Earnings Call Transcript - RMBS Q2 2021

Operator, Operator

Welcome to the Rambus Second 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 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 second 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. The press release for the results that we will be discussing today have 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 ID number, 7478989 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 are 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 p.m. 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 third quarter of 2021, and related drivers, risks and potential adverse impacts related to or arising from 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 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 at the 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 our operational performance. The order of our call today will be as follows. Luc will start with an overview of the business. Rahul will discuss our financial results, including 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

Thanks, Des, and good afternoon, everyone. Q2 was an exciting quarter for the company. We complemented our excellent financial performance with a number of strategic advancements to capture the next wave of semiconductor growth focused on next-generation data center architectures. This quarter, we delivered $84.9 million in quarterly revenue and $51.6 million in cash from operations, beating expectations for the top and bottom line. In addition, the company launched our CXL Memory Interconnect Initiative announced the acquisitions of PLDA and AnalogX and initiated a $100 million accelerated share repurchase program. Each of these activities grows the size and scale of our chip and IP businesses and puts the company in a great position to capitalize on the next wave of semiconductor growth in data centers. As we have discussed before, Rambus sees the tremendous opportunity to lead the market and accelerate the adoption of CXL Interconnect in next-generation data centers. CXL is going to be a critical enabler for memory expansion and pooling in disaggregated and composable architectures. Through our CXL Memory Interconnect Initiative, Rambus is leveraging our unique combination of technology experience and expertise to develop breakthrough solutions to these new high-performance use cases. The acquisitions of PLDA and AnalogX strengthen this initiative by providing critical building blocks for high bandwidth chip and subsystem interconnect solutions. The complementary CXL and PAM4-based interface solutions augment our interface IP offerings. And when combined with our existing interface and security IP, we have all of the necessary ingredients to be an industry leader in CXL and PCIe IP, as well as offer differentiated CXL based interconnect products. Turning back to this quarter’s performance, we continue to consistently meet or beat financial targets. Our balanced portfolio of chips and Silicon IP continues to scale and will continue to drive growth in the coming quarters. Product revenue from memory interface chips remained solid with another quarter of $30 million in revenue. And we expect record product revenue in Q3. Silicon IP revenue was up 10% quarter-over-quarter bolstered by a number of design wins as the industry continues to build solutions for data center and AI. Demand for our memory interface chips continues to be robust. We have sustained momentum in DDR4 and a strong market position in DDR5. We have received orders and have started to deliver production DDR5 memory interface chips to the market. On the supply side, we are now seeing some of the shortages and cycle time challenges experienced by our peers in the semiconductor industry. We are actively 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. This quarter’s performance also saw excellent performance in our Silicon IP business with record revenue from security and digital controller IP. The demand for Silicon IP remained strong, particularly high-performance data center and AI applications, where the growing need for bandwidth and security compresses product development timelines, accelerating the need for trusted and reliable off-the-shelf IP. The acquisitions of Northwest Logic and Verimatrix have delivered extremely well and provide a blueprint for successful integration as we bring AnalogX and PLDA into our Silicon IP business. In addition to the strong performance from our businesses this quarter, we continued to make great strides in the codification of our environmental and social programs. We are committed to responsible and sustainable practices and as a fabless semiconductor provider, we know that one of the biggest impacts we can have on the environment is through the selection of our partners. With that, we have joined the Responsible Business Alliance, an organization dedicated to corporate social responsibility in global supply chains. Our formalized governance structure and oversight committee ensure that our policies and actions align with our passion for creating a safer and more sustainable future. The health and safety of our global workforce, customers, and partners remain our top priority. We are actively monitoring the human impact of the global pandemic and are appropriately responding in each of our geographic locations. In closing, the company had an excellent second quarter. We took some very important strategic steps to accelerate our roadmap and grow our market position. Rambus is uniquely positioned to address the critical challenges facing the industry and remains on the forefront of next-generation data-intensive architectures. We continue to grow faster than the market and are taking the right steps to support the company and our customers as we increase in size and scale. There will be new challenges as we continue our transition to a leading product company. And I’m very excited about the many opportunities in front of us this year and beyond. 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 second quarter on Slide 8. Once again, we delivered a solid quarter with financial results at the high end of expectations and generated $51.6 million in cash from operations. Now, let me talk you through some financial highlights on Slide 9. We’ve consistently realized 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 future growth. Let me walk you through our non-GAAP income statement on Slide 10. Revenue for the second quarter was $84.9 million above expectations. Royalty revenue was $41.9 million, while licensing billings were $65.2 million. The difference between licensing and billings and royalty revenue primarily relates to timing as we don’t always recognize revenue in the same quarter as we bill our customers. Product revenue was $31.2 million, consisting primarily of the buffer chip business. Buffer chip revenue was slightly below the midpoint of expectations and would have demonstrated growth if not for a shipment delay at the very end of the quarter. Contracts and other revenue was $11.8 million consisting primarily of the silicon IP business. As Luc noted, we were delighted to report quarterly records for the digital controller business we acquired from Northwest Logic and security IP. Our execution bodes well for the integration of the two acquisitions we announced in June. Overall, the silicon IP business grew over 10% quarter-over-quarter. Total operating expenses, including COGS for the quarter came in at $56.1 million. Operating expenses of $43.7 million were lower than expectations due to the timing of certain discrete R&D expenses. We expect to grow investment in our product roadmap, including through acquisitions in the coming quarters to drive for long-term growth. We ended the quarter with headcount at 592, roughly flat from the previous quarter. I expect headcount in Q3 to increase as we integrate the strong engineering talent from AnalogX and PLDA. Under ASC 606, we recorded $2.4 million of interest income related to the financing component of fixed-fee licensing arrangements for which we recognize revenue, but have not yet received payment. We incurred $0.8 million of interest expense primarily associated with our convertible note. This was offset by incremental interest income related to the return on cash and investment portfolio. After adjusting for non-cash interest expense on the convertible note, this resulted in non-GAAP interest and other expense for the quarter of $1.6 million, excluding the financing interest income related to ASC 606; this would have been $0.8 million of interest and other expense. Assuming a flat rate of 24% for non-GAAP pre-tax income, non-GAAP net income for the quarter was $23.1 million. With continued focus on cost and disciplined execution, we delivered profit that was nicely above expectations. Now let me turn to the balance sheet details on Slide 11. Our ability to generate cash has helped us to both invest in growth drivers and consistently return capital to shareholders. End-of-quarter cash, cash equivalents, and marketable securities totaled $477.1 million down from the previous quarter as cash from operations of $51.6 million was offset by the $100 million accelerated share repurchase program we initiated in the quarter. 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 Q2, we had contract assets worth $324 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 allows us to recognize revenue each quarter. Second quarter CapEx was $5.8 million, while depreciation was $5.1 million. We delivered $45.8 million of free cash flow in the quarter. Looking forward, I expect CapEx for the third quarter to be roughly $5 million. I continue to expect depreciation of roughly $20 million for the full year of 2021. Now let me turn to our guidance for the third quarter on Slide 12. 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 under ASC 606, we've also been providing information on licensing billing, which is an operational metric that reflects amounts invoiced to our licensing customers during the period adjusted for certain differences. As we had reported historically, licensing billings closely correlate with what we had historically reported as royalty revenue under ASC 605. Under ASC 606, we expect revenue in the third quarter to be between $76 million and $82 million. We expect royalty revenue between $25 million and $31 million and licensing billings between $59 million and $65 million. As Luc mentioned, this outlook represents record revenue for the buffer chip business. Like many others, we're now starting to see some of the strain in the semiconductor supply chain, but as of now maintaining our lead times and delivery commitments to our customers. We expect Q3 non-GAAP total operating costs and expenses, which include COGS to be between $65 million and $61 million, as we increase investment in programs. Our guidance includes incremental expenses from AnalogX, which we closed in July, but we don't expect any incremental revenues due to the acquisition accounting. Our forward-looking projections do not contemplate PLDA, which we expect to close later this quarter. Under ASC 606, non-GAAP operating results for the third quarter are expected to be between an $11 million and $21 million profit. For non-GAAP interest and other income expense, which exclude interest income related to ASC 606, we expect approximately $1 million of expense, which includes $0.6 million of interest expense related to the notes due in 2023. We expect the pro forma tax rates to remain consistent at roughly 24%. The 24% rate is higher than the statutory 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 $2 million and $5 million in Q3. We expect Q3 share count to be roughly 113 million basic and diluted shares outstanding. Overall, we anticipate a non-GAAP profit per share range between $0.07 and $0.13 for the quarter. Let me finish with the summary on Slide 13. Over the past several years, we've made substantial progress strategically, operationally, and financially. We've realigned our portfolio to address opportunities in the data center and to support long-term growth. Our product businesses are well positioned in the market and we anticipate long-term growth in each segment. Q2 was an excellent demonstration of our successful capital allocation strategy. We continue to invest organically in products like DDR5 and our CXL initiative, make inorganic investments like AnalogX and PLDA, and return value to our shareholders through share repurchases. 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?

Operator, Operator

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

Gary Mobley, Analyst

Good afternoon guys. Thanks for taking the question. I want to start out by asking about CXL in your approach there. First question is, when would you expect to productize CXL or how should we think about the different phases of the product innovation of CXL, whether it relates to IP, licensable IP and then eventually chip-related revenue? And then specific to two acquisitions, which help form a portion of the basis for the CXL initiative. How should we think about the revenue contribution from each of those? Maybe not so much in the near term, but when you don’t have the purchase accounting headwind and then as well, the related expenses to those two. Thank you.

Luc Seraphin, CEO

Gary, this is Luc. Great questions. So for us, with CXL, we kind of hit three targets with one strategy. First, it improves our IP offering for memory expansion and disaggregation for anyone who wants to build chips for that market. So that revenue from IP is going to start almost immediately post-acquisition. People will buy IP, integrate that IP into their products, and address the CXL market with those products. So that's the first goal. The second thing is, we are going to be able to use that IP in building our own semiconductor products. And that's critical because these CXL products are complex, especially in terms of latency. Having the IP in-house is critical for the successful development of those products; those products will take a few years to develop, and we expect to hit the market in about three years from now. The third aspect, which is not related to revenue growth, is that in these competitive times, the acquisitions of these two companies allow us to bring very talented engineering teams into Rambus. Therefore, it shows three objectives for us: bringing talent on board, increasing our IP revenue in the short run, and increasing our product revenue in the longer run. We expect these two acquisitions combined to bring about $20 million of royalty revenue in the first year.

Gary Mobley, Analyst

Okay. I appreciate all the color, Luc. And it's my follow-up question. I'm interested to hear I'm sure others as well, what sort of challenges there were on the buffer chip business late in the quarter and what steps you took to fix it, and to what degree does your Q3 buffer chip revenue contemplate any additional supply chain constraints? Thank you.

Luc Seraphin, CEO

First of all, I would say that we've been able to manage our supply chain quite well over the last few years by building redundancy in the supply chain. We grew the revenue, as you know, from about $36 million in 2018 to $114 million last year. So, we are seeing the supply chain constraints later than some of our competitors. Now we see some pockets of supply constraints across different products, and we are working very actively with our suppliers to ensure that we address each one of these potential challenges immediately, and that we don't disrupt our ability to serve the markets and meet the demand, which continues to be very high. We do see across the supply chain people increasing their lead times or some pockets of shortages. And as I said, it affects different products in different ways, but at this point in time we are actively working with our suppliers to make sure it does not disrupt the demand that we see ahead of us.

Operator, Operator

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

John Pitzer, Analyst

Yes. We’ve just a follow-up on Gary's question on the supply side, I guess, how much better could your product revenues have been in the September quarter? And I guess importantly, as you look into December, do you see some incremental supply coming on such that it's pretty clear that you'll show sequential growth on the product side in the December quarter as well?

Rahul Mathur, CFO

I'll start, yes, great question. I think for the third quarter, we are able to manage the situation. This is short term and we have great visibility of what we can do. So we feel comfortable with a third quarter, but with respect to the fourth quarter, we just have a lack of visibility. I think we continue to improve the situation with our suppliers, but between the challenges with suppliers and the transition between DDR4 and DDR5, it's difficult to predict what Q4 is going to be. What I would say is that our design win momentum continues. Our backlog for DDR5 continues to grow very fast, demand for the products continues to work in, and the support from our suppliers is there. It's just difficult to predict what Q4 is going to be at this point in time, but we feel quite confident with our Q3 number.

John Pitzer, Analyst

And then, Luc, on the DDR5, I think Micron on their earnings call talked about DDR5 perhaps ramping a little bit later than they thought next year. I’d be curious to kind of get your thoughts on the DDR5 ramp. And I guess, importantly, what kind of revenue add or should that be to you either on ASP and our market share? And do you have a sense of how much the market could shift to DDR5 as an exit trajectory at the end of calendar year 2022?

Luc Seraphin, CEO

Yes, we heard about the potential delay of DDR5, but what’s happening in the ecosystem is that people are building systems ahead of the launch. So, we do see very solid orders from all memory customers for products that they will ship to their customers, because the ecosystem, despite the potential delay, is building systems to be able to run the products. Therefore, it has had very little impact on our order book or backlog, which is a good thing. We expect to see a price increase when we move to the downside, and we see these as part of our backlog. As we said in earlier calls, our footprint on DDR5 is quite strong because we started early. So, when it ramps in the market, we should actually see our share continue to grow. At this point in time, we have a strong backlog and continue to receive orders from our customers. Their customers are building systems in anticipation of the ramp of DDR5. So from that standpoint, all looks good. We’ll see when the actual launch is going to happen.

Operator, Operator

Your next question comes from Sidney Ho with Deutsche Bank. Your line is open.

Sidney Ho, Analyst

Great. Thanks for taking my question. So a couple of questions on the memory buffer chip side. I know you don’t want to talk about Q4 guidance yet, but what kind of regular expectations do you expect from DDR5 chipsets? And the second question, I know you talk a lot – talk about three waves of memory TAM expansion, potentially doubling the TAM by 2025. Can you maybe talk about what are the sizes and timing of these various waves that that’s going to happen over the next few years?

Luc Seraphin, CEO

Sure. As for the first question about the DDR4 versus DDR5 hypermix, I mentioned we have little visibility over Q4, but what I can say is despite the discussions about the potential delay of DDR5, we see our mix between DDR4 and DDR5 to be favorable toward DDR5. We’re monitoring the mix as well closely. The ecosystem, despite a few months of delay, is building products for that market. As for the product growth, we see the total addressable market doubling by 2025, and this includes the buffer chip in addition to other interface products based on CXL. The market today is around $600 million to $620 million in size and is expected to double by 2022 or 2024. This growth is driven by the need from cloud service providers to have access to more memory capacity with lower latency, creating demand for both memory expansion use cases and disaggregation.

Sidney Ho, Analyst

Okay, great. Maybe a follow-up question is on the licensing and billings. If I’m not mistaken, I think typically your third quarter is your strongest, usually up about 5%. Curious, why licensing billings and your guidance will be lower this year, given the strong utilization in the industry. I understand you don’t recognize any revenue from AnalogX, because of purchase accounting and you probably don’t have anything in PLDA in the guidance. But just curious, is it the typical for Q3 for you guys to have a decline in billings and licensing billings?

Rahul Mathur, CFO

Hi, good question. What I’ll tell you is that any given quarter, we’re perpetually in the process of renewing partners. As a result, licensing billings can fluctuate from quarter to quarter based on how we structure those contracts and negotiations. The other aspect is that we’ve observed more of our Silicon IP revenue show up in licensing billings this year than we anticipated. I initially thought it’d be closer to $20 million, but I now project it could be closer to $40 million. So, as we monitor this number, you will see some fluctuations depending on how our Silicon IP contracts are structured. Our core business remains robust, and I believe we’ll stay within a $200 million to $220 million business for the next several years. Our Silicon IP business is also growing nicely, demonstrated by the increase we spoke of already. So, that’s how I view it; I wouldn’t read too much into the quarter-over-quarter change.

Operator, Operator

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

Mehdi Hosseini, Analyst

Yes. So, thanks for taking my question. Want to go back to the growth opportunities from a bigger picture. It seems to me that you would need to have DDR5 implementation for other opportunities like CXL to materialize. But once there’s a change in architecture, then there will be several different growth drivers. Am I thinking about this correctly, or could CXL stand on its own? In other words, can there be elements with Silicon IP that can be viewed as independent of DDR5?

Luc Seraphin, CEO

Great question, Mehdi. At a high level, a CXL memory expander has a CXL interface on the processor side and a DDR interface on the memory side. Therefore, it complements the buffer chip business. Our buffer chip business will connect to the standard memory interface on the processor, and once fully populated, when the CSPs need more memory, they will attach additional memory to the CXL bus. That's why it was strategically important for us to bring that IP on board, as we have a complete set of critical IP needed to develop the next generation of standard buffer chips as well as to develop those memory expanders that will help processors address more memory than they can via the standard bus.

Mehdi Hosseini, Analyst

I guess, what I’m trying to understand is, let’s say the CPU company is late with their CPU upgrade. Can other CPU or GPU-based vendors or ARM-based CPU chips that are coming to the market enable the adoption of a new memory architecture, either DDR5 or CXL or both? I think there is some confusion around Sapphire Rapids, and I’m just trying to understand how your growth opportunities are tied to the introduction of Sapphire Rapids.

Luc Seraphin, CEO

Right. So I’ll start at the end with Sapphire Rapids. Sapphire Rapids is going to feature DDR5 standard memory interfaces, which bodes well with our DDR5 buffer chip offering and drives the growth we've talked about for the coming quarters. It will also include some PCI Gen 5 and CXL 2.0 interfaces, which will be present in the ecosystem from Intel and AMD. The mainstream processors are going to drive the markets to utilize those interfaces. Furthermore, specialized CPUs or GPUs emerging could align to those same CXL 2.0 and PCI Gen 5 interfaces, which would benefit them significantly if they have that capability. This would also allow them to accelerate their roadmap and move faster to CXL 3.0 or PCI Gen 6. This is another reason why we made the acquisitions of AnalogX and PLDA, as they are advanced in developing the next-generation CXL standard and PCI Gen 6. By bringing those companies on board, we can meet the needs of those developing specialized processors for data-intensive uses, in addition to our mainstream business.

Mehdi Hosseini, Analyst

Right. And just a final comment, I guess, given what you just laid out perhaps a year from now, your revenue volume would be different than what we’re dealing with today. Like a year from now, there will be a relatively broader diversification because of what you just said. Would that be a fair statement?

Rahul Mathur, CFO

Maybe that’s exactly how I look at it. As I mentioned earlier, we continue to have a very stable, predictable licensing business due to fantastic cash flow, which allows us to invest organically, inorganically and continue capital returns. You will see wonderful growth opportunities for our silicon IP business. As we noted in Q2, we achieved records for the controller business that we acquired from Northwest Logic, as well as for our security IP business. You will also see growth potentials in product opportunities, not just with the buffer chip but, as Luc mentioned, in the future with CXL. Next year, you’ll likely observe growth in IP in particular. So, I think we’re positioned quite nicely to continue to grow across our portfolio in the years to come.

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.

Luc Seraphin, CEO

Thank you, everyone who has joined us today for your continued interest and time. We hope each of you stay safe and healthy. And 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.