Earnings Call Transcript - RMBS Q3 2023

Operator, Operator

Welcome to the Rambus Third Quarter Fiscal Year 2023 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Desmond Lynch, Chief Financial Officer. You may begin your conference.

Desmond Lynch, CFO

Thank you, operator, and welcome to the Rambus third quarter 2023 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 supply chain shortages and other market challenges, 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 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 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, and good afternoon, everyone. We delivered another strong quarter with revenue and earnings above the midpoint of guidance as we continue to execute on our strategy and successfully navigate the complexities of the industry transition to DDR5 in a challenging macro environment. The company generated $52 million in cash from operations, enabling a consistent return of value to our stockholders, most recently with the completion of a $100 million accelerated share repurchase program. We also closed the sale of our IP business, strengthening our focus on the development of differentiated chips and digital IP that expand our opportunities in the data center market. Generative AI and other data-intensive workloads continue to drive increasing requirements for memory performance and capacity across the computing landscape. This is a very positive long-term trend for Rambus. Currently, the training of large language models is boosting the demand for AI servers with the most advanced multi-core CPUs provisioned with DDR5 RAM to maximize main memory bandwidth alongside server GPUs with dedicated HBM memory. In addition, high-performance general-purpose servers enabled with DDR5 are seeing increasing demand to meet the growing computing infrastructure requirements of the AI data pipeline. This increases the opportunity for our expanding family of memory interface chips. As the industry builds out the infrastructure for the broadening adoption of AI, we look forward to continued innovation and growth in server CPUs as well as workload optimized accelerators. This trend also creates opportunities for our silicon IP business. The ongoing specialization of computing systems makes our high-performance CXL, PCIe, HBM, and GVR IP controller increasingly critical. In addition, the move to application-specific silicon driven by AI and other advanced workloads creates increased vulnerabilities to attack as data is distributed across systems. This trend increases the need for advanced security IP, an area where we lead the industry. With that, AI is a strong catalyst for demand and a very positive long-term growth driver for the company. As I mentioned last quarter, we are investing in initiatives to broaden our portfolio of offerings. Just last week, we announced our HBM3 memory controller IP is now supporting operations at 9.6 giga transfers per second, which is 50% higher than current top-end data rates. We are also working in close collaboration with the ecosystem and continue to make good progress on expanding our chip offering to support the ongoing evolution of high-performance server and client systems for years to come. Turning now to our quarterly results. We continue to lead and invest in our areas of focus. In Q3, memory interface chips delivered strong results with quarterly product revenue above the midpoint of guidance at $52 million. By executing well in a challenging environment, year-to-date results are up 7% over the same period last year. As we have highlighted in past quarters, the industry transition to DDR5 continues to be dynamic. In Q3, we were very pleased to continue volume shipments of DDR5 solutions, which again are the predominant unit shipments this quarter. We continue to work with customers to manage through the ongoing DDR4 inventory correction. As we have said previously, we expect DDR4 headwinds to continue through the remainder of the year, in line with the broader ecosystem, but we look forward to inventories normalizing in the early part of 2024. We remain positive on the outlook for DDR5 as we focus on execution and actively work with customers and partners through the transition. With the accelerated pace of DDR5 platform rollout, we are poised to offer our customers and partners a range of solutions with multiple generations of our memory interface chips, shipping in volume, qualification of sampling. In addition, our close collaboration with the ecosystem continues on novel memory, advanced clocking, and power management solutions to support the roadmap of future computing platforms, including developments for CXL attached memory, which we look forward to demonstrating publicly later this year. In closing, this was a strong quarter for the company with solid results. While we navigate dynamic market conditions in the near term, our focused execution and strategic investments position us well for long-term profitable growth. As always, I'd like to thank our customers, partners, and employees for their ongoing support. And with that, I'll 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, and we are very pleased with the company's continued execution on our strategic initiatives to drive long-term profitable growth. We delivered strong financial results with both revenue and earnings above our expectations. In Q3, we executed a $100 million accelerated share repurchase program, which retired approximately 1.85 million shares. Our continued strong cash generation allows us to consistently return cash to shareholders. As Luc discussed in Q3, we completed the divestiture of our PHY IP business, which will enable us to redeploy our investments into higher growth areas of products and digital IP. Let me walk you through our non-GAAP income statement. Revenue for the third quarter was $105.3 million, above our expectations, driven by higher product revenue in the quarter. Third quarter revenue included approximately $5 million in revenue from the IP business that we divested in early September. Royalty revenue was $28.9 million, while licensing billings was $57.9 million. The difference between licensing billings and royalty revenue mainly relates to timing as we do not always recognize revenue in the same quarter as we bill our customers. Product revenue was $52.2 million, consisting primarily of memory interface chips. Contract and other revenue was $24.2 million, consisting predominantly 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, were $72.9 million. Operating expenses of $52.4 million were in line with our expectations and down $3.5 million versus Q2 as we continue to be disciplined in our expense management. And we ended the quarter with a total headcount of 624, down from Q2, which is a result of the FYP divestiture. GAAP interest and other income for the third quarter was $2.3 million. This included $400,000 of ASC 606 interest income related to the financing component of fixed fee licensing arrangements for which we have recognized revenue but not yet received payment. Excluding the financing interest income related to ASC 606, this would have been $1.9 million of net interest income. Using an assumed flat tax rate of 24% for non-GAAP pretax income, non-GAAP net income for the quarter was $26.4 million. Now let me turn to the balance sheet details. We ended the quarter with cash and cash equivalents in marketable securities totaling $375.5 million. This is up from Q2 through a combination of continued strong cash generation from operations of $51.6 million and the net proceeds from the IP divestiture of $106.3 million, partly offset by the $100 million accelerated share repurchase program, which we completed in the quarter. At the end of Q3, we had contract assets worth $67.7 million, which reflects the net present value of unbilled accounts receivable related to licensing agreements 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 work to restructure our patent agreements in a manner that allows us to recognize revenue each quarter during the life of each agreement. Third quarter CapEx was $11.4 million, while depreciation expense was $7 million. We delivered $40.2 million of free cash flow in the quarter. Now let me turn to our guidance for the fourth quarter. As a reminder, the forward-looking guidance reflects our current best estimates at this time. We continue to actively monitor the macro environment, and our actual results could differ materially from what I'm about to review. In addition to the financial outlook under ASC 606, we also provide 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. As a reminder, in Q3, we divested our PHY IP business, which, on a full quarter basis, the business has been breakeven at approximately $6 million in revenue, offset with $6 million in cost. Under ASC 606, we expect revenue for the fourth quarter to be between $117 million and $123 million. We expect royalty revenue to be between $42 million and $48 million and licensing billings between $56 million and $62 million. The quarterly increase in royalty revenue reflects the Samsung patent licensing extension that was signed last year, which will be recognized as a variable contract under ASC 606 on a go-forward basis. We are pleased with our continued execution and progression on our memory interface chip business, and we are well positioned in the market to deliver long-term profitable growth. As Luc mentioned earlier, the transition to DDR5 continues to be dynamic. While we are pleased with our execution on DDR5 shipments, we continue to be impacted by the DDR4 inventory digestion, which will continue through the remainder of the year. We expect Q4 non-GAAP total operating costs, which includes COGS, to be between $73 million and $69 million. We expect Q4 CapEx to be approximately $8 million. Under ASC 606, non-GAAP operating results for the fourth quarter are expected to be between a profit of $44 million and $54 million. For non-GAAP interest and other income and expense, which excludes interest income related to ASC 606, we expect $2 million of interest income. 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 $11 million and $13 million in Q4. We expect Q4 share count to be 110 million diluted shares outstanding. Overall, we anticipate a non-GAAP earnings per share range between $0.32 and $0.39 for the quarter. Let me finish with a summary. I am pleased with our strong results and the team's ongoing execution in this challenging and unpredictable macroeconomic environment as we continue to make progress against our strategic initiatives. Our portfolio is well positioned to address growing opportunities in the data center fueled by AI. We continue to grow the business profitably with strong cash generation and a robust balance sheet, which has enabled consistent capital return to 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.

Operator, Operator

Our first question comes from Gary Mobley with Wells Fargo.

Gary Mobley, Analyst

I want to start out by gaining an appreciation of the undercurrents in the product revenue between DDR4 and DDR5. Can you verify if your DDR5 DIMM chipset sales grew sequentially in the third quarter? And how low the DDR4 related revenue may have trended for the quarter? And contrast that against what you think would be a normalized quarterly shipment number for DDR4 that may eventually layer on top of the growth in DDR5?

Desmond Lynch, CFO

Gary, I'll take the answer. Thanks for the question. We've been very pleased with our execution in 2023. As Luc mentioned in his prepared remarks, product revenue is up 7% on a year-to-date basis through a market that was down double digits. So we've successfully navigated a dynamic environment by posting solid results, which will result in year-over-year share gains versus our competitors. Looking at our product mix in Q3, the shipments were predominantly DDR5. For the second quarter in a row, we shipped out minimal DDR4 products in the quarter. Comparing Q3 versus Q2, DDR4 shipments were down, which was offset by modest growth in the DDR5 shipments. Going into Q4, we do expect to see a similar product mix with continued growth in DDR5 and minimal DDR4 shipments in the quarter as customers continue to take a conservative posture towards inventory management at year-end. So overall, we've been very pleased with our execution in this challenging environment, and we're pleased to see the continuation of growth in DDR5 shipments, which is positive for us.

Gary Mobley, Analyst

Okay. A follow-up to the product sales mix. I noticed that the product gross margin was well off of the strong performance you had in the second quarter despite the higher mix of DDR5. Maybe if you could just speak to why the negative variance relative to that long-term view, what, 60%, 65%, or relative to the prior quarter? And maybe if you could just give us a sense of the different moving pieces there between DDR4 and DDR5?

Desmond Lynch, CFO

Yes, Gary, great question. We are very pleased at how we continue to manage our product gross margins as a company. If you look at our year-to-date product gross margins again through Q3, our gross margins in the products are around 63%, which is in line with the midpoint of the communicated long-term product gross margins of 60% to 65%. In Q3, our product gross margins were 63%, which were down from the high of 66% in Q2, mainly driven by ASP erosion as the DDR5 products are now shipping in volume production. The ASP erosion was anticipated and in line with our expectations. As a company, we'll continue to be disciplined in our ASP management and will continue to drive product cost savings to offset any ASP erosion. Again, with a similar product mix going into Q4, we expect product gross margins to be relatively flat at the 63%. We're very pleased with how we've been able to execute on the gross margin performance, which will be roughly in line with the midpoint of our long-term gross margin range of 60% to 65%.

Operator, Operator

Our next question is from Mehdi Hosseini with SIG.

Mehdi Hosseini, Analyst

Yes. Can you please provide us an update on where we are with companion chips? I believe last time we were expecting qualification with high-volume manufacturing by mid-24, and is that correct? Can you give us an update? And I have a follow-up.

Luc Seraphin, CEO

Thanks, Mehdi. Yes, we're pleased with the investments we're making in our companion rollout. We are currently shipping in small volumes our SPD hub and temperature sensor to the market. We believe to have more contribution from these products towards the second half of 2024. We have also sampled our customers with our initial power management chips, and the initial feedback from our customers is very good. You should expect some announcement next quarter around these products. I think they will contribute to our revenue starting in the second half of 2024 and into 2025. Although these are not companion chips to the data center, we're also working with our customers on a set of client products in the clock space or the power management space, which will contribute to revenue in 2025 and beyond. We are rolling out products and are pleased with the progress. We started to ship the SPD hubs and temperature sensors and are working on the client rollout of products. All of these should start contributing substantially more in the second half of 2024.

Mehdi Hosseini, Analyst

Great. And 1 follow-up for that. Your Q4 guide implies OpEx of $50 million, taking the midpoint. I want to better understand how we should think about the scaling of OpEx once the revenue starts to grow once DDR5 RC or buffer chip starts shipping. Can you manage the business with the $50 million to $51 million of OpEx as you scale revenue? Or would the OpEx need to increase?

Desmond Lynch, CFO

Thanks for your question. I think as a company, we've done a very nice job of managing our expenses given the softer macroeconomic outlook. In Q3, our operating expenses were around $52 million, down from $58 million in Q1, which shows discipline and focus on managing our expenses. In Q4, you are right that our OpEx will come down roughly to $50 million to $51 million for the quarter. What I would say is that we've highlighted when we divested the PHY IP businesses that we would reinvest some of the R&D back into product programs, which will drive revenue into 2025 and beyond. Looking at 2024, our spend historically has been around 23% to 25% of revenue. I would expect to be within that sort of range going forward. In SG&A, we'll continue to be disciplined with inflationary type increases. You will see some nice leverage as we continue to grow the business. Overall, we've managed our OpEx very well, striking the right balance of being prudent to our short-term expenses while also balancing the need to invest in long-term opportunities.

Operator, Operator

Our next question is from Kevin Cassidy with Rosenblatt Securities.

Kevin Cassidy, Analyst

Congratulations on the strong quarter. Just as we talk about DDR5, I think you mentioned sampling or qualifying the next generation. Is there an opportunity, you mentioned about ASPs with the next generation, does it imply a reset on ASP as you go to Gen 2, Gen 3, and so forth?

Desmond Lynch, CFO

Kevin, thanks for your question. What we see is that when we look ahead to the next generation of products, we will see an ASP reset with each generation. The generations of DDR5 are evolving faster, now on a 12-month cadence, compared to the prior 24 months cadence under DDR4, providing the opportunity for an ASP reset. We have been very disciplined in our approach to pricing and have a good track record of maintaining healthy product gross margins. This year, we're projecting our product gross margins to be around 62% to 63%, consistent with the midpoint of our long-term product gross margin range of 60% to 65%.

Kevin Cassidy, Analyst

Okay, great. Regarding the HBM3 device or that IP, are you recognizing revenue for it? Did you recognize revenue in the September quarter, or is it included in your December quarter guidance?

Luc Seraphin, CEO

The HBM3 announcement we've made is an IP that we've just announced at the top end of speeds in the 9.6-giga transfers per second. This is a product to come that will contribute to revenue in the future. It's not a product that has generated revenue this quarter or next quarter.

Operator, Operator

Our next question is from Nam Kim with Arete Research.

Nam Kim, Analyst

I have 2 questions. One, I think the market shift to DDR5 seems to be happening much faster than expected. Can you share your latest view on DDR5 crossover timing? And the second question, also demand for DDR5 Gen 2 is picking up recently. You mentioned the PMIC qualification on DDR5 Gen 2. Can you give us some color on how you compare with the existing big PMIC suppliers such as TI, Samsung, MPS, and what your selling point really is versus others?

Luc Seraphin, CEO

Thank you for your questions. We still see the crossover in the market happening in the first half of 2024 for servers. We do see a slow burn of DDR4 inventory at the customer side, but it's still a slow burn. Our shipments of DDR5 compared to DDR4 have passed that crossover point, as you noticed in our Q2 and Q3 results, but the crossover point in the market is expected in the first half of 2024. DDR5 Gen 2 is gaining momentum. We are shipping some volumes to our customers as they order them. We will go through the same process and cadence as with other generations. People will prebuild systems, and we will go through the standard qualification process. We still believe Gen 2 will start in earnest in the second half of 2024. Regarding the PMIC, it has been a challenge for the ecosystem in general in that first generation. We have built a team for PMIC and have worked on a solution. We have sampled the solutions to our customers, and the feedback is very positive at this point. The initial feedback is about the quality and robustness of the solution. We have to go through the standard process of validating that solution in the market. As mentioned earlier, we expect to hit the market towards the second half of 2024 with that product, but we're actively working with customers as we speak.

Operator, Operator

Our next question is from Sidney Ho with Deutsche Bank.

Sidney Ho, Analyst

Great. It sounds like the timing of the DDR4 inventory digestion hasn't really changed much from a quarter ago. What gives you that confidence that timing is not moving out? Any tangible data points can you share with us? And a follow-up to that is if you look at 2024, not looking for guidance here, but what should we think about the split between DDR4 and DDR5 in product revenue for the entire year?

Desmond Lynch, CFO

Sidney, thanks for your question. With regards to DDR4 inventory at our customers, it did come down in the September quarter, which is the second quarter in a row. We are encouraged to see that all customers saw an inventory decline in the September quarter versus the June quarter. From our discussions with customers, we expect the inventory digestion to be substantially complete by year-end. It is a fluid situation, and we're working with the customers on the timing of the DDR4 reordering pattern, which we expect to take place across Q1 and Q2 next year. Our visibility is limited on this, but we expect that DDR4 will continue to have a long tail of demand. For the second part of your question regarding product revenue growth and the timing of DDR4 and DDR5 for next year, we only guide one quarter at a time, which is prudent given the macro uncertainty. We are very pleased with our execution in 2023, and assuming the midpoint of our guidance for Q4, our 2023 product revenue is projected to be relatively flat at $226 million, which provides a strong foundation for us to grow next year. It is important to put this performance in context as the market has declined double digits this year. We expect to grow market share in 2023 versus competitors. For 2024, we anticipate growth aligned with industry research, and we're excited about our competitive product offerings and the growth of DDR5 platforms, alongside a recovery of DDR4. We would also expect to see a greater contribution from companion chips in the second half of next year. Overall, our products are well positioned, and we expect to grow faster than the market and continue to gain share in 2024.

Sidney Ho, Analyst

Okay, that's helpful. Then my follow-up question is you touched upon this in the prepared remarks, but it sounds like you're positioned to benefit from AI. Can you summarize the different ways you can benefit from that ramp both from a product and licensing standpoint? I understand the memory licensing business is somewhat fixed, so I want to make sure to understand the opportunity.

Desmond Lynch, CFO

Yes, if you look at the three pillars of our business, our patent licensing business is not affected by AI. On the product side, let's start with the buffer chips. AI servers utilize general-purpose servers in the AI boxes. Typically, these general-purpose servers have a high memory content and typically DDR5. The positive impact of AI has been to accelerate the demand for DDR5 modules. This explains the profile of our DDR4 and DDR5 mix between Q1, Q2, and Q3. AI is leading to the emergence of specialized compute nodes and disaggregated architectures, which require our CXL and PCIe IP as chips need to communicate with each other in new architectures. GDDR and HBM are likewise critical; that's why we announced our next-generation HBM at extremely high speed. Additionally, the rise of specialized chips in the data center raises the need for enhanced security for data in motion or at rest, making our security IP portfolio even more relevant to the market. As we sold our PHY business, we noted plans to continue investing in our IP portfolio, seeing significant opportunities from semiconductor companies building chips for this market.

Operator, Operator

Our next question is from Mehdi Hosseini with SIG.

Mehdi Hosseini, Analyst

Yes. I want to return to your prior statement. Would it be fair to say that your product revenue is mostly driven by the number of temps, not necessarily with the DDR5 number of bits? In other words, your business is units of HBM driven, not bits of DDR5. Would that be a fair statement?

Luc Seraphin, CEO

That's correct. There are several factors going into the capacity equation. One is the density of the memory itself. But the core of our product business is indeed the number of units.

Mehdi Hosseini, Analyst

Yes. And then there are a number of new server CPUs coming out, each with a different number of channels for CPUs and a number of DIMMs per channel. It will take some time for the end customer to determine which configurations will meet their demands. As we go through this transition, this inflection point will depend on when the CPU is available and how end customers configure their systems based on the number of DIMMs per CPU. Is that fair?

Desmond Lynch, CFO

That's correct. The volume of buffer chips depends on the number of DIMMs, number of channels, and number of DIMMs per channel, all of which depend on the specific customers. The trend is towards capacity expansion, with efforts to populate as many channels as possible and maximize the number of DIMMs per channel to fill the gap between compute power and memory capacity and bandwidth.

Operator, Operator

There are no further questions. That concludes the question-and-answer session. I would now like to turn the conference over to the company.

Desmond Lynch, CFO

Thank you. I would like to thank you all for your time and your interest, and we'll talk to you later. Bye, bye.

Operator, Operator

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.