10-Q 1 rmbs-2017930x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________
FORM 10-Q
_______________________________
(Mark One)
ý     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 000-22339
_______________________________
RAMBUS INC.
(Exact name of registrant as specified in its charter)
_______________________________
Delaware
 
94-3112828
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
1050 Enterprise Way, Suite 700
 Sunnyvale, California
 
 
 
94089
(Address of principal executive offices)
 
 
 
(ZIP Code)

Registrant’s telephone number, including area code: (408) 462-8000
_______________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
 
Accelerated filer o
 
 
 
Non-accelerated filer o (Do not check if a smaller reporting company)
 
Smaller reporting company o
 
 
 
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. o




Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
The number of shares outstanding of the registrant’s Common Stock, par value $.001 per share, was 109,778,058 as of September 30, 2017.



RAMBUS INC.
TABLE OF CONTENTS
 
 
PAGE
Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017 and 2016
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016

3


NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. These forward-looking statements include, without limitation, predictions regarding the following aspects of our future:
Success in the markets of our products and services or our customers’ products;
Sources of competition;
Research and development costs and improvements in technology;
Sources, amounts and concentration of revenue, including royalties;
Success in signing and renewing license agreements;
Terms of our licenses and amounts owed under license agreements;
Technology product development;
Dispositions, acquisitions, mergers or strategic transactions and our related integration efforts, including our acquisitions of Smart Card Software Ltd., the assets of Semtech Corporation's Snowbush IP group and Inphi Corporation's Memory Interconnect Business;
Impairment of goodwill and long-lived assets;
Pricing policies of our customers;
Changes in our strategy and business model, including the expansion of our portfolio of inventions, products, software, services and solutions to address additional markets in lighting, memory, chip, mobile payments, smart ticketing and security;
Deterioration of financial health of commercial counterparties and their ability to meet their obligations to us;
Effects of security breaches or failures in our or our customers’ products and services on our business;
Engineering, sales and general and administration expenses;
Contract revenue;
Operating results;
International licenses, operations and expansion;
Effects of changes in the economy and credit market on our industry and business;
Ability to identify, attract, motivate and retain qualified personnel;
Effects of government regulations on our industry and business;
Manufacturing, shipping and supply partners and/or sale and distribution channels;
Growth in our business;
Methods, estimates and judgments in accounting policies;
Adoption of new accounting pronouncements, including our expectations regarding the new revenue recognition standard on our financial position, results of operations or cash flows;
Effective tax rates;
Restructurings and plans of termination;
Realization of deferred tax assets/release of deferred tax valuation allowance;
Trading price of our common stock;
Internal control environment;
The level and terms of our outstanding debt and the repayment or financing of such debt;
Protection of intellectual property;
Any changes in laws, agency actions and judicial rulings that may impact the ability to enforce intellectual property rights;
Indemnification and technical support obligations;
Equity repurchase plans;

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Issuances of debt or equity securities, which could involve restrictive covenants or be dilutive to our existing stockholders;
Effects of fluctuations in currency exchange rates;
Outcome and effect of potential future intellectual property litigation and other significant litigation; and
Likelihood of paying dividends.
You can identify these and other forward-looking statements by the use of words such as “may,” “future,” “shall,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” “projecting” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.
Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Part II: Item 1A, “Risk Factors.” All forward-looking statements included in this document are based on our assessment of information available to us at this time. We assume no obligation to update any forward-looking statements.


5


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
RAMBUS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2017
 
December 31,
2016
 
(In thousands, except shares
and par value)
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
182,345

 
$
135,294

Marketable securities
1,287

 
36,888

Accounts receivable
49,799

 
21,099

Inventories
5,015

 
5,633

Prepaids and other current assets
10,998

 
17,867

Total current assets
249,444

 
216,781

Intangible assets, net
102,545

 
132,388

Goodwill
209,318

 
204,794

Property, plant and equipment, net
54,035

 
58,442

Deferred tax assets
206,503

 
168,342

Other assets
2,283

 
2,749

Total assets
$
824,128

 
$
783,496

LIABILITIES & STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
7,016

 
$
9,793

Accrued salaries and benefits
12,278

 
14,177

Convertible notes, short-term
131,490

 

Deferred revenue
21,224

 
16,932

Other current liabilities
10,731

 
10,399

Total current liabilities
182,739

 
51,301

Convertible notes, long-term

 
126,167

Long-term imputed financing obligation
37,471

 
38,029

Other long-term liabilities
14,381

 
15,217

Total liabilities
234,591

 
230,714

Commitments and contingencies (Notes 9 and 13)


 


Stockholders’ equity:
 

 
 

Convertible preferred stock, $.001 par value:
 

 
 

Authorized: 5,000,000 shares
 

 
 

Issued and outstanding: no shares at September 30, 2017 and December 31, 2016

 

Common stock, $.001 par value:
 

 
 

Authorized: 500,000,000 shares
 

 
 

Issued and outstanding: 109,778,058 shares at September 30, 2017 and 111,053,734 shares at December 31, 2016
110

 
111

Additional paid-in capital
1,187,987

 
1,181,230

Accumulated deficit
(592,863
)
 
(615,051
)
Accumulated other comprehensive loss
(5,697
)
 
(13,508
)
Total stockholders’ equity
589,537

 
552,782

Total liabilities and stockholders’ equity
$
824,128

 
$
783,496

See Notes to Unaudited Condensed Consolidated Financial Statements

6


RAMBUS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) 

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands, except per share amounts)
Revenue:
 

 
 

 
 

 
 

Royalties
$
72,787

 
$
68,298

 
$
211,733

 
$
194,010

Product revenue
8,661

 
7,092

 
27,966

 
14,306

Contract and other revenue
17,686

 
14,465

 
51,506

 
30,722

Total revenue
99,134

 
89,855

 
291,205

 
239,038

Operating costs and expenses:
 

 
 

 
 

 
 

Cost of product revenue*

5,152

 
7,031

 
17,882

 
12,581

Cost of contract and other revenue
14,456

 
12,393

 
43,274

 
33,139

Research and development*
36,196

 
33,820

 
109,718

 
91,100

Sales, general and administrative*
26,799

 
24,795

 
82,122

 
69,679

Gain from sale of intellectual property
(479
)
 

 
(479
)
 

Gain from settlement

 

 

 
(579
)
Total operating costs and expenses
82,124

 
78,039

 
252,517

 
205,920

Operating income
17,010

 
11,816

 
38,688

 
33,118

Interest income and other income (expense), net
208

 
142

 
491

 
1,522

Interest expense
(3,287
)
 
(3,193
)
 
(9,754
)
 
(9,497
)
Interest and other income (expense), net
(3,079
)
 
(3,051
)
 
(9,263
)
 
(7,975
)
Income before income taxes
13,931

 
8,765

 
29,425

 
25,143

Provision for income taxes
6,236

 
4,254

 
16,119

 
14,878

Net income
$
7,695

 
$
4,511

 
$
13,306

 
$
10,265

Net income per share:
 

 
 

 
 

 
 

Basic
$
0.07

 
$
0.04

 
$
0.12

 
$
0.09

Diluted
$
0.07

 
$
0.04

 
$
0.12

 
$
0.09

Weighted average shares used in per share calculation:
 

 
 

 
 

 
 

Basic
109,555

 
110,214

 
110,353

 
109,951

Diluted
113,119

 
113,723

 
113,861

 
112,805

_________________________________________
*    Includes stock-based compensation:
Cost of product revenue
$
20

 
$
14

 
$
53

 
$
42

Research and development
$
2,969

 
$
2,337

 
$
9,048

 
$
6,526

Sales, general and administrative
$
3,975

 
$
3,092

 
$
11,068

 
$
8,788


See Notes to Unaudited Condensed Consolidated Financial Statements

7


RAMBUS INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Net income
 
$
7,695

 
$
4,511

 
$
13,306

 
$
10,265

Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Foreign currency translation adjustment
 
2,581

 
(2,704
)
 
7,177

 
(8,903
)
Unrealized gain (loss) on marketable securities, net of tax
 
339

 
(374
)
 
634

 
(745
)
Total comprehensive income
 
$
10,615

 
$
1,433

 
$
21,117

 
$
617


See Notes to Unaudited Condensed Consolidated Financial Statements

8


RAMBUS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) 
 
Nine Months Ended
 
September 30,
 
2017
 
2016
 
(In thousands)
Cash flows from operating activities:
 

 
 

Net income
$
13,306

 
$
10,265

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Stock-based compensation
20,169

 
15,356

Depreciation
9,971

 
9,388

Amortization of intangible assets
31,436

 
26,045

Non-cash interest expense and amortization of convertible debt issuance costs
5,324

 
5,025

Deferred income taxes
(4,108
)
 
(4,157
)
Excess tax benefits from stock-based compensation

 
(927
)
(Gain) loss from disposal of property, plant and equipment
169

 
(29
)
Effect of exchange rate on assumed cash liability from acquisition

 
(985
)
Change in operating assets and liabilities, net of impact of acquisitions:
 

 
 

Accounts receivable
(23,656
)
 
333

Prepaid expenses and other assets
6,824

 
(3,143
)
Inventories
617

 
(744
)
Accounts payable
(2,795
)
 
2,302

Accrued salaries and benefits and other liabilities
(2,658
)
 
(4,772
)
Deferred revenue
3,248

 
7,532

Net cash provided by operating activities
57,847

 
61,489

Cash flows from investing activities:
 

 
 

Purchases of property, plant and equipment
(5,444
)
 
(4,750
)
Acquisition of intangible assets
(120
)
 

Purchases of marketable securities

 
(54,869
)
Maturities of marketable securities
32,048

 
85,746

Proceeds from sale of marketable securities
4,450

 
50,546

Proceeds from sale of property, plant and equipment
28

 

Acquisitions of businesses, net of cash acquired

 
(202,523
)
Net cash provided by (used in) investing activities
30,962

 
(125,850
)
Cash flows from financing activities:
 
 
 
Proceeds received from issuance of common stock under employee stock plans
10,792

 
12,277

Principal payments against lease financing obligation
(625
)
 
(476
)
Payments of taxes on restricted stock units
(3,525
)
 
(1,861
)
Repurchase and retirement of common stock, including prepayment under accelerated
share repurchase program
(50,036
)
 

Excess tax benefits from stock-based compensation

 
927

Net cash provided by (used in) financing activities
(43,394
)
 
10,867

Effect of exchange rate changes on cash and cash equivalents
1,636

 
(791
)
Net increase (decrease) in cash and cash equivalents
47,051

 
(54,285
)
Cash and cash equivalents at beginning of period
135,294

 
143,764

Cash and cash equivalents at end of period
$
182,345

 
$
89,479

 
 
 
 
Non-cash investing activities during the period:
 

 
 

Property, plant and equipment received and accrued in accounts payable and other liabilities
$
1,294

 
$
1,344

Non-cash financing activities during the period:
 
 
 
Additional purchase consideration from acquisition
$

 
$
10,779


See Notes to Unaudited Condensed Consolidated Financial Statements

9


RAMBUS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Rambus Inc. (“Rambus” or the “Company”) and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements.
In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring items) necessary to state fairly the financial position and results of operations for each interim period presented. Interim results are not necessarily indicative of results for a full year.
The unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable to interim financial information. Certain information and Note disclosures included in the financial statements prepared in accordance with generally accepted accounting principles have been omitted in these interim statements pursuant to such SEC rules and regulations. The information included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto in Form 10-K for the year ended December 31, 2016.
Operating Segment Definitions
Operating segments are based upon Rambus' internal organization structure, the manner in which its operations are managed, the criteria used by its Chief Operating Decision Maker ("CODM") to evaluate segment performance and availability of separate financial information regularly reviewed for resource allocation and performance assessment.
The Company determined its CODM to be the Chief Executive Officer and determined its operating segments to be: (1) Memory and Interfaces Division ("MID"), which focuses on the design, development, manufacturing through partnerships and licensing of technology and solutions that is related to memory and interfaces; (2) Rambus Security Division ("RSD"), which focuses on the design, development, deployment and licensing of technologies for chip, system and in-field application security, anti-counterfeiting, smart ticketing and mobile payments; (3) Emerging Solutions Division ("ESD"), which includes the Rambus Labs team, the computational sensing and imaging group as well as the development efforts in the area of emerging technologies; and (4) Rambus Lighting Division ("RLD"), which focuses on the design, development and licensing of technologies for advanced LED-based lighting solutions.
For the three and nine months ended September 30, 2017, only MID and RSD were reportable segments as each of them met the quantitative thresholds for disclosure as a reportable segment. The results of the remaining other operating segments were shown under “Other.”
Reclassifications
Certain prior periods' amounts were reclassified to conform to the current year’s presentation. None of these reclassifications had an impact on reported net income for any of the periods presented. Product revenue and related cost of product revenue were reclassified from contract and other revenue and cost of contract and other revenue, respectively. Refer to the Unaudited Condensed Consolidated Statements of Operations.
2. Recent Accounting Pronouncements
In July 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2017-11, "Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815)." The amendments in Part I of this ASU change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial

10


conversion features (in Subtopic 470-20, Debt-Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this ASU recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the FASB codification, to a scope exception. Those amendments do not have an accounting effect. This ASU is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, "Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting," which amends the scope of modification accounting for share-based payment arrangements. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This ASU is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Topic 310): Premium Amortization on Purchased Callable Debt Securities," which amends the amortization period for certain purchased callable debt securities held at a premium. This ASU will shorten the amortization period for the premium to be amortized to the earliest call date. This ASU does not apply to securities held at a discount, which will continue to be amortized to maturity. This ASU is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment," which removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business." The amendment seeks to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. This ASU is effective for interim and annual reporting periods beginning after December 15, 2017, including interim periods within those periods. The amendments should be applied prospectively on or after the effective dates. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15 which amends the guidance on the classification of certain cash receipts and payments in the statement of cash flows. This ASU is effective for annual and interim reporting periods beginning after December 15, 2017 and is applied retrospectively. Early adoption is permitted including adoption in an interim period. The Company is currently evaluating the impact that this guidance will have on its financial condition and results of operations.
In June 2016, the FASB issued ASU No. 2016-13. The purpose of this ASU is to require a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019. The Company is currently evaluating the impact that this guidance will have on its financial condition and results of operations.
In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting." This ASU simplifies the accounting for share-based payment transactions including the accounting for income taxes, forfeitures, statutory tax withholding requirements and classification in the statement of cash flows. The updated standard no longer requires cash flows related to excess tax benefits to be presented as a financing activity separate from other income tax cash flows. The update also allows entities to repurchase more of an employee's shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments to taxing authorities made on an employee's behalf for withheld shares should be presented as a financing activity on the statement of cash flows, and provides for an accounting policy election to account for forfeitures as they occur. The Company adopted this ASU on January 1, 2017. The impact of the adoption is as follows:
This ASU requires excess tax benefits to be recognized regardless of whether the benefit reduces taxes payable. The adoption of this guidance on a modified retrospective basis resulted in the recognition of a cumulative-effect adjustment of $38.2 million that reduced the Company's accumulated deficit and increased its deferred tax assets as of January 1, 2017. The previously unrecognized California excess tax effects were recorded as a deferred tax asset net of a valuation allowance.

11


The Company has elected to continue to estimate forfeitures expected to occur to determine the amount of stock-based compensation cost to be recognized in each period. As such, the guidance relating to forfeitures did not have an impact on its accumulated deficit as of January 1, 2017.
Additionally, the Company anticipates the potential for increased periodic volatility in future effective tax rates as a result of the continued application of ASU No. 2016-09.
In February 2016, the FASB issued ASU No. 2016-02, "Leases." This ASU requires lessees to recognize right-of-use assets and liabilities for operating leases, initially measured at the present value of the lease payments, on the balance sheet. In addition, it requires lessees to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This ASU will become effective for the Company in the first quarter of fiscal year 2019, and requires adoption using a modified retrospective approach. The Company is evaluating the impact of adopting this new accounting standard update on its consolidated financial statements and related disclosures and anticipates this new guidance will materially impact the Company’s financial statements given the Company has a significant number of operating leases.
In July 2015, the FASB issued ASU No. 2015-11, "Simplifying the Measurement of Inventory (Topic 330)," which applies to inventory that is measured using first-in, first-out (“FIFO”) or average cost. Under the updated guidance, an entity should measure inventory that is within scope at the lower of cost and net realizable value, which is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Subsequent measurement is unchanged for inventory that is measured using last-in, last-out (“LIFO”). This ASU is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively with early adoption permitted at the beginning of an interim or annual reporting period. The Company adopted this ASU on January 1, 2017. The adoption of this ASU did not have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“Standard”). The core principle of the Standard is for a company to recognize revenue for goods or services transferred to customers in an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services. To do so, a company will be required to exercise more judgment and make more estimates than under current guidance, including in identifying the performance obligations included in the arrangement, estimating and revising the variable consideration, if any, to be included in the transaction price and allocating the transaction price to distinct performance obligations. The FASB further clarified the Standard by issuing ASU No. 2016-10 (Identifying Performance Obligations and Licensing); ASU No. 2016-12 (Narrow-Scope Improvements and Practical Expedients); and ASU No. 2016-20 (Technical Corrections and Improvements).
The Standard may be applied retrospectively to each prior period presented (full retrospective method) or retrospectively with the cumulative effect recognized as of the date of initial application (modified retrospective method). The Standard, as amended, is effective for the Company on January 1, 2018. The Company has yet to make a final decision regarding the adoption method it will use but believes it will adopt the Standard on a full retrospective basis, with a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2016 determined on the basis of the impact of the Standard on the accounting for contracts that are not completed as of that date.
Although the Company has yet to finalize its evaluation and quantification of the effects that the Standard will have on its consolidated financial statements, and to finalize the design and implementation of related changes to its policies, procedures and controls, the Company expects the Standard to materially impact the timing of revenue recognition for its fixed-fee intellectual property (IP) licensing arrangements (including certain fixed-fee agreements that license the Company's existing IP portfolio as well as IP added to this portfolio during the license term) as a majority of such revenue would be recognized at inception of the license term, as opposed to over time as is the case under current U.S. GAAP, and the Company will be required to compute and recognize interest income over time as control over the IP generally transfers significantly in advance of cash being received from customers. In addition, the Company is currently assessing its minimum guarantee contracts to determine whether, under the Standard, revenue should be recognized at contract inception or over the contract term. The Company expects that any change to current revenue recognition practices may significantly increase volatility in its quarterly revenue trends.
In accordance with existing U.S. GAAP, the Company currently recognizes revenue from per-unit royalty-based IP licenses in the period the licensee reports its sales, generally in the quarter after the underlying sales by the licensee occurred. On adoption of the Standard, such royalties will be recognized as revenue during the period in which the licensee's sales are estimated to have occurred, which will result in an adjustment to revenue when actual amounts are subsequently reported by the Company's licensees.
As part of the Company’s assessment and implementation plan, the Company is evaluating and implementing changes to its policies, procedures and controls.


12


3. Earnings Per Share
Basic earnings per share is calculated by dividing the net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing the earnings by the weighted average number of common shares and potentially dilutive securities outstanding during the period. Potentially dilutive common shares consist of incremental common shares issuable upon exercise of stock options, employee stock purchases, restricted stock and restricted stock units and shares issuable upon the conversion of convertible notes. The dilutive effect of outstanding shares is reflected in diluted earnings per share by application of the treasury stock method. This method includes consideration of the amounts to be paid by the employees and the amount of unrecognized stock-based compensation related to future services. No potential dilutive common shares are included in the computation of any diluted per share amount when a net loss is reported.
The following table sets forth the computation of basic and diluted net income per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income per share:
(In thousands, except per share amounts)
Numerator:
 

 
 

 
 
 
 
Net income
$
7,695

 
$
4,511

 
$
13,306

 
$
10,265

Denominator:
 
 
 
 
 
 
 
Weighted-average shares outstanding - basic
109,555

 
110,214

 
110,353

 
109,951

Effect of potential dilutive common shares
3,564

 
3,509

 
3,508

 
2,854

Weighted-average shares outstanding - diluted
113,119

 
113,723

 
113,861

 
112,805

Basic net income per share
$
0.07

 
$
0.04

 
$
0.12

 
$
0.09

Diluted net income per share
$
0.07

 
$
0.04

 
$
0.12

 
$
0.09

For the three months ended September 30, 2017 and 2016, options to purchase approximately 1.8 million and 1.8 million shares, respectively, and for the nine months ended September 30, 2017 and 2016, options to purchase approximately 1.9 million and 2.2 million shares, respectively, were excluded from the calculation because they were anti-dilutive after considering proceeds from exercise and related unrecognized stock-based compensation expense.
4. Intangible Assets and Goodwill
Goodwill
The following tables present goodwill information for each of the reportable segments for the nine months ended September 30, 2017:
Reportable Segment:
 
As of December 31, 2016
 
Additions to Goodwill (1)
 
Impairment of Goodwill
 
Effect of Exchange Rates (2)
 
As of September 30, 2017
 
 
(In thousands)
MID
 
$
66,643

 
$

 
$

 
$

 
$
66,643

RSD
 
138,151

 
803

 

 
3,721

 
142,675

Total
 
$
204,794

 
$
803

 
$

 
$
3,721

 
$
209,318

(1) During the first quarter of 2017, the Company corrected an immaterial error related to an overstatement in prepaids and other current assets that originated in 2016.

(2) Effect of exchange rates relates to foreign currency translation adjustments for the period.
 

13


 
 
As of
 
 
September 30, 2017
Reportable Segment:
 
Gross Carrying Amount
 
Accumulated Impairment Losses
 
Net Carrying Amount
 
 
(In thousands)
MID
 
$
66,643

 
$

 
$
66,643

RSD
 
142,675

 

 
142,675

Other
 
21,770

 
(21,770
)
 

Total
 
$
231,088

 
$
(21,770
)
 
$
209,318

Intangible Assets
The components of the Company’s intangible assets as of September 30, 2017 and December 31, 2016 were as follows:
 
 
 
As of September 30, 2017
 
Useful Life
 
Gross Carrying
 Amount (1)
 
Accumulated
 Amortization
 
Net Carrying
 Amount
 
 
 
(In thousands)
Existing technology
3 to 10 years
 
$
258,792

 
$
(183,590
)
 
$
75,202

Customer contracts and contractual relationships
1 to 10 years
 
68,376

 
(46,133
)
 
22,243

Non-compete agreements and trademarks
3 years
 
300

 
(300
)
 

In-process research and development
Not applicable
 
5,100

 

 
5,100

Total intangible assets
 
 
$
332,568


$
(230,023
)
 
$
102,545

(1) The change in gross carrying amount reflects the effects of exchange rates during the period.

 
 
 
As of December 31, 2016
 
Useful Life
 
Gross Carrying
 Amount
 
Accumulated
 Amortization
 
Net Carrying
 Amount
 
 
 
(In thousands)
Existing technology
3 to 10 years
 
$
256,656

 
$
(156,577
)
 
$
100,079

Customer contracts and contractual relationships
1 to 10 years
 
65,109

 
(37,900
)
 
27,209

Non-compete agreements and trademarks
3 years
 
300

 
(300
)
 

In-process research and development
Not applicable
 
5,100

 

 
5,100

Total intangible assets
 
 
$
327,165

 
$
(194,777
)
 
$
132,388


During the three and nine months ended September 30, 2017, the Company acquired patents related to its memory technology for an immaterial amount. During the three and nine months ended September 30, 2016, the Company did not sell any intangible assets.

Included in customer contracts and contractual relationships are favorable contracts which are acquired software and service agreements where the Company has no performance obligations. Cash received from these acquired favorable contracts reduces the favorable contract intangible asset. For the three months ended September 30, 2017 and 2016, the Company received $0.5 million and $0.6 million, respectively, related to the favorable contracts. For the nine months ended September 30, 2017 and 2016, the Company received $2.8 million and $4.7 million, respectively, related to the favorable contracts. As of September 30, 2017 and December 31, 2016, the net balance of the favorable contract intangible assets was $2.2 million and $3.6 million, respectively.

14


Amortization expense for intangible assets for the three and nine months ended September 30, 2017 was $10.5 million and $31.4 million, respectively. Amortization expense for intangible assets for the three and nine months ended September 30, 2016, was $10.2 million and $26.0 million, respectively. The estimated future amortization of intangible assets as of September 30, 2017 was as follows (amounts in thousands):
Years Ending December 31:
Amount
2017 (remaining 3 months)
$
11,775

2018
29,624

2019
19,877

2020
19,133

2021
12,653

Thereafter
9,483

 
$
102,545


It is reasonably possible that the businesses could perform significantly below the Company's expectations or a deterioration of market and economic conditions could occur. This would adversely impact the Company's ability to meet its projected results, which could cause the goodwill in any of its reporting units or long-lived assets in any of its asset groups to become impaired. Significant differences between these estimates and actual cash flows could materially affect the Company's future financial results. If the Company determines that its goodwill or long-lived assets are impaired, it would be required to record a non-cash charge that could have a material adverse effect on its results of operations and financial position.

5.  Segments and Major Customers
For the three and nine months ended September 30, 2017, MID and RSD were reportable segments as each of them met the quantitative thresholds for disclosure as a reportable segment. The results of the remaining operating segments were shown under “Other.”
The Company evaluates the performance of its segments based on segment operating income (loss), which is defined as revenue minus segment operating expenses. Segment operating expenses are comprised of direct operating expenses.
Segment operating expenses do not include sales, general and administrative expenses and the allocation of certain expenses managed at the corporate level, such as stock-based compensation, amortization, and certain bonus and acquisition costs. The “Reconciling Items” category includes these unallocated sales, general and administrative expenses as well as corporate level expenses.
The tables below present reported segment operating income (loss) for the three and nine months ended September 30, 2017 and 2016, respectively.
 
For the Three Months Ended September 30, 2017
 
For the Nine Months Ended September 30, 2017
 
MID
 
RSD
 
Other
 
Total
 
MID
 
RSD
 
Other
 
Total
 
(In thousands)
 
(In thousands)
Revenues
$
68,787

 
$
26,312

 
$
4,035

 
$
99,134

 
$
206,784

 
$
72,883

 
$
11,538

 
$
291,205

Segment operating expenses
21,130

 
11,796

 
7,802

 
40,728

 
65,187

 
36,409

 
25,191

 
126,787

Segment operating income (loss)
$
47,657

 
$
14,516

 
$
(3,767
)
 
$
58,406

 
$
141,597

 
$
36,474

 
$
(13,653
)
 
$
164,418

Reconciling items
 

 
 
 
 

 
(41,396
)
 
 

 
 
 
 

 
(125,730
)
Operating income
 

 
 
 
 

 
$
17,010

 
 

 
 
 
 

 
$
38,688

Interest and other income (expense), net
 

 
 
 
 

 
(3,079
)
 
 

 
 
 
 

 
(9,263
)
Income before income taxes
 

 
 
 
 

 
$
13,931

 
 

 
 
 
 

 
$
29,425


15


 
For the Three Months Ended September 30, 2016
 
For the Nine Months Ended September 30, 2016
 
MID
 
RSD
 
Other
 
Total
 
MID
 
RSD
 
Other
 
Total
 
(In thousands)
 
(In thousands)
Revenues
$
63,142

 
$
22,532

 
$
4,181

 
$
89,855

 
$
171,154

 
$
53,040

 
$
14,844

 
$
239,038

Segment operating expenses
20,060

 
12,493

 
6,840

 
39,393

 
44,797

 
37,507

 
21,594

 
103,898

Segment operating income (loss)
$
43,082

 
$
10,039

 
$
(2,659
)
 
$
50,462

 
$
126,357

 
$
15,533

 
$
(6,750
)
 
$
135,140

Reconciling items
 

 
 
 
 

 
(38,646
)
 
 

 
 
 
 

 
(102,022
)
Operating income
 

 
 
 
 

 
$
11,816

 
 

 
 
 
 

 
$
33,118

Interest and other income (expense), net
 

 
 
 
 

 
(3,051
)
 
 

 
 
 
 

 
(7,975
)
Income before income taxes
 

 
 
 
 

 
$
8,765

 
 

 
 
 
 

 
$
25,143

The Company’s CODM does not review information regarding assets on an operating segment basis. Additionally, the Company does not record intersegment revenue or expense.
Accounts receivable from the Company's major customers representing 10% or more of total accounts receivable at September 30, 2017 and December 31, 2016, respectively, was as follows:
 
 
As of
Customer 
 
September 30, 2017
 
December 31, 2016
Customer 1 (RSD reportable segment)
 
*

 
17
%
Customer 2 (Other segment)
 
*

 
12
%
Customer 3 (MID reportable segment)
 
12
%
 
13
%
Customer 4 (MID reportable segment)
 
19
%
 
*

Customer 5 (MID reportable segment)
 
10
%
 
*

_________________________________________
*    Customer accounted for less than 10% of total accounts receivable in the period
Revenue from the Company’s major customers representing 10% or more of total revenue for the three and nine months ended September 30, 2017 and 2016, respectively, was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
Customer 
 
2017
 
2016
 
2017
 
2016
Customer A (MID and RSD reportable segments)
 
18
%
 
17
%
 
17
%
 
20
%
Customer B (MID reportable segment)
 
12
%
 
19
%
 
13
%
 
20
%
Customer C (MID reportable segment)
 
13
%
 
13
%
 
13
%
 
13
%

Revenue from customers in the geographic regions based on the location of contracting parties was as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
South Korea
 
$
29,476

 
$
32,519

 
$
86,736

 
$
95,604

USA
 
43,532

 
32,951

 
123,115

 
84,835

Japan
 
4,933

 
9,551

 
18,508

 
20,449

Europe
 
9,160

 
4,271

 
17,850

 
12,362

Canada
 
933

 
1,162

 
3,353

 
2,544

Singapore
 
4,927

 
4,429

 
17,563

 
13,574

Asia-Other
 
6,173

 
4,972

 
24,080

 
9,670

Total
 
$
99,134

 
$
89,855

 
$
291,205

 
$
239,038


6. Marketable Securities
Rambus invests its excess cash and cash equivalents primarily in U.S. government-sponsored obligations, commercial paper, corporate notes and bonds, money market funds and municipal notes and bonds that mature within three years.  As of

16


September 30, 2017 and December 31, 2016, all of the Company’s cash equivalents and marketable securities had a remaining maturity of less than one year.
All cash equivalents and marketable securities are classified as available-for-sale. Total cash, cash equivalents and marketable securities are summarized as follows:
 
 
As of September 30, 2017
(In thousands)
 
Fair Value
 
Amortized
 Cost
 
Gross
 Unrealized
 Gains
 
Gross
 Unrealized
 Losses
 
Weighted
 Rate of
 Return
Money market funds
 
$
12,882

 
$
12,882

 
$

 
$

 
0.90
%
U.S. Government bonds and notes
 
30,489

 
30,491

 

 
(2
)
 
0.95
%
Corporate notes, bonds, commercial paper and other
 
98,887

 
98,900

 

 
(13
)
 
1.13
%
Total cash equivalents and marketable securities
 
142,258

 
142,273

 

 
(15
)
 
 

Cash
 
41,374

 
41,374

 

 

 
 

Total cash, cash equivalents and marketable securities
 
$
183,632

 
$
183,647

 
$

 
$
(15
)
 
 

 
 
As of December 31, 2016
(In thousands)
 
Fair Value
 
Amortized
 Cost
 
Gross
 Unrealized
 Gains
 
Gross
 Unrealized
 Losses
 
Weighted
 Rate of
 Return
Money market funds
 
$
10,681

 
$
10,681

 
$

 
$

 
0.41
%
U.S. Government bonds and notes
 
48,292

 
48,291

 
1

 

 
0.39
%
Corporate notes, bonds, commercial paper and other
 
62,178

 
62,199

 

 
(21
)
 
0.66
%
Total cash equivalents and marketable securities
 
121,151

 
121,171

 
1

 
(21
)
 
 

Cash
 
51,031

 
51,031

 

 

 
 

Total cash, cash equivalents and marketable securities
 
$
172,182

 
$
172,202

 
$
1

 
$
(21
)
 
 


Available-for-sale securities are reported at fair value on the balance sheets and classified as follows:
 
As of
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Cash equivalents
$
140,971

 
$
84,263

Short term marketable securities
1,287

 
36,888

Total cash equivalents and marketable securities
142,258

 
121,151

Cash
41,374

 
51,031

Total cash, cash equivalents and marketable securities
$
183,632

 
$
172,182


The Company continues to invest in highly rated quality, highly liquid debt securities. As of September 30, 2017, these securities have a remaining maturity of less than one year. The Company holds all of its marketable securities as available-for-sale, marks them to market, and regularly reviews its portfolio to ensure adherence to its investment policy and to monitor individual investments for risk analysis, proper valuation, and unrealized losses that may be other than temporary.


17


The estimated fair value of cash equivalents and marketable securities classified by the length of time that the securities have been in a continuous unrealized loss position at September 30, 2017 and December 31, 2016 are as follows:
 
Fair Value
 
Gross Unrealized Loss
 
September 30,
2017
 
December 31,
2016
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Less than one year
 

 
 

 
 

 
 

U.S. Government bonds and notes
$
27,489

 
$
18,395

 
$
(2
)
 
$

Corporate notes, bonds and commercial paper
97,600

 
54,377

 
(13
)
 
(21
)
Total Corporate notes, bonds, and commercial paper and U.S. Government bonds and notes
$
125,089

 
$
72,772

 
$
(15
)
 
$
(21
)

The gross unrealized loss at September 30, 2017 and December 31, 2016 was not material in relation to the Company’s total available-for-sale portfolio. The gross unrealized loss can be primarily attributed to a combination of market conditions as well as the demand for and duration of the U.S. government-sponsored obligations and corporate notes and bonds. There is no need to sell these investments, and the Company believes that it can recover the amortized cost of these investments. The Company has found no evidence of impairment due to credit losses in its portfolio. Therefore, these unrealized losses were recorded in other comprehensive income. However, the Company cannot provide any assurance that its portfolio of cash, cash equivalents and marketable securities will not be impacted by adverse conditions in the financial markets, which may require the Company in the future to record an impairment charge for credit losses which could adversely impact its financial results.
See Note 7, “Fair Value of Financial Instruments,” for discussion regarding the fair value of the Company’s cash equivalents and marketable securities.
7. Fair Value of Financial Instruments
The following table presents the financial instruments that are carried at fair value and summarizes the valuation of its cash equivalents and marketable securities by the above pricing levels as of September 30, 2017 and December 31, 2016:
 
As of September 30, 2017
 
Total
 
Quoted
 Market
 Prices in
 Active
 Markets
 (Level 1)
 
Significant
 Other
 Observable
 Inputs
 (Level 2)
 
Significant
 Unobservable
 Inputs
 (Level 3)
 
(In thousands)
Money market funds
$
12,882

 
$
12,882

 
$

 
$

U.S. Government bonds and notes
30,489

 

 
30,489

 

Corporate notes, bonds, commercial paper and other
98,887

 
1,287

 
97,600

 

Total available-for-sale securities
$
142,258

 
$
14,169

 
$
128,089

 
$

 
As of December 31, 2016
 
Total
 
Quoted
 Market
 Prices in
 Active
 Markets
 (Level 1)
 
Significant
 Other
 Observable
 Inputs
 (Level 2)
 
Significant
 Unobservable
 Inputs
 (Level 3)
 
(In thousands)
Money market funds
$
10,681

 
$
10,681

 
$

 
$

U.S. Government bonds and notes
48,292

 

 
48,292

 

Corporate notes, bonds, commercial paper and other
62,178

 
303

 
61,875

 

Total available-for-sale securities
$
121,151

 
$
10,984

 
$
110,167

 
$


The Company monitors its investments for other-than-temporary impairment and records appropriate reductions in carrying value when necessary. The Company monitors its investments for other-than-temporary losses by considering current factors,

18


including the economic environment, market conditions, operational performance and other specific factors relating to the business underlying the investment, reductions in carrying values when necessary and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in the market. Any other-than-temporary loss is reported under “Interest and other income (expense), net” in the condensed consolidated statement of operations.
For the three and nine months ended September 30, 2017 and 2016, there were no transfers of financial instruments between different categories of fair value.
The following table presents the financial instruments that are not carried at fair value but require fair value disclosure as of September 30, 2017 and December 31, 2016:
 
 
As of September 30, 2017
 
As of December 31, 2016
(In thousands)
 
Face
 Value
 
Carrying
 Value
 
Fair Value
 
Face
 Value
 
Carrying
 Value
 
Fair Value
1.125% Convertible Senior Notes due 2018 (the "2018 Notes")
 
$
138,000

 
$
131,490

 
$
163,737

 
$
138,000

 
$
126,167

 
$
173,961


The fair value of the convertible notes at each balance sheet date is determined based on recent quoted market prices for these notes which is a level 2 measurement. As discussed in Note 8, "Convertible Notes," as of September 30, 2017, the 2018 Notes are carried at their face value of $138.0 million, less any unamortized debt discount and unamortized debt issuance costs. The carrying value of other financial instruments, including accounts receivable, accounts payable and other liabilities, approximates fair value due to their short maturities.

8. Convertible Notes
The Company’s convertible notes are shown in the following table:
(In thousands)
 
As of September 30, 2017
 
As of December 31, 2016
1.125% Convertible Senior Notes due 2018
 
$
138,000

 
$
138,000

Unamortized discount
 
(6,014
)
 
(10,913
)
Unamortized debt issuance costs
 
(496
)
 
(920
)
Total convertible notes
 
$
131,490

 
$
126,167

Less current portion
 
131,490

 

Total long-term convertible notes
 
$

 
$
126,167

As of September 30, 2017, the 2018 Notes were reclassed from a long-term liability to a short-term liability as they will be due on August 15, 2018.
Interest expense related to the notes for the three and nine months ended September 30, 2017 and 2016 was as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
2018 Notes coupon interest at a rate of 1.125%
$
388

 
$
388

 
1,164

 
1,164

2018 Notes amortization of discount and debt issuance costs at an additional effective interest rate of 5.5%
1,801

 
1,699

 
5,324

 
5,025

Total interest expense on convertible notes
$
2,189

 
$
2,087

 
$
6,488

 
$
6,189



19


9. Commitments and Contingencies
As of September 30, 2017, the Company’s material contractual obligations were as follows (in thousands):
 
Total
 
Remainder of 2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Contractual obligations (1)
 

 
 

 
 

 
 

 
 

 
 

 
 

Imputed financing obligation (2)
$
17,511

 
$
1,593

 
$
6,447

 
$
6,602

 
$
2,869

 
$

 
$

Leases and other contractual obligations
28,336

 
3,020

 
6,000

 
5,631

 
4,662

 
4,793

 
4,230

Software licenses (3)
16,317

 
2,609

 
10,176

 
3,532

 

 

 

Convertible notes
138,000

 

 
138,000

 

 

 

 

Interest payments related to convertible notes
1,552

 

 
1,552

 

 

 

 

Total
$
201,716

 
$
7,222

 
$
162,175

 
$
15,765

 
$
7,531

 
$
4,793

 
$
4,230

_________________________________________
(1)
The above table does not reflect possible payments in connection with uncertain tax benefits of approximately $22.9 million including $20.7 million recorded as a reduction of long-term deferred tax assets and $2.2 million in long-term income taxes payable as of September 30, 2017. As noted below in Note 12, “Income Taxes,” although it is possible that some of the unrecognized tax benefits could be settled within the next 12 months, the Company cannot reasonably estimate the outcome at this time.
(2)
With respect to the imputed financing obligation, the main components of the difference between the amount reflected in the contractual obligations table and the amount reflected on the unaudited condensed consolidated balance sheets are the interest on the imputed financing obligation and the estimated common area expenses over the future periods. The amount includes the amended Ohio lease and the amended Sunnyvale lease.
(3)
The Company has commitments with various software vendors for non-cancellable agreements generally having terms longer than one year.
Building lease expense was approximately $1.2 million and $3.2 million for the three and nine months ended September 30, 2017, respectively. Building lease expense was approximately $1.1 million and $2.7 million for the three and nine months ended September 30, 2016, respectively. Deferred rent of $0.5 million and $0.5 million as of September 30, 2017 and December 31, 2016, respectively, was included primarily in other current liabilities.
Indemnification
From time to time, the Company indemnifies certain customers as a necessary means of doing business. Indemnification covers customers for losses suffered or incurred by them as a result of any patent, copyright, or other intellectual property infringement or any other claim by any third party arising as result of the applicable agreement with the Company. The Company generally attempts to limit the maximum amount of indemnification or liability that the Company could be exposed to under these agreements, however, this is not always possible. The fair value of the liability as of September 30, 2017 and December 31, 2016 is not material.
10. Equity Incentive Plans and Stock-Based Compensation
As of September 30, 2017, 5,287,247 shares of the 35,400,000 cumulative shares approved under both the current 2015 Equity Incentive Plan (the “2015 Plan”) and past 2006 Equity Incentive Plan (the “2006 Plan”) remain available for grant, which included an increase of 4,000,000 shares approved under the 2015 Plan. On April 23, 2015, the Company's stockholders approved the 2015 Plan, which authorizes 4,000,000 shares for future issuance plus the number of shares that remained available for grant under the 2006 Plan as of the effective date of the 2015 Plan. The 2015 Plan became effective and replaced the 2006 Plan on April 23, 2015. The 2015 Plan was the Company’s only plan for providing stock-based incentive awards to eligible employees, executive officers, non-employee directors and consultants as of September 30, 2017. No further awards will be made under the 2006 Plan, but the 2006 Plan will continue to govern awards previously granted under it. In addition, any shares subject to stock options or other awards granted under the 2006 Plan that on or after the effective date of the 2015 Plan are forfeited, cancelled, exchanged or surrendered or terminate under the 2006 Plan will become available for grant under the 2015 Plan.

20


A summary of shares available for grant under the Company’s plans is as follows:
 
Shares Available
 for Grant
Shares available as of December 31, 2016
7,305,368

Stock options granted
(498,426
)
Stock options forfeited
1,858,653

Nonvested equity stock and stock units granted (1) (2)
(4,376,615
)
Nonvested equity stock and stock units forfeited (1)
998,267

Total available for grant as of September 30, 2017
5,287,247

_________________________________________
(1)
For purposes of determining the number of shares available for grant under the 2015 Plan against the maximum number of shares authorized, each share of restricted stock granted reduces the number of shares available for grant by 1.5 shares and each share of restricted stock forfeited increases shares available for grant by 1.5 shares.
(2)
Amount includes 394,853 shares that have been reserved for potential future issuance related to certain performance unit awards granted in the first and third quarters of 2017 and discussed under the section titled "Nonvested Equity Stock and Stock Units" below.
General Stock Option Information
The following table summarizes stock option activity under the 2006 Plan and 2015 Plan for the nine months ended September 30, 2017 and information regarding stock options outstanding, exercisable, and vested and expected to vest as of September 30, 2017.
 
Options Outstanding
 
 
 
 
 
Number of
 Shares
 
Weighted
 Average
 Exercise Price
 Per Share
 
Weighted
 Average
 Remaining
 Contractual
 Term (years)
 
Aggregate
 Intrinsic
 Value
 
(In thousands, except per share amounts)
Outstanding as of December 31, 2016
7,008,833

 
$
9.34

 
 
 
 

Options granted
498,426

 
$
12.74

 
 
 
 

Options exercised
(989,613
)
 
$
7.12

 
 
 
 

Options forfeited
(1,858,653
)
 
$
10.54

 
 
 
 

Outstanding as of September 30, 2017
4,658,993

 
$
9.69

 
5.64
 
$
19,594

Vested or expected to vest at September 30, 2017
4,592,934

 
$
9.66

 
5.46
 
$
19,533

Options exercisable at September 30, 2017
3,621,650

 
$
9.13

 
4.87
 
$
17,843


No stock options that contain a market condition were granted during the three and nine months ended September 30, 2017. As of September 30, 2017 and December 31, 2016, there were 50,000 and 1,135,000, respectively, stock options outstanding that require the Company to achieve minimum market conditions in order for the options to become exercisable. The fair values of the options granted with a market condition were calculated, on their respective grant dates, using a binomial valuation model, which estimates the potential outcome of reaching the market condition based on simulated future stock prices.
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value for in-the-money options at September 30, 2017, based on the $13.35 closing stock price of Rambus’ common stock on September 29, 2017 on the NASDAQ Global Select Market, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options outstanding and exercisable as of September 30, 2017 was 4,156,223 and 3,132,148, respectively.
Employee Stock Purchase Plan
Under the 2015 Employee Stock Purchase Plan ("2015 ESPP"), the Company issued 361,994 shares at a price of $10.33 per share during the nine months ended September 30, 2017. Under the 2015 ESPP, the Company issued 340,349 shares at a price of $8.96 per share during the nine months ended September 30, 2016. As of September 30, 2017, 1,089,649 shares under the 2015 ESPP remain available for issuance.

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Stock-Based Compensation
For the nine months ended September 30, 2017 and 2016, the Company maintained stock plans covering a broad range of potential equity grants including stock options, nonvested equity stock and equity stock units and performance based instruments. In addition, the Company sponsors the 2015 ESPP, whereby eligible employees are entitled to purchase common stock semi-annually, by means of limited payroll deductions, at a 15% discount from the fair market value of the common stock as of specific dates.
Stock Options
During the three months ended September 30, 2017, the Company did not grant any stock options. During the nine months ended September 30, 2017, the Company granted 498,426 stock options with an estimated total grant-date fair value of $2.1 million. During the three and nine months ended September 30, 2017, the Company recorded stock-based compensation expense related to stock options of $0.7 million and $2.1 million, respectively.
During the three months ended September 30, 2016, the Company did not grant any stock options. During the nine months ended September 30, 2016, the Company granted 440,000 stock options with an estimated total grant-date fair value of $2.1 million. During the three and nine months ended September 30, 2016, the Company recorded stock-based compensation expense related to stock options of $1.0 million and $3.3 million, respectively.
As of September 30, 2017, there was $4.0 million of total unrecognized compensation cost, net of expected forfeitures, related to non-vested stock-based compensation arrangements granted under the stock option plans. That cost is expected to be recognized over a weighted-average period of 2.4 years. The total fair value of shares vested as of September 30, 2017 was $18.9 million.
The total intrinsic value of options exercised was $1.9 million and $5.7 million for the three and nine months ended September 30, 2017, respectively. The total intrinsic value of options exercised was $3.0 million and $7.0 million for the three and nine months ended September 30, 2016, respectively. Intrinsic value is the total value of exercised shares based on the price of the Company’s common stock at the time of exercise less the cash received from the employees to exercise the options.
During the nine months ended September 30, 2017, net proceeds from employee stock option exercises totaled approximately $7.1 million.
Employee Stock Purchase Plan
For the three and nine months ended September 30, 2017, the Company recorded compensation expense related to the 2015 ESPP of $0.4 million and $1.3 million, respectively. For the three and nine months ended September 30, 2016, the Company recorded compensation expense related to the 2015 ESPP of $0.3 million and $1.1 million, respectively. As of September 30, 2017, there was $0.1 million of total unrecognized compensation cost related to stock-based compensation arrangements granted under the 2015 ESPP. That cost is expected to be recognized over one month.
Tax benefits realized as a result of employee stock option exercises, stock purchase plan purchases, and vesting of equity stock and stock units for the three and nine months ended September 30, 2017 calculated in accordance with accounting for share-based payments were $0.2 million and $0.8 million, respectively. There were no tax benefits realized as a result of employee stock option exercises, stock purchase plan purchases, and vesting of equity stock and stock units for the three and nine months ended September 30, 2016 calculated in accordance with accounting for share-based payments.
Valuation Assumptions
The fair value of stock awards is estimated as of the grant date using the Black-Scholes-Merton (“BSM”) option-pricing model assuming a dividend yield of 0% and the additional weighted-average assumptions as listed in the table below.

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The following table presents the weighted-average assumptions used to estimate the fair value of stock options granted that contain only service conditions in the periods presented.
 
Stock Option Plan
 
Nine Months Ended
 
September 30,
 
2017
 
2016
Stock Option Plan
 

 
 

Expected stock price volatility
32
%
 
36
%
Risk free interest rate
1.8% - 1.9%

 
1.7
%
Expected term (in years)
5.3 - 5.4

 
6.1

Weighted-average fair value of stock options granted to employees
$
4.12

 
$
4.66

There were no stock options granted during the three months ended September 30, 2017 and 2016.
 
Employee Stock Purchase Plan
 
Nine Months Ended
 
September 30,
 
2017
 
2016
Employee Stock Purchase Plan
 

 
 

Expected stock price volatility
27
%
 
33
%
Risk free interest rate
0.98
%
 
0.41
%
Expected term (in years)
0.5

 
0.5

Weighted-average fair value of purchase rights granted under the purchase plan
$
2.87

 
$
2.86

Nonvested Equity Stock and Stock Units
The Company grants nonvested equity stock units to officers, employees and directors. During the three and nine months ended September 30, 2017, the Company granted nonvested equity stock units totaling 463,346 and 2,654,508 shares under the 2015 Plan. During the three and nine months ended September 30, 2016, the Company granted nonvested equity stock units totaling 884,724 and 2,909,364 shares under the 2015 Plan. These awards have a service condition, generally a service period of four years, except in the case of grants to directors, for which the service period is 1 year. For the three and nine months ended September 30, 2017, the nonvested equity stock units were valued at the date of grant giving them a fair value of approximately $6.0 million and $34.1 million. For the three and nine months ended September 30, 2016, the nonvested equity stock units were valued at the date of grant giving them a fair value of approximately $12.6 million and $37.6 million. During the first quarters of 2017 and 2016, the Company granted performance unit awards to certain Company executive officers with vesting subject to the achievement of certain performance conditions. The ultimate number of performance units that can be earned can range from 0% to 150% of target depending on performance relative to target over the applicable period. The shares earned will vest on the third anniversary of the date of grant. The Company's shares available for grant have been reduced to reflect the shares that could be earned at 150% of target.
During the third quarter of 2017, the Company granted performance unit awards to a Company executive officer with vesting subject to the achievement of certain performance and market conditions. The ultimate number of performance units that can be earned can range from 0% to 150% of target depending on performance relative to target over the applicable period. The shares that will become eligible to vest will be measured over a three-year period ending on December 31, 2019, unless the performance period is shortened because of a change of control of the Company or a termination of the executive officer’s employment without cause. The Company's shares available for grant have been reduced to reflect the shares that could be earned at 150% of target. The fair value of the market condition of these performance units was calculated, on its respective grant date, using a binomial valuation model, which estimates the potential outcome of reaching the market condition based on simulated future stock prices. The stock-based compensation expense related to these awards will be recorded over the respective requisite service period of approximately 2.4 years. During the three months ended September 30, 2017, the achievement of the performance condition for these performance units was considered probable, and as a result, the Company recognized an immaterial amount of stock-based compensation expense related to these performance unit awards.
During the three and nine months ended September 30, 2017, the Company recorded $1.2 million and $3.1 million, respectively, of stock-based compensation expense related to all outstanding nonvested performance unit awards. During the

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three and nine months ended September 30, 2016, the Company recorded $0.7 million and $2.0 million, respectively, of stock-based compensation expense related to all outstanding nonvested performance unit awards.
For the three and nine months ended September 30, 2017, the Company recorded stock-based compensation expense of approximately $5.9 million and $16.7 million related to all outstanding nonvested equity stock grants. For the three and nine months ended September 30, 2016, the Company recorded stock-based compensation expense of approximately $4.1 million and $10.9 million related to all outstanding nonvested equity stock grants. Unrecognized stock-based compensation related to all nonvested equity stock grants, net of estimated forfeitures, was approximately $46.4 million at September 30, 2017. This amount is expected to be recognized over a weighted average period of 2.5 years.
The following table reflects the activity related to nonvested equity stock and stock units for the nine months ended September 30, 2017:
Nonvested Equity Stock and Stock Units
 
Shares
 
Weighted-
 Average
 Grant-Date
 Fair Value
Nonvested at December 31, 2016
 
4,863,056

 
$
12.33

Granted
 
2,654,508

 
$
12.84

Vested
 
(835,776
)
 
$
12.23

Forfeited
 
(636,732
)
 
$
12.51

Nonvested at September 30, 2017
 
6,045,056

 
$
12.55


11.  Stockholders’ Equity
Share Repurchase Program
During the nine months ended September 30, 2017, the Company repurchased shares of its common stock under its share repurchase program as discussed below.
On January 21, 2015, the Company's Board approved a share repurchase program authorizing the repurchase of up to an aggregate of 20.0 million shares. Share repurchases under the plan may be made through the open market, established plans or privately negotiated transactions in accordance with all applicable securities laws, rules, and regulations. There is no expiration date applicable to the plan.
On May 1, 2017, the Company initiated an accelerated share repurchase program with Barclays Bank PLC. The accelerated share repurchase program is part of the broader share repurchase program previously authorized by the Company's Board on January 21, 2015. Under the accelerated share repurchase program, the Company pre-paid to Barclays Bank PLC, the $50.0 million purchase price for its common stock and, in turn, the Company received an initial delivery of approximately 3.2 million shares of its common stock from Barclays Bank PLC, in the second quarter of 2017, which were retired and recorded as a $40.0 million reduction to stockholders' equity. The remaining $10.0 million of the initial payment was recorded as a reduction to stockholders’ equity as an unsettled forward contract indexed to the Company's stock. The number of shares to be ultimately purchased by the Company will be determined based on the volume weighted average price of the common stock during the terms of the transaction, minus an agreed upon discount between the parties. The program is expected to be completed by November 2017.

As of September 30, 2017, there remained an outstanding authorization to repurchase approximately 8.3 million shares of the Company's outstanding common stock under the current share repurchase program.

The Company records stock repurchases as a reduction to stockholders’ equity. The Company records a portion of the purchase price of the repurchased shares as an increase to accumulated deficit when the price of the shares repurchased exceeds the average original proceeds per share received from the issuance of common stock. During the nine months ended September 30, 2017, the cumulative price of $29.4 million was recorded as an increase to accumulated deficit.

12. Income Taxes
The Company recorded a provision for income taxes of $6.2 million and $4.3 million for the three months ended September 30, 2017 and 2016, respectively, and $16.1 million and $14.9 million for the nine months ended September 30, 2017 and 2016, respectively. The income taxes for the three and nine months ended September 30, 2017 is primarily comprised of

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the Company's U.S. federal, state and foreign taxes and income tax expense recognized from exercises and expiration of out-of-the-money fully vested shares from equity incentive plans. Similarly, the income taxes for the three and nine months ended September 30, 2016 was primarily comprised of the Company's U.S. federal, state and foreign taxes and income tax expense recognized from exercises and expiration of shares from equity incentive plans.
During the three and nine months ended September 30, 2017, the Company paid withholding taxes of $4.7 million and $15.6 million, respectively. During the three and nine months ended September 30, 2016, the Company paid withholding taxes of $5.5 million and $16.5 million, respectively.
As of September 30, 2017, the Company’s unaudited condensed consolidated balance sheets included net deferred tax assets, before valuation allowance, of approximately $225.0 million, which consists of net operating loss carryovers, tax credit carryovers, amortization, employee stock-based compensation expenses and certain liabilities, partially reduced by deferred tax liabilities associated with the convertible notes.
The Company has U.S. federal deferred tax assets related to research and development credits, foreign tax credits and other tax attributes that can be used to offset federal taxable income in future periods. These credit carryforwards will expire if they are not used within certain time periods. As of September 30, 2017, the Company determined that there is sufficient positive evidence to conclude that it is more likely than not sufficient taxable income will exist in the future allowing the Company to recognize these deferred tax assets. It is possible that some or all these attributes could ultimately expire unused. If facts and circumstances change in the future, the Company may determine at that time a valuation allowance is necessary. A valuation allowance would materially increase the Company's tax expense in the period applied and would adversely affect its results of operations and statements of financial condition. Changes in the Company's underlying facts or circumstances, such as the impact of the acquisitions, will be continually assessed and the Company will re-evaluate its position accordingly.
As of September 30, 2017, the Company continues to maintain a valuation allowance against the majority of its state deferred tax assets. Management periodically evaluates the realizability of the Company's net deferred tax assets based on all available evidence, both positive and negative. The realizability of the Company's net deferred tax assets is dependent on its ability to generate sufficient future taxable income during periods prior to the expiration of tax attributes to fully utilize these assets. The Company continues to maintain a deferred tax asset valuation allowance of $29.0 million as of September 30, 2017.
The Company maintains liabilities for uncertain tax positions within its long-term income taxes payable accounts and as a reduction to existing deferred tax assets to the extent tax attributes are available to offset such liabilities. These liabilities involve judgment and estimation and are monitored by management based on the best information available including changes in tax regulations, the outcome of relevant court cases and other information.
As of September 30, 2017, the Company had approximately $22.9 million of unrecognized tax benefits, including $20.7 million recorded as a reduction of long-term deferred tax assets and $2.2 million in long-term income taxes payable. If recognized, approximately $2.2 million would be recorded as an income tax benefit. As of December 31, 2016, the Company had $21.9 million of unrecognized tax benefits, including $19.7 million recorded as a reduction of long-term deferred tax assets and $2.2 million recorded in long-term income taxes payable.
Although it is possible that some of the unrecognized tax benefits could be settled within the next 12 months, the Company cannot reasonably estimate the outcome at this time.
The Company recognizes interest and penalties related to uncertain tax positions as a component of the income tax provision. At September 30, 2017 and December 31, 2016, an immaterial amount of interest and penalties is included in long-term income taxes payable.
Rambus files income tax returns for the U.S., California, India, the U.K., the Netherlands and various other state and foreign jurisdictions. The U.S. federal returns are subject to examination from 2014 and forward. The California returns are subject to examination from 2010 and forward. In addition, any research and development credit carryforward or net operating loss carryforward generated in prior years and utilized in these or future years may also be subject to examination. The India returns are subject to examination from fiscal year ending March 2012 and forward. The Company is currently under examination by California for the 2010 and 2011 tax years and New York for the 2013, 2014 and 2015 tax years. The Company’s India subsidiary is under examination by the Indian tax administration for tax years beginning with 2011, except for 2014, which was assessed in the Company's favor. These examinations may result in proposed adjustments to the income taxes as filed during these periods. Management regularly assesses the likelihood of outcomes resulting from income tax examinations to determine the adequacy of their provision for income taxes and believes their provision for unrecognized tax benefits is adequate.
Additionally, the Company's future effective tax rates could be adversely affected by earnings being higher than anticipated in countries where the Company has higher statutory rates or lower than anticipated in countries where it has lower statutory rates, by changes in valuation of its deferred tax assets and liabilities or by changes in tax laws or interpretations of those laws.

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13. Litigation and Asserted Claims
Rambus is not currently a party to any material pending legal proceeding; however, from time to time, Rambus may become involved in legal proceedings or be subject to claims arising in the ordinary course of its business. Although the results of litigation and claims cannot be predicted with certainty, the Company currently believes that the final outcome of these ordinary course matters will not have a material adverse effect on our business, operating results, financial position or cash flows. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense and settlement costs, diversion of management resources and other factors.

The Company records a contingent liability when it is probable that a loss has been incurred and the amount is reasonably estimable in accordance with accounting for contingencies.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 as described in more detail under “Note Regarding Forward-Looking Statements." Our forward-looking statements are based on current expectations, forecasts and assumptions and are subject to risks, uncertainties and changes in condition, significance, value and effect. As a result of the factors described herein, and in the documents incorporated herein by reference, including, in particular, those factors described under “Risk Factors,” we undertake no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this report with the Securities and Exchange Commission.
Rambus, CryptoFirewallTM, CryptoMediaTM and CryptoManagerTM are trademarks or registered trademarks of Rambus Inc. Other trademarks that may be mentioned in this quarterly report on Form 10-Q are the property of their respective owners.




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Executive Summary
During the third quarter of 2017, we announced the industry’s first silicon-proven server DIMM buffer chipset capable of achieving the speeds expected for next-generation DDR5. Additionally, we teamed up with eftpos domestic debit card network in Australia to support the roll out of Apple Pay with tokenization software. Key 2017 third quarter financial results included:

Revenue of $99.1 million;
Total Operating Costs and Expenses of $82.1 million;
Diluted net income per share of $0.07; and
Cash flows provided by operating activities of approximately $15 million.

Business Overview
Rambus creates innovative hardware and software technologies, driving advancements from the data center to the mobile edge. Our chips, customizable IP cores, patent licenses, software, services, and other innovations improve the competitive advantage of our customers. We collaborate with the industry, partnering with leading ASIC and SoC designers, foundries, IP developers, processor companies, EDA companies and validation labs. Our innovations are integrated into a wide range of devices and systems, powering and securing diverse applications, including Big Data, Internet of Things, mobile, consumer and media platforms.

While we have historically focused our efforts on the development of technologies for memory, SerDes and other chip interfaces, we have expanded our portfolio of inventions and solutions to address chip and system security, mobile payments and smart ticketing. We intend to continue our growth into new technology fields, consistent with our mission to create value through our innovations and to make those technologies available through the shipment of products, the provisioning of services, as well as our licensing business models. Key to our efforts continues to be hiring and retaining world-class inventors, scientists and engineers to lead the development and deployment of inventions and technology solutions for our fields of focus.

Our strategy is to continue to augment our patent license business model to provide additional technology, products and services while creating and leveraging strategic synergies to increase revenue. In support of our strategy, we acquired four businesses in 2016 in the fields of mobile payments, smart ticketing, memory buffer chips and SerDes IP cores. On January 25, 2016, our Security division completed the acquisition of Smart Card Software, Ltd. (“SCS”), a privately-held company incorporated in the United Kingdom, for a pound sterling equivalent of $104.7 million in cash. Through this purchase we acquired two complementary businesses: Bell Identification Ltd., a leader in mobile payments, and Ecebs Ltd., a leading supplier of smart ticketing systems. We believe these businesses complement our security division by allowing us to extend our foundational security technology to offer differentiated, value-added security solutions to our customers.

On August 4, 2016, our Memory and Interfaces division completed the acquisition of all the assets of Inphi’s Memory Interconnect Business for $90 million in cash. The acquisition included product inventory, customer contracts, supply chain agreements and intellectual property. On August 5, 2016, our Memory and Interfaces division completed the acquisition of the assets of Semtech Corporation’s Snowbush IP group for $32 million in cash. Snowbush IP, formerly part of Semtech’s Systems Innovation Group, is a provider of silicon-proven, high-performance serial link solutions. We believe these acquisitions strengthen our market position for memory buffer chip products and bolster our SerDes and IP offerings enabling us to better address the needs of the server, networking and data center market.

Organization

We have organized the business into four operational units: (1) Memory and Interfaces, or MID, which focuses on the design, development, manufacturing through partnerships and licensing of technology and solutions that is related to memory and interfaces; (2) Security, or RSD, which focuses on the design, development, deployment and licensing of technologies for chip, system and in-field application security, anti-counterfeiting, smart ticketing and mobile payments; (3) Emerging Solutions, or ESD, which encompasses our long-term research and development efforts in the area of emerging technologies; and (4) Lighting, or RLD, which focuses on the design, development and licensing of technologies for advanced LED-based lighting solutions. As of September 30, 2017, MID and RSD met quantitative thresholds for disclosure as reportable segments. Results for ESD and RLD are shown under “Other.” For additional information concerning segment reporting, see Note 5, “Segments and Major Customers,” of Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q.





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Revenue Sources

Our inventions and technology solutions are offered to our customers through patent, technology, software and IP core licenses, as well as product sales and services. Today, our primary source of revenue is derived from patent licenses, through which we provide our customers a license to use a certain portion of our broad portfolio of patented inventions. The license provides our customers with a defined right to use our innovations in the customer’s own digital electronics products, systems or services, as applicable. The licenses may also define the specific field of use where our customers may use or employ our inventions in their products. License agreements are structured with fixed, variable or a hybrid of fixed and variable royalty payments over certain defined periods ranging for periods of up to ten years. Leading consumer product, industrial, semiconductor and system companies such as AMD, Broadcom, Cisco, Freescale, Fujitsu, GE, IBM, Intel, LSI, Micron, Nanya, NVIDIA, Panasonic, Qualcomm, Renesas, Samsung, SK hynix, STMicroelectronics, Toshiba and Xilinx have licensed our patents. The vast majority of our patents were secured through our internal research and development efforts across all of our business units. Royalties from patent licenses accounted for 68% and 67% of our consolidated revenue for the three and nine months ended September 30, 2017, respectively, as compared to 70% and 76% for the three and nine months ended September 30, 2016, respectively.

We also offer our customers technology licenses to support the implementation and adoption of our technology in their products or services. Our customers include leading companies such as Eaton, GE, IBM, Panasonic, Qualcomm, Samsung, Sony and Toshiba. Our technology license offerings include a range of technologies for incorporation into our customers’ products and systems. We also offer a range of services as part of our technology licenses which can include know-how and technology transfer, product design and development, system integration, and other services. These technology license agreements may have both a fixed price (non-recurring) component and ongoing use fees and in some cases, royalties. Further, under technology licenses, our customers typically receive licenses to our patents necessary to implement these solutions in their products with specific rights and restrictions to the applicable patents elaborated in their individual contracts with us. Royalties from technology licenses accounted for 6% of our consolidated revenue for both the three and nine months ended September 30, 2017, as well as for the three and nine months ended September 30, 2016.

The remainder of our revenue is product revenue, contract services and other revenue, which includes our product sales, IP core licenses, software licenses and related implementation, support and maintenance fees, and engineering services fees. The timing and amounts invoiced to customers can vary significantly depending on specific contract terms and can therefore have a significant impact on deferred revenue or account receivables in any given period. Product revenue accounted for 9% and 10% of our consolidated revenue for the three and nine months ended September 30, 2017, respectively, as compared to 8% and 6% for the three and nine months ended September 30, 2016, respectively. Contract and other revenue accounted for 18% of our consolidated revenue for both the three and nine months ended September 30, 2017, as compared to 16% and 13% for the three and nine months ended September 30, 2016, respectively. As we continue to execute on our strategy to augment our traditional patent licensing business model to provide additional technology, products and services, product revenue and related cost of product revenue were reclassified from contract and other revenue and cost of contract and other revenue, respectively, during the second quarter of 2017. Refer to the Unaudited Condensed Consolidated Statements of Operations of this Form 10-Q.

Expenses

Cost of product revenue for the three months ended September 30, 2017 decreased approximately $1.8 million to $5.2 million from $7.0 million for the same period in 2016 primarily due to the absence of the $1.2 million related to the purchase accounting adjustment for inventory fair value step-up from the acquisition of the Memory Interconnect Business in the third quarter of 2016. Cost of product revenue for the nine months ended September 30, 2017 increased approximately $5.3 million to $17.9 million from $12.6 million for the same period in 2016 primarily due to increased cost of sales associated with higher sales of memory and security products as we transition from legacy to new product lines.

Engineering expenses continue to play a key role in our efforts to maintain product innovations. Our engineering expenses for the three months ended September 30, 2017 increased $4.5 million as compared to the same period in 2016 primarily due to increased prototyping costs of $1.9 million, increased expenses related to software design tools of $1.5 million, increased amortization costs of $0.7 million, increased stock-based compensation expense of $0.6 million and increased headcount related expenses of $0.5 million, offset by decreased bonus accrual expense of $0.7 million, decreased consulting expenses of $0.5 million and decreased depreciation expense of $0.5 million. Engineering expenses for the nine months ended September 30, 2017 increased $28.8 million as compared to the same period in 2016 primarily due to increased headcount related expenses of $8.9 million, increased amortization costs of $5.5 million, increased expenses related to software design tools of $5.1 million, increased stock-based compensation expense of $2.5 million, increased prototyping costs of $2.4 million, increased consulting costs of $0.9 million, increased travel costs of $0.6 million and increased bonus accrual expense of $0.5 million.

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Sales, general and administrative expenses for the three months ended September 30, 2017 increased $2.0 million as compared to the same period in 2016 primarily due to increased headcount related expenses of $1.0 million, increased stock-based compensation expense of $0.9 million, increased bonus accrual expense of $0.8 million, increased depreciation expense of $0.3 million and increased sales and marketing expenses of $0.2 million, offset by decreased accounting and audit costs of $0.4 million, decreased acquisition related costs of $0.4 million and decreased consulting costs of $0.3 million. Sales, general and administrative expenses for the nine months ended September 30, 2017 increased $12.4 million as compared to the same period in 2016 primarily due to the business acquisitions during 2016. This includes increased headcount related expenses of $3.9 million, increased bonus accrual expense of $3.1 million, increased consulting costs of $2.9 million, increased stock-based compensation expense of $2.3 million, increased sales and marketing expenses of $2.0 million and increased travel costs of $1.0 million, offset by decreased acquisition related costs of $3.0 million.

Intellectual Property

As of September 30, 2017, our semiconductor, lighting, security and other technologies are covered by 2,088 U.S. and foreign patents. Additionally, we have 589 patent applications pending. Some of the patents and pending patent applications are derived from a common parent patent application or are foreign counterpart patent applications. We have a program to file applications for and obtain patents in the United States and in selected foreign countries where we believe filing for such protection is appropriate and would further our overall business strategy and objectives. In some instances, obtaining appropriate levels of protection may involve prosecuting continuation and counterpart patent applications based on a common parent application. We believe our patented innovations provide our customers with the ability to achieve improved performance, lower risk, greater cost-effectiveness and other benefits in their products and services.

Trends
There are a number of trends that may have a material impact on us in the future, including but not limited to, the evolution of memory and SerDes technology, adoption of mobile payment, smart ticketing and security solutions, adoption of LEDs in edge-lit general lighting, the use and adoption of our inventions or technologies generally, industry consolidation, and global economic conditions with the resulting impact on sales of consumer electronic systems.
We have a high degree of revenue concentration. Our top five customers for each reporting period represented approximately 57% and 56% of our revenue for the three and nine months ended September 30, 2017, respectively, as compared to 59% and 65% for the three and nine months ended September 30, 2016, respectively. For the three and nine months ended September 30, 2017, and for the three and nine months ended September 30, 2016, revenue from Micron, Samsung and SK hynix each accounted for 10% or more of our total revenue. While we expect Samsung, SK hynix and Micron to account for a significant portion of our ongoing licensing revenue, the particular customers which account for revenue concentration have varied from period-to-period as a result of the addition of new contracts, expiration of existing contracts, renewals of existing contracts, industry consolidation and the volumes and prices at which the customers have recently sold to their customers. These variations are expected to continue in the foreseeable future.
Our revenue from companies headquartered outside of the United States accounted for approximately 56% and 58% of our total revenue for the three and nine months ended September 30, 2017, respectively, as compared to 63% and 65% for the three and nine months ended September 30, 2016. We expect that revenue derived from international customers will continue to represent a significant portion of our total revenue in the future. To date, the majority of the revenue from international customers has been denominated in U.S. dollars. However, to the extent that such customers’ sales to their customers are not denominated in U.S. dollars, any revenue that we receive as a result of such sales could be subject to fluctuations in currency exchange rates. In addition, if the effective price of licensed products sold by our foreign customers were to increase as a result of fluctuations in the exchange rate of the relevant currencies, demand for licensed products could fall, which in turn would reduce our revenue. We do not use financial instruments to hedge foreign exchange rate risk. For additional information concerning international revenue, see Note 5, “Segments and Major Customers,” of Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q.
Our licensing cycle for new licensees as well as renewals for existing licensees is lengthy, costly and unpredictable without any degree of certainty. We may incur costs in any particular period before any associated revenue stream begins, if at all. Our lengthy license negotiation cycles could make our future revenue difficult to predict because we may not be successful in entering into licenses with our customers in the amounts projected, or on our anticipated timelines.
The semiconductor industry is intensely competitive and highly cyclical, limiting our visibility with respect to future sales. To the extent that macroeconomic fluctuations negatively affect our principal customers, the demand for our products and

29


technology may be significantly and adversely impacted and we may experience substantial period-to-period fluctuations in our operating results.
The royalties we receive from our semiconductor customers are partly a function of the adoption of our technologies by system companies. Many system companies purchase semiconductors containing our technologies from our customers and do not have a direct contractual relationship with us. Our customers generally do not provide us with details as to the identity or volume of licensed semiconductors purchased by particular system companies. As a result, we face difficulty in analyzing the extent to which our future revenue will be dependent upon particular system companies.
Global demand for effective security technologies continues to increase. In particular, highly integrated devices such as smart phones are increasingly used for applications requiring security such as mobile payments, corporate information and user data. Our RSD operating segment is primarily focused on positioning its DPA countermeasures, CryptoMedia™, CryptoFirewall™ and CryptoManager™ technology solutions, and the introduction of in-field applications mobile payments and smart ticketing solutions to our offerings to capitalize on these trends and growing adoption among technology partners and customers.
Engineering costs as well as sales, general and administrative expenses in the aggregate increased and cost of product revenue in the aggregate decreased in the third quarter of 2017 as compared to the same period in 2016. Cost of product revenue, engineering costs as well as sales, general and administrative expenses as a percentage of revenue decreased during the nine months ended September 30, 2017 as compared to the same period in 2016. Cost of product revenue, engineering costs as well as sales, general and administrative expenses in the aggregate increased during the nine months ended September 30, 2017 as compared to the same period in 2016. Cost of product revenue and engineering costs as a percentage of revenue increased and sales, general and administrative expenses as a percentage of revenue decreased during the nine months ended September 30, 2017 as compared to the same period in 2016. In the near term, we expect these costs in the aggregate to be higher as we intend to continue to make investments in the infrastructure and technologies required to increase our product innovation in semiconductor, security, mobile payments, smart cards and other technologies. In addition, while we have not been involved in material litigation since 2014, to the extent litigation is again necessary, our expectations on the amount and timing of any future general and administrative costs are uncertain.
As a part of our overall business strategy, from time to time, we evaluate businesses and technologies for potential acquisition that are aligned with our core business and designed to supplement our growth, including the acquisitions of SCS, the assets of the Snowbush IP group and the Memory Interconnect Business. Similarly, we evaluate our current businesses and technologies that are not aligned with our core business for potential divestiture.
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“Standard”). The Standard, as amended, is effective for us on January 1, 2018. We have yet to make a final decision regarding the adoption method we will use, but we believe we will adopt the Standard on a full retrospective basis, with a cumulative-effect adjustment to the opening balance of retained earnings on January 1, 2016 determined on the basis of the impact of the Standard on the accounting for contracts that are not completed as of that date. Although we have yet to finalize our evaluation and quantification of the effects that the Standard will have on our consolidated financial statements, and to finalize the design and implementation of related changes to our policies, procedures and controls, we expect the Standard to materially impact the timing of revenue recognition for our fixed-fee intellectual property (IP) licensing arrangements (including certain fixed-fee agreements that license our existing IP portfolio as well as IP added to our portfolio during the license term) as a majority of such revenue would be recognized at inception of the license term, as opposed to over time as is the case under current U.S. GAAP, and we will be required to compute and recognize interest income over time as control over the IP generally transfers significantly in advance of cash being received from customers. We are also evaluating the form and content of any guidance that we may provide following implementation of the Standard and expect our guidance metrics to change. We expect that any change to current revenue recognition practices may significantly increase volatility in our quarterly revenue trends.



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Results of Operations
The following table sets forth, for the periods indicated, the percentage of total revenue represented by certain items reflected in our unaudited condensed consolidated statements of operations:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 

 
 

 
 

 
 

Royalties
73.4
 %
 
76.0
 %
 
72.7
 %
 
81.2
 %
Product revenue
8.7
 %
 
7.9
 %
 
9.6
 %
 
6.0
 %
Contract and other revenue
17.9
 %
 
16.1
 %
 
17.7
 %
 
12.8
 %
Total revenue
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Operating costs and expenses:
 

 
 

 
 

 
 

Cost of product revenue*
5.2
 %
 
7.8
 %
 
6.1
 %
 
5.2
 %
Cost of contract and other revenue
14.6
 %
 
13.8
 %
 
14.9
 %
 
13.9
 %
Research and development*
36.5
 %
 
37.7
 %
 
37.7
 %
 
38.1
 %
Sales, general and administrative*
27.0
 %
 
27.6
 %
 
28.2
 %
 
29.1
 %
Gain from sale of intellectual property
(0.5
)%
 
 %
 
(0.2
)%
 
 %
Gain from settlement
 %
 
 %
 
 %
 
(0.2
)%
Total operating costs and expenses
82.8
 %
 
86.9
 %
 
86.7
 %
 
86.1
 %
Operating income
17.2
 %
 
13.1
 %
 
13.3
 %
 
13.9
 %
Interest income and other income (expense), net
0.2
 %
 
0.2
 %
 
0.2
 %
 
0.6
 %
Interest expense