Business Context and Reporting Period
Rambus Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The company licenses semiconductor, memory-interface, security, lighting and related technologies and also provides technology development, engineering and product services. Reportable segments were Memory and Interfaces Division (MID) and Cryptography Research Division (CRD), with remaining activities reported as Other.
Royalties remained the primary revenue source, representing 90.6% of third-quarter revenue and 89.4% of nine-month revenue. The company had 116.5 million common shares outstanding at September 30, 2015.
Financial Performance and Position
| Metric | Q3 2015 | Q3 2014 | Change |
|---|---|---|---|
| Total revenue | $73.8 million | $69.7 million | 5.8% |
| Royalties | $66.8 million | $64.0 million | 4.4% |
| Contract and other revenue | $7.0 million | $5.7 million | 22.0% |
| Operating income | $17.6 million | $14.5 million | 21.9% |
| Operating margin | 23.9% | 20.7% | Up 3.2 points |
| Net income | $182.0 million | $5.5 million | Substantial increase |
| Diluted EPS | $1.52 | $0.05 | Substantial increase |
| Metric | 9M 2015 | 9M 2014 | Change |
|---|---|---|---|
| Total revenue | $219.5 million | $224.5 million | (2.2%) |
| Royalties | $196.2 million | $207.4 million | (5.4%) |
| Contract and other revenue | $23.3 million | $17.1 million | 36.2% |
| Operating income | $51.1 million | $57.8 million | (11.6%) |
| Operating margin | 23.2% | 25.8% | Down 2.6 points |
| Net income | $198.4 million | $18.4 million | Substantial increase |
| Diluted EPS | $1.67 | $0.16 | Substantial increase |
Third-quarter revenue growth reflected higher royalties, including increased contributions from IBM and SK hynix, a one-time customer audit payment, and higher contract and other revenue. Nine-month revenue declined because patent royalties decreased by approximately $12.6 million, primarily from NVIDIA, Renesas, STMicroelectronics and a smartphone and tablet manufacturer.
Research and development expense increased to $27.8 million in the quarter and $85.5 million for the nine months, while sales, general and administrative expense declined to $17.9 million and $53.7 million, respectively. Engineering costs increased 3.6% in the quarter and 6.0% for the nine months.
The reported tax benefit was $167.0 million in the quarter and $155.7 million for the nine months, primarily from releasing a valuation allowance on U.S. federal and state deferred tax assets. The company released a $174.4 million valuation allowance against U.S. federal deferred tax assets and retained a $20.9 million valuation allowance, primarily related to California assets. Reported net income and margins therefore benefited materially from this non-operating tax item.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $216.6 million at September 30, 2015, compared with $154.1 million at December 31, 2014.
- Marketable securities were $146.3 million, resulting in total cash, cash equivalents and marketable securities of $362.9 million versus $300.1 million at year-end 2014.
- Cash provided by operating activities was $54.3 million for the first nine months, compared with $50.4 million in the prior-year period. The cash flow statement includes a $171.5 million deferred-tax adjustment related to the valuation allowance release.
- Investing cash use was $1.6 million, compared with $99.0 million in the prior-year period. Financing cash provided was $9.7 million, compared with $164.4 million used in 2014, when the company repaid $172.5 million of convertible notes.
- The outstanding 1.125% convertible senior notes due 2018 had a $138.0 million principal amount and $119.4 million carrying value at September 30, 2015. The balance sheet also included a $38.8 million long-term imputed financing obligation.
- Total contractual obligations were $186.5 million, including the $138.0 million convertible notes principal due in 2018. Possible payments related to approximately $20.7 million of unrecognized tax benefits were excluded because timing could not be reasonably estimated.
Management stated that existing cash, investments and operating cash flow should meet cash needs for at least the next 12 months. The company authorized a 20.0 million-share repurchase program in January 2015 but made no repurchases during the nine months.
Material Changes, Outlook and Unusual Items
- In June 2015, Rambus extended its SK hynix agreement for six additional years through July 1, 2024. SK hynix is expected to pay an average quarterly amount of $12.0 million, subject to specified payment options and conditions. The company received $16.0 million from SK hynix in the quarter and $40.0 million year to date.
- Rambus received $10.0 million from Micron in the quarter and $30.0 million year to date. The remaining scheduled Micron payments were estimated at $204.5 million through 2020, assuming no contractual adjustments.
- Settlement-related cash receipts were allocated between royalty revenue and settlement gains. In the third quarter, SK hynix and Micron generated $25.5 million of patent royalties and $0.5 million of settlement gain; for the nine months, they generated $68.5 million of patent royalties and $1.5 million of settlement gain.
- Rambus introduced the R+ DDR4 server memory chipset, RB26, and was sampling it to potential customers and ecosystem partners. Management did not expect material revenue contribution from the chipset through 2016.
- CRD was selected to manage the VIDITY Key Issuance Center for the Secure Content Storage Association, supporting security for 4K Ultra HD and other content.
- Management expected engineering and sales, general and administrative costs to remain relatively flat in the near term.
- After quarter-end, the board approved a restructuring expected to reduce headcount by 8%. The reduction was expected to be completed by the first quarter of 2016, with approximately $3.5 million of cash severance costs and $1.0 million of non-cash expense.
- Revenue concentration increased: the top five customers represented approximately 71% of third-quarter revenue and 65% of nine-month revenue. Micron, Samsung and SK hynix each represented at least 10% of revenue.
Risks and Contingencies
- Revenue depends heavily on licensing renewals, customer product volumes, pricing and adoption of Rambus technology. Licensing cycles are lengthy and unpredictable.
- The semiconductor industry is cyclical and competitive, and customer consolidation, alternative technologies or lower customer product demand could reduce royalties.
- International customers represented approximately 59% of nine-month revenue, exposing the company indirectly to foreign exchange, geopolitical, regulatory and economic risks.
- The company remains exposed to intellectual-property litigation, patent validity challenges, third-party infringement claims, indemnification obligations and changes in patent law, although it reported no material pending legal proceedings.
- Rambus has $138.0 million of convertible notes due in 2018 and could face cash demands upon maturity, conversion or certain fundamental-change transactions.
- Deferred tax asset realizability depends on generating sufficient future taxable income. Future tax rates could change because of tax audits, uncertain tax positions, tax-law changes or revisions to valuation allowances.
- Goodwill and long-lived assets could require impairment charges if operating performance, cash-flow expectations or market conditions deteriorate.
Important Facts for Investors to Verify
- Whether royalty revenue stabilizes after the 9M 2015 decline and how much is attributable to fixed settlement-related payments versus volume-based royalties.
- The sustainability of profitability excluding the $174.4 million U.S. federal deferred-tax valuation allowance release and related tax benefit.
- Customer concentration, renewal terms and payment performance for Samsung, SK hynix, Micron and other major licensees.
- Execution, customer adoption and future revenue timing for the RB26 chipset and CRD security offerings.
- The timing and realized costs of the announced 8% workforce reduction.
- Cash generation and available liquidity relative to the $138.0 million convertible-note maturity in 2018 and other contractual obligations.
- Results of California and India tax examinations and the potential settlement of approximately $20.7 million in unrecognized tax benefits.