PDF Solutions Inc (PDFS) 2005 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 fiscal quarter ended Thursday, March 31st, 2004. 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 at that time. If you need assist assistance during the call, please press star, then zero on your touchtone telephone. 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 rate 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 26 through 34 of PDF's Annual Report on Form 10K for the fiscal year ended December 31st, 2004 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 would like to introduce John Kibarian, PDF's President and Chief Executive Officer, and Steve Melman, PDF's Vice President Finance and Administration and Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you and welcome everyone. For the first quarter of 2005 PDF Solutions is reporting total revenue of $18.1 million, a new record for us, and non-GAAP net profit of $0.10 per share. We believe that we achieved these results in spite of a lackluster semiconductor business environment because the growing benefits to our customers of our integrated solutions and software. I'd like to take a few minutes to discuss how these benefits are affecting our business and then Steve will go over the details of our financial results.

Semiconductor companies that are designing next generation products and ramping the leading edge processes to manufacture them understand that applying PDF CV infrastructure during R&D and production provides real cost reductions and time to market advantages. What we saw last quarter even as some of our customers made difficult cost cutting decisions company wide was that they considered PDF CV infrastructure a necessary part of a successful ramp. During the first quarter of 2005 we entered into one new engagement and one significant contract extension, both for production ramps, both with existing customers, one at 65 nanometer, one at 90 nanometer. The 65 nanometer customer is a good example of the point I was just making. For that customer despite having missed one of the revenue incentive thresholds on their R&D engagement last year as we discussed during our call in January, they decided that PDF CV infrastructure was key to the production ramp for that same node. Therefore, in spite of a sluggish semiconductor environment, they engaged with us for the 65 nanometer ramp before the end of the first quarter. We have said that our CV infrastructure is becoming a core component in our customers' ramps and often part of their process of record. Both of these contracts demonstrate this.

By expanding our partnerships with companies providing software IP and equipment to the semiconductor market we also continue to increase the number of applications using the data made available by our CV test chips. This is a significant benefit to the companies using our CV infrastructure. For example, during this past quarter at the European Design and Test Conference Magma Design Automation and Virage Logic [ph] demonstrated the advantages of their products that utilize our yield aware DSM technology, PDFX. When chip designers these products fabrication facilities that have been characterized with our proprietary CV test chips can produce more manufacturable designs. Already in this quarter an additional EDA partner is demonstrating PDFX enabled software products to their customers.

Another benefit to our customers is the expanding footprint in the fab. For example we continue to drive leverage from our 2003 acquisition of the Data Power Yield Management Software System. Over the past year we made significant improvements to PDF's yield rib infrastructure by using components of Data Power in our CV test chip analysis system and vice versa we used analysis algorithms developed during our yield ramps to increase the functionality of Data Power. The result of this combination is enhanced capability across our proprietary software programs that create, analyze and use CV data. The benefit to PDF is twofold, a significantly increased installed base of Data Power and a growing revenue from software licenses. The benefit to our customers is a broader base of proven technologies for tackling the industry's design and process integration problems at current and future nanometer nodes.

One final regarding our gain share performance during the first quarter. Our gain share results, unlike our record revenue as a whole, reflect the lackluster performance of the semiconductor industry. Last quarter we had forecast Q1 and Q2 gain share to be low, primarily due to our missing a yield target and associated revenue incentive on a process R&D engagement. However, gain share results for the first quarter also reflect volume production under existing gain share contracts that was ultimately below our expectations. On the bright side in Q1 we saw an increase in the number of customers and engagements that contributed to gain share. As this trend continues over time and depending on the overall wafer volumes we expect this growing base of engagements contributing to gain share to improve our quarterly gain share performance. Now we'll turn the call over to Steve who will discuss in detail our financial results for the first quarter 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 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.

Revenue for the first quarter ending March 31st, 2005 totaled 18.1 million, a record for PDF, our ninth quarter of sequential revenue increases and within the range we provided in January. This represents an increase in revenue of 43 % compared to the first quarter of last year and a slight increase sequentially from last quarter. The increase from the first quarter last year was due to increases in both design silicon yield solutions and gain share while the increase from last quarter was due to increases in design silicon yield solutions more than offsetting the expected decrease in gain share. Design for silicon yield solutions revenue totaled $16 million for the first quarter, a 37% increase from the comparable period last year and an increase of 5% from last quarter. The increases from last year and last quarter were again the result of strong demand for PDF's product and services at advanced nodes. 15 engagements from 11 customers each contributed over 250,000 in revenue during the quarter. As John mentioned, we kicked off one new integrated yield ramp engagement during the quarter at an existing customer at 65 nanometers and we significantly extended a previous engagement at 90 nanometers also at an existing customer.

Additionally this past quarter with increases in software sales we passed the threshold for required reporting of software licenses. As a result we have split design to silicon yield solutions into two categories, integrated solutions and software licenses. Software licenses is comprised of revenue from sales of PDF software, which is unbundled from integrated solutions. For the quarter ended March 31st, 2005 software licenses contributed 3.4 million to design to silicon yield solutions, up from 2.2 million in the comparable quarter last year. Reiterating John's comments we are very pleased with the industry's interest in our various software products and will continue to sell software products unbundled from integrated solutions when it's advantageous to our customers.

Gain share revenue for the first quarter generated from 6 customers and 8 engagements, up 1 customer and 2 engagements from last quarter, totaled approximately 2.1 million, a 113% increases versus the comparable period last year but a 24% decrease from last quarter. While we previously projected a decline in gain share we did not anticipate such a significant decline in wafer volumes that contributed to the current period's gain share. As a result, total gain share for the quarter was below the range we provided in January. However, we are confident that with more and more contracts entering their gain share periods we are well positioned to benefit once volumes again increase.

Gross margin for the first quarter excluding amortization of core technology was 67% of total revenue, an increase from 66% during the first quarter of last year and an increase from 65% in the fourth quarter of 2004. The increase from last year was primarily the result of a more favorable mix of design to silicon yield solutions elements and higher gain share. The increase from last quarter was primarily a result of a more favorable mix of design to silicon yield solutions elements offsetting the decrease in gain share.

Total operating expenses before amortization and stock based compensation and acquired intangible assets were 9.3 million for the quarter, up approximately $235,000 or 3% from the first quarter of 2004 while decreasing approximately 89,000 or 1% from last quarter. This reflects our continued effort to control costs and leverage increased revenue. Research and development expense totaled 5.3 million for the first quarter, an increase of approximately $118,000 or 1% from the first quarter of 2004. Research and development expenses were slightly lower sequentially from the fourth quarter of 2004.

Selling, general and administrative expenses were 3.9 million in the first quarter of 2005, up approximately 117,000 or 3% from the first quarter of 2004. This modest increase was primarily due to increases in sales personnel and outside sales commissions. SG&A expenses compared to the fourth quarter of 2004 decreased approximately $73,000 or 2%.

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 first quarter ending March 31st, 2005 totaled approximately 2.7 million or $0.10 per share, at the top of the range provided in January. This compares with non-GAAP net loss of approximately 373,000 or $0.01 per share for the comparable period last year and non-GAAP net income of approximately 3.6 million or $0.13 per share during the fourth quarter of 2004, a period that included a significant tax benefit resulting from an increase in 2004 disqualifying dispositions. During our first quarter we conducted research and collected data with regards to a state benefit that could be achieved depending upon historical hiring practices in the San Jose region. As a result of this effort we did record a one-time tax benefit of approximately $200,000 resulting in additional earnings per share during the quarter of $0.01. Without such an effort our non-GAAP earnings per share would have been $0.09, in the middle of the range provided in January. For the remainder of 2005 we continue to forecast our tax rate in the 28% to 30% range. On a GAAP basis including amortization of stock based compensation and acquired intangible assets I'm pleased to report net income for the third sequential quarter of approximately 1.4 million or $0.05 per share.

Turning to our balance sheet at March 31st, total cash increased to 48.4 million, an increase of approximately 2.7 million during the quarter. Operating activities generated positive cash flow of 1.6 million while employee stock option exercises contributed 1.7 million. Capital expenditures totaled approximately $492,000 partially offsetting the cash generated from operating and financing activities while there were no additional repurchases under our stock buyback program. Our accounts receivable increased approximately 2.4 million to 18.4 million while our aging of receivables remained healthy. Lastly, as of this morning over 30% of outstanding billed accounts receivable at March 31st has already been collected.

Before looking at guidance a quick note about Sarbanes-Oxley Section 404 compliance for 2004. I'm pleased to say that we filed our 2004 10K on schedule on March 16, 2005. Included in the 10K were certifications from management and unqualified opinions of our independent registered public accounting affirm that our internal controls including those over financial reporting were effective as of December 31, 2004. Now that our efforts for initially complying with SOX are behind us, we will benefit as a business going forward.

Turning 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 and Q3, 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 introductions, client's products and demand for PDF design for silicon yield solutions. PDF's actual results could differ materially. You should refer to our current SEC filings and understand that the 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 second quarter of 2005 we reiterate the guidance we provided in our outlook Press Release earlier today. Revenue is expected in the range of 18.6 to 19.4 million, no change from the guidance we provided in January. Non-GAAP earnings per share is expected in the range of $0.09 to $0.11, also no change from our guidance provided in January. And guidance for the second quarter gain share is in the range of 2.1 to 2.5 million. Reiterating guidance for the third quarter of 2005, which was also provided earlier today in our outlook Press Release, revenue is projected in the range of 19.4 to 20.2 million with non-GAAP earnings per share in the range of $0.10 to $0.12. With that I would like to turn the call back over to the Operator to open the floor for questions.

[Operator Instructions] Dennis Wassung from Adams Harkness.

First question on the gain share side, you had a couple of increased I guess incremental contracts in the gain share mix. You had 8 contracts still with 5 customers. Did you have any contracts fall out of the mix or is it just 2 new ones that got in the mix?

It was 8 contracts from 6 customers and we did not have any fall out of the mix although, as we had discussed during our first quarter's conference call, the gain share we could have achieved on that previous contract was not going to flow out to continuing quarters although it was included in the first quarter.

Okay so is that the R&D contract, 65 nanometers you were talking about before?

Yes.

Okay and so obviously you saw a pretty good increase here in the number of contracts and I think John mentioned that this number could keep going higher. Is that your expectation here to see that number go up from quarter-to-quarter throughout the rest of this year?

Well from-- you know I don't want to say quarter-to-quarter-to-quarter type of growth but over the longer term, yes, we expect more and more contracts to come into gain share mode.

Okay and I guess sort of on top of that looking at sort of the gain share guidance and I guess John's comments here on just of the broader environment, are you seeing any change in terms of the volumes that your customers turning at this point? Obviously Q1 not necessarily was a fantastic quarter for the industry but given the fact that you guys are more leading edge in a lot of these contracts, is the trajectory looking to be up sequentially from here outside of the June number that you guided for?

This is John, Dennis. We saw-- I think the volumes where we thought they were a little bit lower than we expected or in some cases more than a little bit, were at the 130 node. We didn't see it too bad at the 90 node and I think we all expected that at the 90 node we don't expect to see to be light at this time. I think as we see more contracts come in and those disproportionately at the more leading edge nodes, we should see a little bit of an improvement and I think that's what the guidance kind of reflects.

Okay great and on the guidance in general when you look at the visibility going out and you guys give 2 quarters rolling guidance at this point, pretty good visibility I'm assuming based on the percent completion accounting I guess profits you guys use. Any change in that visibility in general I guess given the environment over the last couple of months?

That's a good question, Dennis. I think actually last quarter if you notice we used to tighten the range on one quarter out to about $500,000 and leave the range two quarters out around $800,000 on the revenue side and since our Q4 conference call we left the first quarter out at about an $800,000 range. So we did-- we typically go into a quarter where I said we see 75% or greater of the revenue for that quarter going into the quarter and typically two quarters out it's greater than 50%. That's pretty much the same although we've guard banded a lot when we provide that kind of outlook going forward. So our leaving a little bit more room on one quarter out starting with last quarter is basically our way of saying that the market is a little bit-- it's not as good as it was let's say a year ago or three quarters ago.

Okay, that's fair enough and I guess last question for you on the new contract here, the extension that you guys had here, is this a customer that was-- I guess when you talk about extension is this an extension of the ramp process or is this an extension of the gain share part of the contract?

It's an extension to the ramp that included more process flavors and some more CVs and incremental activity drive up different flavors of that process in that same facility.

Okay so is there a similar type of revenue opportunity in an extension like that as you're going into a new flavor or I guess how should we think about that?

It's [indiscernible-multiple speakers] like they start competing with each other in a fab, right, so at some point no. It does help you. What it effectively hopefully does is shelter your risk that the mix doesn't shift and you don't lose from that. You want to cover all the flavors of a technology. You know if you have embedded DRM [ph] and non-embedded DRM logic SOI etcetera.

Okay and last quick one, the other engagement you talked about 65 nanometers as the production version of that R&D contract you had issues with last time around. How many 65 nanometer contracts do you have in place at this point?

2 or 3. We're actually sitting and looking at each other.

Yes, I think it's--

It's 3 at 65 and below.

Okay and then so you have one 45 contract you talked about, right?

Right.

And to that end are you seeing a lot of your activity at this point being focused at your bigger customers at 65 nanometer or is there still a lot of work to be done with your major customers at 90?

There's still a fair amount of work at 90. Typically obviously with our existing customers we've moved a lot of them to 90s. We're in the process of 90s now so for those existing customers we will start seeing-- yes, we do see extensions on 90 and incremental facilities. We start seeing the new activity with those customers at 65. For our new customers, when you set up new customers it's probably still at the 90 node in this year would be my guess but it's a little early to tell.

Garo Toomajanian from RBC Capital Markets.

With the one new DYS engagement and the one extension, does that bring the total now up to 17 or 18 or were there some completions also?

7 or 18 what, Garo?

The number of DYS contracts or engagements that are in process now?

Well the ones that were contributing over 250,000 in the quarter were 15 from 11 customers.

Okay, secondly you've talked about different ways that you write some of the gain share contracts, especially at existing customers going to more of a wafer volume based gain share as opposed to yield improvement from a base line. I guess what are the criteria that you're using now for basing your gain share contracts?

Yes, I'll take that. So for the R&D ones it's often an incentive on achieving some yield measure like we talked about last quarter on the R&D contracts. For the gain share for the production contracts historically what they were is even after the work had been done each quarter there would be a yield to be measured against and then the payment would be based on the performance against that yield, even after the implementation had been completed. And we still have some contracts even at 90 that work that way that were signed way back in the 2002 time frame. For most of them now they work where there is an implementation period and at the end of that period there's one or two measurements that establish the benefit in terms of the value per wafer and then on the subsequent quarters the still volume risk but there's no yield risk on them on a going forward basis. And occasionally for the customers that generally keep their factories full sometimes we'll take out the volume risk and say, "Okay with this much yield on this size factory it's this much per quarter." And some of the IDMs have-- they run their factories at 80 plus percent utilization so the volume risk there for them isn't that great so we can just assign a value to it.

Okay and is that renewed R&D engagement from last quarter, is that still and R&D engagement?

No. It's a ramp now.

Okay good and last question I have is a couple of your customers are involved in the cell [ph] chip. Can you say if your technology is implemented in that production and if you'll see gain share from that?

No. We can't say that, Garo.

Gus Richard from First Albany Capital.

Yes, quickly on the gain share contracts, how many are 130 and how many are 90 and 65?

Quite a few of them are still 130 in terms of what's producing now. Let's see some of the numbers.

Let me ask the second question while you're looking for those. Sales pipeline for new customers, can you talk a little bit about that, how the prospects look on getting new customers into the fold?

Just looking at it the majority of them that were contributing were 130 and there was a couple at 90. And then to get to your-- you're going to have to repeat that because I was studying when you asked the question, Gus.

I'm sorry. Sales pipeline for new customers.

We see a pretty typical pipeline for this time of the year if you compare it with this time last year. It's I'd say similar. There's-- we expect 1 to 3 contracts, new contracts per quarter on a typical basis, somewhere around there. And in terms of whether they're new or existing accounts, we see a lot of activity at new accounts and probably still like we always say we see most of the activity at existing accounts, more of it at existing accounts, because we're not really penetrated at any of the existing accounts fully. We still believe there's more opportunity at the existing accounts.

And then finally on the gross margin I missed some of the call. There was an upside relative to my model. Could you just talk about the sequential increase in gross margins and what's driving that?

I think the sequential increase was a result of a favorable mix of the design to silicon yield solutions elements that more than offset the decline in gain share from quarter-to-quarter so the overall mix and higher margin design to silicon yield solutions overall contributed.

Okay I'm sorry that didn't-- what part of the design to silicon yields have higher margins relative to other ones just so I can understand? Is it [indiscernible-multiple speakers]?

Well, we've split it out into integrated solutions and software licenses so software licenses maintain a fiscal characteristic similar to gain share. There's very little cost while the design to silicon yield solutions, which we generally price at 55% margin, has some swing depending upon whether you're being effective on any given engagement or whether you're bundling more materials so in this particular quarter the mix of elements, the software license component and the margins on the integrated solutions contributed favorably to overcoming the decline in gain share from last quarter.

So essentially to simplify this for myself, your software sales were up sequentially pretty strong and that carried gross margins higher?

It contributed to the increase in gross margin. Yes.

Got it. All right, thank you.

Gary Mobley from B. Reilly & Company.

Could you talk about the climate for some of the dedicated foundries out there and I know it has been somewhat lackluster in gaining traction there but has it gotten even worse with utilization rates being as low as they are?

Gary, it's a good question. I don't think it has gotten-- climate for new opportunities there have gotten much worse. We still see all of them trying to innovate their way into 90 and 65 nanometer. We have an ongoing engagement this time that we've talked about and even I think Charter [ph] talked about in their annual report on fab 7 with their 90 nanometer ramp and we view that as a very strategic and important ramp obviously because it demonstrates the placeability [ph] of our technology in that marketplace. We believe in this year we will see incremental business in the foundry market and I don't think that the utilization, which from what we see is mostly at 130 and above, will have a negative impact on that selling opportunity.

Got you and you guys are making a lot of noise, probably Virage making more noise in its silicon ware IP and I believe it's using the data you guys have collected and I think on the last call you mentioned that you might have another IP company, which there would still be possibly off so incorporating your data. Where do you stand on that front?

Specific companies until we make press announcements we can't disclose who they are. We have signed 2 incremental design automation companies up that are including our technology in their software and 1 incremental IP vendor up who is also working with us in including our technology and they are a logic IP. And as they get ready to being able to make customer announcements or a product announcements I should say, then we'll be able to make press announcements as we have with Magma and Virage who are in the market now with product.

All right, great. Thanks.

Dennis Wassung.

Sort of to follow up there on the EDA vendors and the IP vendors, are you getting any revenue at this point from these, I guess the announced engagements you talked about from either Virage or Lava or at Magma Design or the new contracts at this point or is it still very much a kind of seed the market with the technology?

Well with some diminimus [ph]-- there's been some diminimus revenue that's come from some of our customers starting to implement designs and requiring some help on setting up the infrastructure for them to use the software and have their internal IP ready to use the Magma full out but I think frankly we're still very early in that and don't really expect-- we're not measuring it on the revenue impact right now. We will start measuring it on the revenue impact as we see tape outs with that design flow. In that case it's with customers internal IP but eventually with Virage IP as well and the other IP and other software providers as that affects our gain share at our IDM customers that are paying us gain share as well as our foundry customers.

Okay fair enough and now that you're breaking out the software revenue piece I'm curious what's-- I guess is there a change in the attitude of selling software at the Company? Is it just something the customers are demanding more or asking for more and how do you see that I guess tracking as we go forward? Is that going to be a growing piece of the revenue pie?

A good question, as I hoped when we acquired Data Power that our sales team would have a change in attitude on selling software because obviously we didn't make a bet like that without expecting to start driving software revenue. Our Data Power revenue, especially for the larger IDMs, tends to start out relatively small number of amount of software, some out of customization because there's always some internal system that they had that had some unique features or functionality that they want to see duplicated that we need to do and add to our system. And then what we expect or hope to see from that over time is them then buying more and more licenses without us having to do much more in terms of customization or integration and data sources. You know we consummated that merger in September of 2003, began on the process of bringing that product out to customers. Our footprint in the industry was a little larger than IDS's. Started signing up customers, going through the laborious process of selling them a combination of software and services. Steve turned to me when we were first doing it saying, "Gee, the gross margins don't look much different than they do for a yield ramp at the beginning." "I thought we bought a software business." And over time we started seeing the incremental licenses after that hard work start to come through and as they came through an improvement in the overall amount of software revenue and hence, the breakout. But it's very much like the IYR business where you do a lot of work up front. The initial business isn't great from a margin standpoint and you hope downstream that that's going to create applications that drive usage of the software and drive up your business with that customer.

Okay so when you look at the software licenses revenue category at this point, is the vast majority of that the Data Power side of it or is there the YRS software piece being a part of this mix as well?

There is some YRS revenue but the vast majority of it is Data Power revenue and going forward I think we will see-- of course, the Data Power family has got a pretty big install base, over 1,000 seats out there so it's as I always say to the sales force, expecting to sell 10 more seats is 1% of the install basis. It's not a lot. You know with the DFM tools and technologies it's still pretty early so selling 10 more seats is a large fraction install base. So going forward you should still expect Data Power to be a big part of that.

Okay, great. I guess another couple of quick questions, on the customer side any customer concentration changes in the quarter? Can you give us any numbers or do you have to wait for the Q for those?

Well, I prefer always to wait for the official Q but I don't there has been--

-- much difference.

-- significantly different.

Okay and, John, in the past you've kind of given us a number of your customers you have in the top 5 of the worldwide chip companies, maybe the top 15, top 10, something like that. Has there been any change there or can you kind of give us an update as to where you stand among the world's top companies?

There's has been more update in the who is in the top 5 I think than there is in the rest of the customers and I'm not sure actually who is in the top 5 right now because I know it has moved around a lot in the last year. There's a top 2 and then a number 3 through number 7 that slosh around a lot. I think suffice it to say in the top 10 it's pretty much the-- we've seen pretty much the same customers. I don't think we've seen any additions in the top 10 over the last one or two quarters.

Do you have for how many of the top 10 you have at this point, roughly?

Not off the top of my head, Dennis. If you give me a second. Can you tell me who you consider in the top 10 right now and then I'll give you a number because it has moved around quite a bit? Honestly, I believe Infinium [ph] moved up pretty high recently in the last rankings and I'm not sure where some of the other ones are. It's over half and it hasn't changed from what we said the last time. If it's changed it's because someone fell out of the top 10, not that we lost a top 10 customer.

Okay, fair enough. Thank you.

Garo Toomajanian.

Thanks. I have another gain share question. I believe that most of your gain share contracts are for a set period of time like 8 to 12 quarters. Obviously there have been a few additions this quarter but outside of those where I guess are we in those gain share contracts? Did you follow the question?

Yes, I did. Probably one of the 130s is nearing the end of its life and the rest of them are all pretty much in the middle of their life on the 130s. With what I actually know two of them being at the beginning of their life so there's probably one that's at the end, two that were at the beginning and the majority of them that are kind of in the middle of their life. The 90s, I think one is a good part way along and the rest of them are at the beginning of their life.

Tim Fox from Deutsche Bank.

Just a couple of quick questions. On gain share I know you mentioned that you've been moving more towards volume based as opposed to the original setup for these contracts. Are you exposed at all to wafer based pricing or is it primarily just volume driven?

Good question, Tim. For the IDMs generally not sensitive to wafer based pricing. There's just a dollar value per yield point per wafer. For the foundries, at least in one case, it is a percentage of ASP. So, yes, in one contract that engaged here now but one of the contracts that is in implementation does have an ASP sensitivity to it.

Do you expect going forward with other foundries as you add them incrementally that you would stick with that percentage of ASP?

The foundries, of course, are more likely to be in that category because they obviously-- the value of the yield point is kind of a function of their ASP to some extent. For the IDMs I suspect not because they're going to haggle over what the ASP is on the wafer because then we'd say, "Great, okay then give us the product revenue ASP." So I think generally on the foundries, yes. You're going to see some of that. On the IDMs I don't think so.

The only other question I had-- I'm not sure if you can answer this.

I'll give it a shot.

Give it a shot. From an end market perspective or application perspective is there any way to think about where you're levered to just to try to look out there and understand the dynamics of volumes?

Yes. Specific products and specific companies, that just gets us in trouble. So what we can say, basically what we see with customers is customers decide, especially the IDMs. We generally win IDMs when they make the transition of the lead product in our process technology is a very high ASP product. For them yield doesn't really matter as long as we get a few good die off per wafer we're fine and then we'll live but then we'll kind of rumble all along the yield curve and then eventually we'll get other products and as the mix is shifted that it's consumer oriented products of game systems, graphic systems, cell phone system chips, all of those they need really low production costs in order to make-- and they use very leading edge technology. Those tend to be the markets that we're the most sensitive to both from signing up the customer and the gain share production.

Helpful. Thank you.

Dennis Wassung.

Sorry to keep jumping back in here. Two last quick questions, a follow-up on Garo's question there, when you look at the contracts that are near the end of the life or I guess on the middle of their life and the gain share today I think you've talked fairly recently that you've kind of changed the contract structure with your newer contracts such that at the end of the life of these contracts either the customer has to sign an extension or the technology is unplugged. Is that fair to say that the contracts that are nearing end of life do not have that feature or am I off there?

There's only one that's at the end of its life and that contract is a very old contract, probably the first 130 we ever did. That one I think pre-dates that change in policy. Most of the rest of them don't and most of the rest of them are as you described. When the gain share period is over there is either an extension required or the technology turns off.

Okay and the other question, on the foundry side of the business obviously most of your customers or at least your big revenue customers today have been IDM related. I was just wondering what your exposure is to the foundry side of the market today? Obviously you're expecting to add new foundries as customers. You've announced Chartered [ph]. I think you've talked about Tower in the past. What kind of exposure do you have today?

Exposure today is pretty small in that I think that in terms of wafer volumes turn is the most significant of them and the rest of them by and large today don't matter that much. Going forward I think that will change but I mean for the remainder of '05 I think it's pretty safe to say that even if we sign them up it would be an implementation mode at this point.

Right so in total revenue today are you looking at maybe less than 10% of revenue?

Yes, probably. Steve is squinting right now. That's probably a safe assumption.

Gary Shenaro from JP Morgan.

Did you say you had 15 engagements this quarter that were great? Is that right?

Right.

And I think in the fourth quarter you had 16. Does that mean one rolled off or--?

Yes. Yes, there was actually one that was not a yield ramp in engagement that didn't contribute over 250 in the quarter and the new ones that we signed haven't backfilled yet.

Okay and, John, you mentioned that one of the gain share contracts was nearing the end of its life. Do you expect that to contribute in the next quarter?

No. I don't believe so, not significantly.

And do you expect other engagements to roll on and contribute?

Possibly one.

Okay, I assume that's the reason for the relatively flat gain share guidance is--

We expect some volumes to pick up a little bit in customers that we see volumes improving a little bit.

Okay and you had more-- that your gain share was down from the fourth quarter but you had I think more engagements contributing?

Yes.

Is that a contract? Does it have anything to do with the contracts or is that pure end market or pure volume?

You know sometimes at the start at the first quarter they're not-- a couple quarters as they roll up the volumes increase and/or the dollars go up so first quarter or two off, sometimes not at the peak of where they end up and we expect that in a few of them.

So that's just timing. It's not like-- there's no reason to expect that there's anything different in the contracts.

No, generally not.

Okay so when you look at the gain share you know obviously you're disappointed but is it just that it is what it is because of the end markets and volumes or is there anything that you could look at either you're doing or something going on at your specific customers that has led to that?

Yes, so I think in always our-- and one of the things I always liked about our business was always our efforts can result in better or worse performance. It always made me feel like we had kind of a start-up mentality. If we don't execute well it shows up and customers that pay a lot are usually the happiest and customers that don't pay a lot because we didn't hit high on the yield targets are the least happy, right? And I always liked that. Customers should be happy for paying you money. You know so, of course, if we execute better on higher up on the curve we would make more money. When we made the guidance forecast in January we obviously took into account the level of execution that we had when we did that and what affected us were the volumes. For sure if you look at a longer term perspective, the better you execute the more money you can make per ramp and the more value the customer perceives and gets and the happier they should be and they generally are. And that's how we spend money in R&D because we believe that's going to help us over time.

Right but I guess so when you--

When we put together this forecast it wasn't about an execution piece as it was last quarter and we talked about that.

Right, okay.

But to be truthful, right, on a longer term horizon you always can see how you could execute it better and drove more revenue. That's what I like about the business.

Okay, great. Thanks, guys.

James Capello [ph] from Kern Capital [ph].

Can you talk a little bit more about the accounting on the gain share piece and also the new software license piece, perpetual versus term?

The accounting on the gain share piece? Could you be more specific?

So it looks to me that you have R&D customers and also production customers so how do those revenue levers work accounting wise in terms of you guys recognizing them versus deferring them in a given quarter?

Yes, there's no difference. It's just an issue of when we begin working with the customer and the mechanisms that we set up to generate gain share whether it's a time to market or it's a yield over for time percentage or in a production ramp it's mass production multiplied by a unit revenue volume but when we achieve any of those, whether it's an R&D engagement or production engagement, at the time we achieve it we recognize the revenue so there is no deferral relative to one versus the other.

Okay and the time line of the given volume that's measured, is that on a quarterly 90-day basis?

It's on a 90-day basis and some of them line up with our production quarters and some of them don't and in general a third of them do, right.

A third of them line up?

Right, because on average we don't know when the customer is going to-- usually there's a volume threshold, right, that establishes when they're starting in production and so that starts the "clock" as we say and that may be the first month of the quarter, second month of the quarter, the third month of the quarter, and then from that point on it's you recognize the result at the end of that 90-day period.

James, what John is referring to is a production ramp that is generally 30 to 36 months. It's a production quarter in the contract that we measure. In an R&D ramp or an R&D engagement it's generally a much shorter period or time and it's usually an incentive based gain share or a target or a time to market gain share or a pilot billed gain share as opposed to a production ramp that is a customer in mass production over an extended period of time.

Okay is there a daily run so on March 30th did you get a daily run on what the production was from each of these clients?

For the volume ramp ones, for the production ramp ones, yes generally.

Okay and then on the license model is it perpetual or is it term or is it a mixture?

Well, there isn't a set answer to that. It depends what the--

Yes, so for Data Power we have mostly perpetuals and some time based licenses. For any of the factories what we've found is they buy it for the factory for the life of the factory so when you talk to the customer basically perpetual is about all they're going to accept because they buy everything else for the factory on that way and then capitalize it over the life of the factory so all their yield improvement is by and large bought that way. The bigger Data Power deals tend to go that way because of the nature of the yield management software. Some of the smaller Data Power deals, especially the ones that are sold to product engineering teams where they're not associated with the factory, you can time base license those and the customers will do that. At the factory especially for yield management software our biggest competitor by and large is KLA. It's a perpetual software business. That's how the customer expects it.

Okay and what do you guys prefer?

I just always think that the time base would be better given the maintenance schedule on the yield management systems typically are close to 20% and the fact that the factory itself only lasts 5 to 7 years you're almost better off with the perpetual license from a software company so I think you actually are better off with the revenue generated on a perpetual license.

Got you and finally has there been any kind of change or do you perceive any change with the relationship you have had with Magma?

No, still working with them.

Have you yielded revenue regarding them yet?

We have as I said to I think maybe Dennis Agato [ph] asked that question or maybe-- no, no it's Gary Mobley. As I said, we had a small amount of revenue that came from an IDM customer that needed to set up their IP to work with our test chip data and their software but it's relatively small.

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

Thank you. We remain focused on providing excellent value to our customers and believe that as a result PDF Solutions will continue to build momentum. Thank you for joining our first quarter 2005 conference call. Good-bye.

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