PDF Solutions Inc (PDFS) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the PDF Solutions Inc. conference call to discuss its fiscal results for the third fiscal quarter ended Sunday, September 30, 2007. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session for which instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

If you have not yet received a copy of the corresponding press release, they have been posted to PDF's website 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 11 through 19 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2006 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 would 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 third quarter of 2007, PDF Solutions is reporting total revenue of $24.1 million and non-GAAP net profit of $0.19 per share. Gained share was $6.8 million. All of these results are in or above the ranges we provided in July. Keith will talk more about these results and our guidance going forward in a few minutes.

Let me start by sharing some highlights of the quarter. First, overall, we had a strong bookings quarter for new and extended engagements. We closed the full contract for the 45-nanometer Yield Aware FDC engagement we announced as an LOA last quarter. Additionally, we closed four new engagements. And integrated the old ramp contract with an existing customer for a 45-nanometer, including a PD BRIX DFM component, a 65-nanometer DFM engagement with an existing fabless customer, a letter of agreement for an R&D 55-nanometer engagement with an existing memory customer, and a 70-nanometer engagement with new memory customer. We also signed further extensions to existing memory engagement and in existing Yield Aware FDC agreement. Lastly, we signed an evaluation agreement for 45-nanometer PD BRIX with an existing customer. Our bookings strength, with contributions covering four continents, is indicative of the effectiveness of our account team.

Second, we generated good interest from the industry for our new solutions. In the quarter, our process control solutions, Yield Aware FDC, continued to yield strong results for our initial client and also was the basis for the new and extended contracts that we mentioned previously. Similarly, PD BRIX, our newest DFM offering, a result of our acquisition of Fabrics in May 2007 was the driver for two engagements. In one case, PD BRIX was part of a larger 45-nanometer yield ramp, which clearly demonstrates the important synergies between our new products and our yield ramp technologies.

Third, we continue to expand our business in the memory market. The overall environment for our memory suppliers continued to be difficult as spot prices from memory remained low during the quarter. Despite this head wind, we continued to gain traction by signing further extensions with existing clients and signing the 70-nanometer engagement with a new client that was mentioned before. We are confident that our solution will provide measurable and differentiated valuable for this growing market segment.

Fourth, although we did not meet our expectations for new software license revenue, we continued to win benchmarks for our software and generate good future business opportunities. As we talk with customers, it becomes clear that client's value integrated solutions where software is combined with other technologies and services that drive additional benefit. This is consistent with our overall strategy of providing a broader solution and having our payments be proportional and timed to our customer's success.

Fifth and lastly, we achieved record gain share. At the time of the second quarter conference call, we provided a conservative estimate for Q3 gain share based upon the then-current volume projections from our client base and moderate estimates for achievable yields. Subsequent to our call, volume projections began to increase for Q3 and remained relatively healthy for Q4. Additionally, we are pleased to say that our client yields have exceeded earlier expectation, resulting in better gain share revenue per wafer. This is extremely important to PDF, because our client's success is the most critical element of our success. We are proud of the yields our clients are achieving. As a result, we expect more meaningful year-over-year growth in gain share due to good revenue per wafer and improved volume.

Taking a step back from the quarterly results, in the early part of this decade, our business was built providing yield RAMP solutions to logic device manufacturers. Core to those ramps was our characterization vehicle business infrastructure and our unique capability to modeling the characteristics of a Fab and simulate product yields in such fabs. After approximately 50 ramps and well over $100 million in R&D, our systems have proven to be very effective, as evidenced by the yields our clients are achieving and our growing gain share revenue.

While we demonstrated our value with these logic reyield ramps, the industry evolved. The memory manufacturers began to consume a larger portion of leading-edge production and in some cases have raised ahead of the logic manufacturers in using leading edge silicon. Moreover, in the past, our customers could achieve cost-effective manufacturing by ramping the yield of a new process more quickly. Today they need to address efficiency and cost across the entire process life cycle. From process and product development through a quick ramp and into volume manufacturing. We believe that our core CV infrastructure is critical to the effectiveness of our DFM and volume manufacturing solutions as well as our Yield Ramp solution. Moreover, these expanded solution address the needs of a market that is much broader than a logic manufacturers need for process yield ramps.

For example, at the end of 2005, we started to apply our technology to memory and image sensor process ramps. We are now achieving our technical targets in those areas. of course, it will take time for -- it will take us some time to realize the full potential of these solutions and our move into the broader market. However, we are encouraged to see the customer's respond positively so early in the rollout of our new technology and offering. Now I'll turn the call over to Keith, who will discuss in detail our financial results for the third quarter and our guidance going forward. Keith?

Thank you, John, and good afternoon, to everyone. Let me again state that this presentation and our press releases issued earlier today include references 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's section of our website located at www.PDF.com.

Revenue for the third quarter ending September 30, 2007, totaled a record $24.1 million, an increase of 24% and 2% when compared to the third quarter of last year and last quarter respectively. These results were within the range we provided in July. Compared to the third quarter of 2006, improvement was the result of increases in both design to silicon yield solutions and gain share. Compared to last quarter, the improvement was the result of an increase in gain share more than offsetting a small decline in design to silicon yield solutions.

We are pleased that gain share was again at record levels, meaningfully over the guidance for the quarter as forecast for generally low customer production volumes adjusted upwards at the end of the quarter as we received final customer production data. Design to silicon yield solutions revenue totaled $17.3 million for the third quarter, an increase of 15% from the comparable period last year and a decline of 3% from last quarter. Integrated solution's revenue increased 46% from the comparable period last year and 2% from last quarter. Stand-alone software license sales continued to show weakness and evidence of volatility, declining 75% and 46% from last year and last quarter, respectively. Stand-alone software sales will continue to be volatile, because new engagements also include services, utilizing design for manufacturability and intellectual property and process control software.

As John discussed, bookings for the quarter were very strong. We closed a full contract from our LOA from last quarter and closed four new engagements with new and existing customers in both logic and memory markets. We also signed further extensions to earlier memory and Yield Aware FDC engagements and sought an evaluation agreement at 45 nanometers for a PD BRIX engagement.

During the third quarter, 14 integrated solution engagements from 13 customers each contributed approximately $150,000 or greater in revenue. This represented a net increase of 1 in the number of engagements and an increase of 2 customers during the quarter. Gain share revenue for the third quarter totaled a record $6.8 million, a 55% increase versus the comparable period last year and a 16% increase from last quarter. Gain share revenue was generated from seven customers and ten engagements, an increase in one engagement during the period.

Gross margin for the third quarter of 2007, excluding stock-based compensation and amortization of core technology was 68% of total revenue, an increase of 67% during the third quarter of 2006 and an as forecasted decrease from 72% from last quarter. The increase from last year was the result of modestly improved service margins on integrated solutions, partially offset by a small decline in combined higher margin, gain share, and software sales. The decline from Q2 of 2007 was expected as a result from lower margins on integrated solutions. Total operating expenses, excluding stock-based compensation expense and the amortization of acquired intangible assets were $13.6 million for the quarter, up approximately $3.2 million or 31% from the third quarter of 2006, but down $413,000 or 3% from last quarter.

The increase from last year was due to increases across all functional areas, primarily the result of our acquisition of Si Automation in October 2006 and [FABRIX] in May of 2007 as well as the opening of our office in China in late July 2006. The decrease from last quarter is the result of lower outside sales commissions and trade show costs, partially offset by the first full quarter of expenses from our FABRIX acquisition. Research and development expenses, excluding stock-based compensation, totaled $8.5 million for the third quarter, an increase of approximately $2.5 million or 42% from the third quarter of 2006 and an increase of approximately $273,000 or 3% from last quarter. The increase from last year was primarily the result of the acquisition of Si Automation on October 31, 2006. The increase from last the quarter was primarily the result of increased personnel related costs in offshore locations, variable compensation accruals, and increased travel. Partially offset by a decrease in the use of outside development resources.

Selling and general administrative expenses, excluding stock-based compensation were $5.1 million during the third quarter of 2007, an increase of approximately $700,000 or 16% from the third quarter of 2006, but a decrease of approximately $686,000 or 12% from last quarter. The increase from the comparable period last year was a result of increased expenses associated with our acquisition of Si Automation and expenses associated with opening the office in Korea, partially offset by reduced outside sales commission and legal costs. The decrease from last quarter was primarily the result of decreases in outside sales commissions, travel and trade show expenses, partially off set by variable compensation accruals.

Reiterating the statement made in our press release, in addition to using GAAP results and evaluating PDF's business, management also believes it is useful to measure its results using a non-GAAP measure of net income, which excludes stock-based compensation expense, amortization of acquired intangible assets, the write-off of in process research and development, and the related tax affect. Non-GAAP income for the third quarter ending September 30, 2007, totaled approximately $5.3 million or $0.19 per share, at the upper end of the range we provided in July. This compares with non-GAAP net income of approximately $3.6 million or $0.13 per share for the comparable period last year and non-GAAP net income of approximately $5 million or $0.17 per share during the second quarter of 2007.

On a GAAP basis, including amortization of stock-based compensation and acquired intangible assets, we reported a net loss for the quarter of approximately $939,000 or $0.03 per share. This net loss included $4 million in stock-based compensation and amortization of acquired intangible assets.

Turning to our balance sheet at September 30, total cash decreased to $50 million, a decrease of $4 million during the quarter. Operating activities generated $3.2 million in cash during the third quarter. Capital expenditures used approximately $278,000 during the quarter, while $2.7 million was used to complete the cash portion of our acquisition of FABRIX, which occurred in late May 2007. Employee stock plans generated $280,000 in cash and $4.5 million was used to complete our previously-authorized $10 million share repurchase. During the period, we repurchased approximately 437,000 shares at an average price of $10.18 per share. Our accounts receivables increased $286,000 to $32.6 million as a modest revenue increase that's partially offset by our strong collection effort. The aging and collectibility of our receivables remains very healthy.

Now turning to guidance, I will again state 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 Q4 of fiscal year 2007 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 products, and demand for PDF designed 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. For the fourth quarter of 2007, we reiterate the guidance we provided in our outlook press release earlier today. Total revenue is expected in the range of 24.5 million to $26 million. Gain share revenue in the fourth quarter is expected to be in the range of 6 million to $6.5 million, as customer current volume projections reflect a small decline in gain share from last quarter. Earnings for the fourth quarter are expected to include a tax benefit of approximately $1 million due to the final utilization of tax credits during the year. Non-GAAP earnings per share for the quarter is expected to be in the range of $0.20 to $0.22 per share.

Assuming we achieve the middle of the range as provided in the fourth quarter ending December 31, 2007, revenues for the year would total $95.2 million and non-GAAP EPS would total $0.71 per share. Increases of approximately 25% and 61% over fiscal year 2006, respectively. With that I would like to turn the call back over to the operator to open the floor for questions.

Thank you, Mr. Jones. (OPERATOR INSTRUCTIONS) Our first question comes from Dennis Wassung.

Thanks. Good afternoon. A couple of questions. First, John, I was wondering if you could go over a little bit more detail on the new engagements you signed? I just wanted to be clear on it. So it sounds like you closed the LOA from Q2 and then you signed four new additional engagements, and two of those are memory; is that correct?

Two are memory, one is logic Yield Ramp. That includes also PD BRIX. One is a 65-nanometer DFM engagement with a fabless customer and then there were a series of extensions on existing engagement, an extension on existing Yield Aware FDC engagement, and on a memory engagement. And then there was a small 45-nanometer evaluation engagement for PD BRIX with an existing customer.

So it sounds like PD BRIX was involved in two of the transactions at this point? And one is an evaluation and another one is a 45-nanometer logic?

Yes.

Okay. And can you give any other detail about some of these customers and geographical locations or--?

I think I said four continents and then I thought to myself, I'm not sure there were four continents. I think it's Asia, Japan, U.S. and, and Europe, and I guess we've promoted Japan to a continent. I think it's four geographies, probably what we should have said. So I think with the memory accounts, we've been very careful not to say exactly which "continent" they are from, as you would guess pretty quickly who they were. I think there was meaningful business in all four geographies. I don't know that we're going to go into much more detail than that.

Okay. Were the memory engagements all DRAM at this point? Was there any flash involved?

That's correct, they're all DRAM at this point.

Okay. When you look at the revenue line here, the integrated solutions line was only up $300,000 in the quarter, but you signed a lot of new deals here. How do you think about that as you go forward? The guidance would imply that there's at least a reasonably sizable increase here into Q4? Were a lot of these deals signed later in the quarter or did you not take a lot of revenue here from these contracts? Is that the right way to think about it?

Dennis, your assumption is correct. Quite a few of the engagements were signed fairly late in the quarter and as you know, the impact to revenue would be not as great in the current period, but some of the gains we did have some meaningful contribution in the quarter, some of the larger engagements. But however, typically when we had talked about the size of and length of our projects for our yield ramps, we had typically talked about approximately a six-quarter service offering. For DRAM, they're a little bit shorter than that for our memory offering. So the total amount of the fixed fees might be a little bit different, but the overall margin contributions and whatnot are fairly healthy. Taking a look out, this is all part of what we had forecasted for our guidance earlier on and we had already baked this assumption into our forecast.

Fair enough. And when you look at the size of these four contracts you signed in the quarter, are these traditional-sized, typical revenue contribution-type contracts to you guys?

The DFM ones tend to be a little bit smaller than the 60s. The ramp ones are pretty much typical.

Okay. Perfect. Then last question for me, I guess, on the gain share side of it, obviously you had a great number here, on the revenue side. The number of contracts involved -- the number of customers involved here, pretty much the same. I guess one contract higher. Do you expect to see those numbers shift at all as you go into Q4 and into next year, or are you just starting to see a lot more content coming through your existing customers and contracts at this point?

Yes. So I think we are modeling that it's a similar number of accounts and contracts. We do see, with things like 65 nanometers, the ramp has been pushed out -- the volume has been pushed out quite a bit. We had originally thought that would be an '07 activity, if you look at all the talk from the foundries, it's really late '07, '08. So a lot of our expectations of these improvements have been dollar amounts coming out of fabs going up. In the quarter we did complete a number of engagements and that's why I was saying, we. either in Q2 or Q3 we achieved our measurement quarter and those are important because they establish the percent achievement that we achieve with the accountant and hence the dollar per wafer that we can achieve with the account.

Some of those accounts we completed the engagements. We do not forecast wafer volumes yet, but do anticipate them to start sometime in '08. So I know that those don't show up on our financial results, but it's really quite important for our business in the future and also our teams to know that we hit a high percentage of our goal and hence we'll establish a good wafer fee at that account for the out quarters.

So those are contracts you were alluding to when you say you were saying you were coming at better than expected yield rates and getting better dollar per wafer?

There were some contracts those customers were already in volume, so those did impact our Q3 gain share. There are other contracts that those customers were not in volume yet and they're not forecasted to be in volume in our Q4 forecast, but we would hope that they turn into volumes somewhere in '08.

Okay. Last quick one on that gain share side, how would you describe the technology node contribution in there? You mentioned 65 nanometer volume coming in later than expected. Is that what's driving some of the higher volumes and higher dollars you're seeing now. Are you starting to get the contribution from 65 or are you still 90-driven?

We still see good contribution from 90 nanometer, quite good contribution. We do see 65 picking up. But I think it's both nodes really contributing at this point.

Great. Thanks, guys.

Our next question comes from Matt Petkun.

Hi. A lot to go through, but a nice quarter, obviously, especially on the new engagement side. So just to be clear, including the deal that you announced on the last call, there were five new engagements, is that right, John?

Four new engagements, Matt.

And then one LOA?

Five integration engagements and an evaluation, if you you will. So five new.

Five if you include the eval?

Correct.

And I thought you maybe said that one of the new deals in this quarter was actually an LOA that you signed, but the engagement hasn't formally begun; is that right?

I started out by saying the LOA that we talked about last quarter, that converted. We weren't including that in the four.

Right.

Then in the four, there was one LOA for a 55-nanometer R&D engagement for DRAM. And the others were all contract.

So when do you expect that the 55-nanometer to convert? Next quarter?

Converts in the next quarter.

Okay. So if we exclude LOAs altogether and include the one that converted this quarter, there were four new engagements in the quarter, or three if you exclude the 45-nanometer assessment; is that correct?

No. So if you want to include the one from last quarter and you want to exclude the PD BRIX evaluation, there would be five, including the LOA, which is at 55-nanometer. If you want to exclude that LOA, then there would be four. Our way of counting is to count the one that convert -- the LOA that converted into a contract at the Q2 engagement. And then we count the four including the LOA from this quarter, although the remainder part of the contract will be finished in Q4.

Understood. Either way, it's way above the two to three that you've talked about needing on a quarterly basis.

That is correct, Matt.

Yes, I'm just--.

It depends on where you want to--.

Yes, I understand that. And of those, how many -- let's exclude the LOA from last quarter, of the new engagements are LOAs, how many new customers again?

One new customer.

The other question that I had, Keith, was on -- I just have an awfully hard time and I can't be the only one estimating your non-GAAP tax benefit every quarter. And I know a lot of that's coming from just tax credits. What do you expect for 2008 in terms of what you would be using for a non-GAAP tax number?

Candidly, Matt, we're actually taking a look at our forecasts for the year and at this point in time, we're not in a position to kind of give out that forecast. But rest assured when we discuss in January, we'll give you appropriate guidance.

Okay. And of the $2.1 million pro forma tax credit that you recognized this quarter, how could you compare that to a cash receipt for PDF Solutions, because you're not purely offsetting taxes that you paid on a GAAP basis?

I think the short answer to that is that it's an asset, if you will, that in the future when we, our profitability increases obviously and there will be a tax liability, instead of writing a check, those credits realize and that reduces the amount that we have to pay. So the affect of that is ultimately a cash savings to PDF.

Okay, okay. But I don't see that on the balance sheet anywhere; is that correct?

You would see that on the balance sheet within the line items for our deferred tax assets and then also within the line item for our other current asset which has a deferred tax asset.

They're not NOLs though, correct?

No, they are not.

They are tax credits.

They are much better than NOLs.

Right. Just your deferred tax asset line item it wasn't up that much sequentially, so I'm trying to correlate the two numbers.

We actually built that into the rate over the year so you're not in an egregious spot.

Okay. Okay. Then just my final question. John, it's pretty exciting to see the PD BRIX technology being employed in these new engagements. Can you talk about kind of what that means from revenue opportunity standpoint, or is it more just attracting customers in new areas where they might not have been interested in engaging with you in the past?

Yes, sure. I think it's a revenue opportunity for us. Let me be clear about this. When we purchase PD BRIX, when we looked at the problems the customers had, we said, if you look at these new technologies there is a difficulty in achieving a good shrink with these new technologies and getting good performance characteristics.

We thought PD BRIX offered a lot of value for and with also really critical to have good characterization technology. As I kind of spoke on the call, we started in the process life cycle on the Yield Ramp and we felt that if you looked back up during the development of a process and the design rolls and the development of a chip, you could really do a lot to affect the overall cost structure of a design or product. And PD BRIX is really a big part of our way of achieving that. It should create for us over time a longer payment on our wafer fees, better wafer fees and give us basically more introduction into the product teams in the account.

Okay. And the new engagements that incorporate the PD BRIX, will those have wafer fees associated with the use of the PD BRIX technology, or just on the traditional ILIR side?

For them to be able to use the BRIX part in production, there is a separate term for that. A wafer fee for that.

Okay. Okay. Thank you.

Great.

Our next question comes from the line of Mahesh Sanganeria.

This is [Casey Rasmah] calling for Mahesh.

How you doing, Casey?

Hi. A couple of quick questions, guys. If you could step back a little and look at the whole picture, can you share your thoughts on the market, the market for Yield products as we go from 65 to 45-nanometers?

I'm sorry. For the Yield products or for the market in general?

The market in general.

The market in general, new products. I think that's a real good question. We see the memory folks marching down the node pretty much on a very standard pace. When we saw our 45-nanometer business, we feel that there's a -- some key early products that go into the node quickly. The game systems, the base band systems, the FPGA and to some extent the graphics products. And then there seems to be more of a lull between that first wave of products and the subsequent, more broad use or products that have generally lower volume characteristics, but more product mix or more tape-out mix. We've seen that trend continuing as we've gone from 90 to 65 to 45.

Also, when we have seen which customers achieve volume and sometimes not our customers, on the logic business, with the advent of some of the newer producers, like Charter, there's more viable suppliers on the leading edge silicon, and there's a lot of competition in markets like base band and we're seeing the winners of the designs, i.e., the system -- who Nokia selects or who Motorola selects, et cetera, affect which factories get the volume. Kind of two stages removed from those.

Okay. As a follow-up to that, do you guys feel that as a percentage of relevant dollars, the 45-nanometer and the (inaudible) in the memory space receive more dollars for Yield improvement, both early on as well as during production than what you saw for the previous nodes?

The general things that customers tell us is the cost to bring up a new technology goes up about 35% generation over generation. So in other words, whatever they spent on 65, they'll need to spend about 35% more than that on 45. That seems to continue. I think that we don't see really a change in that. Some of the things we're doing with BRIX and some of the things we're doing with Yield Aware FDC are trying to help the customers slow that rate of increase and also slow the rate of increase in production control costs. But net I think the costs generally continue to stay up. Of course, the number of transitions we ship per centimeter also scale up at a steeper rate so the benefit is generally still there for the account.

Okay. So is it fair to then assume that on a multiyear basis, a 35% increase in Europe is a rough ballpark to be in.

Well, they generally introduce the technology every two nodes -- every two years, two to two and a half years. So the time lag between -- that's the cost of 45 versus the cost of 65. So that cost, I think you would probably look at a longer horizon on their costs going up, probably every couple of years to get to that 35% number.

Okay.

Now how that affects our revenues, I think is a different ball of wax. I think if you looked over the past four years, we've grown at greater than a 20% compound annual growth rate, which would be a little bit higher than that number would imply.

All right. Switching gears a little bit, can you talk a little bit about incremental dollars, what you guys plan to get from your engagement with Magma and the participation for future engagement with other EDA companies?

Sure. I think after our second quarter conference call, first the design automation, we announced that we were working with Magma on a product for Yield simulation that was based on our YRF technology and their Quartz technology. We have not forecasted our revenues for that product until that product is successful in its beta site. I think that market is a very new market and we haven't speculated much on what the total opportunity is for that product offering. We do from time to time identify design automation tools that would benefit from our yield models and yield simulations and we look at ways to leverage the design automation company's channels for that and create revenue streams. That's been something that's been a part of our strategy only over the last couple of quarters and it's really too early for us to forecast what we're going to generate revenue-wise.

So we've been fairly conservative in building that into our models. Actually not including that, but it's part of our long-term strategy, obviously.

Okay, thanks. Thank you.

Thank you.

There are no further questions at this time.

Thank you. The third quarter was a good quarter for PDF Solutions and sets the foundations for better results in the future. We are pleased that clients see promise in our new offerings. We are also pleased with our ability to expand our sales in the DRAM market. Finally, our gain share performance demonstrates the results our clients are achieving with the application of our technology. These three points reinforce that we are on the right track. Thank you for joining our conference call. Good-bye.

This concludes today's conference. You may now disconnect.