PDF Solutions Inc (PDFS) 2006 Q2 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 second fiscal quarter ended Friday, June 30th, 2006.

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 assistance during the conference please press star, then zero, on your touch-tone telephone. As a reminder, this conference is being recorded.

If you have not received a copy of the corresponding press releases, they have been posted to PDF’s 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 ‘Risk Factors,’ on pages 10 through 18 of PDF’s Annual Report on Form 10-K for the fiscal year ended December 31st, 2005 and similar disclosures in subsequent SEC filings.

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

Now, I’d like to introduce John Kibarian, PDF’s President and Chief Executive Officer, and Keith Jones, PDF’s Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone.

For the second quarter of 2006 PDF Solutions is reporting total revenue of $18 million and non-GAAP net profit of $0.13 per share. Gain share was a record $5.7 million. Keith will talk more about the financial details behind these results and discuss our guidance going forward in a few minutes.

There were many notable business accomplishments in the second quarter. We entered into a significant number of new deals, ramp engagements, our gain share. an indicator of our clients' success, continue to grow to a record level, and we gained traction in our DataPower software business in our IYR client base.

As we stated in our last conference call, in Q2 and Q3 we needed to focus on strengthening our pipeline of active yield ramp contracts. Our strategy to achieve this included moving to an account team organization structure, which we implemented in Q1.

During the quarter we began to reap the benefits of the changes we made, benefits that we expect to continue growing. In fact, this was our best quarter for signing new engagements since Q2 of 2004, with significant progress on four deals. We signed LOAs on two new engagements. One, a 65-nanometer Logic engagement with a new client, and, one, a 70-nanometer DRAM engagement with a new IYR client.

We signed a significant extension to an existing 130-nanometer engagement. And, lastly, while we reached agreement on a 90-nanometer ramp with a new client, the contract did not close until early July, causing a slight shortfall on our Q2 revenue. These four engagements were spread out geographically, with one each from the U.S., Asia, Japan, and Europe.

With the DRAM engagement we have the opportunity to demonstrate the extension of our solution to the memory market. This is important to our business because over the last year the build-out of capacity in DRAM and Flash has outstripped the growth of Logic capacity.

Our DRAM offering, like our CMOS image sensor offering, benefits from our recent development of our [PD5] platform. Our PD5 test 2s and 3s are capable of accurately characterizing performance variability yield loss, which is critical for Logic, DRAM, Flash, and image sensors. We expect the solution we are delivering to our DRAM clients to also be appropriate for Flash clients.

In the second quarter we realized the largest gain share revenue in the history of the Company, reaping the benefits of 90-nanometer ramps begun in 2003 and 2004. Our record gain share performance from nine contracts proves that our solutions and technology work. Our gain share revenue is a result of our clients' success in applying our technology to their most leading edge product and process ramps.

As a company committed to the success of our clients, we are particularly proud of the results our clients are achieving. Last quarter we saw improved traction of our DataPower business. While the total license revenue was not large we closed DataPower business with nine customers. Two of the sales came from [yield ramp] clients who saw the power of our analysis solutions during the ramp and purchased preliminary [CV] software at the completion of a ramp. At [Semicon] last week, Microsoft invited us to demonstrate DataPower in their booth as a partner.

In addition to delivering on revenue growth, we continue to focus on improving the delivery of our services. Next Monday we will be celebrating the grand opening of our Shanghai office. The initial purpose of this office will be the center of excellence for analysis of our proprietary CV type chip data. By centralizing this engineering service that can be standardized our clients will receive better results more efficiently.

Our guidance for Q3 reflects our belief that we can continue enlisting two to three new IYR engagements per quarter and continue making progress on the DataPower business. This is consistent with our expectations from our last conference call.

Our revenue guidance for Q3 is $1 million below our previous guidance range. In our previous guidance we had anticipated gain share increasing over Q2. However, updated expectations for gain share is between $5 million and $5.5 million due to changes in volume expectations at a few clients. As we have said many times, our gain share is the result of both our clients' success with our technology and their volumes.

While we expect an increase in aggregate YOY we do expect variability quarter to quarter. Our guidance for Q3 and Q4 reflect our confidence that gain share will be over $20 million in 2006, almost 100% increase over 2005. In general, we are pleased with the guidance as it reflects our clients' confidence in our solutions.

Now, I'll turn the call over to Keith, who will discuss in detail our financial results for the second quarter and our guidance going forward.

Thank you, John. And good afternoon, everyone. Let me again state that this presentation and our press releases issued earlier today includes references to certain non-GAAP financial measures. The press releases contains 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 second quarter ending June 30th, 2006 totaled $18 million, a decrease of 2% and 9% compared to the second quarter of last year and last quarter, respectively. These results were just shy of the guidance we provided in April. That's two contracts expected to close in Q2, flipped to Q3, and those that did close during the quarter closed later than expected, resulting in lower Q2 revenue.

As John mentioned, one of the two contracts that slipped into Q3 has already closed, and the other is expected to close shortly. In summary, the decreases from the second quarter of last year and last quarter were due to decreases in design-to-silicon-yield solution, more than offsetting increases in gain share. We are very pleased to report record gain share revenue for the quarter. Our [higher] bookings with new existing customers that close at a rate not seen since Q2 2004 and our first DRAM IYR project, ever.

Total design-to-silicon-yield solutions revenue totaled $12.3 million for the second quarter, a 21% and 17% decline in the comparable period last year and last quarter, respectively. Both software license and integrated solutions revenue contributed to the decline. This quarter, 12 integrated solution engagements from 10 customers each contributed approximately $150,000 or greater in revenue, a decrease of one engagement from last quarter but an increase of two customers.

The third quarter will be one more quarter for [fix and fee] periods on multiple engagements will have ended. However, as John talked about on last quarter's call and again today, we reorganized our sales efforts in Q1 to have an account focus and we're seeing the positive results. With strong bookings in Q2 and our sights set on a robust pipeline our confidence continued to build that our reorganization has put us back on the right track to build a healthy backlog.

Gain share revenue for the second quarter totaled $5.7 million, a 98% increase versus the comparable period last year, a 14% increase from last quarter, and above the upper end of the range we provided previously. Gain share revenue was generated from seven customers and nine engagements. We got one engagement during the quarter, as two engagements ended the end of their gain share period, and one new engagement at an existing customer was added.

Gross margin for the quarter excluding stock based compensation and amortization of core technology was 66% of total revenue. A decline from 68% and 71% during the second quarter of last year and last quarter, respectively. This drop is partially the result of starting work on the two engagements that flipped into Q3. As a result of that decision, the expenses were charged off to sales with no associated revenue.

The remainder of the decline was from the role of the new PDF [fast test] products. The expansion of PDF fast test configurations can greatly improve our test capabilities in overall project success. Additionally, the thicker layer of technology we provide to our customers. During Q2 we delivered a number of PDF fast test products at an additional cost which negatively impacted margin. We'll see the benefits of this expense in future gain share results. Looking ahead, we expect gross margin to regain its upper momentum.

Total operating expenses excluding stock based compensation expense and amortization of acquired intangible assets were $10.4 million for the quarter, up approximately $741,000 or 8%, and approximately $461,000 or 5% from the second quarter of 2005 and last quarter, respectively. The increases in research and development were the result of accelerating strategic initiatives.

Research and development expenses excluding stock compensation totaled $6.3 million for the second quarter, an increase of $648,000 or 12% and approximately $65,000 or 12% in the second quarter of 2005 and last quarter, respectively. The increases are primarily the result of increased use of outside resources for development projects and costs of opening our China Office where 23 local employees have recently started work.

We expect quarterly expenses in the second half of 2006 to decline from current levels, but not to the levels of the first quarter due to the full core utilization of our China Office, coupled with the annual midyear compensation reviews.

Selling, general, and administrative expenses excluding stock compensation were $4.1 million during the second quarter of 2006, down approximately $186,000 or 4% from the second quarter of 2005. SG&A expenses compared to the first quarter of 2006 increased $76,000 or 2% as a result of higher legal expenses.

Reiterating a statement made in our press release, in addition to using GAAP results in evaluating PDF's business, management also believes that it's useful to measure its results using non-GAAP measure, non-GAAP net income which excludes stock based compensation and amortization of acquired intangible assets.

Non-GAAP net income for the second quarter ending June 30th, 2006 totaled approximately $3.6 million or $0.13 per share, $0.01 above the range provided in April. This compares with non-GAAP net income of approximately $2.9 million or $0.11 per share for the comparable period last year, and non-GAAP net income of approximately a $3.3 million or $0.12 per share during the first quarter of 2006.

During the quarter higher costs and the slight shortfall of revenue were more than offset by the benefit of a quarterly non-GAAP tax rate that compared favorably to our annual non-GAAP tax rate, still estimated at 25%. In Q3 we expect our non-GAAP tax rate to be below our annualized tax rate, and in Q4 we expect our non-GAAP tax rate to be slightly above our annual tax rate.

On a GAAP basis including amortization of stock based compensation, [and] intangible assets, we reported a loss of approximately $847,000 or $0.03 per share. The net loss included $1.8 million of stock compensation expenses resulting from SFAS 123R.

Turning to the balance sheet at June 30th, total cash increased to $69.1 million, an increase of approximately $4 million during the quarter. Operating activities generated a positive cash flow of $3 million, while employee stock option exercises contributed $1.4 million.

Capital expenditures totaled approximately $405,000, partially offsetting the cash generated from operating and financing activities. Our accounts receivables decreased $996,000 to $20.6 million, while our aging of receivables remained healthy.

Now turning to guidance. I'll say 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 Q3 and Q4 2006, are forward-looking. These statements include expectations about future financial results and performance, growth rates, the success of any business objectives, product and service features and introductions, [our] products, and demand for PDF, PDF's design-to-silicon-yield solution. 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 on information available today. We assume no obligation to update them.

And now for the third quarter of 2006 we reiterate the guidance we provided in our outlook press release earlier today. Revenue is expected in the range of $19.2 million to $20.2 million, a decrease of $1 million from the range provided in April, due to, as John has already mentioned, a decrease in expected gain share due to changes in expectations with regards to customer production volume. Gain share in the second quarter is expected to be in the range of $5 million to $5.5 million, and non-GAAP EPS is expected to be in the range of $0.12 to $0.14. No change from the non-GAAP EPS guidance provided in April.

Reiterating guidance for the fourth quarter of 2006, we also provided earlier today in our outlook press release, revenues projected in the range of $21.2 million to $22.2 million with non-GAAP EPS expected to be in the range of $0.13 to $0.15. We believe that the organizational changes we made in the first half of 2006 will drive success in the second half of the year, leading to another record year and positioning us to grow the Company even faster in 2007.

With that, I'd like to turn the call back over to the Operator to open the floor to questions.

[OPERATOR INSTRUCTIONS.]

Our first question comes from the line of Dennis Wassung.

Thank you. Two questions. I guess, first, on the engagement activity in the quarter, how many engagements did you sign in Q2? I know there was a couple of IYR signed, and one that slipped and signed in July. How many were, I guess, revenues in the second quarter?

We signed two new engagements for IYR yield ramps, and then we also signed one major extension. So we've had a total of three new contracts that contributed revenue in this quarter for the IYR side of the business.

Okay. So when you talked about the 65-nanometer Logic for the new client, that was one of the three, as well as the DRAM deal?

That is correct.

Okay. I guess when you look at the activity you're seeing now, there's been some discussion over the last couple of quarters about 65-nanometer contracts and customers delaying the beginning of these contracts that they pushed out their ramp dates. Now, any update on that side? What's happening now with customers as they move toward 65?

This is John. So I think that both the DRAM, I mean 70-nanometer DRAM is feature size equivalent to the 65-nanometer Logic. It's just I think a naming convention. Both of those were engagements that we're being in discussion with customers for, actually we expect it in Q3, and those are the ones that actually happened a little faster, the ones, the key essential ones that we expected in Q2 that actually one signed in the beginning of Q3 and the other one expects to sign relatively soon.

We do see a fair amount of activity in discussion with customers and proposals going out in this quarter and next on 65-nanometer, and we have a number of those scheduled now, and we anticipate over the next couple of quarters we'll see some of those come in.

Okay, so these are sort of follow-on deals from your 90-nanometer customers that you're talking about, as you look forward?

Yes.

Okay. So in terms of deals that closed in the quarter, just so I'm clear, you talked about one 90-nanometer deal that was a new client and that was signed in July?

Yes, that's correct.

Okay. And the other deal that slipped was one that you didn't talk about, really, right? Not with the other four, this is another deal that was supposed to sign in the quarter, correct?

One that we anticipated at the beginning of the quarter which has not signed yet.

Okay. Fair enough. I guess when you look at the DRAM in the Flash side of the market, here, this is your first DRAM contract. I know you've signed one Flash deal in the past.

How do you look at that opportunity now? Is this something where you're seeing a lot of activity and expect to see new deals come on? Or is this something more like the image sensor market opportunity, where you're talking about a couple of quarters ago where you might see one or two deals over the next [inaudible] or so?

Yes, well, let's see if I can take that one, Dennis. So in the case of the memory in the Flash, we have been marketing the solution for the customers now over the last couple of quarters. But we started to see traction with them, as it's being something that they find essentially useful. It is built around some of our newer technology that we had developed for the parametric variability issues we have been seeing at 55 and 45 on Logic that we find is also appropriate for the image sensor customer base.

We do believe that there is a general need for this, and we do expect that over the next few quarters as we've been talking to other customers we will see repeat business.

And, by the way, it's not that we don't think that it's repeat opportunity with image sensor, it's just that the total dollar or total number of key accounts in image sensor is smaller than the total number of Flash and DRAM taken together. So I do think, we do believe there's a follow-on opportunity at other image sensor accounts, as well as at existing accounts.

Okay, thanks, guys. I'll get back into queue.

Our next question comes from the line of Matt Pecune.

Hi. Would you guys expect, I know you didn't go into complete specifics on Q4, but would you expect gain share to be up sequentially in Q4?

I generally do expect it to be, you know, it will, I'll say quarter to quarter we do expect it to be up, yes.

Okay, okay. And then looking at that DRAM engagement that you guys won, how would you compare the 60 versus gain share breakout relative to some of your more traditional deals?

Well, that's a good question, Matt. So this is, the big [fees] are actually pretty similar. The gain share piece we gave a little bit more flexibility to the customer. This is really our first DRAM engagement, whatsoever, and we are doing some development of technology along with the customer. So in total contract value is multimillions of dollars. It is not as big as our largest Logic deals. It is not as small as our smallest.

Okay. And then based – just looking at the guidance you were talking about, obviously, a little bit lower than expected gain share in Q3, but you did have a deal slip from this quarter into next quarter. I'm not sure why that wouldn't offset unless, do you see what I'm saying? The deal, the IYR deal on the solution side that you saw slip into Q3, I thought that should have offset that?

I'm sorry, go ahead.

I can answer that. If you look at that, that typically is something with, between $4 million and $6 million maybe seen over five or six quarters. So if you slip it into this quarter and you get a full quarter's worth of work, you know, the percent completion, if you just think about it ratable for a minute, it's roughly, let's say $1 million a quarter.

So you're still going to see this million, this quarter's worth of million dollars. You would have seen last quarter, you know, a month, maybe two months of work, right? So what this really does is kind of effectively tack-on the end six quarters from now what will be incremental work that would have been done or recognized in the May/June timeframe.

Okay, that makes perfect sense. And then, John, I know on the last call you had talked about in conjunction with your need to restructure some of your sales efforts, the specific challenges of working with some of the global accounts that have technology sharing agreements with one another. Was that one of the deals that you were able to finally sign this quarter, and can you give us an update on kind of how that sales process is working out?

Yes, that's a good question. So one of the deals was actually that we signed last quarter was one of the global partner related accounts. And one of the other deals that we talked about today was actually one of those partners for their own particular production. One of the deals that did not close yet is another one of those partnership activities that we're still working on.

Okay. Thanks. That's all I have for now.

Our next question comes from the line of Stewart Mueder.

Yes, thanks. Good afternoon. I guess, first, on memory, DRAM as well as nan, John, are you in discussions with other nan and DRAM manufacturers? And would you expect some further announcements by the end of the year?

Well we are, Stewart, are in discussion with others. You know, it was one of these things, or one of the people that has been putting together the software says, 'oh, I think we really have the message that is resonating with customers, I think we've really got our mix right.'

And I kind of look at it cynically is that my own experience has been is that it's usually they decide to buy more about when they recognize that they need to characterize silicon differently, then we somehow have the right marketing presentation that gets them excited.

So I think as we're seeing customers move to the 70-nanometer, DRAM on the Flash side, we are seeing more yield lots and more related to mechanisms that they're not typically used to. So if this is something that I think is industry wide, while they're respective of how effective we are we will get traction with the customer.

And you know cynically I kind of half believe that almost how effective you are, if there's not really a big problem there, if this is an isolated case then we won't necessarily see repeats. The data that I have now leaves me some confidence that there's going to be repeat business over the next couple of quarters.

Okay, that's helpful. And on the [UN] going to copper, there's kind of some mixed data points out there. You know, what's your perspective?

When we've, you know, started characterizing, you know, we just started to characterize customers' 70-nanometer now. When you look, when we look at the data, when we've done kind of a presales activity, we don't see that the – you know, aluminum still works fine at 70. And it doesn't, you know, you repair out so many of the mechanisms that it really would have to be related to performance to make the reason to change.

And so far we're not sure that we see that. I know that there are some customers that are relying on copper, but we see others that when we discuss with them in sales activities they don't seem to be as excited about that move. So I think it's going to be a mixed bag here for a couple of generations.

Yes, that's kind of what we're hearing, so that's consistent. And then one more question, in terms of the decline in the gain share revenue for Q3, is it really just one customer that's throttling back, [stops] for a particular product? Or, you know, is there any color you can help provide to help us understand this phenomenon?

Yes, that's a good question. So there's one product, one customer that we did notice, frankly, I'd expected it to be their numbers for this quarter to be a little larger than they are. That's a good chunk of it, but there are a couple of others where one case they didn't cross the threshold yet, which I always like to actually delay as long as possible because you want as many quarters of good volume as possible. And one case where I think it's just the pickup in volume, the volume came back down more than I expected it to.

Okay.

So if you kind of go from 57, there's a couple that kind of bring it down. And then there was one that I expected it to kind of contribute. You know, those I expected to go up, and one I expected to go up, to start on top of that. That would have brought you over 57, pretty substantially.

Okay, that's helpful. Thank you.

Our next question is a follow-up question from Dennis Wassung.

Oh, hi. I guess a couple of thoughts, and one right after Stewart's question there. The contract that didn't make the volume threshold, was that a brand-new contract in the gain share mix? Or was that something that was larger and it kind of slowed down in the quarter?

Yes, I believe it's an incremental contract.

Incremental contract.

Incremental contract that had been new to this quarter.

Okay, perfect. And another one on sort of – I think you talked about this in the prepared remarks, but as you look at the integrated solutions revenue line, you had sort of a hole a little bit here in the last couple of quarters, with a little bit of revenue fallout from contracts there. What was the impact? I can't remember if you said that, or at least I didn't hear it, in Q1 and Q2. How much out of that mix that you had to replace with new contract?

So, overall, from Q1 to Q2 we have 13 contracts for 13 engagements that contributed more than $150,000 of revenue. In this quarter we see about 12. So there's a little bit of slippage. And then you know that we signed three new engagements.

So we do see a little bit more of a handful of contracts coming to completion in Q3, however, with the pace that we see in signing new engagements in our pipeline we think our overall customer count will maintain, and we'll start seeing some recovery for back-selling some of those older engagements where, in particular, this particular quarter for the new engagements that we signed we only had a partial revenue contribution for the period.

Okay. So you said there were 13 contracts over 150 in Q2, or was that Q1?

In Q1.

In Q1, and the 12 in Q2?

Correct.

Okay. Okay. And as you look at the second half, you know, you just talked a little bit about it, but I guess how long – maybe just a little more detail on that? At what point do you have I guess a more stable number in that mix? Or, obviously, you had a lot of contracts, you know, a number of quarters ago that are starting to roll-off. Is there a period where that's more stable over the next few quarters?

That's a good question to ask, and it's – in Q4 we've seen that number stabilize, where the contracts that we have that are contributing to revenue in the out quarters have been signed for or have some significant periods, some tails on that for the fixed fee period. So we should see some stability in Q4 in terms of customer accounts contributing to revenue, significant revenue.

Okay. And I guess a last question, back on the gain share side of things, you talked about, you know, a couple of dynamics there with just one customer lower revenue than expected, and another one didn't make a threshold.

But do you see anything in the environment that's changed that would, you know, kind of change your confidence in that number as you look out? Or is it just really, you know, a couple of contracts that were just a little different than expected? I guess there's a lot of uncertainty out there right now in the industry, and I'm just curious just as to whether or not you're seeing any of that as it rolls through? Obviously, you're at the higher end of the food chain on the [profit] side.

We're on the leading edge. So, it's a good question. And this is John. I'll take that. We've seen a lot of [tape-on] activity. We see a lot of designs, but a lot of them often don't contribute very much to gain share, they don't matter much.

There's usually in any given fab a few designs that make-up most of the muscle, and any change of them, you know, up or down 20 or 30% can have a huge impact. So it's hard to draw a general trend off a couple of designs, and in this case I think Stewart kind of alluded to that, that there are, on any given side you can count one or two designs that you see there. Starts go down significantly, and it does have a big impact on our dollar number, even though you see a fair amount of tape-out activity in that [side].

So you don't se people's tape-ups slowing down. You do see kind of volume mixes adjusting a little bit, and I'm not sure if that's particular to specific products or a general issue. I think it's hard for us to tell right now. I don't feel like it's a general issue because the customers are – there's too much activity going on for the customers to be saying, 'gee, I see this happening all across the board.' Customers seem really robust.

Okay, great. Thanks, that's helpful.

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

Thank you. In summary, in Q2 we achieved our targets for new engagements, gain share revenue grew, and the number of new DataPower accounts increased. Our account team focused strategy gained momentum throughout the quarter, and we remain focused on driving our business to reach our potential. Thank you for joining our second quarter 2006 conference call. Good-bye.

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