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Executives

Satish Rishi – SVP and CFO

Ron Black – President and CEO

Analysts

Mark Strouse – JPMorgan

Suji De Silva – Topeka Capital

Vahid Khorsand – BWS Financial

Matthew Galinko – Sidoti & Co.

Rambus Inc. (RMBS) Q2 2013 Earnings Conference Call July 18, 2013 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Rambus Inc. Q2 2013 Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Satish Rishi. Sir, you may begin.

Satish Rishi

Thank you, operator, and welcome to Rambus' second quarter 2013 conference call. I'm Satish Rishi, CFO. On the call with me today is Dr. Ron Black, our President and CEO. Also joining us today for Q&A is Jae Kim, our General Counsel.

The press release with the results that will be discussed here 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 18188767 when you hear the prompt. In addition, we are simultaneously webcasting this call, and along with the audio, will be webcasting slides. So even if you're joining us via conference call, you may want to access the website for the slide presentation. A replay of this call can be accessed on our website beginning today at 5:00 p.m. Pacific Time.

In an effort to provide clarity in the financials, we are using both GAAP and non-GAAP pro forma format in the press release and on this call.

I need to advise you that the discussion today will contain forward-looking statements regarding our financial prospects pending current litigation and demand for technologies among other things. These statements are subject to risks and uncertainties that are discussed during this call and may be more fully described in the documents we filed with the SEC including 8-K's, 10-Q's and 10-K's. These forward-looking statements may differ materially from our actual results and we are under no obligation to update these statements.

Further, as mentioned, we will discuss non-GAAP financial results today and have posted on our website reconciliations of these non-GAAP financials to the most directly comparable GAAP measures. You can find a copy of earnings release under Reconciliation on our website at rambus.com on the Investor Relations page and the financial releases.

Now I'll turn the call over to Ron.

Ron Black

Thank you, Satish, and good afternoon everyone. Let me start by saying that we were pleased with our second quarter of 2013 results. As Satish will review in more detail later, we ended with revenue of $57.9 million which is at the top end of our upwardly revised guidance, and customer licensing income of $61.3 million which was above what we guided. For Q3 we are expecting considerable growth with customer licensing income to be in the range of $69 million to $74 million.

Our strategy of bringing invention to market and broadly collaborating with the industry was demonstrated again last quarter by our signing of the patent license agreements with SK Hynix and STMicroelectronics. The agreement with Hynix ends a nearly 13-year legal dispute and provides them a license to our patented innovations for all of their semiconductor products in exchange for $240 million over the next five years as well as forgiveness of some fines and fees that we previously owed Hynix.

As we mentioned during the call when we announced the deal, this agreement is the second largest in Rambus' history and we think it's very good for shareholders. With the SK Hynix agreement, we have now licensed 80% of the DRAM market, leaving Micron as the only substantial DRAM producer not licensed to Rambus technology. We believe that the settlement with Hynix has reaffirmed the market rate that we have established with Samsung and Elpida and we are hopeful in reaching a settlement with Micron now that they can be confident about the fair market value of our technology.

Turning to the STMicroelectronics deal, this accomplished three goals for Rambus. The first was to increase our revenues through the patent license, the second to resolve past legal matters, and the third to provide a framework for Rambus and ST to more broadly collaborate. ST plays a crucial role in the deployment of content production across the set-top box space, and with a license to our security technology, ST can now protect these customers, their customers, and even consumers. If you recall, Broadcom, a key competitor of ST, had previously taken a license and announced deployment of the technology, so now we have the top two set-top box chipset manufacturers licensed.

As part of the agreement with ST, they also have access to our memory and interface technologies and we will have access to their fully depleted silicon insulator or FD-SOI process technology, giving us the opportunity to collaborate with ST on future memory and interface solutions. For clarity, we have not signed a cross-license agreement with ST nor do we need to. Our agreement provides information about the design technology that will allow us to develop solutions from each of the customers.

And while litigation is not our main focus, patents are a core part of our value proposition and we are continuously inventing and developing a strong intellectual property position. Thus, we were pleased with the US Court of Appeals for the Federal Circuit ruling which reversed the decision by the US Patent and Trademark Office against Rambus. Specifically the Fed Circuit has validated one of our [Baric] patents which covers certain DDR memory types. While we've already settled all outstanding claims and the action that led to this conclusion, it is rewarding to have the Fed Circuit reverse the US PTO's decision and find voidity in this important patent.

Moving now to our focus markets, following the successful Q1 launch of our R+ enhanced industry standard memory and interface solutions, this quarter some of our engineers and scientists presented multiple papers at both the Electronic Systems Technology Conference and the Electronic Component Technology Conference. At these conferences we discussed our views on signal and power integrity requirements for 3D ICs as well as developments in the areas of 3D interposer design, high-frequency effects and physical architectures, and high-speed parallel bus design. We also participated in a thought leadership forum in India discussing technical and economic trends to a large group of industry leaders and influencers.

On the security front, our CRI team is continuing to make great progress. First, we actively engaged with the Secure Content Storage Association or SCSA to develop specifications for delivering secured content across new models of media distribution. This is an important consortium of industry-leading companies, and we look forward to being able to share the developments of this standard at the appropriate time.

Also at the National Broadcasters Association Show in April, in conjunction with Verimatrix and STMicroelectronics, we demonstrated our CryptoFirewall core integrated with the Verimatrix video content authority systems for an IPTV cardless security solution. This solution was embedded in an ST device with components and system integration support provided by SypherMedia. This multi-company effort shows how collaboration and integration are important cornerstones to our overall strategy, and we continue to make progress on deploying our DPA countermeasures across a variety of incredibly security-sensitive segments including government, military, and mobile applications, which we'll discuss more at a later date.

On the lighting front, we had a busy quarter with both bulbs and fixtures. We expanded our bulb offerings with both PAR30 and BR30 bulb types and also introduced a very cool-colored temperature change capability for these bulbs. Since LEDs come in a variety of shades of light, there is a high degree of variation with the light output, which makes it difficult to blend new LED bulbs with existing lighting. This color-temperature adjustment capability enables users to choose whether they want a cool or warm white light with just a simple turn of a dial on the bulb and without additional LEDs or expensive multichannel drivers. We are seeing great interest in this development from our customers and partners. These bulbs are in certification now and will be available for shipment later this year.

Also, just this week, our A19 bulb has received full Energy Star certification and is now making its way to consumers. Through our commercial partner, The Elite Group, we've received initial orders from a well-known do-it-yourself outlet and our bulbs will be in stores within the next month or so. This initial order is only available in limited markets, but we are excited to see the manifestation of our tag line, that of bringing invention to market, coming true in product and store shelves.

And we continue to make progress and traction with both Cooper Lighting and GE with fixtures. We are actively engaged with those companies as they bring -- as they work to bring product space in our edge-lit technology to market. For example, we have been providing Cooper with production light guides for several of its new lighting solutions.

Also during the quarter, we transferred another set of display-related patent assets to Acacia Research, these relating to automotive industry. As with the other group of patent assets we transferred to Acacia, we expect to receive payments based on the licensing of these patents. With this and particularly given the commercial progress with our bulb and fixtures, our lighting business continues to track to the growth plans in the second half of this year, but primarily in the fourth quarter.

From an R&D group, particularly Rambus Labs, we continue to highlight and promote our work at various conferences around the world. This past quarter, we were invited to present at two prestigious imaging conferences. At the International Image Sensor Workshop, we presented silicon test results of our binary pixel technology we introduced earlier this year where we've expanded the dynamic range by a remarkable factor of 14 when compared to conventional image sensor. And at the Computational Sensing and Imaging Meeting, we discussed some early work on our Lensless Ultra-Miniature Images, which we believe will lead to significant improvements in imaging and sensing across various fields such as medicine, defense, industrial inspection, and testing. We have a lot of exciting developments underway in this group, particularly related to the Internet of things, and we look forward to sharing more in the coming months.

Okay, that's a quick recap of the business this quarter. And with that, I'll now turn it over to Satish.

Satish Rishi

Thanks, Ron. As a reminder, we use non-GAAP pro forma numbers, which we believe are indicative of our complete performance as it includes certain cash events and excludes certain non-cash and discrete events such as impairment charges and restructuring charges, which we believe are not indicative of long-term performance.

Customer license income is a non-GAAP measure that includes cash proceeds that we receive under a signed patent license agreement as well as cash proceeds from the sale of intellectual property. It is how we measure the top line of our business, and it may be different than revenue within a particular period when the amount of cash received from a customer is different than the revenue recognized.

Let me start by reviewing some highlights for the second quarter before going into additional detail.

Customer license income for the quarter was $61.3 million and revenue for the quarter was $57.9 million, at the top end of our revised guidance of $56 million to $58 million. As Ron mentioned, one of the highlights in Q2 was the agreement we signed with SK Hynix, but due to the fact that all releases were effective in July, and we received the first payment in July, there was no CLI or revenue recognized from the Hynix agreement in Q2.

Pro forma expenses came in at $48 million for the quarter, at the lower end of our guidance of $53 million to $48 million. Pro forma net income was a gain of $6.6 million as compared to our guidance of breakeven to $6 million.

Let me provide a little more detail on the quarter. As I mentioned, customer licensing for the quarter was $61.3 million. During the quarter we signed agreements with STMicroelectronics, resolving a litigation and entering into comprehensive multi-division license, settled with Hynix, and as Ron mentioned, sold an additional portfolio to Acacia.

Just a few more details on the mix of the CLI, our total fixed royalties contributed about 36% of our CLI. Ninety-four percent of our CLI was from patent licensing revenue, but the remaining being solution and contract revenue. The new businesses represented approximately $14 million of total CLI, higher than the run rate we had at the end of the year. Depending on the mix, this ratio of new businesses [might shrink] quarter over quarter, but for the full year we still expect the new businesses to be between 15% to 20% of total CLI.

Pro forma operating expenses which exclude restructuring and impairment charges, retention bonuses, stock-based compensation, amortization of intangible assets, and the one-time reversal of Hynix-related litigation costs [previously] awarded was $48 million, flat to the previous quarter. It is worth mentioning that a year ago our pro forma operating expenses were $56 million and we have been diligently managing our expenses and driving leverage in our business model. Pro forma interest and other expenses were $3.3 million, relatively flat to the previous quarter. For pro forma tax expenses we're using a flat rate of 36% on pro forma pretax income. Pro forma net income this quarter was $6.6 million as compared to $13.4 million last quarter.

Overall cash defined as cash, cash equivalents and marketable securities was $206 million, a decrease of $9 million from the previous quarter. Just as a reminder, during the quarter we paid out the second installment of retention bonuses for our past acquisitions of approximately $17 million as well as our semi-annual interest gains on our bonds, resulting in the use of cash from operations of $10 million.

With the Hynix payment in Q3, we expect to be cash flow positive in Q3 and are forecasting a cash balance of approximately $216 million as of the end of Q3. As of this quarter, our outstanding convertible bond has been reclassed as a short-term liability. We remain -- we continue to remain net cash positive and we have a couple of different options. We could issue a smaller new convertible. We could do a buy-and-extend with existing -- with a portion or all of our existing convertibles, do a combination of both, or do nothing.

Let me give you some thoughts regarding the third quarter 2013. This guidance reflects our [reasonable] estimate and our actual results could differ materially for what I'm about to review.

The Hynix settlement and related payments related to past dues, future payments as well as the relief from litigation, from an accounting perspective, this is what we call a multi-element transaction and we will have to calculate the fair value of each of these elements with the result that even though we received $12 million from Hynix during the quarter, not all of it will be booked as revenue. These allocations will be done solely for accounting purposes and do not reflect any understanding or agreement by the parties in the context of an agreement. As such, part of the $12 million will show up in revenue and the balance will be reflected in the operating section as a gain from settlement. Net-net all $12 million will show up in the operating income line but the components of it may vary in different geographies.

The calculation of fair value of various elements was complicated and time-consuming, and we are currently in the process of estimating these fair values and I do not have a breakdown between revenue and a gain from settlement. However, since all $12 million will show up in CLI, the way we defined CLI, the guidance I will provide will only for CLI, not revenue.

For the third quarter we expect customer licensing income to be between $69 million and $74 million. We expect pro forma operating expenses which excludes restructuring charges, retention bonuses, stock-based compensation, amortization of intangible assets and gain from settlements to be between $49 million and $52 million. These amounts include an estimate for litigation expenses of between $1 million to $2 million. Pro forma net income is expected to be between $9 million and $14 million.

I would like to close by saying that we had a solid quarter again and are well-positioned for growth and improved profitability in 2013. We came in higher than initial guidance range for Q2 while continuing to deliver operating leverage. We remain focused on execution and on new businesses while investing in areas which will drive future revenue growth and profitability.

We are now ready to open the line for Q&A. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions].

Our first question comes from Paul Coster of JPMorgan. Your line is now open.

Mark Strouse – JPMorgan

Yeah, hi. It's Mark Strouse on for Paul. Thanks for taking our questions.

I guess can you just give an update on the visibility from the Acacia partnership? Do you have -- I think last time you talked about it was it still early days, so you weren't baking anything in the guidance. Is it at that point now or do you have some of that revenue baked into 3Q CLI?

Ron Black

We do not, Mark. They are very proactively engaged in negotiating deals, but there is nothing that we have baked into Q3, nor do I believe that there would be anything even if they closed deals in Q3 as the terms of our contract, I think, have it paid one quarter in arrears.

Mark Strouse – JPMorgan

Got it. Okay. That makes sense.

And then just on the lighting side, the initial orders that you have with the Elite Group channel that will be shipping next month, I believe I heard, is that recognized on a sell-in basis or a sell-through basis? And can you just talk about, you know, other opportunities that you guys are exploring as far as channel expansion? Thanks.

Satish Rishi

Sure, Mark. The revenue recognized when we sell to the channel partners, so typically the deal is done (inaudible), so we end up recognizing revenue when we sell to them, not when they sell to the channel, so, from that perspective, we are recognizing, you know, we don't have any risk once they take title. We are looking at other channels and, you know, we're looking at the professional channels as well as the retail channel. There's a lot of interest and demand as a market for LEDs as you can tell, and we believe we have a unique product, and as Ron mentioned, with the color-change bulb that we introduced this quarter, which should be shipping sometime later in the year, you know, the technical progress we bring to being able to delight the customer is probably unsurpassed.

Mark Strouse – JPMorgan

Okay, got it. I will hop back in the queue. Thank you very much.

Operator

Thank you. Our next question comes from Suji De Silva of Topeka. Your line is now open.

Suji De Silva – Topeka Capital

Hi, Ron; hi, Satish. Nice job on the quarter.

The STMicro, as you said, all that -- how much was the contribution in 2Q and does that recur or is that sort of a one-time, much like the 1Q for LSI?

Satish Rishi

This is a recurring payment. This is a longer-term contract, and unlike LSI which is one-time, this will have recurring payments both for our semi -- well, both for our memory division and also for CLI.

Suji De Silva – Topeka Capital

Okay. And then with STMicro you have this agreement to work up with their manufacturing. It sounds like that's an important element of being able to collaborate better, Ron, if you could clarify with the memory guide. Is that something you have similar arrangements with, to be able to work on roadmap technologies, or is this something specific by STMicro that made the manufacturing [which] (ph) will make sense there?

Ron Black

Yeah. STMicro has some very interesting technology that works particularly well at high speeds. And of course when we were in litigation, it was very, very difficult for us to collaborate and jointly work with customers. So, by having this particular issue removed, we're very proactively working together, especially with mutual customers. So, it's one of the reasons that from the very beginning on the strategy, we really wanted to settle these litigations as long as people were willing to pay fair market value for the technologies that we did develop and provide.

Suji De Silva – Topeka Capital

Do you require similar arrangements with the memory guys to be able to work on roadmaps and be more collaborative over time?

Ron Black

Yeah, it's always much easier to collaborate when you don't have those issues, which is nice as I said in the prepared script. Really it's just Micron at this moment as the only substantial memory manufacturer who has not taken a license.

Suji De Silva – Topeka Capital

Right.

Ron Black

So we're proactively working with Elpida and Samsung and now Hynix as well.

Suji De Silva – Topeka Capital

Okay. So, that was just unclear at this point, I got that then.

Okay, the last question, I think a follow-up to the prior question, I think the question was you have lighting, you have a footprint in retail that I think you said relatively limited initially. Is that something we should expect to expand as a footprint in retail relatively quickly or would it be a slow expansion of the footprint in retail? Just I guess that was kind of the answer to the question I think to the prior caller.

Ron Black

Yeah. You know, I wish I could tell you precisely. We really have to see how the sell-through goes both for us and the DIY store. We're cautiously optimistic, so -- but we have to wait and see how it goes.

Suji De Silva – Topeka Capital

It'll be success-based I guess.

Ron Black

Yes.

Suji De Silva – Topeka Capital

Okay, great. Thanks a lot.

Operator

Thank you. Our next question comes from Vahid Khorsand of BWS Financial. Your line is now open.

Vahid Khorsand – BWS Financial

Hi guys. A couple of questions. First question, will a slowdown being widely reported in the smartphones sales in the US have an impact on your photography business or internal growth timeline?

Ron Black

No. It really doesn’t have a direct influence. There is one handset vendor that is licensed, but we don't see it affecting our business at all at this point.

Vahid Khorsand – BWS Financial

Okay. And during your last call, it sounded as though you were focused on LED and cryptography, but isn't the ramp for mobile a highly growing field and wouldn't that benefit Rambus?

Ron Black

Yeah. So, the way our contracts work, and Satish can follow up with some more details on a case-by-case basis, we tend to get paid either fixed payments or variable payments based on revenue. And we like the mobile parts very much, both because it was growing in volume but also because the ASPs are higher. So, it's really a very dynamic forecasting issue. In most of the cases, we're pretty accurate because we get paid two quarters in arrears. But we definitely like memory and the high-performance server as well.

Vahid Khorsand – BWS Financial

Okay. Thank you.

Operator

Thank you. [Operator Instructions].

Our next question comes from Matthew Galinko of Sidoti. Your line is now open.

Matthew Galinko – Sidoti & Co.

Hi, thanks. Question is, you know, if the initial run of the bulb is successful, how quickly can you ramp production or do you have some flexibility there?

Ron Black

The cycle time through the manufacturing partner is about eight weeks. We compress that by doing some strategic procurement of the long lead parts. So, we can respond fairly quickly, but we are also very cautious that we do not build inventory on this. Coming -- both Satish and I came from manufacturing companies, so we have a lot of discipline to avoid that type of use of cash.

Satish Rishi

Yeah, hi, Matt. This model currently is a build-to-order model, so as Ron mentioned, we don't want to have an inventory on our books, number one. Number two, in terms of capacity, the contract manufacturer we're using, they have ample capacity to meet our near-term needs, so ramping up should not be an issue if there's demand.

Matthew Galinko – Sidoti & Co.

Okay. Thanks.

Ron Black

Welcome.

Operator

Thank you. Our next question is a follow from Suji De Silva of Topeka. Your line is now open.

Suji De Silva – Topeka Capital

Hi, Ron, Satish. One follow-up here. Can you talk about -- you gave us a metric on how much the new business would be as a percent of revenue that you track forward. Can you rank-order within that group which ones you're the most optimistic on near term?

Satish Rishi

How near term are you looking, Suji?

Suji De Silva – Topeka Capital

Well, to make sure, the next 12, maybe 12 to 18 months.

Satish Rishi

If I -- you like asking us to choose between our children, they're all equally good.

Suji De Silva – Topeka Capital

Okay. So all the segments have good near-term growth potentially --

Satish Rishi

Right.

Suji De Silva – Topeka Capital

-- some being longer term, that was the essence of the question.

Satish Rishi

Okay.

Suji De Silva – Topeka Capital

All right, great. All right. Thanks guys.

Satish Rishi

Thanks, Suji.

Operator

Thank you. And at this time, I'm not showing any further questions. I'd like to turn the call back to Ron Black for any further remarks.

Ron Black

Thank you all for your continued interest and support. Q2 was certainly busy with lots of big developments. We look forward to continuing this momentum and to speaking with you again soon. Have a nice day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.

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