PDF Solutions Inc (PDFS) 2002 Q2 法說會逐字稿

Thank you, and welcome to our second-quarter 2002 financial results conference call. By now, you should have each received a copy of the corresponding press releases. If you do not have a copy of the releases, and would like one, please refer to our website at www.PDF.com, where the press releases have been posted.

Some of the statements that will be made in the course of this conference are forward-looking, including statements regarding our future financial results and performance, growth rates, demand for our solutions, and the success of any business objectives or models, products and service features and introductions.

PDF's actual results could differ materially. You should refer to the section entitled "factors which may affect future results" on Pages 20 through 28 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2001, and similar disclosures in subsequent SEC filings.

The forward-looking statements and risks stated in this conference call are based on information available to PDF today. PDF assumes no obligation to update them.

Now, I'd like to introduce John Kibarian, PDF's president and chief executive officer, and Steve Melman, PDF's vice president, finance and administration, and chief financial officer.

John, please go ahead.

Thank you. And welcome, everyone.

The second quarter of 2002 was another record revenue quarter for us and we're pleased to report total revenue of $12.2 million and pro forma earnings per share of 6 cents.

Both total revenue and pro forma earnings per share results are in line with our prior guidance for the quarter.

These solid results make the second quarter of 2002 our 17th consecutive quarter of revenue growth. Steve will talk more about our results and provide additional details for our Q3 and total-year guidance. At the end of the call, we'll take your questions.

During the quarter, we started two new significant engagements, both of which - both with gain share potential, and continue to be the leader in process design integration space. However, the number of new engagements we signed during the second quarter are less than anticipated due to customer delays in the deployment of new technologies.

This impact is reflected in our guidance provided in today's press release.

When we held our first-quarter 2002 conference call in April, we said to you that we were not yet seeing evidence of the much talked about upturn in the semiconductor industry as a whole, and in particular, in our customers' wafer volumes. At that time, we said we were experiencing continued adoption of our design to silicone yield solutions at the smaller process nodes, which we attribute, for example, to the industry's preparation for high-volume .13 production.

As a result, we revised our forward-looking guidance mostly with respect to lowering expectations for gain share revenue, which is that portion of our revenue tied directly to production. We anticipated at that time continued spending by leading semiconductor companies on infrastructure implementations, which translate into relatively optimistic guidance on the [inaudible] portion of our revenue. What we saw at the end of the second quarter was the erosion of any optimism of an immediate upturn in the industry, and further budget restrictions on investments in new technologies, as companies began second guessing the forecast beginning of the upturn.

It became quite evident that spending was going to be delayed, and particularly at the .13 micron node, where production volumes have been lower than anticipated.

How has this scenario affected PDF Solutions? As you are probably aware, we recognize revenue from our infrastructure implementations on a percentage of completion accounting basis. Percentage of completion accounting means we were able to recognize only that portion of the total contract that we had performed during the quarter, which may be a relatively small amount of the total fixed fee in the contract. This is in contrast to perpetual software license financial models where most of the revenue for the quarter can be made on the last day. Hence, our model provides us less ability to affect a quarter's results late in the quarter, but affords us greater long-term predictability and visibility.

For the most part, the delayed contracts I mentioned earlier have not disappeared. The opportunities that existed during the second quarter are still being discussed with our clients. However, due to the industry's continued decline and lack of clarity as to its recovery, it's difficult to predict when they might close. If they close late in the third quarter of this year, because of percentage of completion accounting, they may only have a small positive effect on that quarter and consequently, the total year's revenue.

As a result, our guidance shows we anticipate that revenue is basically flat for the remainder of the year, with Q3 probably lower than Q4 as a result of some summer vacation schedules impacting the signing of contracts.

Because of our model's predictability and visibility, we've been able to react to the rapid changes in the business environment and moderate our spending appropriately. As a result, we have made budget decisions that will allow us to maintain a reasonable level of profitability during these times.

Also, because of our business model, good things that happen now mean amplified results in future periods, so I'd like to tell you what good things are happening at PDF Solutions.

We are seeing significant successes in achieving serious traction in our customer base. Although we are prohibited by the confidentiality that we've promised our customers from telling you customer names or details that are too specific, I can tell you the following: First, during the second quarter, we entered into a significant OEM contract with a world-class equipment vendor. There will be an announcement concerning this partnership in the near future, and we encourage you to stay tuned for the details. We believe that working with an equipment vendor provides PDF the opportunity to expand our product offerings into the heart of the fab.

Since it is an OEM agreement, we will be utilizing their sales and support for this product.

Second, for a world-class IDM customer, we successfully designed and produced a silicone germanian transistor for wireless applications that has achieved competitive performance to leading-edge suppliers after only two silicone experiments. Highlighting the value of PDF's simulation technologies.

Third, our infrastructure was successfully used by a world-class IDM customer to transfer a .13 advanced CMOS process into production at what we believe are world-class [inaudible] and yields.

Fourth, we successfully calibrated our yield ramp simulator to a leading-edge foundry .13 and .15 processes. As a result, our customers can now use our DBYI product to design end yield before fabbing their chip and therefore, without incurring the risks associated with reruns in initial production. This technology achievement has been validated in the marketplace in this quarter in two ways.

First, we delivered our DBYI platforms for .13 and .15 micron technologies to a leading fabless company. Second, an IDM customer validated through silicone the accuracy of our calibrated simulator. I can't overemphasize the importance to the industry to have an accurate simulator for design yields. We do not know of another product in the market that can accurately simulate a design yield for leading-edge foundry capacity and that simulator is already calibrated for the leading-edge technologies.

Lastly, as you may have seen in last week's press release, we have greatly improved the core software products on our yield ramp simulator software tool, and we will revise - be releasing version 3.0 in August.

YRS software is the [inaudible] ramp simulation software that is a key component of our DBYI and integration ramp offerings. Using this software, our client service professionals and clients are able to quickly and accurately analyze and correct the interactions of a specific IP design and its related manufacturing process. Version 3.0 will offer an order of magnitude throughput improvement over prior versions and includes more flexible [inaudible] to extract design attributes from a design or proposed design.

As we look at the customer base, it is difficult for us to predict how soon we will see real volumes at 130 nanometer. However, what is clear is our - as - that our industry innovates itself out of recession, and that means they will design their way out, whether they target 130 nanometer, 150, or even 90 nanometer, ultimately there will be more designs integrated with the growing number of derivative processes. This creates opportunities for PDF, a process design integration company.

What is also clear is that the length of a downturn strengthens companies with real technology advantage and ultimately widens their commercial advantages over their potential competitors. During the second quarter of 2002, PDF made the right strategic moves in terms of OEM agreements, technology developments, and customer agreements, positioning itself for the future.

Now I'll turn the call over to Steve, who will discuss our financial results for the second quarter, and give more detail about our projections. Steve?

Thank you, John. And good afternoon to everyone.

I'm going to talk about three things today: Our Q2 results, fiscal responsibility, and our outlook for the remainder of 2002.

For the second quarter ending June 30th, 2002, the numbers in our press release speak for themselves. Results were pretty much in the middle of the range we provided in April. Revenue of 12.2 million was up 40% compared to last year's second quarter and represented our 17th consecutive quarter of revenue growth. Pro forma EPS for the quarter was 6 cents versus 1 cent for the comparable period last year.

Design to silicone yield solutions revenue for the second quarter totaled 9.5 million, a 46% increase over the comparable period last year and up modestly - 13% - from last quarter.

Gain share revenue from four customers and six engagements totaled 2.7 million, a 23% increase over the comparable period last year, although down 11% from last quarter.

The path to consistent growth in our customers' volumes remains unclear as we enter the third quarter, and we won't be surprised to see quarterly fluctuations in gain share for the foreseeable future. However, the gain share financial model continues to be accepted by our customers, and the inclusion of the gain share component in most yield ramp engagement contracts with both new and existing customers is typical.

As a result, we remain confident that the long-term trend in gain share as a percentage of total revenue will continue upward.

Gross margin for the second quarter was 66% of total revenues, flat from the 66% reported in the first quarter of 2002.

Gross margin in - in the second fiscal quarter of 2002 increased 5% from the second quarter of 2001 due to both the impact of increased gain share and higher margin infrastructure implementations.

Total operating expenses before stock-based compensation, were 6.6 million for the quarter, up approximately 1.1 million, or 20%, from the second quarter of 2001. Operating expenses in the second quarter of 2002 represented a sequential increase of 834,000, or 15% from the first quarter of 2002.

Both increases were primarily the result of higher research and development expenses.

Research and development expenses for the second quarter increased approximately 1.1 million, or 37%, from 2.9 million for the second quarter of 2001, while sequentially increasing approximately $775,000, or 24%, from the first quarter of 2002. Both increases were primarily the result of nonrecurring engineering expenses in excess of $500,000 for development of joint products with a large semiconductor equipment manufacturer and increases in personnel-related expenses.

These increases were anticipated, and guidance was given for such an increase during the last conference call.

We anticipate nonrecurring engineering costs will decrease in the third quarter, and for the remainder of the year, and as a result, we will see a flattening or even a decrease in R and D expenditures in absolute dollars.

Selling, general, and administrative expenses were 2.6 million in the second quarter of 2002, flat with the second quarter of 2001, while increasing less than $100,000 sequentially from the first quarter.

We anticipate SG and A expenses to increase somewhat during the second half of the year as we initiate more aggressive sales and marketing efforts. It is worth noting that the previously disclosed lawsuits against PDF claiming, among other things, that PDF misappropriated trade secrets in connection with the hiring of an employee, was settled by all parties in the second quarter. As is disclosed in publicly-available court filings, there was never any evidence of wrongdoing by PDF.

All expenses related to the lawsuit have been reflected in our current financial statements.

We recorded our tax provision year to date at 34% of pretax income after adding back stock-based compensation expense. This provision is based upon our annual profit before tax projections and reflects a reduction of 4% from earlier estimates.

Pro forma net income for the quarter, excluding amortization and stock-based compensation and intangibles, totaled 1.4 million or 6 cents per share. This compares with pro forma net income of 95,000 or 1 cent per share for the second quarter of 2001. This quarter's results also represent our fifth consecutive quarter of pro forma net income.

On a GAAP basis, we were also profitable for the second sequential quarter. Both pro forma and GAAP net income were just slightly below the record levels of last quarter.

Looking at the balance sheet as of June 30th, our financial position remains strong, with approximately $67 million in cash, accounts receivable of 11.1 million, and no bank debt.

Total accounts receivable increased $951,000 from last quarter, as contract negotiations continued to reflect some contractual billing schedules skewed towards the end of customers' fiscal quarters that manifest themselves in receivables being outstanding at the end of our fiscal quarters. However, as a whole, our receivables are rock solid.

Clearly, our customers are more cash flow conscious than they have ever been, but as I will talk about in a minute, we are very conservative as to when and how we bill customers. Our un-billed accounts receivable position, included in the total accounts receivable balance, was 1.5 million at June 30th. This balance reflects nothing more than the inconsistency between contractual payment schedules and percentage of completion accounting.

I'd like to back up to comment on our cash balance, which dropped 3.2 million during the quarter.

PDF Solutions has never burned cash from operations, nor do we intend to start doing so now. You'll note that while our cash dropped, so did our liabilities. In particular, accrued compensation and related benefits dropped 2.7 million, as we paid performance incentives for 2001 during the period, and as John mentioned earlier, we invested in characterization vehicle foundry technology for our DBYI product which accounted for the majority of our $940,000 increase in net fixed assets.

At this time, I'd like to take a moment, before I turn to guidance, to talk about fiscal responsibility and integrity at PDF Solutions.

PDF, over its history, has proven its fiscal responsibility. We raised $8.5 million in total as a private company, and filed for our IPO with $7 million in the bank. We raised $62 million net in our offering, have $67 million in the bank today, and are projecting neutral to positive cash flow from operations for the remainder of the fiscal year.

We have grown the company for 17 consecutive quarters, and excluding stock compensation, we have been near break-even or profitable throughout our entire existence. Integrity has always been a top priority at PDF Solutions. We treat information and technology as a family jewel, whether it belongs to our customers, our partners, our vendors, or our employees.

Integrity is key to our financial reporting as well. Over 95% of our revenue is generated from contracts between our customers and PDF Solutions, Inc. directly. On a quarterly basis, new contracts and our percentage of completion revenue calculation are reviewed thoroughly by our outside auditors. Additionally, with the exception of contracts calling for automatic billings on a monthly or quarterly basis, our customers sign acceptance documents before we will bill them for contractual deliverables. The bottom line, our financial statements are rock solid.

Now, to reiterate the forward-looking statements made in our outlook press release today regarding projected financial results, for the third quarter of 2002, we are providing guidance for sequential revenue in a range of 11 to $12 million, and for pro forma earnings per share of 3 to 5 cents. For fiscal year 2002, we are providing guidance for revenue in the range of 46.5 to 48.5 million, and pro forma earnings per share in the range of 19 to 23 cents, reflecting, as John mentioned already, eroded optimism in the semiconductor industry's recovery in 2002 and customers that are clearly curtailing spending on new technologies.

We are also projecting to remain break-even or profitable on a GAAP basis for the second half of fiscal 2002, and should achieve neutral to positive operating cash flow for the remainder of the year.

Assuming we achieve these results or better, our year end results will show annual revenue growth of approximately 25 to 30% and annual pro forma net income growth of 150% to 200% versus 2001.

During a period of major decline in the semiconductor industry, our employees should be proud of what we have accomplished in 2002.

With that, I would like to turn the call back over to the operator to open the floor for questions. 00:23:12

Thank you. Ladies and gentlemen, if you have questions at this time, please press star, then the number 1, on your telephone keypad. If you are using a speakerphone, please lift the handset before asking a question. Please wait one moment for our first question.

Our first question comes from Greg [Wagenhoffer] of CSFB.

Hi. Good afternoon, guys.

Hi, Greg.

How you doing?

On the engagements that you mentioned were delayed or anticipated to sign in the June quarter, were these new customers or were they follow-on engagements with current customers?

Yeah, this is John. I'll take that one, Greg. I would say by and large they were newer customers. I think the customers that are already engaged with PDF understand better the value that our technology and people deliver, so it's - I think they make decisions more quickly than the ones that are evaluating this type of technology for the first time.

Okay. So is it fair to assume that they - that the new customers would still be more - coming in a little bit later in the process development phase and doing more firefighting and thus not being involved from ground zero?

Generally, yes, that would also be true. They're more likely to be at some stage during the transfer and say, gee, maybe things - maybe we should look at a different way of doing this, and that's generally what starts the discussion that we have with the customer. And generally speaking, you know, we're able to demonstrate to them how our technology will differ - bring them their ramp in a different way and have been very successful at that. What we did see in this past quarter was, you know, folks - you know, I had - I heard one conversation was, "well, maybe, you know, we're not going to see these products going to significant volumes for a while anyway and we can bumble along for a bit longer. We are going to need this. We'd like to continue talking with you, but, gee, maybe we should look and see what's happening."

I think it's a relatively short-term phenomenon. The question just is how short is short-term.

And fill-in, you're flattish, slightly down for next quarter and maybe slightly up for the fourth quarter guidance. Are you imbedding in there just a handful of new engagements or can you give us a little color there?

Yeah. I think we're - we're imbedding what is a relatively modest number of new engagements in - in both quarters, something on par with what we've seen in - frankly in Q2. Some of those may be able to - will be able to come from existing corporate entities that we already have business engage - business with, and some would be coming from potentially new customers that we don't have business - new corporate entities that we don't have business with at this time.

Okay. And then given that we're towards the end of July and I think you guys have some visibility into wafer activity, whether it's, you know, [inaudible] or loading that's going to be occurring right now, what's your confidence in gain share? And I think - I guess your guidance implies bouncing around the 2.7, $2.8 million range a quarter?

Yeah. I think we've - we - you're right. I mean in fact, if you look at it kind of - you go back and look at this, back in April when we made the call that we thought wafer volumes at .13 were down, we got a lot of heat from folks saying, "Hey, but everyone says it's turning around."

Well, you know, we look at what we see in the customer - our customer base and we just don't see that. We see tape-out activity, but we don't see a lot of things going to real volumes. And, you know, we have that same visibility now. We do see tape-outs. We see stuff in engineering sample mode, but we don't see a lot of real winners on the very deep micron nodes at this point. And so I think your estimates of bouncing around where they are right now is probably pretty accurate. About where things are going to be.

And, you know, generally we've got a good look ahead on that because stuff that's going into fab now is going to be coming out, you know, at the beginning - at the end of this quarter. That would be Q4, light gain share activity.

Okay. Yeah. And then on the OEM agreement with the equipment manufacturer, is this something we can look for revenue in the fourth quarter or is it - is it more pushing into early next year?

And then is it - I mean, maybe you can't tell us yet, but is it a percentage of the tool sales price or how is that going to work?

Yeah. As far as when we forecast revenue, we didn't forecast any revenue in this year for that. There is a possibility, but we don't really understand, you know - an OEM business like this, we've never undertaken before, so it wouldn't be prudent for us to start forecasting when we would exactly see that revenue come in.

In terms of the revenue, this is typical products, like OEM agreement, where we get a percentage of the selling price of the product itself, and the product is a combination of a number of technologies that will be disclosed I believe when we make the announcement of the product.

Okay. And one last question. On the fabless side of the world in that last quarter you mentioned you were, you know, involved already with your first customer.

Uh-huh.

How have the conversations been going? Is it kind of a similar situation with some of the IDMs where, you know, volumes aren't really justifying the expense or how is that going?

It's an interesting one with the - you know, the design-based yield improvement product. We've seen good traction in some of the fabless and actually better traction at the IDMs that seems to be more bold about going onto the advanced technologies, be it at the - their own internal capacity or at the foundries.

With the fabless companies, at least the smaller ones, I think they are sizing up which foundries they're going to target and which technology nodes, be it 150 or 130, and we - I know that our sales force did have discussions with folks rethinking about whether they were going to target out 130 or go back - drop back to 150. Both of those are good opportunities for us, so they do need to make a decision about which one they're going to be targeting. And generally the time from when a fabless company engages with PDF to volume should be shorter, because, again, we've already done characterization of the - their target foundry and therefore already have their models in place, as opposed to an IDM for internal capacity where they - we would need to deliver to them our infrastructure first.

So they're - they've - the fabless folks have a little bit more luxury about making that decision a bit later, and frankly, I - we saw a number of customers rethinking about where products were targeted for the second half of this year, early next year.

So you expect to add one or more in the second half?

Yeah. We still expect to see good traction there, I think. We do anticipate some of the product mix - the revenue mix that we talked about being our design-based yield improvement - based on our Stein-based yield improvement offering. I think it's a little bit difficult to say who specifically, is it going to be - you know, if it's going to be company A or IDM B. But nevertheless, you know, we find that folks are very interested in what technology can do, definitely see a need for it. There's more and more of an awareness in the world that what you do on the design impacts the yield, and there isn't anything else out there to simulate what that yield's going to be accurately and imbedded in their IP and we think we've got a very unique offering there and it plays well.

Okay. Great. Thanks, guys.

Your next question comes from Garo [Tomajnian] of RBC Capital Markets.

A question for you. I know the last quarter you did start to see some gain share from wafers at .13. I'm wondering if you still saw basically gain share at that node and at what other geometries you saw gain share revenue.

Was that - I guess that's for me, John, or for Steve?

I'll take a stab at it qualitatively.

Sure.

Since I don't know the numbers -

Qualitative is fine.

Yeah. I can be safer that way and Steve can - Steve would actually know the details enough to get us in legal issues with our customers.

So what we did see is still some revenue at .13 and we anticipate that throughout the remainder of the year, but the bulk of it would be on nodes at like the .15 or even .18 node.

Still, relatively low volumes at .13. What I'd classify as sample level volumes.

Okay. And on the new OEM agreement, I would guess that - I mean the product hasn't been announced yet. I would guess that it's less of a combination product and service offering and more of a product-only offering. I don't know if you can get into that, but if you can.

Yeah. As we - as I think I had in my text, I might not have read it correctly, but we're anticipating - the way this agreement is set up, it will be their sales force and their support organization, so we are training the supporters fundamentally, but we're not going to be having to go and have a lot of costs associated with the delivery of this product into the customer base.

Okay. And can you tell us how the OEM agreement with [inaudible] is going so far? Has that produced any revenue.

That continues to produce - Steve can probably answer that better than me.

Yeah. It was generally a three-year licensing agreement and a five-year support services agreement. We're just approaching the beginning of the third year of the agreement this month.

Okay. Are you in sort of renewal talks with [inaudible]?

I think it's a little bit premature for that. I mean, we'll probably wait till the early part of next calendar year.

Okay. I know that in prior quarters, you've said that - and you said it again, you know, tonight, that when you look to, say, the current quarter's revenue forecast, that the visibility, you know, regarding that revenue number has been fairly high. Typically, you're considering about 50%. Has that deteriorated at all as well?

No, I don't think it has deteriorated. Most assuredly the smaller piece of the revenue in the quarter is contingent upon closing new contracts and if, as a result, a contract is closed even later than in the quarter or pushes into the new quarter, it would impact our current quarter revenue, but we still feel very comfortable that we have good visibility, good predictability, and good repeatability.

Great. Thanks very much.

Okay.

Your next question comes from Kevin [inaudible] of [inaudible] capital management.

There were some comments in the call. You mentioned that sales and marketing expenses would be increasing in subsequent quarters. Can you give us any more details as to what types of things you're going to be spending additional money on, whether it's - you know, and what its geographic emphasis might be, and do you feel like you've possibly underspent on sales and marketing to date?

Well, thanks, Kevin. This is John. I'll take that call. Do we feel we've underspent on sales and marketing to date. I don't think that we've underspent, necessarily. However, when we look at what we've done with the product offering, we've really increased our - our ability to drive a lot of incremental business because of the way we've standardized on things like our design-based field improvement platform for the foundry technologies, so we feel our capacity to take on customers has gone up. And in fact, in those markets, the selling model is a little bit different than where it would be with a traditional integrated device manufacturer. So we've been making the marketing investment or the sales investment in what would be the foundry fabless interface or foundry interface part of the business, more so than the classic large IDMs where we use pretty much our traditional model and we felt it was appropriate. When I say IDM business, I mean IDM business for their existing capacity.

We are still making an investment in the sales and marketing for the IDMs that are targeting foundry capacity because from our perspective, they look a lot like a fabless company. So that's mostly where that would be. And then that means that there's two parts of that investment. One part would be where the design organizations are, intrinsically in the United States and the other part would be where the factory capacity is, intrinsically in Taiwan and China.

Okay. And then one other follow-up question. Aside from the overall business environment affecting your customers' behavior for spending and spending intentions, do you feel like your current outlook is affected at all by, you know, a bit of a delay in going to more advanced nodes, such as .13 on the part of your customers?

Thanks, Kevin. That was a good question.

With the fabless community, we do see - when we talk to folks, there's a lot of fear about .13 microns and questions whether they should re-target .15.

Because I think they believe that their costs at .13 for the - you know, the non-few hundred dollar chips, the kind of ten-dollar, fifty-dollar chips, may not be there yet, may not be in line yet, and so we do see a fair amount of hesitance on those customers. We think there's as much of an opportunity with that customer at 150 nanometer as there is at 130, but when they're in that hesitant mode of rethinking where they want to be, it doesn't seem like anybody wants to be first when you're targeting a new - a new factory.

We do see that as being - as affecting their decision-making process. We believe our technology takes a tremendous amount of that risk out of there and have been able to convince some of the customers that is the case. And going forward, as we gain more traction in the marketplace, we fully expect more - you know, the big leverage that PDF provides the foundry community is the ability to have their customers more confidently get to their capacity, and they've made a big investment and they need to have a way of making sure they get that back.

Okay. Thanks.

At this time, I would like to remind everyone in order to ask a question, please press star, then the number 1, on your telephone keypad.

At this time, there are no further questions. Mr. Kibarian, you may proceed, sir.

Okay. Thank you very much. Again, this second quarter was a great quarter for PDF Solutions, as evidenced by our record revenue, and also evidenced by the traction we made in the marketplace. We thank you all for participating in the Q2 conference call and look forward to talking to you again on Q3. Good-bye.

Ladies and gentlemen, thank you for participating in the PDF Solutions quarter 1 2002 conference call. This concludes the program. 00:41:54 Thank you.