PDF Solutions Inc (PDFS) 2004 Q4 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 4th fiscal quarter ended Friday, December 31, 2004. At this time, all participants are in listen-only mode. Later we will conduct a q-and-a session for which instructions will be given at that time. If you need assistance during the conference, please press star then zero on your touchtone phone. As a reminder this conference is being recorded.

If you have not yet received a copy of the corresponding press releases, they have been posted to the PDF web site at www.pdf.com.

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 its solutions. PDF’s actual results could differ materially. You should refer to the section entitled Factors Which May Affect Future Results on pages 25 through 31 of PDF’s annual report on form 10K for the fiscal year ended December 31, 2003, and similar disclosures and 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 CEO; and Steve Melman, PDF’s VP Finance & Administration and CFO. Mr. Kibarian, please go ahead.

Thank you, and welcome everyone.

For the 4th quarter of 2004 PDF Solutions is reporting total revenue of $18.1 million and non-GAAP net profit of 13 cents per share. Gain share was $2.8 million. In comparison to our guidance, revenue was in the middle of the range we provided in October. Non-GAAP earnings are above the range we provided which Steve will discuss in more detail shortly. And, gain share was at the lower end of the range.

For the year ending 2004, PDF is reporting total annual revenue of $62.3 million and non-GAAP net income of 22 cents per share. In comparison to 2003, our revenue was up 46%, and we moved early in the year from incurring losses to generating profits on a non-GAAP basis.

Throughout 2004, we established ourselves as the only commercial solution for ramping up new semiconductor processes. This is an emerging market opportunity because of the increase complexity and costs of new processes, and the frequent partnering on process development. PDF is benefiting from developing this market both by the growth in our designed-to-fill [inaudible] yield revenue and because it creates an opportunity for the deferred rewards we call gain share. As most of you know, gain share’s wafer based fee and incentives tied to the yield improvement we have created with our technology and methodology.

In 2004, PDF continues to develop its market by opening relationships with new customers and expanding business with existing customers. We also expanded our product portfolio by developing new characterization vehicles and software to address the demands of the most advance technology notes and designs. Let me share with you some of the highlights for 2004 in general, in Q4 in particular.

In 2004, we increased the market penetration of our integrated yield ramp or IYR solution. We signed five new 90 nanometer ramps, one of those in Q4, bringing the total number of 90 nanometer ramps we have worked on to nine. Key customer wins include a major U.S. IC manufacturer and chartered semiconductor, a major foundry. As another indication of our continued technology leadership, we also signed our first 45 nanometer integrated yield ramp contract and continued our leadership at 65 nanometers. In 2004, we extended our footprint in the fab by realizing benefit from our Q3 2003 acquisition of IDS. We increased the install base of DataPower, our yield management software solution and created a more integrated solution for manufacturers by combining the key technologies from IDS and PDF. This culminated the Q4 release of a new CD test chip analysis software, PDCV, and our new bitmap functionality in DataPower 6.4. In 2004, through partnerships, we extended the reach of our DFM solutions by driving our yield models up into the hands of designers. PDFX, our DFM solution for standard cell based logic designs was integrated in Magma design automation’s blast yield, a Virage Logic’s ASAP Library. During Q4 we also signed Memorandums of Understanding with another significant IP company and another leading EDA company. We anticipate further partnerships and related product announcements to be made later in 2005.

Let me now turn to our gain share performance and prospects. As we have discussed many times, our gain share is deferred awards created mostly from prior implementations. In Q4, gain share grew consistently through the year due to healthy chips finds manufactured under IYR infrastructures we delivered in 2003 and early 2004. Similarly, in 2005 gain share revenue will be driven by IYRs delivered in the prior years.

In 2004, we continue to work successfully with many of our customers to solve the design to silicon integration issues and to improve their yields. In Q4, we narrowly missed the yield target for one customer. As a result, our Q4 gain share was at the lower end of the range we had expected and we expect lower planned gain share in Q1 and Q2.

That being said, the performance of other gain share contracts is expected to more than offset this impact in subsequent quarters. In general, going forward, from time to time there will be other ramps with similar volatility. However, as our breadth of 90 nanometer contracts increases so will our experience at ramping this note and subsequent notes. A growing experience of this note already well beyond that of any other company will enhance our credibility at setting targets and maximize our ability to achieve such targets. Additionally, with a growing base of contracts contributing to gain share, we expect the performance of any single ramp to have lesser impact on our overall results.

Overall, we expect 2005 to be another growth year for PDF. From our vantage point sitting across the industry, we have seen caution among some of our customers and business as usual with others. However, interest in momentum for PDF continues to grow. We expect to find more 90 nanometer ramps in 2005, and will see increased gain share as more of our current 90 nanometer ramps come to volume during the second half of the year. We also expect to engage in more 65 nanometer ramps during 2005.

In closing, the key priorities we will continue to focus on are executing on our IYR solutions to deliver yield improvement and end results with existing customers; expanding our penetration of major semiconductor manufacturers; continuing to develop and deliver advance methodologies and technologies for process ramp-up; extending our footprint in the fab through our data power product and partnership with inspection and other equipment vendors; and driving the impact of our yield models into the design community through our EDA and IP partnerships. Now I’ll turn the call over to Steve who will discuss in detail our financial results for the 4th quarter, our summary of 2004, and our guidance going forward. Steve.

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

Revenue for the 4th quarter ending December 31, 2004, totaled $18.1 million, a record for PDF and our eighth quarter of sequential revenue increases. This represents an increase of 50% compared to the 4th quarter of last year and an increase of 10%, sequentially from last quarter. These results were in the range provided in October during our last conference call. The increase from the 4th quarter of last year and last quarter were due to increases in both design silk and yield solutions and gain share. Design silk and yield solutions revenue totaled $15.3 million for the 4th quarter, a 46% increase from the comparable period last year and an increase of 9% from last quarter. The increases from last year and last quarter were the result of strong demand for PDF’s products and services. 16 engagements from 11 customers each contributed over $200,000 in revenue during the quarter. As John mentioned, we kicked-off one new yield improvement engagement during the quarter, added an existing customer at 90 nanometers, giving us a total of nine new engagements over calendar year 2004.

Gain share revenue for the 4th quarter generated from five customers and six contracts, up one in each category from last quarter, totaled approximately $2.8 million, a 70% increase versus the comparable period last year, and an increase of 14% from last quarter. Gain share for the 4th quarter was at the bottom of the range provided in October. Gross margin for the 4th quarter excluding amortization of core technology was 65% of total revenue, a decrease from 69% during the 4th quarter of last year, but an increase of 1% from the 3rd quarter of 2004. The decrease in margin from last year was primarily the result of increased expenses associated with the expansion of our office in Japan, travel and variable compensation. The increase from last quarter was primarily the result of improved margins on design silk and yield solutions and higher gain share.

Total operating expenses before amortization of stock-based compensation and acquired intangible assets were $9.3 million for the quarter, up approximately $282,000 or 3% from the 4th quarter of 2003 while increasing approximately $598,000 or 6% from last quarter.

Research and development expenses totaled $5.3 million for the 4th quarter, an increase of approximately $34,000 or 1% from the 4th quarter of 2003. The sequential increase in research and development expenses of approximately $412,000 or 8% from the 3rd quarter of 2004 was primarily the result of increased personnel related costs, including variable compensation accruals.

Selling, general and administrative expenses were $4 million in the 4th quarter of 2004, up approximately $248,000 or 7% from the 4th quarter of 2003. This increase was primarily due to increases in legal and audit services, the result of Sarbanes Oxley compliance activity and outside sales commissions. SG&A expenses compared to the 3rd quarter of 2004 increased approximately $186,000 or 5%, also the result of increases in legal and audit services, and outside sales commissions.

Now that we have exited 2004, the first year of Sarbanes Oxley, Section 404 compliance which requires an opinion on the effectiveness of our internal controls, I wanted to take a moment to update our investor community on the status of our SOX Program. While the conclusion is not final until we file our 10K in March of this year, at this point, with our testing behind us, we believe there are no material weaknesses that would preclude an unqualified opinion from our registered public accountants, Deloitte and Touche.

Reiterating the statement made in our press release, in addition to using GAAP results in evaluating PDF’s business, management also believes it useful to measure results using a non-GAAP measure of net income which excludes amortization of stock-based compensation and acquired intangible assets. Non-GAAP net income for the 4th quarter ending December 31st totaled approximately $3.6 million or 13 cents per share. This compares with non-GAAP net loss of approximately $135,000 or one cent per share for the comparable period last year, and non-GAAP net income of approximately $1.5 million or six cents per share during the 3rd quarter of 2004. These 4th quarter results were significantly above the top of the range provided in October, primarily the result of a favorable adjustment to our tax rate for the full fiscal year.

During our 4th quarter, as a result of employee stock exercises and sales, our disqualifying dispositions rose dramatically. The impact of such dispositions other than an unexpected increase in diluted outstanding shares, resulted in a favorable swing in our tax rate that contributed approximately four cents to our non-GAAP earning per share. Without such an affect, our non-GAAP earnings per share would have been nine cents, in the middle of the range provided in October. For 2005, we forecast our tax rate to be 30% assuming modest disqualifying dispositions.

On a GAAP basis, including amortization of stock-based compensation and acquired intangible assets, I’m again pleased to report net income for the quarter of approximately $1.6 million or six cents per share.

Turning to our balance sheet at December 31st, total cash increased to $45.7 million, an increase of approximately $2.7 million during the quarter and $6.6 million since last year-end. Operating activities, again, generated positive cash flow during the quarter and approximately $6 million in positive cash flow for the year.

Capital expenditures totaled approximately $450,000 and $1.7 million for the 4th quarter and total year, respectively. While there were no repurchases under our Stock Buy-Back Program during the 4th quarter, employees exercised stock options and purchased ESPP shares generating $2.3 million. Our accounts receivable increased approximately $510,000 to $16 million, while our aging of receivables remained healthy.

Lastly, as of this morning, about 30% of outstanding billed accounts receivable of December 31st has already been collected. 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’re about to make with respect to Q1 and Q2 2005 are forward looking. These statements include expectations about our future financial results and performance, growth rates, the success of any business objectives, product and service features and introduction, client products and demand for PDF design silk and yield solutions. PDF actual results could differ materially. You should refer to our current SEC filings and understand that forward looking statements made during this conference call are based upon information available to PDF today. We assume no obligation to update them.

Now for the first quarter of 2005, we reiterate the guidance we provided in our outlook press release earlier today. Revenue is expected in the range of $17.6 to $18.4 million, a small decline from the guidance we provided in October. Non-GAAP earnings per share are expected in the range of eight to 10 cents, also a small decline from our guidance of nine to 11 cents provided in October. The change in range for both revenue and non-GAAP earnings per share estimates is a result of the projected decline in gain share, primarily a result of missing a yield target on one customer engagement in Q4. Again, I point out what we have said before, gain share is volatile, especially when only a handful of engagements are contributing. If we miss one customer’s target at this stage of our maturation process, its impact is obvious and will be so for a period of time. However, as we get further into 2005 more 90 nanometer ramps will be entering their gain share periods providing continued growth in gain share from 2004 levels and more insulation from the volatility that one contract may cause.

Gain share for the first—guidance for the 1st quarter gain share is a range of $2.2 to $2.6 million. Reiterating the guidance for the 2nd quarter of 2005 which we provided earlier today in our outlook press release, revenue is projected in a range of $18.6 to $19.4 million with non-GAAP earnings per share in the range of nine to 11 cents.

Needless to say, we are not satisfied with our execution on all gain share contracts. However, that doesn’t detract from what was an excellent growth year for PDF in 2004, and the positive momentum we have going into 2005. With revenue growth of 47%, non-GAAP EPS of 22 cents, GAAP profitability for the second-half of the year, and positive cash flow of approximately $7 million, 2004 was a year to be proud of. We look forward to strong financial results in 2005. With that I would like to turn the call back over to the operator to open the floor for questions.

Thank you, Mr. Melman. Ladies and gentlemen, if you have a question at this time, please press star one on your touchtone phone. If you’re using a speaker phone, please lift the handset before asking a question. Please wait one moment for our first question.

Our first question comes from Garo Toomajanian from RBC Capital Markets.

Some more color on the gain share contract that missed its targets. Why don’t I start with that? I mean, is there anything that you can say that would characterize it that would give us a sense of how much targets were missed by and whether that is something that could snap back and improve in Q1 or if its something that would take a couple quarters time to start to see some improvements in?

Yes, Garo, this is John. This was an R&D on an advanced note actually, 65 nanometer, and the contract was set-up to demonstrate yields on prototypes and then would convert into—or we anticipated converting into a yield ramp in sometime of the 2005 timeframe. So, the money here is basically lost on this contract and what we are doing now is sitting down with this customer and discussing the follow-on yield ramp, and actually have a pretty favorable discussion with them about that. So this is a very leading edge note and I think a fair amount of risk in execution on that target as it turned out to be; although quite frankly the miss was pretty de minimus.

And how would I tie that with your guidance for gain share decreasing sequentially?

Yes, so, there are two elements there, Garo. So, this would—would have provided our incentives over the next few quarters on prototype ships which we will not see, and we did see in a couple of 130 notes decrease in volume a little bit on those contracts which is decreasing the revenue contribution expected out of a couple of them for Q1 over their Q4 revenue, or what would be there for their Q3 production versus their Q4 production.

Ok. But, also, in your commentary you said that you do expect to see some additional new gain share contributors come on-line in 2005, do have a sense of what the number of new contributors might look like?

Yes, that’s a good question. Basically if you look at most of the contracts today, their four to six quarters.

Right.

So when we announce a contract today, let’s say for Q4 of last year, you can expect that four to six quarters from them, that should start contributing.

Ok.

So, if you look at—you go back four to six quarters look at how many we signed up then and then cut them out forward. It’s on the order of one or two per quarter.

Ok. And, you also mentioned in your commentary that you signed your—I think it was your first 45 nanometer deal, is that right?

That was in—earlier in 2004, that is correct.

Ok. And, any sense from talking to customers and potential customers what that might look at in ’05, could we see some more?

On 45, I suspect, at most, one more, if that. I think we expect to see 65 nanometer ramps start to take off in ’05, probably towards the middle part of the year, possibly one in the 1st quarter, but more likely as we get into the 2nd and 3rd quarter of this year. I think 45 is pretty—still pretty far off from a yield ramp standpoint.

And, where is 90 for you guys now, are there still customers that you’re talking to at that note or is that kind of starting to--?

No, we still expect 90 nanometer ramps in 2005. In terms of what’s going to be the relative new sign-ups of 90 versus 65—will there be more 65s than 90s this year for us? A little bit too early to say yet, at this stage of the game there’s a fairly good mix of both. I think we’ll see how it goes throughout the year.

Ok, thank you.

Our next question comes from Dennis Wassung from Adams, Harkness.

Thank you. A couple more questions on some of the gain share contracts, I think you gave the number that you had five customers and six contracts in the mix for Q4 and I believe that’s up from four and five, respectively in Q3, is that right?

Right, that’s correct.

And, with the sort of the yield issue you had at—during, I guess, one of the contracts, did you still get some gain share revenue from that contract?

Yes, we did.

Ok. So you really—so you had one new contract in the quarter in the mix?

Yes.

So, there were—I’m trying to understand if anybody else sell out of the mix or get sort of the dynamics of that total mix?

No, I had nobody sell out. No, we had one new one.

Ok. And just to try to get a little more color on sort of your gain share mix at this point, it sounds like you had the yield—I guess the gain share contract where you had the yield issue this quarter with a 90 nanometer contract, I think you mentioned you had a couple of 130s in the mix that are slightly smaller volumes in Q1—I guess in Q4 production—Q4 production at the fab, Q1 gain share, is that accurate?

I think the miss was on a 65 nanometer. The gain share by and large in the past quarter was 90s, 130s, and maybe still a 150, I’m not sure. But, probably most of the revenue was off the prior notes.

Ok.

So that was like very early, as I said to Garo, it’s on a very early R&D, prove-out samples kind of contract.

Ok. So, basically, you have no—in the gain share mix today you don’t have any gain share coming from .18 or larger at this point?

I don’t believe there’s .18 or larger, I’m pretty sure it’s all 150 and below.

Ok. And, I guess as I’m trying to look forward this year and I think Garo exhausted some the question here, but if you look into Q2 for gain share are you expecting see sequential growth after you see sort of the sequential decline down here in Q1?

Yes, I think we—over the year we expect it to grow throughout the year. We do expect the second half to be better than the first half. The Q1 and Q2—we expect Q2 probably to be better than Q1, not substantially better, and we signed up a number of contracts in the 2nd quarter—the 1st and 2nd quarter of 2004 that we expect to be kicking into gain shares, we got through Q3 and Q4 of ’05.

Ok. So when you look forward in the second half, it sounds like there’s the opportunity at least to see almost a step-function improvement in the gain share line as this issue goes away that you had in Q4 and you’ve got a number of new contracts entering the mix?

Yes.

Ok. And, one more question on the new engagement you signed in the quarter and just make sure I’ve got it correct. It was one new engagement signed in Q4, it was a 90 nanometer deal with an existing customer?

Yes.

Ok. So what is the total number of 90 nanometer deals you have signed at this point?

I believe it’s nine.

Nine?

Yes.

Ok. And, is there any other detail you can give I guess along the lines of that contract? Is this—I guess, any geography or any type of whether it’s IDM fabulous or founder rather?

Its actually in Japan and it’s a IDM.

Ok. Great, thank you much.

Sure.

Our next question comes from Gus Richard from First Albany Capital.

Good afternoon, guys.

Hi, Gus.

Let’s see—real quickly. Could you just tell me the length of your current gain share contracts? Are they 12, 18, 24 months? Is there a distribution of duration?

Yes, it’s John. The majority of them are somewhere between eight to 12 quarters.

Ok. And, are the shorter contracts that you negotiated earlier, say the 130 note, are those pretty much rolled-off now—the contracts that you’re working on are the longer-term contract?

Most of them, although there’s I think still some 130s that are still contributing and are on the—longer in the tooth.

Ok. So you would expect those to—do those also roll-off in the first half of the year?

Probably one of them does.

Ok. And, then could you just walk me through the revenue recognition on the gain share? I know you’re in the low-end of your guidance, but I would think that that’s—as you come into a quarter a number you should have a fair amount of confidence—what you’re going to hit for the current quarter you’re reporting?

Yes. So I think our range in total was somewhere around a few hundred thousand dollars. Correct.

Right, what’s the variability there? How does that—as I understand it you recognize the gain share from the prior—

Right.

then you should know what that number is to the penny, theoretically and there’s always a variability and I just—

If I can answer that, Gus. I think as we stated before, production quarters and fiscal quarters don’t align. So some production quarters would have, let’s say, ended on September 30th in which case it’s purely one quarter in the rear. For that contract we know exactly what the dollar amount is, pretty much.

So it’s in the—

The production quarter may be September, October and November, then the invoice quarter is December, January and March.

Got it. So—

December, January and February.

It’s clocked on the signing of the contract as opposed to the ending of a quarter?

Oh, right, sure.

The signing of the contract or sometimes at volume target. When they hit a certain volume target or they meet a certain—reach a certain milestone that starts the clock. So the issue is not the date of the contract or not necessarily the production quarters that we might identify in the contract. If there’s a trigger for mass production or a certain volume level at mass production that starts the 1st quarter measurement, depending on what that first month is it could either match-up succinctly with our fiscal quarter or it could overlap one or two months.

Additionally, in this particular contract, we had incentive milestones that were identified in the new quarter, so when we provided our forecast at the last quarter of 2.8 to 3.2, we were assuming but did not know if we were going to achieve those milestones; hence, we established the range that would have impacted us in the 4th quarter. When we didn’t achieve the milestones it precluded us from hitting higher up in the range.

So, does that gain share bump into the next quarter and the subsequent bump out a little bit? Is that how that works?

Well, as a result of that contract, measurement triggered current and subsequent quarter gain share payments or gain share measurements. As a result of missing the milestone, we didn’t get to measure in the current quarter and we don’t get to measure in the subsequent quarters.

Right. So, the ramp is shifted to the write-up quarter effectively, is one way of thinking about it?

Except for the fact on this particular contract, it’s not that we will catch-up on the money we’ve lost in the quarters. That money is lost, we missed it.

Right. Ok. Right, because you only have eight to 12 quarters to capture this and you’ve missed one of the quarters you could have captured it in? I’m sorry to be so dense.

Well, this particular contract was for prototype wafers and—

If I can provide some comment, Gus. So for—a lot of times we’re seeing customers come to us and say we want to work on 65 nanometer; they’re probably two years away or three years away at that point from—this is a 2003 contract—from achieving a volume ramp and they can’t even give us targets for the volume ramp or whatever. So, we’ll establish a program or we’ll characterize early process R&D, establish milestones on hitting time to market targets for them and upon successful completion convert that into a full yield ramp for the production facility. But if you miss a time to market targets, you miss that incentive money. And then what you need to do is sit down with them and convert that into a ramp anyway, because we’re still far away from when this customer’s going to be adding volume at 65 nanometers—

Got it.

[inaudible]

Got it. Ok, that—alright, that helps me a lot.

We lose basically, that--what would have been the time to market on their proto-ships over the next couple of quarters.

Ok. Thanks, I appreciate the explanation.

Yes, no problem.

Our next question comes from Gary Mobley from B. Reilly & Company.

Hey, guys.

Could you give a little color on your degree of caution and the contract revenues for the 1st and 2nd quarter given the industry conditions and I think you briefly touched on that in your opening comments, but maybe a little more color there would be helpful and maybe you can approach it from caution from the foundries versus the IDMs?.

Yes, sure, Gary. This is John. Yes, I think if you look at the guidance what we’re basically saying is that we still see a very good customer interest across the product line. The foundries clear out a little bit more soft, but most of our revenue doesn’t come from there today, it comes from the IDMs and to some extent the fabulous companies as well, as we have a fair number of fabulous customers that are data power customers.

The revenue guidance for Q1 and Q2 was mostly on the flow-down in the ramp on the gain share that we anticipated it being over $3 million in Q1, and subsequently—and subsequent Q2, and our reciting that down, and that’s where the softness comes in. Frankly, in Q4 we signed both a yield ramp and data power contracts with customers, and so those customers had basically pre-announced. So, it was a good quarter and we still saw a lot of demand from the customers and continue to see that in Q1 as well. The dollars that—the difference between our original Q1 guidance in October and our Q1 guidance today is pretty much off the miss on this contract.

Does that provide the answer you’re looking for there, Gary?

I’m sorry, Gary, I can’t hear you.

Gary, if you’re on cell phone we must have a bad connection here, we can’t hear you at all.

Ok, sorry.

Is there an additional question or a next question, please?

Yes, sir. We’ll go to our next question which comes from Dennis Wassung. A follow-up question from Adams, Harkness.

Hi, I just wanted to follow-up on—actually it’s sort of the last question there, on the data power side. Did you say you had a new—another contract in Q4 there? I’m curious about what’s happening with that side of the business. I know you’ve talked, I think in the past about that becoming a driver and a component of your overall IYR deals as well as sort of ongoing product offerings with the customer. I’m curious if you’re seeing a more stand-alone business with that product line as well?

Yes, it’s a good question, Dennis. We’ve been doing a lot to integrate it with our integrated yield ramps and that’s why we talked about that on—about our Q4 achievement of the PDCV, which is really built from data power elements, and use it pretty aggressively on most of our ramps as well. With respect to the marketplace for data powers as a product, we do sell it when folks build new fabs. Your opportunity inside a fab is pretty much when they commission a new fab. We sell incremental licenses into the existing install base which is over a 1,000 seats now, and with respect to the fabulous community there is a bigger and bigger need for having a yield management system as the fabulous companies are starting to look at their yields and I think when we first acquired data power, we talked about their customer win at QualComm as being a pretty impressive customer win. We continue to see, every quarter, some customer wins in fabulous community. The seat count typically is small, anywhere from one to 10 seats sometimes. So, relatively, it’s not a big—big dollars, but it does give us reason to get in front of those customers and talk about more broadly what PDF is doing. And, of course, now as we get more and more fabulous companies using data power then the data format that they want to see from their suppliers is the same format that we use as well, and that’s something that we do want to leverage as we go forward.

Ok. And, I guess, sort of just a follow-up on—over on the PDFX side of things, using that as another tool to drive more business on the IYR side, is that—it sounds like that’s still in beta with Magma Blast yield tool, any idea when you expect to see that out in the field with customers and, I guess, sort of correspondingly, getting the PDFM files, the characterization files for specific processes out to these customers, how is that process working so far? I don’t know if that’s something you can even comment on at this point, but do you anticipate a lot of demand with your existing customers that you probably already have that file generated for?

Yes. It’s—actually I see a couple of things. I believe Magma is close to green release on Blast yield which include the PDFM Reader, and we had a beta customer who’s been doing a design with the Magma Blast yields release using our PDFM files, and we’ve also gone and talked to multiple customers jointly, some of them existing PDF customers and existing Magma customers, and some of them new for PDF, and frankly we do see a lot of interest in both cases. Clearly, in the case of our existing customers it’s relatively easy to turn them on because we already have or they already have the ability to generate a PDFM file, and what that does for us is drive need or demand for them to run characterization vehicles. For new customers, it gives us a whole way to talk about why getting a commercial solution to a yield ramp is valuable for them in tying their design community together with their [inaudible] fab. And, you know, we do expect as we get into 2005 from not just Magma, our relationship and partnership, but from many of the others we do see customer interest and customer demand for PDFM file which is creating opportunity for us, at customers that we don’t presently have today.

Ok, that’s great. And, last question. Any update on the—sort of the standard cell partnership with Virage in terms of coming out with the process or libraries?

We are working with Virage on that and I think also we’ve been on—Virage has been going around the world talking about their overall offering and we’ve been participating in that as they’ve talked about their PDFX compliant ASAP Library, with a number of customers. They’ve got seminars going on around the world right now where that’s being discussed. So, it out there now and customers are evaluating it.

Thank you.

Our next question, a follow-up question, comes form Gary Mobley from B. Reilly & Company.

Hi, Gary.

Hopefully you guys can hear me better this time.

Yes, much better.

Ok. Have you seen an improvement in the pipeline among the various foundries given the industry shift to die pricing versus wafer pricing and the increased motivation for those foundries to prove yields.

That’s a good question, Gary. I think our charter—customer win in 2004 was an example of that. Frankly, I think that—we still believe that’s going to be slow in coming, so whereas we did win charter last year and we expect to win other foundries as we get into 2005, I think that there’s still business model issues with those customers when they look at what’s the value of yield to them, especially if they’re utilizations drop. And, as you know, as you kind of eluded to on your first question, they tend to—their utilizations tend to drop more quickly.

Ok. And, did the deal with Virage—it’s the same sort of push-pull strategy that you’re barking out with the EDA tool companies, in other words, you’re trying to get in there with the fabulous companies with Virage and hopefully drive some deals with foundries that Virage is engaged with?

Yes, I think it’s not just limited to foundries, but IDMs as well. Virage does have a fairly large customer base in the IDM also. But, in both cases the opportunity is the same. We want to have it available for folks to get PDF compliant design tools, IP and design methodologies, so that when they look at how they’re going to characterize and bring up the next generation process, if they do it with PDF characterizations vehicles they have an automatic tie-in to most of the design community. And, of course, when the fabulous foundry interface that’s a market advantage for the customer, and the integrated IDM is less marketing advantage, but there’s still technical advantage.

Alright, great, thanks guys.

Our next question comes from Erach Desai from American Technolgy.

Hi, Erach.

Hi, gentlemen, how are you?

Good, how are you doing?

I’m ok. I had a question with regard to—now that you’ve, well you’re past 2004 is there a way to perhaps just on a surface level look at the impact of IDS on your revenues? Is there a way for Steve or you, John, to sort of say IDS contributed X amount of the overall revenues? Because when you really look at your design to yield solution revenue you had a nice year-over-year clip throughout the year and I’m just wondering what layer that added in?

I think from a financial standpoint, Erach, it would be rather subjective and misleading to the investment community to try to put a value on all of the IDS help that we’ve gotten internally as well as externally. Clearly, stand-alone software sales are one thing, but utilization was—utilization by our internal teams was something that we always were interested in and was a primary driver to the acquisition. That—a YMS was a technology that we wanted to develop and we either needed to make it or we needed to buy it. So the fact that there are stand-alone revenues is an added benefit, but it’s not something that we could realistically break-out and provide a clear picture.

Ok. You didn’t answer that, but that’s ok, I can understand that Steve. John, sort of a bigger picture question; there’s been a lot of press lately in terms of Sony’s next generation gaming platform which is going to supposedly be more than just a gaming platform and perhaps a home-networking, home-entertainment hub type of processor, and you guys have a historical relationship with Sony, so I don’t think I’m looking for anything new there, particularly. There’s also another player, Microsoft working with IBM, sort of trying to take the same approach with X-Box II, can you give us any sense of whether you’re—you’ve aligned your bets on both horses?

You know, I think that one’s one I’m not going to go and answer, Erach, if you don’t mind. You know, we’ve got a lot of confidentiality agreements with customers. I find that the foundries are the ones that—are the only ones that let us make press announcement pretty quickly after we’ve announced—signed contracts. As an example, one of the charter contracts this past year. You have to go back and put that together yourself one way or another, and I really can’t directly answer that.

Fair enough. I think the rest of my questions have been answered. Thank you.

Our next question comes from Gary Shenaro from JP Morgan.

Hi, John. Hi, Steve. I was a little confused on the yield mix, maybe you said this earlier. Can you give a little more granularity on what happened? What it that you set your target too aggressively, was it a timing issue, was it an execution issue, what was it?

Of course, if you were to go sit down and ask the engineer if the target was too aggressive. But, when you look at, I think what it really comes down to is that execution on achieving the yield target. At the end of the day you can argue whether that target was too aggressive. It’s a very new note, so it’s difficult to set targets on that note at this point in the game. But, nevertheless, frankly customers expect to get great results when applying PDF technology and it’s important for us to always exceed the expectations once we’ve agreed to them. So, prior to signing that contract it was maybe an aggressive target; once you sign that contract that is the standard that you need to be measured against, and fundamentally we missed that.

Ok. And, at the beginning of the call you mentioned—I thought you said you had five new something and I missed that?

Sure. That was during—I was summarizing 2004 and we had five new 90 nanometer contracts in the year.

Ok, and the one includes one in the 4th quarter.

Right.

Ok, and when you look at your 2nd quarter ’05 guidance you’ve got gain share—you didn’t give a specific gain share guidance, but presumably gain share should be up from 1st quarter. Is that based on either volume in yield increases or is that from more contracts?

Primarily from more contracts.

Ok, great. Thanks, guys.

Our next question comes from Greg Weaver from Kern Capital.

Hi. I guess I’m trying to learn here still. Can you give us the—a sense of what’s the length of time for a gain share contract that it generates revenue to PDF, typically?

Generally, the large majority of contracts we’re writing today are 30 months. You know—10 quarters going forward—the particular contract where we didn’t execute as well as would have liked was a contract with—that was driving incentives. It wasn’t—ultimately that contract may yield to a 30-month gain share period. But that wasn’t the form of this R&D contract.

And, we’ve done those when customers have asked us to provide characterization vehicles for very early notes. This was a 2003 contract for a 65 nanometer. So at that point, it’s pretty early on. Most of our customers can’t give us a production forecast or anything under which we can put together terms. In fact, its in this case, not even a production fab, its an R&D fab where they won’t run any real production. So we’ve done that to provide characterization vehicles for the customers, early on, primarily because for the customer, once they standardize in the characterization vehicle its difficult to change. And, so, its important for us—part of our strategy of winning accounts is to take on R&D. We like to tie the R&D all the way through to production as we did—talked about a 45 nanometer contract that we signed in early 2004, that contract has two or three years of fixed [inaudible] followed by 10 or 12 quarters of production going out for a number of years. In that case, it’s a very long-standing customer who has an experience with the characterization vehicles and it goes from early R&D all the way out to the production ramp. But, for some of the newer customers if we get involved in R&D, frankly, it’s too difficult to put together something that goes from early process creation where they’re designing design rules or picking out the design rules through to volume production.

What portion of your gain share revenue is associated with actual production volume?

The majority of it.

Right, I mean that where you get the big ramp in revenue, right?

Yes, frankly the customers really value the time to market on the process R&D, and we haven’t really tested the waters to see what would be the maximum extent you could charge for that. Recognize that the way we charge gain share is on a cost-savings. Right here, five yield points higher then that’s worth something to you and has the concept of gain share. If your node—your process node is qualified a quarter earlier or on time that also creates for the customer a tremendous leverage in value and, frankly, today for the R&D contracts we are not charging an awful lot for that the—the gain share maybe capped it $3 or $4 or $5 million, as a way of getting the production contract. You could argue whether that’s the best way to go, but fundamentally today that’s what we’ve chosen to do, because we have the same opinion that you have, we want to get the production contract out of it.

Yes, I guess I’m just trying to understand—so if we go back to say 2002, right, you did like 10 million in gain share back then? I guess—how many engagements were you—did you have back then and were they mostly all production?

You know, I really—I can tell you it’s a small number of contracts and a small number of engagements back then. The breakdown of what it was, frankly I don’t remember off the top of my head and—

But, would you say the deal sizes are getting smaller then [inaudible] over time, because you got a lot more deals like you said than you used to in the past, but the aggregate revenue number is not as large?

No, I wouldn’t—[inaudible] puts that together. I wouldn’t necessarily say that though in aggregate because they tend to be longer valued contracts—longer time period contracts today then they were then. So you’re looking at revenue on a different time horizon, and frankly at that time period we were very, very exposed to the very early stages of the PS2 ramp which the die sizes then were still huge, so the wafer ships were quite large. So I’m not sure that the unit—the number of wafers it represented then was a fairly large number, and I’m not sure if you look at them at dollars per wafer, I believe the dollars per wafer are still very competitive, if not more competitive then they were then.

Right, I got you. Ok, thank you.

At this time there are no more questions. I will now turn the call back over to Mr. Kibarian for closing remarks.

Thank you. In summary, 2004 was the year in which the industry increased adoption of PDF Solutions, especially at the 90 nanometer process note and 300 millimeter wafer fabrication facilities. We are particularly pleased that we grew revenue and profits, and penetrated more new customers than we did in 2003. PDF Solutions enters 2005 stronger and better positioned to continue to gain market share. Thank you for joining our 4th quarter 2004 conference call. Goodbye.

Ladies and gentlemen, this concludes the program. Thank you.