Welcome to the Rambus second quarter and fiscal year 2020 earnings conference call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question- and- answer session. If you would like to ask a question, you may press star one on your touch-tone pad at any time. If anyone should require assistance during the conference, please press star zero on your touch-tone pad at any time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Rahul Mathur, Chief Financial Officer. You may begin your conference.
Thank you, operator, welcome to the Rambus second quarter 2020 results conference call. I'm Rahul Mathur, CFO, on the call with me today is Luc Seraphin, our CEO. The press release for the results that we will be discussing today have been furnished to 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 then entering ID number 1788075 when you hear the prompt. In addition, we are simultaneously webcasting this call, along with the audio, we're webcasting slides that we will reference during portion of today's call. Even if you're 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 5:00 P.M. Pacific Time.
Our discussion today will contain forward-looking statements, including our financial guidance for future periods, product 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, risks and the potential adverse impacts related to or arising from the novel coronavirus or 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're under no obligation to update these statements.
In an effort to provide greater clarity in our financials, we're using both GAAP and non-GAAP financial presentations in both our press release and also 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. 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, including our guidance for future periods, 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?
Thanks, Rahul, and good afternoon, everyone. This was another excellent quarter for Rambus, delivering in line or above expectations for the eighth consecutive quarter. We delivered $59.9 million in revenue and, most notably, $62 million in cash from operations, breaking a 10-year record for quarterly cash generation. This tremendous performance was enabled by our sustained focus on quality and execution, demonstrating our ability to consistently deliver. The team is fully adjusted to remote operations and continues to maintain high levels of productivity as well as our commitments to our customers. One thing that has remained constant during these uncertain times is the increased demand for data bandwidth and performance, driven by the significant increase in online activity from corporations and consumers. We expect the outlook for data center to remain healthy as trends like working from home and online learning are likely to continue longer term.
As a result, we are seeing sustained investment from our customers in products and solutions that will help improve the performance of the global data infrastructure. memory interface chips led our strong performance with the fifth consecutive quarter of record revenue. This sustained growth trajectory is driven by a combination of ongoing data center and OEM qualifications and strong overall demand in the market. The confluence of existing technology trends like AI at the edge and the transition to the cloud with a paradigm shift to remote collaboration is accelerating infrastructure deployment and upgrades. This translates into greater demand and increased shipments for cloud DRAM and server modules. From an operational standpoint, our supply chain remains strong, with solid wafer supply and good cycle times on test.
The operations team has done an excellent job of actively managing any potential risks, and as a result, we continue to meet all of our customer commitments. Based on the latest round of data from our customers and the industry, we believe first half inventory levels in the overall server supply chain were slightly above normal, but remain healthy given the increased uncertainty in the current environment. As of this time, we expect demand to remain consistent and stable in the second half, but we'll continue to monitor inventories. Looking forward, DDR5 continues to progress with the recent formal publication of the specification by JEDEC.
We are working closely with the industry and our customers, as illustrated by the recent Micron announcement of their DDR5 ecosystem enablement program to support the rollout of our next generation systems. Rambus remains poised as the first mover and will be on the forefront of DDR5 deployment with our customers. Finally, for silicon IP, we maintained our momentum with further interface and security IP design wins at Tier 1 SoC makers across data center, AI, and communications. We continue to deliver solutions that enable new architectures and capabilities for high-performance systems across our focus markets. In closing, we continue to deliver excellent results, demonstrating the resilience of our business model and ability to execute in these unprecedented times. Rambus is developing products and solutions to address the mega trends which are reshaping the data center and the network at large.
We are confident in our ability to execute on our technology roadmap and believe we are well-positioned to capture the growing opportunity in data-centric applications. With that, I'll turn the call to Rahul to discuss the quarterly financial results. Rahul?
Thanks, Luc. I'd like to begin with our financial results for the second quarter. Let me start with some highlights on slide five. As Luc mentioned, we continue to execute in our product businesses and delivered excellent financial results at the high end of our revenue and earnings expectations while continuing to strengthen our balance sheet. We've adopted ASC 606 using the modified retrospective method, which does not restate prior periods, but rather runs 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 our company's progress. We will continue to provide operational metrics such as license and billings to give our investors better insight into our operational performance.
We delivered revenue of $59.9 million and licensing billings of $60.7 million at the high end of our expectations. We have a very strong balance sheet and ended the quarter with cash equivalents, and marketable securities of $486.1 million, up from the previous quarter due to cash from operations of $62 million, our best quarterly performance in over 10 years. Our continued execution on our strategy and our operational discipline have yielded excellent financial results and a strong balance sheet that affords us flexibility on our strategic initiatives. Let me talk you through some revenue details on slide six. Revenue for the second quarter was $59.9 million at the high end of our expected range due to another record quarter for our buffer chip business.
Royalty revenue for the second quarter was $17 million, while licensing billings was $60.7 million. The difference between licensing billings and royalty revenue primarily relates to timing, as we don't always recognize revenue in the same quarter we bill our customers. Going into additional detail, our product revenue was $31.7 million, consisting primarily of our buffer chip business. Our contracted other revenue was $11.2 million, consisting primarily of our silicon IP business. Our silicon IP business was down quarter-over-quarter, as expected, due to the timing of customer engagements. As you saw in our press release, we expect this to return in Q3. For the year, there's roughly $35 million of our silicon IP business that's being reflected in our licensing billings.
This is almost double what we expected at our Analyst Day last year due to the structure of our contracts and acquisition accounting. Let me walk you through our non-GAAP income statement on slide seven. Along with our excellent revenue performance in Q2, we again exceeded our profitability targets. Total operating expenses, including COGS for the quarter, came in at $59.5 million. Operating expenses of $47.7 million were lower than our expectations due to lower spending on employee-related expenses. With higher revenue and disciplined execution on spending, our profit was nicely above our expectations. We ended the quarter with headcount of 670, flat from 665 in the previous quarter.
Under ASC 606, we recorded $3.7 million of interest income related to the financing component of our fixed-fee licensing arrangements, for which we have recognized revenue but not yet received payment. We incurred $0.8 million of interest expense, primarily associated with our convertible notes. This was offset by incremental interest income related to the return on our cash and investment portfolio. After adjusting for non-GAAP interest expense on our convertible notes, this resulted in non-GAAP interest and other income for the second quarter of $3.8 million. Excluding the interest income related to the financing component related to ASC 606, this would have been $0.1 million. Using an assumed flat rate of 24% for non-GAAP pre-tax income, our non-GAAP net income for the quarter was $3.2 million. Now, let me turn to the balance sheet details on slide eight.
Over the past several years, we've built a very strong balance sheet. Cash, cash equivalents, and marketable securities totaled $486.1 million, up significantly from the previous quarter, primarily through cash from operations of $62 million. As I mentioned previously, this is our best performance in over 10 years. In the first half of this year, we've generated nearly $100 million of cash from operations. At the end of Q2, we had contract assets worth $444.5 million, which reflects the net present value of unbilled AR related 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 arrangements, as several customers have royalty-based agreements that allow us to recognize revenue each quarter under ASC 606. Second quarter CapEx was $14.9 million, and depreciation was $4.8 million. We delivered $47.1 million of free cash flow in the quarter. Looking forward, I expect roughly $19 million of CapEx for the third quarter and roughly $36 million for the full year of 2020, a third of which is related to the relocation of our headquarters facility. I also expect depreciation of roughly $5 million for the third quarter and roughly $20 million for the full year of 2020. Our strategic refocus on our core markets and operational efficiencies have set a solid foundation for our company.
Our predictable high-margin licensing business has put us in a position to come out of the current environment stronger than ever. We continue to build cash and have limited debt. With a disciplined financial approach that has built capital while investing in growth, we are well positioned to grow both organically and inorganically. Our historical and ongoing investments in technology R&D have helped us build a patent portfolio that is foundational to our industry. Our historical agreements, including those we signed this quarter, position us well for our licensing renewals in the upcoming periods. Let me turn to our guidance for the third quarter on slide nine. As a reminder, our forward-looking guidance reflects our current best estimates, 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 billings, which is an operational metric that reflects amounts invoiced to our licensing customers during the period, adjusted for certain differences. As you see in the supplemental information we provided on slide 13 of our earnings deck, licensing billings closely correlates with what we'd historically reported as royalty revenue under ASC 605. We feel that we are very well positioned in the market but remain cautious regarding a near-term outlook due to the lack of visibility created by COVID-19. With that said, under ASC 606, we expect revenue in the third quarter between $54 million and $60 million. We expect royalty revenue between $9 million and $15 million. We also expect licensing billings between $55 million and $61 million. Quarter-over-quarter, we expect growth in our silicon IP business to offset small reductions in patent licensing.
We expect Q3 non-GAAP total operating costs and expenses, which includes COGS, to be between $64 million and $60 million as we continue to invest in programs. Under ASC 606, non-GAAP operating results for the third quarter is expected to be between $0 and a $10 million loss. For non-GAAP interest in other income and expense, which excludes interest income related to ASC 606, we expect this to be approximately $0, which includes $0.6 million of interest expense related to the notes due in 2023. Based on the tax legislation passed at the end of 2017, we expect our pro forma tax rate in 2020 to remain consistent with our 2019 pro forma tax rate of roughly 24%. The 24% 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 our licensing agreements with our partners in Korea. We expect non-GAAP taxes to be between a benefit of $0 and $2 million in Q3. We expect our Q3 share count to be roughly 116 million basic and diluted shares outstanding. This leaves you to between a non-GAAP loss per share of $0.07 and $0 for the quarter. While we don't provide guidance beyond Q3, as a reminder, in Q4, we will see our last step down related to one of our large licensing agreements. With no other changes, this represents incrementally better profit than current consensus estimates for Q4. As I've mentioned previously, in the coming years, I expect licensing billings to stabilize at the same level we expect to see in 2020.
Our product growth will provide leverage on both the top line and the bottom line. Let me finish with a summary on slide 10. We are proud of the excellent performance by our team and the progress we continue to make against our strategic initiatives to drive long-term profitable growth. While we understand that ASC 606 added a level of complexity to our financial reporting, it's important to reiterate that the underlying financial strength of our business remains strong, reflected in our demonstrated ability to generate cash. We have refocused our product portfolio around Rambus's core strengths in the semiconductor industry, improved our operational efficiency and profitability, generated solid cash from operations, and leveraged our strong balance sheet to support our strategic initiatives. We continue to focus on our core markets and are well positioned to come out of the current environment stronger than ever.
Before I open up the call to Q&A, I would once again like to thank our employees for their amazing 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?
Thank you, Rahul. Ladies and gentlemen, if you have a question, please press star one on your touch-tone telephone. Your first question comes from the line of Gary Mobley with Wells Fargo Securities. You may now ask your question.
Yeah, thanks. Hey, guys. Let me start out by asking about some reconciliation items from GAAP to non-GAAP results and focusing specifically on substituting royalties for billings. If I make that adjustment, that gets to an adjusted revenue number for the just reported quarter of roughly $103.6 million. Am I doing the math right there?
Gary, it's Rahul. Great to hear your voice, and I hope that you and your family are well. I think what you're doing is you're substituting licensing billings for what we typically report for royalty revenue. Obviously, that's not a GAAP measure, but if I were to do the math, I'd get the same number.
Okay. Translating down the different GAAP to non-GAAP reconciliation items from the expenses, you get to roughly, what, $0.29 for the quarter?
Yes, Gary. If I were to do that math as you did, I would get the same number. Again, those aren't numbers that we present.
Understood. All right. I wanted to ask about gainability of your buffer chip business. It's been great now for several quarters. There's been a lot of chatter and concerns as you addressed on your prepared remarks about inventories of DIMMs in the channel, and related to that, some buffer chip inventory. To the best of your knowledge, how much of your strength in that portion of your revenue has been driven by sustained demand for server capacity in data center operations versus inventory increases versus market share shifts vis-a-vis your handful of competitors and any sort of step-up in the market for what you're addressing, just given the various changes in Intel processor cycles?
Hey, Gary. Nice to talk to you. We have a little bit of all happening. We continue to gain market share in the DDR4 generation of products as Cascade Lake ramps into the market. We expect our design win progress to continue as new generations hit the market. By the end of this year, Ice Lake is going to be introduced, and we have a very good footprint there. There's going to be an increase of number of channels with Ice Lake, which can probably also increase the total demand. The traction in the market is there, and again, is driven by the demand for work from home, learn from home, online entertainment. Now, we don't see, with our direct customers, a building of inventories. We sell directly to our customers, and we're able to meet their commitments.
We hear some slight inventory build-up at the system level. I think people took some caution about any possible disruption in the supply chain. We've seen a little bit of build-up during the first half of this year, but we don't expect to have a huge correction in the second half. We're prudent for the second half, but I think the inventory build-up is very reasonable and is there to just prevent any possible disruption with the supply chains, given the COVID-19 environment.
Okay.
In the long run, we see more demand for buffer chip. When we move to Ice Lake, we're going to have another chip with DB. When the market moves to DDR5, we expect the market to be probably twice the size as what it is today by 2024. DDR5 is going to see more content on the modules, and we are going to invest in all of these chips that are going to be on DDR5 modules. In the long run, we're going to see very high market growth for these products. We continue to be very optimistic in the long run with this business.
Okay. That's helpful, Luc. On the topic of the buffer chip business, I think maybe you were originally guiding this business a couple of years ago to be at best a 60% gross margin business. It was 63% in 2019. It's 68% in the most recent quarter. What's the limit on this, and what's sort of sustainable over the long term?
Hey, Gary, it's Rahul. Yes, we've been delighted with our gross margins. Any given quarter, it'll go a little bit higher, a little bit lower, just depending on mix and shipments and these other things as well. Obviously, as we continue to ramp volumes, as you've seen our record time and time again over the last five quarters, we get to leverage some of our existing costs. What I've talked about is gross margins in the 55%-60% range long term. We've been posting, as you noted, closer to about 65%. I think somewhere in that 60%-odd range long term is sustainable for us.
All right. Thanks, guys. I'll turn it over.
Thanks, Gary.
As a reminder, to limit your question to one question and one follow-up. Your next question comes from the line of Sidney Ho with Deutsche Bank. You may now ask your question.
Hi, this is Jeff Rand on for Sidney. Congratulations on the nice quarter. With the licensing step down in Q4, do you think this points towards a sequential revenue decline in 4Q, or do you think your product and contract growth can offset this?
Yeah, Jeff. Nice to talk to you, and I hope that you're well. We gave guidance for Q3 because we guide one quarter at a time. As we mentioned in the prepared remarks as well, there's still a little bit of a lack of visibility related to COVID-19. If everything else stayed flat, you'd see exactly that. I think what I've talked about historically is that specific contract has a step down. It's just structural. It was something that negotiated, I think, five, seven years ago of about $5.5 million in Q4. That steps back up in Q1.
All other things being held equal, you'd see a Q4 that was down 5.5 on the top line, you run that through, we run a pro forma 24% tax rate, that's about $0.04. Right now it's kind of hard to gauge what's going to happen in the fourth quarter. We're very pleased with the progress that we have across our businesses. Licensing has come in exactly as we thought at the beginning of the year. You're seeing buffer chip perform very well. We expect to see our silicon IP business rebound in Q3. Right now we're taking it one quarter at a time.
Great. Thank you. That's helpful. You've had some design wins recently. How should we think about the incremental revenue opportunities from these wins and how quickly should they ramp up?
The design wins. Hi, Jeff, this is Luc. We continue to have design wins on the buffer chip, as we talked about earlier, with our customers and with our customer's customers. Every time a new processor, a new DRAM, or a new DIMM architecture is introduced to the market, that gives us an opportunity to win designs. That explains the growth we have on the buffer chip. We continue on the IP cores and security to have a healthy design win history and pipeline. Most of our design wins, half of them are in the data center field. The other half is split between IoT, 5G, and AI types of applications. The business model for IP cores is a bit different. People pay us for license, and sometimes royalties or reuse fees.
The revenue comes quite quickly after we win the designs, typically within the year or year and a half that follows that design. Our design win pipeline is healthy. We had some slowdown in Asia earlier in the year when everything shut down. Our activities continues to be healthy.
Great. Thank you so much.
Thank you, Jeff.
If you have a question, please press star one on your touch-tone telephone. Your next question comes from the line of Suji Desilva with ROTH Capital. You may now ask your question.
Hi, Luc, hi, Rahul. Congratulations on the strong cash flow here. Very impressive. Just following up on Gary's question. Yeah, sure. Following up on Gary's question about the revenue EPS, just asking about now the third quarter, the guidance stuff. If I do my math here, I think it implies $103 million, just slightly down sequentially revenues and EPS of $0.27, also down a little bit. Does that math sound right, Rahul?
I think, Suji, again, what you're doing is you're taking the guidance for licensing billings and substituting that for what we guide for royalty revenue. Then if I were to do the same math, I'd get the same as you, which is 103. On a like comparison, that's roughly flat quarter-over-quarter. I'm sorry, what did you say on the bottom line?
$0.27.
Yeah. Same thing. If I run that through in a pro forma expense and tax affected at the 24%, I get the same.
Great. Okay, a question on the business on the memory interface side. You've kind of cross currents in the marketplace. You have strong share gain and growth for your memory buffer, maybe some customers took some excess in the beginning to kind of prepare for the second half. Can you talk about the memory interface business and whether you expect it to continue to grow steadily at this point, or would it potentially pause after five quarters of growth there? Any color there would help.
Yes, Suji. Hi. I think we saw some, as we said, in the first half of the year, we saw our customers taking some precaution because of COVID-19. We believe that the inventory levels are still healthy. Going into the second half of the year, we are prudent with our outlook for buffer chip. We don't think there's going to be a correction. We think that the inventory level are still healthy. We'll continue to support that business with design wins. At the end of the year, we're going to start seeing Ice Lake popping up. Next year, Ice Lake is going to ramp, DDR5 is going to start to ramp. As I said, when DDR5 ramp, because we were the first to introduce DDR5 samples in the market, we believe our market share is going to continue to increase.
In addition to that, we're developing companion products that are going to go on the same DDR5 DIMMs. The potential market for us is going to further increase when that happens. Second half, as I said, inventory levels are healthy, but we're just prudent.
Okay, understood. Last question, coming off of Intel's earnings, they talked about the manufacturing challenges and emphasized perhaps use of chiplets. I think I'm curious for your silicon IP business and the SerDes, if that's a potential tailwind, and if so, you could kind of maybe talk about how important that could be to that kind of breaking up of the chips and connecting them.
Yeah, that's a great question, Suji. When you move into very thin technologies like seven nanometer or thinner, like five nanometer, the cost of masks and the complexity of designing, especially analog parts, is increasing. One of the solution to that problem is to actually separate the interface from the main chip itself and produce chiplets, high performance chiplets. We have those developments in-house. We are full speed developing 112G, very short range IP interface that can be used in chiplets. That's an area that we watch very closely. I think there is a great market potential for that, and that plays into one of our strengths, which is a very short reach, 112G SerDes technology.
Okay. Thanks, Luc. Congratulations again.
Thank you.
Thanks, Suji.
If you have a question, please press star one on your touch-tone telephone. 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.
Thank you everyone who has joined us today for your continued interest and time. We hope each one of you stays safe and healthy and look forward to speaking with you again soon. Have a great day.
Thank you. This now concludes today's conference. You may now disconnect.