119 million and $125 million. We expect royalty revenue between $29 million and $35 million and licensing billings between $59 million and $65 million. We expect Q4 non-GAAP total operating costs which includes COGS to be between $86 million and $82 million. Under ASC 606, non-GAAP operating results for the fourth quarter is expected to be between a profit of $33 million and $43 million. For non-GAAP interest and other income and expense which excludes interest income related to ASC 606, we expect approximately $500,000 of interest expense. We expect the pro forma tax rate to remain at approximately 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 approximately $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 $8 million and $10 million in Q4. We expect Q4 share count to be 110 million basic and diluted shares outstanding. Overall, we anticipate a non-GAAP earnings per share range between $0.22 and $0.29 for the quarter. Let me finish with a summary. I am pleased with our excellent results and the team's execution in this macroeconomic environment. Our strategy is paying off and we have a diversified portfolio fueled by continued product revenue growth in memory interface chips, sustained momentum in silicon IP and the stable backbone of our licensing business. We were pleased to announce we extended our licensing agreement with Samsung for an additional 10 years in substantially the same financial terms which demonstrates the continued strength and relevance of our patent portfolio and innovation engine. I'm really pleased that when this extension comes into effect, we expect to account for this agreement to be recognized quarterly under ASC 606. With continued discipline and focus, we are now well positioned to execute on our long-term strategic plans. We continue to grow the business profitably with strong cash generation and minimal debt which has enabled consistent capital returns to our shareholders. Before I open the call up to Q&A, I would like to thank our employees for their continued teamwork and execution. With that, I'll turn the call back to our operator to begin Q&A.

Kevin Cassidy, Analyst

Congratulations on the terrific results. On the Samsung contract, this was a bit of a surprise. I thought it was going to be – it seems like it’s been pulled in by about a year. Is there any reason for that? Or was it a surprise for you? I guess, have you already been in negotiations?

Luc Seraphin, CEO

Kevin, this is Luc. Thanks for the question. It was important for us to engage with Samsung in this renewal earlier rather than later so that we could secure some stability in our cash flows for the years to come. We could show more predictability in our results for the long term and visibility in our results. And it also lays the foundation for further strategic relationship with Samsung as we develop technologies and products for the data center for the years to come. So it was important for us to put this behind us and to lay the foundation for a long-term relationship, long-term product development with them. So that's the reason we did it earlier.

Kevin Cassidy, Analyst

Okay, great. And are you working with SK Hynix also then?

Luc Seraphin, CEO

So of course, we are in constant negotiation or discussions with our partners. The SK Hynix is scheduled for the second quarter of '24. As with Samsung, we have a strong relationship and partnership with SK. And we will try to have an early renewal but we don't make commitment on this at this point in time. Some patent renewals can take a lot of time. But the very fact that Samsung has renewed on the same terms is a strong validation of our patent portfolio. So we're quite confident in reengaging in discussions with SK but there's no guarantee that it's going to be done earlier.

Kevin Cassidy, Analyst

Okay, great. And just one other question about the CXL IP licensing. Are you seeing an increase in that? Most people expect that volume production of CXL will begin in 2024, but the integrated circuits for that must be in design now. Are you noticing an uptick in requests for IP related to CXL?

Luc Seraphin, CEO

Yes. So as indicated in our prepared remarks, our silicon IP business has grown about 20% year-over-year. And a large portion of that was due to the introduction of CXL and PCIe IP to our customers. So our silicon customers are building products using CXL. And we’ve seen that in the growth that we’ve shown in our silicon IP business for this year over last year. When it comes to our CXL silicon products, our own products, we’re building our products and these products will hit the market in 2024.

Mehdi Hosseini, Analyst

Yes, two follow-ups for the team. I'm just curious if you have looked into the competitive landscape, especially one competitor in China and whether increased restrictions would change the competitive landscape? And I have a follow-up.

Luc Seraphin, CEO

Thank you, Mehdi, for your question. Certainly, 2023 will show some cross currents of both economic and geopolitical situations. Our business in China is mostly around silicon IP and this is a small portion of our business. So if there is any impact, the impact is going to be in the grand scheme of things minimal. This being said, we are monitoring that situation between the economic slowdown in China, the possible recession outside of China and some restrictions on IP export to China; we may see some headwind for our silicon IP business in China. But again, the portion of the China business in our silicon IP remains modest.

Mehdi Hosseini, Analyst

Sure. Okay. And one quick follow-up as it relates to the product of buffer chip. If I just take the midpoint of your guide for Q4, you’re on par to grow that part of the business by almost 58%. And we haven’t even really started volume shipment for adoption of DDR5. And hopefully, I’m not mixing the two. So are these all engineering work you’ve done? Or how should I think about what’s driving the demand here? And how could we think about the opportunities once the DDR5 crossover happens in early ‘24.

Luc Seraphin, CEO

Thank you for the question. In 2022, we experienced exceptional growth for the buffer chip due to two main factors. First, our customers began building modules for DDR5 in preparation for its ramp-up. Second, delays in the DDR4 to DDR5 transition led our customers to purchase more DDR4 than they anticipated. As a result, we received more DDR4 orders than expected while facing supply constraints for DDR4 shipments. In Q3, we could have shipped more if we had sufficient supply, and in Q4, there remains a gap between our supply and market demand. The demand for DDR4 has surpassed expectations due to the transition delays. We expect adjustments beyond Q4 as customers address their DDR4 backlogs, and we will work on increasing supply. We will begin full production of DDR5 in the second half of the first quarter, which may lead to fluctuations in our revenue and margin mix. Overall, 2022 was remarkable, with anticipation for DDR5 driving our growth, even though its rollout has shifted. Despite these short-term adjustments, we anticipate continuing to outpace market growth throughout the year.

Mehdi Hosseini, Analyst

Do you mind if I just ask a very quick follow-up? I think it’s very important to understand. Your DDR5 buffer chip carries a higher pricing. So even if DDR4 buffer chip units were to decline, the higher price DDR5 buffer chip could offset that. We shouldn’t expect this like a pause or a drop off here as we transition from 4% to 5%. Is that a fair characterization?

Luc Seraphin, CEO

At the start of introducing new technology in ASP, there is a noticeable difference between the old generation and the new generation, which is also influenced by the volume ramp. As production increases, the pricing gap narrows. In the first half of the year, we will need to navigate this transition as customers work through their backlog of DDR4, which currently stands at 30, while also beginning to build their backlog for DDR5. We can expect some price fluctuations during this process, and we are keeping a close eye on that.

Desmond Lynch, CFO

Maybe just to add on to what Luc said, DDR4 certainly does have more ASP; DDR5 does have the higher ASP and now can tell you to form the normal pricing curves going forward. I think we’ve done a great job of managing the product mix over the last seven quarters where we’ve been able to deliver record product revenue growth and that’s what we hope to continue going forward. But as Luc mentioned, we are in a dynamic transition here between DDR4 and DDR5 but I think we’re well positioned going forward.

Sidney Ho, Analyst

I just want to follow up with the last question. With the adjustment period you kind of expect in Q1 or the first half of next year that you just mentioned, what is your current expectation of product revenue for next year? And maybe just a follow-up to that. Some of the memory companies are commenting that lower DDR5 prices in the current environment can lead to faster adoption of DDR5. Are you starting to see that? And conversely, are you seeing any price pressure for your DDR5 products as a result of lower memory prices?

Desmond Lynch, CFO

Sidney, thanks for the question. As you know, we only guide one quarter at a time. So looking ahead into fiscal year '23, it's a little bit ahead of us just now. I think what we have done is a fantastic job of executing on our sort of product growth in balancing the mix between DDR4 and DDR5 from there. As Luc mentioned in his prepared remarks, we have seen some lumpiness in demand for DDR5 and we expect that sort of to continue into sort of Q4 and Q1. So we'll continue to carefully monitor and manage this product mix dynamic as we go forward. From a pricing perspective, we continue to see DDR5 following a normal sort of pricing curves in line with previous generations from there. So we expect to continue to see the normal sort of pricing which is to go into sort of next year. But overall, we've done a really nice job of managing our ASPs as well as our sort of gross margin on the product side, we ended up at 63% for Q3. So again, that was relatively flat to slightly up versus Q2. So we've done a really nice job in managing both the ASP and also the margin profile.

Sidney Ho, Analyst

Okay, that's helpful. Just a follow-up question.

Desmond Lynch, CFO

No, go ahead, Sidney. Sorry.

Sidney Ho, Analyst

Sure. So my second question is, we’ve started to see some slowdown in data center build-out, either because of supply constraints or just more cautious spending by customers. We’re certainly seeing some inventory adjustments from a component standpoint. Are you concerned that there’s too much inventory for your parts at these customers? And how do you see the demand over the next few quarters? Anything you would highlight in terms of backlog orders will be appreciated.

Luc Seraphin, CEO

So at a high level and I'll let Des comment on the numbers. At a high level, we still see some demand for more bandwidth and more capacity from our vantage point. And we're also facing a major technology and platform transition. So we still do see growth in that market from our standpoint. What we're seeing, however, is that, as I said earlier, we have in Q3 and Q4 a backlog that is higher than what we can ship. What we see is the inventory levels are still lean on DDR4 generation of products. And what we have to deal with in the first half of next year is to deal with the platform transition, supply management and the price elasticity, as you mentioned, between DDR4 and DDR5. So we’re looking at these three variables. But overall, based on what we see with our customers and partners, when all of these aspects stabilize, we will continue to grow our share in that market. The first half of the year is going to be that half of the year where we’ll have to deal with, as I said, price elasticity, supply management and the platform transition. But we don’t see a buildup of inventory at this point in time. We still see customers in high demand of DDR4 as they’re waiting for the ramp-up of DDR5. And as we said in earlier calls, we have a strong position in our DDR5 footprint when this starts in the market.

Ashley McCurry, Analyst

This is Ash McCurry on for Gary Mobley at Wells Fargo. On that supply situation, I just want to ask our customer order lead times for buffer chips: Is that shrinking as a result of additional supply coming online? And any additional comments in terms of the supply situation as well as any inventory build on the buffer chip side of things?

Desmond Lynch, CFO

Ashley, it's Des. Thanks for your question there. From a supply perspective, we are seeing some additional supply coming online which has enabled us to drive to the higher revenue growth that we've been able to trend both in Q3 and Q4. As Luc mentioned though, our demand on DDR4 products was higher than what we could actually supply. And we'll work with the customers over the next sort of three to six months to minimize that gap going forward. From an inventory sort of buildup perspective, I think, Luc covered a bit in the last sort of question. DDR4 continues to sort of remain lean from a customer inventory perspective. And DDR5, the customers have been building some inventory there in advance of the sort of product transition which will take place in the sort of first half and into the sort of second half of next year. But overall, I think the supply situation is improving for us. We’ve been able to deliver higher product revenue. And overall, the inventory levels remain sort of normal to lean from there.

Unidentified Analyst, Analyst

On behalf of Mark Lipacis, we received encouraging feedback from the hyperscalers regarding CapEx trends. We're interested to know if this is reflected in your product revenues, specifically whether there is increased order visibility for next year or any additional insights on demand dynamics.

Luc Seraphin, CEO

Thank you, Brian. Good question. This CapEx from the cloud service providers translates into the need for more capacity and bandwidth on the memory subsystems. And the direct impact on us is going to translate into the demand for the next generation of DDR5 on the memory bus because it actually adds capacity and bandwidth directly on the memory bus compared to the DDR4 generation of products. And as we mentioned earlier, we're also developing CXL products which adds a tier of memory to those systems and allows these cloud service providers to either add more memory or a given computing capability or to share memory resources between processors. And this is the whole usage case of the CXL products that we are developing. So we do see this CapEx investment from the cloud service providers as a good thing for us and this is what's driving our roadmap on both the buffer chip and the CXL products.

Kevin Cassidy, Analyst

You’ve mentioned in your prepared remarks about security IP as part of silicon IP. Can you give us a description of how fast is that growing? And what’s the opportunity pipeline in number of customers, just a rough estimate?

Desmond Lynch, CFO

So as we said, our silicon IP business is now on a stable run rate of $30 million to $35 million a quarter, approximately half of it is interface IP and half of it is security. We have, in these businesses, multiple customers and multiple applications, in particular, for security IP. The main markets that we're addressing today are AI and data centers but we do see growth in government applications and automotive as well. This is an area we're watching. We saw some very nice growth in 2022. We mentioned about 20% growth over the prior year. We have to watch the potential headwinds for that business given the economic environment. A lot of these customers are start-ups and the funding for new projects may slow down in the current economic environment. We also have to watch what’s happening in China and the possible restrictions we have to address that market. So we will continue to grow. We have multiple customers, multiple markets and will grow faster than market but we think the market is going to not grow as fast as last year. And I think we’re not going to grow as fast as we do last year just because of the economic environment.

Operator, Operator

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 for any closing remarks.

Luc Seraphin, CEO

Thank you, everyone, who has joined us today for your continued interest and time. We look forward to speaking with you again soon. Have a very good day. Thank you.

Operator, Operator

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