PDF Solutions Inc (PDFS) 2003 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the PDF Solutions, Inc. Conference Call to discuss its financial results for the first quarter ended March 31, 2003. I will now turn the call over to Rochelle Krause, Director of Investor Relations. Go ahead Rochelle.

Thanks [Michael]. By now you should have each received a copy of the corresponding press releases for our first quarter ended March 31, 2003. Please be advised that the press releases, as well as some of the statements that will be made today, reference certain non-GAAP financial measures. The press releases contain a reconciliation of such measures to the most directly comparable GAAP measures.

If you do not have a copy of the releases and would like one, please refer to PDF’s Web site at www.PDF.com, where the releases and the reconciliations have been posted. Also, please be advised that some of the statements that will be made in the course of this conference are forward-looking, including statements regarding PDF’s future financial results and performance, growth rates, and demand for solution.

PDF’s actual results could differ materially. You should refer to the section entitled Factors Which May Affect Future Results on pages 21 through 29 of PDF’s Annual Report on Form 10K for the fiscal year ended December 31, 2002, as well as 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.

At this time all participants are in a listen only mode. Later, we will conduct a question-and-answer session, for which instructions will be given by the Operator at that time. If you need assistance during the conference, please press “*” and “0” on your touch-tone telephone. As a reminder, this conference is being recorded.

Now I will turn the call over to 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. For the first quarter of 2003 we are reporting a total revenue of $9.1m, and pro forma loss of $0.03 per share. We are pleased that this quarter’s results are incrementally better than the top of the ranges that we provided on last quarter’s conference call.

Included in these results is a new multi-million dollar assessment contract, with a new top ten semiconductor company, which was signed earlier in the quarter than we had anticipated. We take such expedience by our customers, and this case a new customer, as another positive indicator of increased traction in the marketplace for PDF’s solutions offerings. As we have stated before, we are experiencing faster, broader, and earlier adoption of our field proven process design integration solutions as IT shrank.

I will provide a few a few additional highlights of the quarter. And then Steve will provide details about the quarter’s financial results, as well as our guidance for the second quarter of 2003. During the first quarter of 2003, PDF’s accomplishments fell into three broad categories.

First, reaping the benefits of our R&D investments, we executed with increased efficiency on our client engagements. Second, we expanded PDF’s customer base by adding a new customer, and expect to add other new contracts at existing and new clients in the next couple of quarters as product negotiations progress. Third, we prepared ourselves from an operational perspective to grow future business.

As to the first accomplishment, the ability of PDF Solutions Technology to provide rapid and accurate analysis of a product’s potential yield is a key differentiator. We are the leading independent company to offer this capability.

In the quarter our client service teams applied our new version of the Yield Ramp Simulator™, and completed a yield assessment in approximately 50% faster than our prior cycle times. Also, leveraging pd FasTest™ [ATCD] [ph] software, we have set a new internal benchmark for the testing and analyzing of test chips, in particular, test vehicles for some of the leading 90-nanometer producers.

For our customers, this means that the time required to achieve optimized silicon is greatly reduced. Key clients with PDF, such as Sony and Toshiba, have announced their intentions to produce 90-nonameter chips this year. We believe that our assessment cycle times are industry leading.

In the [inaudible] our yield simulations is field proven. Fast and accurate assessments from PDF Solutions of yield enable our customers to quickly and cost-effectively identify and resolve positive design integration issues, while it has more business impact for them.

Regarding the second accomplishment, during the first quarter we expanded our customer base by adding a top ten semiconductor company headquartered in the United States. We consider it significant that PDF’s technology and capabilities impressed this account sufficient to garner a multi-million dollar assessment contract at a leading edge node.

Further, considering all engagements entered into in recent quarters, we believe we have made significant progress in penetrating existing customers and adding new customers, to effectively distribute PDF’s revenue across a broad base of deep submicron technology nodes. Active negotiations for new engagements down to 65-nanometer nodes, once completed, will deepen this growing base.

As to our third accomplishment, you have probably seen our recent announcements concerning the expansion of our senior management team. Specifically, we have a new Vice-President of Marketing, Michael Buehler-Garcia. Michael’s experience as a marketing executive at [Tarid] Semiconductor and Cadence will be valuable for us as we expand PDF’s Design Based Yield Improvement™ offering.

The addition of Michael to the staff not only deepens our team, but also allows Dave Joseph, who previously held the position of Executive Vice-President of Sales, Marketing and Business Development, to focus his efforts on PDF’s strategic direction as Chief Strategy Officer. Further, Cees Hartgring’s rose is now expanded to include worldwide strategic business development as well as sales.

With these operational changes we believe that PDF has completed another important step in its preparation for the future expansion and growth when the industry recovers. To that point, in general, meetings with our customers tend to indicate that while the recovery is still difficult to forecast, there is an improving outlook for growth in leading edge technology nodes. And in a recent technology forum, as reported in e.Times, TSMC stated that it is now seeing customers move not only first, but also a second generation version of products to a 130-nanometer node. Our discussions with customers would support that same trend.

We believe that 130-nanometers is the inflexion point, where process design integration needs to become an integral part of the product design. At TSMC’s forum, TSMC’s representatives also told attendees that yield is a designer’s issue. And they expect designs to be involved at 90-nanometers and improving yields.

We at PDF Solutions are encouraged that our world’s leading foundry is sharing our view that Design-Based Yield Improvement™ is becoming a requirement. We believe that PDF Solutions Yield Ramp Simulator™ software is the most effective tool for simulating the yield of a design layout. While we are encouraged by these statements, and while forecasts look slightly better, semiconductor companies continue to be cautious about their spending. And, as a result, we will continue to be cautious in our outlook.

Now I’ll turn the call over to Steve, who will discuss the details of our financial results for the first quarter of 2003, and provide projections for the second quarter of 2003. Steve?

Thank you John, and good afternoon to everyone. First, let me state that this presentation and our press releases issued earlier today include reference to certain non-GAAP financial measures. The press releases contain a reconciliation of such measures to the most directly comparable GAAP measures. And you may access the press releases and reconciliations in the investor section of our Web site located at www.PDF.com.

As John already stated, for the first quarter ending March 31, 2003, revenues and pro forma loss per share were slightly better than the guidance we provided in January. Revenue for the first quarter totaled $9.1m versus prior guidance of $8.5m to $9m. Pro forma loss per share was $0.03, versus prior guidance of pro forma loss per share of $0.04 to $0.06, while reported net loss per share was $0.06.

Revenue for the first quarter represented a decrease of 21% compared to last year’s first quarter, and a 1% increase sequentially from last quarter. The decrease from last year’s first quarter, and only a modest increase sequentially from Q4, were due in large part to the drop in gains share.

Design-to-silicon yield solutions revenue for the first quarter totaled $8.1m, a 3% decrease from the comparable period last year, and an increase of 7% from last quarter. The decrease from last year was the result of the general weakness in the semiconductor industry that has manifested itself in delayed purchases in connection with the introduction of new process technology. The modest increase from Q4 is the result of continued growth in our customer base, amongst little evidence of a return to the robust semiconductor environment we have seen in the past.

Customers remain extremely cautious with regard to new investments. However, winning new strategic business in each of our last two quarters shows that PDF’s technology is key to performance at deep submicron nodes.

[ANC] [ph] revenue for the first quarter, generated from three customers and three engagements, totaled $1m, a 69% decrease versus the comparable period last year, and a 32% decrease from last quarter. This decrease was anticipated, and communicated during our last conference call. The silver lining is that we still believe a modest recover at leading edge process nodes should lead to a stronger Gain Share revenues for the remainder of this year.

We continued to book new engagements with Gain Share components, continuing the traction of our business model. However, it will be, in most cases, an additional six to nine months before these new contracts enter their respective Gain Share periods.

Gross margin for the first quarter was 62% of total revenue, a decrease of 4% from the first quarter of last year, and a decrease of 1% from the fourth quarter of 2002. We have held margins on design-to-silicon yield solutions. But the significant decline in higher margin Gain Share revenue has taken its toll on overall margins.

Total operating expenses, before amortization of stock-based compensation, were $70m for the quarter, up approximately $1.3m or 22% from the first quarter of 2002, while increasing approximately $418,000 or 6% from last quarter. The increase from last year was primarily the result of higher research and development expenses.

Research and development expenses for the first quarter increased approximately $1.1m or 36% from $3.2m in the first quarter of 2002, while sequentially increasing approximately $228,000, or 6%, from the fourth quarter of 2002, primarily due to increases in personnel related expenses and expansion of development activities in Europe.

Selling, general and administrative expenses were $2.7m in the first quarter of 2003, up approximately $148,000 or 5% from the first quarter of 2002, and increasing approximately $190,000 or 7% sequentially from the fourth quarter. Increases in personnel costs, particularly in sales and marketing functions, were only partially offset by a decrease in net accruals to establish a reasonable bad debt reserve, and a drop in general recruiting and re-location expenses.

Pro forma net loss for the quarter, excluding amortization of stock-based compensation and intangibles, totaled approximately $658,000 or $0.03 per share. This compares with pro forma net income of $1.4m or $0.06 per share for the first quarter of 2002, and a pro forma net loss of approximately $264,000, or $0.01 per share in the fourth quarter.

We continue to invest in our future, and stay the course with regard to our longer-term business objectives, acknowledging what we believe will be relatively short-term pressure on our top line growth rate. This means, however, that until our revenue grows to levels achieved during the first few quarters of fiscal 2002, we could continue to report small pro forma losses. We’ve proven our fiscal responsibility, and will continue to watch our costs and manage our cash very closely. However, we will not jeopardize our future to improve our short-term financial results.

Looking at the balance sheet as of March 31, 2003, we continue to maintain our excellent financial position. Cash grew slightly during the period, and remained above $70m. Accounts receivable totaled $7.5m, down from $7.9 last quarter. And our current ratio is just under eight to one.

Additionally, $3m or 41% of outstanding accounts receivable at March 31, have already been collected. And lastly, included in our accounts receivable balance is unbilled accounts receivable of approximately $500,000, down from $1m last quarter, and again reflecting nothing more than the inconsistency between contractual payment schedules and percentage of completion accounting.

Before I turn to guidance, I will state again that some of the statements made in the course of this conference call, including the ones that we are about to make with respect to Q2 2003, are forward-looking. These statements include expectations about our future financial results and performance, growth rates, the success of any business objectives, products and services, features and introductions, client products, and demand for PDF design-to-silicon yield solutions.

PDF’s actual results could differ materially. You should refer to our current SEC filings, and understand that forward-looking statements and risks made during this conference call are based upon information available to PDF today. We assume no obligation to update that.

Now for the second quarter of 2003, we reiterate the guidance we’ve provided in our outlook press release earlier today. Revenue guidance is in a range of $10m to $10.5m, the result of continuing traction with infrastructure implementations, and a modest increase in Gain Share revenue. We are also providing guidance for pro forma bottom line results in the range of break-even to a loss of $0.02 per diluted share, the result of modestly higher expenses, partially offsetting the benefit of increased revenue.

With that, I would like to return the call to the Operator, and open the floor for questions.

Thank you Mr. Melman. (Caller Instructions.) Our first question comes from the line of Garo Toomajanian of RBC Capital Markets.

Hi. Thanks a lot. One of the things that I’m wondering in looking at the results, and noticing the up side on the [inaudible] and yield solutions revenue, is I wonder if some of that up side came from the new contract that you just announced, or if we’re seeing some of the effects of the five year contract that was announced last quarter coming into play.

Yes. Hi Garo. This is Steve Melman. There are some revenues from the new contract. But there are no revenues to speak of related to the foundry contracts from last quarter. So the up side is the result of our existing revenue base and our new contract, but not from the foundry customer from last quarter.

When do you think we could start seeing an impact from that foundry customer?

Okay. We’re hoping to see some modest revenues by the end of the second quarter. But it will continue out for another two years after it starts. So it won’t be significant in any quarters going forward.

Okay. Got you. What would you say your visibility looks like for Q2 then, and also for the year? And a general sense on whether the visibility is improving or deteriorating. From your commentary it sounds like things could be improving suddenly from a visibility point of view. Is that a fair assessment?

Yeah Garo, this is John. We are seeing – we always have seen typically 70-75% or more going into a quarter. We continue to see that as we go into each quarter. As we look out, it’s still a little difficult to know when customers’ volumes pick up. We’ve seen volumes of the deep submicron nodes for some of our more mature customers pick up. But it’s still – their estimates are still inaccurate at times. And so we’re still pretty cautious about how the roll out going forward.

Okay. Also I think – I forget if it was you, John, or Steve mentioned that you do expect Gain Share to start picking up probably in Q2. And one of the things that I’m thinking about is, is that increase in Gain Share – I guess basically there’s three designs from three engagements that contributed this quarter. Is the increasing Gain Share coming from additional designs that you expect to be contributing? Or is it just further production of existing design that are in production?

This is John. I’ll take that. It’s a little bit of both. For something like 130-nanometer nodes, some of our customers we’re seeing the volumes – the end volumes tick up. So we expect the out volumes to tick up. And that would – those would have been in some cases contracts that did contribute somewhat to Gain Share in last quarter. And some of it is we anticipate contracts going into Gain Share mode in the second quarter contributing. So I suspect we’ll have more contracts contributing in Q2 than we did in Q1.

Okay. That’s great. Thank you.

Your next question comes from the line of Bill Frerichs of D.A. Davidson & Company.

Hi. Garo and I are having exactly the same day too. Cash flow from operations Steve - ?

Yes?

Was there a number associated with that?

Oh, I – to be honest with you, I don’t have the cash flow statement in front of me. But I suggest it’s about break-even. Our – we didn’t have any investing activities. Our acquisition purchases were fairly small for the quarter. And our cash went up for the period. So it’s probably break-even.

Probably break-even. And were there 10% customers in the quarter?

Yes there was. We will release those when we file our Q coming up.

Was the 10% customer – or were they – was any one of them this new U.S.-based major semiconductor company?

No. It wasn’t.

Okay. So that was a booking, but not a revenue event.

No. It achieved revenue. Just not the level of the 10% in the quarter.

Got it. Okay. And John, are you pretty much thinking of staying the course on Gain Share as a model, and sharing in the risk? The EDA companies don’t have the kind of risk that you have, because they just throw it over the wall and the stuff will work. And Gain Share is something that’s still fairly theoretical, although you’ve had some experience, although not a lot of dollars. And have you revisited that idea as a business proposition? And are you daunted in any way?

Thanks for the question Bill. No. I think that there’s a couple of elements in the Gain Share model, right? One is success-based, or tied to the customer’s business results. And clearly we take risk there. The second point is tied to the customer’s volumes.

If you look at the general industry trend, the number of design starts last year, in a pretty bad year in the industry, went down 20%. Yet I think square centimeters of semiconductors shipped went up or at least stayed constant.

And I would argue that the model of tying your revenue to design seats is an artificial number. It’s an artificial way to think about the value that gets created for the customer. And we’re obviously going to continue to make adjustments to the Gain Share model. We want to take, obviously, as much risk in the customer’s yield that is possible, and power as much of it to the customer’s wafer ship, because we know that number is a generally up-trend number.

And as we go forward and we prove out our technology, we – and our existing customers do do that. So if you look at our customers that are in their second or third generation Gain Share contract, they tend to have a dollar amount that’s more tied to the wafer ship than the yield actually achieved on that wafer. And we believe that that will be a trend over time with more and more of the customers, as our technology and the need for the technology is proven out.

However, I think it would be unwise for us to tie our business model to a seat-based model, as the design automation folks do, because I don’t think there is scale in that model.

Okay. Great. Thanks.

Thank you.

Your next question comes from the line of Gus Richard of First Albany Corporation.

Good afternoon guys.

Hi Gus.

A couple quick questions. First, Steve, for you. The tax rate was a little bit less than I was modeling at 34%. What should we use for our model going forward?

Yeah, I would use the rate of 34% in the first quarter for the whole year. As you know, accounting guidelines say that at the beginning of the year you project your tax rate for the year. And then you use that rate for booking or provision for taxes in first quarter. And that is an adjusted rate that we have calculated, based on our research and development credits and our investment tax credits, etc. So I would use that going forward Gus.

Got it. And then in the revenue line, you have that power needs foundries, where you’ve got the revenue recognition issue of last quarter. Did you recognize any of that revenue this quarter? Or is that to come?

It’s primarily to come. As you’ll see it rolling out, if all goes well going forward in the next three months, you’ll see it rolling out consistently over the next 24 to 28-29 months.

Okay. And I noticed there wasn’t much of a change in deferred revenue. Was there some element coming out and not coming in in that [inaudible]?

Right. Right.

Yeah. Okay.

Yeah, I believe I suggested that in the last conference call, that our normal decline in deferred revenue as it gets amortized back to the P&L was offset by increases as a result of invoicing this foundry customer, but not being able to recognize the revenue.

Okay. Is the new customer in the United States a foundry?

No, it is not.

Okay. Thank you.

It’s a top ten semiconductor company.

Okay. That narrows it down for me.

Sure.

And then can you talk – someone asked earlier about your pipeline. And I just was hoping you’d give a little bit of color as to – you mentioned you had some contracts that could close in the next couple quarters. If you could give a little color on that.

Yeah, this is John. I’ll do that. A couple of things. As you know, April 1 is the start of the next fiscal year in Japan. So typically for a lot of our Japanese customers we brought in the account starting in the spring. And we anticipate for the customers in Japan that we see that, both by customers that we’ve historically had, as well as some new accounts that we are talking to.

As you’ve probably seen from our press announcements over the last couple of quarters, we’ve added to our sales team, both by bringing in Cees, as well as hiring from Interon Asian Sales, [Tom Lui]. So we have obviously active discussions going on in both Asia as well as the United States and Europe. So the new accounts would be in those areas, as well as the expansion in the existing accounts.

Gus Richard. Okay.

As far as the visibility of the pipeline, I think we’ve got probably more discussions going on with more customers at this point than we’ve had in my experience with the firm. I think what may be difficult to say in this environment is exactly who closes when and what’s going to happen, because our customers still have a fair amount of lack of visibility in their business. So it’s still difficult to say exactly when each of them is going to close, and whether they close, because they could not close it obviously.

Got it. And then finally, you were working with an OEM with pd FasTest™. And I was wondering how that product launch was coming. As I recollect, it was a mid-year launch.

Yes. We are in beta on the product, and continue to be working with the OEM, as well as the end customers, and see that technically good results are coming out. And we’re very encouraged by them. As you suggest, pd FasTest™ is part of that overall solution. And that’s a part that we also sell directly and have a handful of installations now already with our customers. And it’s being used daily, to be honest with you. The integration with the OEM’s products is really what’s under beta at this point.

Right. Right. Right, exactly. And so that would be a revenue event third quarter potentially?

The selling is obviously through the OEM. So as far as when it happens, we don’t forecast at this point. Once it comes out of beta, they will be doing an overall watch, and be selling the product. We anticipate that. And how that results in revenue for us is something that we haven’t forecast at this time.

Got it. All right. Thanks so much.

Thanks Gus.

Your next question comes from the line of Dennis Wassung of Adams, Harkness & Hill.

Thank you. A few questions. First off on the Gain Share. You mentioned that you have three designs and three engagements today. Have you talked about what technology nodes those are out of? Are those still winding down from previous generations? Or are those – are any of those at .13 at this point?

Yeah. So I think – this is John, Dennis, first of all. So a couple of things. It’s the three engagements – three contracts, three engagements of three customers. The number of designs, I’m not sure how many it is. But I would assume it may be more than three. Typically it is.

I believe some of them are also next generation contracts that are still smaller dollar amounts and Legacy contracts, that would be later technology, lower technology nodes or higher physical dimensions, larger physical dimensions. But I believe there are some .13 designs in that mix.

Okay. And as we look into Q2, with a modest increase in Gain Share revenue, would that be I guess higher volumes at the .13 node that would be driving that, do you think at this point?

It’s contracts at the .13 node primarily, I believe, and .15 in some cases.

Okay. In terms of the new customer that you signed, is this going to be a similar contract that you’ve had in the past, i.e., a $2-4m up front engagement, along with a Gain Share component? Is there any structural difference to this contract or a magnitude?

Yeah. I can take that. This is a $2m contract. And essentially it’s set up like our other contracts. It’s a little bit different. We’ve got it for six months contract, where it has a 60 end Gain Share portion. The technology comes out at the end of the six months. And the customer gets to decide if they want to extend by continuing the wafer-based license, just like we have with our other customers.

What is new is the brevity. It is six months. The reason why we can do that is, frankly, because of the investment we’ve been making in R&D. We actually can get the technology put into the customer’s shop and add value to the customer’s factor in a much shorter amount of time than we typically – or we did in the past or historically. And that’s greatly because of the advantage that we’re getting from pd FasTest™ and the software we use to – the software that we and the customers use to analyze the results that come off pd FasTest™.

So it is a – the time scale is a little bit smaller than what we’ve done in the past. We think it’s very important for us, because we’ve got to demonstrate to our customers that this technology works and adds value to their business. The neat thing is – in the past when we used to sell fire fighting contracts, they were by far about a half of the size of this contract, for the same length of time, and same size [team] [ph]. So frankly, it’s a pretty big win for us.

Okay. So you’re essentially doing the same things that you had been in other contracts. It’s just a shorter duration to get the processing simulation and whether or not it’s going to be –

And we demonstrate some amount of value, but not full that the customer would get from continually using the technology on an ongoing basis. And they’ve got a conditional ability to license the technology going forward if they choose.

Okay. So at the end of the six months they decide whether or not they want to utilize the technology to generate – I guess that would eventually generate Gain Share for you? Or are you locked into the Gain Share prospect at this point?

There’s some amount of Gain Share on this, based on the improvement they see initially. This is why we call it an assessment. It’s a smaller contract than a full-blown infrastructure implementation. And at the end of that they have a choice to continue to use the technology to gain additional Gain Share throughout the life of the technology license. So it’s like we do with our existing customers.

Okay. That’s very helpful. Also on the large foundry customer that there’s been a few questions about, any status in terms of how far along that project you are in terms of the implementation? Is everything I guess pretty much as planned at this point?

Things are tracking as planned. And I think we said on the last conference call that we expect that towards the end of the first half of the year we would get through the entire sign-off, as we called it, for the license period. And we still anticipate around the first half of the year achieving that – by the end of the first half of the year.

Okay great. And lastly, if you could just comment on the Design Based Yield Improvement™ business. Anything to talk about there? Obviously the foundry customer - part of that strategy was to open the door to some more foundry - potential customers through that foundry customer. Just wondering if you’re getting any follow-through there, any new leads? And how big of the – I guess how big of a percentage of the overall business is the DBYI™ products at this point?

Yeah. The exact percentage I don’t know. I think it’s still a small percentage of the overall business. The business that we have with the foundry, as well as a number of other – for a number of other reasons, just general market awareness I believe, has meant that we’ve been in a number of discussions with customers about our Design Based Yield Improvement™ offering.

We’ve also gone back internally and, I think, made a significant investment in R&D to make the system overall more seamless to the designer, provide more value, and address more of the issues that we’re seeing on our 90-nanometer process ramps. I think one of the great advantages customers get from buying PDF Design Based Yield Improvement™ is that we are already out on a number of 90-nanometer ramps.

So we see the issues that have – where process design interactions do affect yields. We do incorporate that in our Design Based Yield Improvement™ platform. So before the customer even gets there, they can have a more proven solution. I think it’s that overall capability, the experience that we’ve got at 90-nanometer, and the feedback of providing R&D, that’s really the driver for the interest from the customer, more so than right now what we – the [package] [ph] we’re getting from our relationship with the foundry. Although I think over time that will also create leverage as well.

Okay. And can you actually disclose how many 90-nanometer engagements you’re working on at this point? Or is that - ?

Yeah. So I think there’s four overall 90-nanometer engagements.

Okay. Anything new this quarter? I don’t know if you can mention or not.

Yeah. I don’t think there was anything new this quarter at 90.

Okay. And last quick question – you mentioned in your sort of opening remarks about Sony and Toshiba making announcements for 90-nanometer this year. Is it fair to assume that you’re involved with those processes, since they are pretty big customers for you? And then getting into production here, could it be a Gain Share opportunity for you?

You know we’re obviously – we’re not allowed, generally, to comment on which technology nodes our customers are applying our technology. However, historically we’ve [gotten] [ph] involved with – they’ve applied our technology at the leading – their most advanced process nodes. So if you were to make that assumption, that would be consistent with an assumption that you may have made in the past and got correct in the past.

Thank you very much.

Sure.

Your next question comes from the line of Joan Tong of Sidoti & Company.

Good afternoon. Actually most of my questions have been answered. I’ve just got one last one here. It is with respect to like currently 70% of, I believe, PDF business is coming from Japan. Would you guys consider refocusing that to the U.S. market? It seems like this is the first quarter that you have signed a big – or strategic customers actually based in the U.S. for a long time. And going forward, what’s the focus going to be?

Thanks Joan. I’ll take this. This is John. I’ll take that question. You know we have a much bigger sales team, or a much more beefed up sales team than we had in the past. So we don’t need to focus as tightly as we did in one geography.

That being said, Japan is a relatively healthy geography, if you look at its capital equipment expenditures. This year they’re a little bit more healthy than some of the other regions. And we do see a lot of interest in Japan, and have a number of contract discussions with customers – existing customers as well as new customers in Japan.

We – so I don’t think our focus is any way going away from Japan. We still believe it’s a very important region, because of the consumer electronics. That being said, we are expanding our ability to sell in the United States, as well as in other parts of Asia and Europe. And we will expand in those areas. So overall, the percentage that Japan represents as a total of our business probably will go down, although we look to always expand the total dollar amount in Japan in every period that we can.

Okay. Thank you.

Thank you.

Your next question comes from the line of Erach Desai of American Technology.

Can you guys hear me?

Yes Erach.

Okay thanks. I would agree that at least my questions have been answered. Let me see if I can tackle lots of questions in different ways. To get meaningful sequential growth in Gain Share – and I’m not asking you to predict a time frame. But obviously in the next four quarters, to get there, do you foresee that you have to get some of the 90-nanometer customers to production?

Or is it that you can get it from enabling other people, who may not yet be customers, to ramp on 130-nanometer? I guess I’m trying to understand relative to where 90-nanometer – obviously leading edge – becomes more mainstream, and how we can time or try to time your Gain Share relative to that.

Okay Erach, this is John. I’ll try to tackle that question. So I think even with the announcements that are made – have been made out there in the past from companies that are our customers, because we see the revenue one quarter in arrears anyway, I don’t think you can expect that for much of 2003 that Gain Share up tick is coming from 90-nanometer technology. That would more likely be a driver as you get into 2004, even from those customers, just because the one quarter is in arrears nature of the revenue.

We do anticipate the growth that we are seeing next year more likely coming from 130 and some 150 contracts. So I think when our – to kind of directly answer your question, we expect that some of the contracts we have right now at the 130, 150 and 180 nodes, because, as you know, we have a contract, for example, with Tower that is a 180 contract, still yet to produce meaningful Gain Share.

So we’re still seeing those technology nodes as being kind of the driver for our Gain Share in this year and in the first part of ’04. And, as you know, 130 is still at its inception point. So it’s well below where its ramp is going to be. So that’s just growth that we expect off contracts we’ve signed in the past that have yet to contribute materially to Gain Share.

At the same time, I think you’ve caused a leading question there, which is gee, aren’t there other people who haven’t gotten decent 130 yields yet? That would be a reasonable place for you to sell. And could that contribute to Gain Share for you in the latter part of ’03 and into ’04? And the answer for that is definitely yes.

So we are out selling. And I think the contract that we signed in this last quarter is an indication of something like that. But we do believe there’s opportunities all around the world. And customers are recognizing that technology like ours is needed. And so yeah, we do believe that there’s up side in the Gain Share from incremental customers that we don’t have today that would be at the 130 and 150 nodes typically.

Thank you John. And John, a different follow-up I guess. Just obviously Sony talking about I guess, what were they called it – embedded DRAM technology at 90-nanometer. It’s whatever is in the press. I know that in the past when you have presented at various points, you have clearly suggested that when a customer even had a given technology node, does something different, and that a DRAM versus X, you know, versus just logic, etc., you – that’s a separate type of engagement for you.

To the extent that – from your previous answer to somebody’s question, that Sony continues to be a loyal customer, will they be continuing to build their relationship with you on these different processes or technology directions, including infrastructure?

Okay. I’ll try to answer that. If you look at companies like Sony and Toshiba, and some of the consumer electronics companies, they tend to be the companies that are driving SOC probably more aggressively than the kind of traditional integrated device manufacturers. As a result, we do see those customers applying technologies, like embedded DRAM, embedded Flash, embedded [FI-G] [ph], etc., more aggressively than the traditionals.

As we look at the roadmap – and I think you’d see it if you look at the foundry roadmaps as well – there’s a bifurcation of the roadmap on a going forward basis, because as you integrate more and more stuff, you start creating more and more derivative technologies. We believe all of those are revenue opportunities for us. And wherever an important customer like Sony’s volume goes, we’re going to make sure our solution is appropriate for it.

Embedded DRAM for the consumer in graphics [spoke] [ph] has been an important technology for them for a couple of generations, albeit this is a different type of embedded DRAM that they’re applying at this stage. And it does create a revenue opportunity for us. We’ve also had business with them and other companies in the C-MOS – traditional C-MOS technology, and anticipate that on a going forward basis we will have revenue within traditional C-MOS as well.

They’re a little bit unusual. But they do leverage embedded DRAM aggressively in terms of the time scale with respect to C-MOS.

Thanks a lot. I think one day we’ll get the full story in terms of how you’ve enabled people like Sony to become the SOC leaders that they are. Thanks.

Thank you Erach.

Your next question comes from the line of Bill Frerichs of D.A. Davidson & Company.

Yeah, just a follow-up question. This 130-nanometer deal with the major domestically headquartered semiconductor company, you characterized it as a six month deal. But you also characterized it as not a fire fighting arrangement. Is that true?

Well that’s a good question. I think what’s unique about it is in the past in fire fights we were never able to bring in our test vehicles and our infrastructure, relying mostly on the software and our teams. Because of the investment we’ve made in R&D, we can actually bring in all that technology and have an impact on the customer in six months.

So it’s a little bit different from our typical kind of ‘prove your technology’ in the past, because we’re able to prove out an entire infrastructure.

I understand that. But my question really is is there a fire?

I think if you look at 130/150 advance nodes, the yields are still not at maturity. I think that people are past the fire stage. But they’re still generally far from being at points where they want to be. And so there’s a lot of room for using our technology to make improvements. And if you look at the volumes at 130, you know that we’re just at the inflexion point now. We suggest that customers still have a lot more incremental improvements to make to be really cost-effective in those matters.

One more question, and I’ll let you go. Does that mean that you’re going into a situation where production is already underway?

That would be probably a good way to characterize it.

Great. Thanks John.

Sure.

Your next question comes from the line of [Gary Sharo] of J.P. Morgan Fleming.

Hi John. Hi Steve.

Hi [Gary].

Hi.

Regarding your pipeline, I thought it was going to take a bit to get new customers, and that they’d need to see successful ramps with your existing customers to be convinced to sign up. Is – what’s made the pipeline get bigger? Is it they don’t need that? They’re saying that - ? What is it?

Thanks [Gary]. I think we’re still cautious on the pipeline. So using words like bigger, we believe it’s getting better. But we’re pretty cautious about it still.

That being said, I think there’s a couple of things that we are seeing. Number one, the customers are in their own business feeling a little bit more confident. And I think that means that they get to be more concerned about their ability to ramp up - tick volumes, without having to ramp up [ready] [ph] for volumes. And so therefore they do need to look at technologies like ours, and the impact it can have on their business.

Number two, we’ve been implementing our infrastructure at a number of customers at the .13 node or 130-nanometer node, for quite a while, and even 90-nanometer now for a few months. And it’s a small industry. And we know our customers talk to each other. In fact, they all tell me that they do. So I suspect that even in different geographies – the U.S. and Asia, Asia and Europe, etc., our customers do talk. And they are – our customers that are expanding their technology with the advanced nodes help communicate to some of the newer customers that we’ve signed up. And I think that’s helping us. We’re getting somewhat of a network effect there.

Right. Thanks. And do you have any contracts ending in the second quarter?

Do we have any contracts ending in the second quarter was [Gary]’s question. [Gary], this is John turning over to Steve. I’m not sure. Generally every quarter there’s some that end and some that start. I don’t know – my guess is a lot of the Japanese contracts end in Q1, and then start up in Q2. So there’s probably more starting than ending.

Okay. And I was going to ask about your buy-back. Probably more of a question for Steve.

Sure.

It doesn’t look like you bought any shares back.

No. We haven’t at the present time. As you know, when you announce a buy back program, you still have to abide by the black-out periods. And we’ve been in a black-out period since the first of the last month of the quarter. So we haven’t even been able to do some, even if we wanted to.

Okay. Right. Thank you very much.

Your next question comes from the line of Greg Weaver of Kern Capital.

Good evening gentlemen.

Hi Greg.

On the [D2SY] [ph], how many engagements have you completed and you’re waiting for Gain Share?

The total number that are completed and waiting for Gain Share. There’s at least a handful that I can think of off the top of my head where we are done or within – mostly done, and are waiting for that customer to start seeing volumes in that technology.

So you have three you’re working on, four at 90-nanometers, and then plus some others that are done at some node?

Mmm-hmm. I think there’s probably more than three that we’re working on, plus the 90-nanometer one. I’m not sure how you make that distinction.

Or it’s three that are actually in production I mean. Sorry.

Oh I see. Yeah. Okay.

So how many are you working on currently?

Well we have 12 engagements that contributed over $100,000 in revenues during the first quarter.

Okay. And then on the engagements, is there any kind of backlog figure there?

It’s not a statistic that we’ve kept. And due to the variability of Gain Share, it being zero or all or some percentage in between. So backlog is not the statistic that we’ve kept.

No. On the [D2SY] engagements.

Yeah, I don’t have a figure that would definitively state the fixed fees associated with the contract, because we look at a contract as a whole, with both a fixed and variable fee. So I don’t maintain the – I don’t break out the fixed fees separately from the total contract.

But like you said, you got 70% of the quarter in backlog when you go into the quarter, right?

Yeah, we typically see 70% of the quarter going into the quarter. I think one way to think about it – I don’t think we have a statistic. But one way, Greg, I would say, if the typical contract is $2-4m, and let’s say there is 10 on average right now. So you’re looking at something like ten contracts, about an average $3m a piece. So that’s $30m. Some of them are an average half done. Right? So you probably could take a number like that and say that represents what’s left out there on the sum total of the contracts.

Got you. Okay.

I would think that’s one way to back into the envelope. But I don’t have the data with me. But [inaudible] sat down and kind of scratch it out on the back of the envelope. Things like that. I mean not the back of the envelope that way. But one way of thinking about it.

Okay. And I guess just lastly, you had mentioned about hesitation on the customer’s part in terms of closing deals, right? So these guys are trying to wait for some visible sign of a pick-up? I mean is there any issue with resource constraint on your part? Or I assume when everybody is going to want your services all at the same time.

Yeah, that’s a good question Greg. Also one of our bottlenecks to get a customer started is to get test vehicles in the tester, and our infrastructure installed in their facility. That’s probably our first and number one bottleneck. If the world semiconductor companies all called us up today and said we all want – we all have different process technologies. And we all want an infrastructure tomorrow, it would create a bottleneck for us. There is no question about that.

We have a couple of things that work in our favor. The world’s design rules are becoming more similar. So the variety of infrastructures that we’re delivering are becoming smaller. And what’s delivered to one customer tends to be pretty reasonable for delivery to the next customer, with less and less customization in it. So that works to our advantage.

Number two, there is generally a kind of a stagger around the world, that different things – Japan tends to go on a half-year cycle, the U.S. on different cycles, etc. So it tends to smooth out more than what you would think in a worst case scenario.

So it’s not a people resource issue in your mind either way?

No. It tends to be a delivery of test vehicles, and deliver of a tester and equipment into the customer. We obviously reduce sort of client services team with the client. But that generally is not the number one bottleneck.

Okay.

We also look at it that unlike a traditional manufacturing organization that has a direct labor work force, and an engineering work force, and if production is down you don’t – you’re not able to utilize your direct labor work force, our client services teams are highly skilled engineers. And in periods where we might not have optimum utilization of those engineers as client services people, they can be moved quite easily into development projects.

So we’ve been taking advantage of that. And our R&D expenses, quite candidly, have flipped up a bit relative to our absolute dollar cost of sales, if you will. But that’s partially a result of utilizing those resources to advance our development programs.

Thank you.

Your next question comes from the line of [Morgan Frank] of Manchester Management.

Hi guys. A couple things. First, noticed that the gross margin on the D to F stuff actually picked up a bit this quarter. You picked up 180 basis points. I was wondering if you could talk about kind of where those gains might have come from.

Well I think what has happened to a degree – I assume you’re comparing it to the first quarter of last year.

Or even from last quarter it looks like it picked up.

Yeah. It’s up a little bit. Relative to last year, a little bit of the effect is along the lines of what I was just speaking to in that last year’s first quarter we were anticipating a more meaningful ramp in design [facility] [ph] solutions. We had resources being trained on customer contracts. We’ve leveled our resource pool, and have some of those folks now working on development projects.

Additionally, in the fourth quarter of this year we had a hardware component delivery of pd FasTest™, which has created some cost pressure in the fourth quarter, where we didn’t have that in the first quarter. So between those two, I think that will account for some of the favorable effect versus the first quarter, and the favorable effect in the fourth quarter. All in all, we’ve been holding our prices and maintaining our margins on design [facility] solutions.

And can you guys give us some kind of estimate as to what the split might be between PDF and Gain Share next quarter?

The difference is always difficult. I think Steve said on his commentary, we expect the Gain Share to modestly recovery. And we expect the overall revenue up over this quarter, as present guidance. I think the exact split on the two - $100,000 here or there would throw percentages off pretty substantially. So I don’t know if we want to –

Yeah, while Gain Share is typically one-quarter in arrears, it doesn’t always align itself with our fiscal quarters. And we are looking at some overlap of periods. So we haven’t given guidance on the portion that will be Gain Share in the upcoming quarter.

I mean does kind of like a million two to a million five seem like a reasonable range?

Yes.

Yes.

Okay. Thanks very much.

At this time there are no further questions. Please be advised that due to technical difficulties earlier in the conference, the beginning of the conference is not Web cast live. The complete Web cast will be available at PDF’s Web site, www.PDF.com, in approximately two hours. We apologize for any inconvenience this may have caused you. I will now return the call to Mr. Kibarian for any closing remarks.

Thank you. To summarize, we continue to execute well and improve efficiencies. We continue to expand our customer base, and see significant interest from existing and new customers at leading edge nodes, which distributes our revenue base more broadly. And lastly, we continue to prepare to reap the rewards of the industry recovery.

Overlaid on this is a cautious market, a market which we clearly see the long-term opportunity for PDF, the process design integration company. Thank you for taking the time to participate in our first quarter 2003 conference call. Goodbye.

Ladies and gentlemen, this concludes the program. Thank you for participating. You may now disconnect.