PDF Solutions Inc (PDFS) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to PDF Solutions, Inc. conference call to discuss the financial results for the third fiscal quarter ended September 30, 2011. 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. (Operator Instructions).

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 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 9 through 13 of the PDF annual report Form 10-K for the fiscal year ended December 31, 2010, and a similar disclosure in subsequent SEC filings. The forward-looking statements and risks stated in the conference call are based on information available to PDF today. PDF assumes no obligation to update them.

Now I would like to turn the conference over to John Kibarian, PDF's President and Chief Executive Officer, and Michael Shahbazian, PDF's interim Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone. I will begin this call with a summary of our results for the third quarter. Next, I will discuss our perspective on our performance. Following, I'll discuss the industry and the implications for the remainder of the year.

In Q3 we achieved total revenues of $16.9 million, non-GAAP profit of $0.07 per share, and a profit of $0.02 per share on a GAAP basis.

Last call we said that we anticipated strong solutions bookings and revenue for Q3 and that we also expect the gain share results to be weaker due to lower manufacturing levels that started in Q2 and continue through Q3. These results are consistent with our expectations, and we are pleased with the business activity that we continue to generate.

During the reported quarter, we successfully closed the following contracts -- a 20-nanometer process R&D engagement with an existing client; a 28-nanometer DFM engagement with an existing foundry client; an early start engagement for a 32-nanometer yield ramp at an existing client; and a follow-on license sale that doubled the installation of our dataPOWER yield management solution at our first LED deployment.

The 20-nanometer engagement I just listed was the contract we discussed in our last call that we said closed just after the end of Q2. This contract was expected in a key R&D collaboration between a number of logic manufactures, the collection of which strategically positions us to deliver far-reaching value at 20 nanometers. The 32-nanometer early start is a short-term contract that we put in place while we negotiate with this repeat client a much larger, multi-node ramp deal.

Let me meet also point out that these engagements show a consistent trend. We continue to expand the business that we generate with existing clients. We innovate and deliver value and are rewarded by follow-on business. Given the large logic fabs built recently by some of our clients, capturing all the nodes on a wafer feed basis contracts propels PDF Solutions to stronger business performance.

In summary, our bookings and continued customer interest in the quarter were again strong in terms of the number of engagements, overall economic value, and strategic value. This gives us additional confidence in our fixed fee revenue for the year, as well as future gain share results that will flow from these bookings.

As to the implications of the current industry environment on our business, the continued trend of mobile computing devices being built from leading-edge logic and active competition in logic manufacturing will continue to drive interest in PDF Solutions' technology from our existing and potential clients. We now anticipate improvements in production volumes at manufacturers in Q4 as compared to Q3.

While we continue to refrain from providing specific quarterly guidance and we may see ups and downs quarter over quarter, we remain confident in our expectations to continue to grow revenues at a pace, which is greater than the estimates for the segment of the chip industry we serve.

Before I turn the call over to Mike to discuss the details of our Q3 financial results, I would like to point out the announcement earlier today that we have appointed Gregory Walker to serve as our Chief Financial Officer and Vice President of Finance beginning on November 10. Great's extensive public company and financial experience in the technology and semiconductor industries make him an ideal addition to our management team. His leadership will be impactful to improve sustainable financial performance.

I would also like to take this opportunity to thank Mike for his significant contributions during this transition period and wish him all the best in his future endeavors. Mike, it has been a pleasure working with you.

Thank you, John. As a reminder, in addition to using GAAP results in evaluating PDF's business, we believe it is also useful to consider our results using non-GAAP measures. Non-GAAP excludes stock-based compensation expenses, amortization of expenses related to acquired technology and other intangible assets, restructuring charges and their related tax effects as applicable. If you can access the press release, it contains a reconciliation of non-GAAP to GAAP results in the Investors section of our website located at pdf.com.

Now let's turn to the review the financial results for the third quarter. First, let me cover some of the highlights.

Total revenues were $16.9 million with a GAAP net income of $626,000. This resulted in an EPS of $0.02 for both basic and diluted shares. Non-GAAP net income totaled $2 million or $0.07 per diluted share. Cash grew by $2.5 million during the quarter. Cost of sales and operating expenses were $15.4 million, a decrease of $900,000 from last quarter. We are pleased with the improvement in the earnings-per-share over the second quarter, and we continue to strengthen the balance sheet.

Total revenues for the third quarter were down 2% as compared to the prior quarter and up 14% compared to the same period in the prior year. Total revenues are comprised of design to silicon yield solutions, revenues of $13.9 million and gain share revenues of $3 million. Yield solutions revenue for the third quarter increased $900,000 sequentially or 7%, and gain share revenues decreased $1.1 million or 29% sequentially. The increase in yield solutions revenues was primarily due to new engagements with existing customers and higher software license sales, while the decrease in our gain share revenues was due to lower manufacturing volumes. Our gain share revenues for the quarter as a percentage of total revenues was 18% as compared to 24% in the prior quarter. The total number of clients contributing to gain share was six, the same as last quarter.

During the quarter, we added three new engagements and a significant software license deal. There were 13 service engagements from nine clients with each contributing at least $150,000 to revenues, including two engagements that were completed in the quarter. As compared to last quarter, the total number of indications declined by one with no change in the number of total clients. 10 clients represented 85% of our revenues in the quarter; three clients contributed revenues greater than 10%, the same number as last quarter and from the same period last year.

On a geographic basis, Asia accounted for 42% of total revenues, Europe represented 34%, and North America accounted for the remaining 24% of total revenues.

The total cost of design-to-silicon-yield solutions was $7.8 million as an approximate increase of $390,000 as compared to the prior quarter, primarily driven by the increased costs to support the higher solution revenues.

Third-quarter gross margin was 53.9% compared to 56.9% last quarter. The lower margin was primarily the result of lower gain share revenues. Gross margin included $521,000 of stock-based compensation expenses versus $522,000 last quarter and $156,000 of amortization of acquisition-related expenses, flat with last quarter.

Non-GAAP gross margin was 57.9% for the quarter compared to 60.7% last quarter. Our total GAAP operating expenses were $7.6 million or 45% of total revenues compared to $8.9 million in the prior quarter. Operating expenses included approximately $670,000 of stock-based compensation expenses compared to approximately $950,000 in the prior quarter. R&D expenses totaled $3.4 million or 20% of total revenues for the quarter compared to $3.7 million in the prior quarter and included approximately $360,000 of stock-based compensation expenses compared to $340,000 in the prior quarter.

SG&A expenses totaled $4.2 million or 25% of total revenues compared to $5.3 million in the prior quarter and included approximately $320,000 of stock-based compensation expense compared to $610,000 in the prior quarter.

As noted in my earlier comments, reported GAAP results for the third quarter included amounts related to amortization of acquisition-related expenses and stock-based compensation expenses. Excluding these items on a non-GAAP basis, net income was $2 million or $0.07 per diluted share.

The effect of foreign currency fluctuation in other income and expenses favorable in this current quarter when compared to the slightly negative impact in the previous quarter. Worth noting, the net income tax provision increased by approximately $200,000 as compared to Q2 and approximately $1.1 million as compared to the same quarter last year. This expense is primarily due to an increase in foreign-source revenue subject to foreign withholding taxes. As the Company realizes taxable income in the US, these foreign tax credits will be utilized.

During the third quarter, the Company realized a benefit in its tax provision of approximately $200,000 due to the statutory expiration period in which tax accruals were previously taken.

As mentioned earlier, we strengthened the balance sheet during the quarter, primarily as a result of our positive operating cash flow. Cash flow from operations was approximately $2.1 million. During the quarter, the Company repurchased $1.5 million in stock, which was offset by $2.1 million in employee stock purchases and stock option exercises.

Headcount at the end of Q3 was 321 worldwide compared to 309 at the end of Q2. Headcount was primarily up to hiring engineers in our China subsidiary.

That concludes the review of the financials for the quarter. Now before I turn it back over to the operator for Q&A, let me take the opportunity to thank John, the PDF management team, and in particular, the finance and administration team for their support during my time at the Company. It has been a privilege to work with all of you.

Now I'll turn the call over to the operator for Q&A.

(Operator Instructions). Tom Diffely.

John, I was hoping to start with the gain share. You talked about how production should be going up in the fourth quarter. I just wanted to clarify it, typically with your gain shares, is it one quarter in arrears, or do you actually see the gain share come up in the same quarter as production does?

It is one quarter of manufacturing arrears, but some of that -- if we have a manufacturing quarter that is, let's say, February, March, April, we would recognize that in the same quarter as the last month. So that would all be in Q2, for example. So one-third of them are purely -- on average one-third of them will be purely one quarter in the arrears, if you just kind of think about that. But they vary from contract to contract.

And is there any way you can characterize the six clients and the gain share on maybe a per-node basis or in the type of end markets?

Yes, that's a good question. So the gain share is all 65 and below. Still, a substantial portion of that is at 65-nanometer. There is, of course, a healthy portion of -- the remainder of it, 45 nanometer and 40 nanometer. I believe there is little or no 32 nanometer, 28 nanometer contributing gain share in the third quarter. We would expect that to change in 2012.

In terms of the end markets, the low-power technologies, which typically in communication devices and things like that, tablets, etc., those tend to be a substantial fraction of the total volume enhanced wafer fees that we collect, historically have been that case.

There is, of course, also another segment and probably the second largest segment is the computing segment for us -- servers and CPUs that go into computers.

And do you see the remaining clients there going up and down with utilization rates, or are some of those fabs being transitioned over so some newer technologies may come off-line?

What we anticipate, as I said in my prepared comments, that we expect to improve in Q4. We do expect some additional facilities to be starting to come online for us from a gain share perspective, and we expect that manufacturing volumes on the leading edge nodes in some of our customers to increase offset by other customers that continue to be unique.

And then maybe switching gears here, you guys were mentioned a couple of times on the A&D conference call the other day as one of their key partners. So that brings up the question, how do you interact between the two, like, the end markets guys and the foundry guys who are teaming together? How does your business, your engagement differ between the two sets of customers?

So, first of all, I mean I did see that. It's nice. Generally we don't comment about specific customers, so I will talk in generalities rather than specifically the situation with A&D.

We do sell what we call DFM engagements with [Salvos] customers. That, by and large, is characterization vehicles and systems, DFM tools and technology like our PV bricks to help them optimize their designs for our manufacturing partners. We often monetize the wafer fees on that at the manufacturing sites.

More and more the -- if you go back and look at the past two years of calls, you'll hear a continued refrain about DFM engagement, DFM engagement on these calls. More and more, we are finding our foundry customers value our business with our fabless customers as we help those customers make access to our foundry customers' leading edge manufacturing capability.

So, if you think about that call, it would be very much in the general. That call, that specific situation is very much like the general situation with the added opportunity of the manufacturing volumes there, of course, are quite significations.

Right. And then also I guess without mentioning names, a couple of your foundry partners or customers are partnering together. And I am just wondering, when you have two large customers that are becoming partners themselves, does that impact how you approach each of them as well?

The network effect for our business is always quite important, always been very positive for us. When companies want to partners, they need to be able to share information. You need a common language for describing the state of technology at multiple manufacturing sites. The most, I think, consistent way of doing that is electrical characterization data by far. Ours is the most widely accepted electrical characterization data in the industry, by and large, runs everywhere. So when you want to compare and when you want a partner, that's usually good news for us. And in this case, I think the one I know you are referring to is good for us, quite good for us.

And then finally, we've heard a lot about companies starting to ramp 28 nanometers, maybe 32 nanometers and 28 nanometers pretty aggressively in the first half of next year. In the past, when they've ramped up new capacity, how long does it take to get to the yield levels where you would typically start to see a game share revenue stream?

Yes, that's a good question.

The previous nodes, 90 nanometers and 65 nanometers, came up relatively quickly. We saw a relatively substantial delay at 45 nanometers, 40 nanometers, some of that due to the additional extension that happened when 40 nanometer was brought up without the benefit of a major node before it. That was really kind of a 1.5 node transition, if you think about it, from a 65 nanometer to 40 nanometer perspective. We did see that take longer. The early stage of that ramp, right, the manufacturers were quite bullish about that ramp, and then I think the shoe dropped at least with some of the larger foundry businesses.

When we look at the 28-nanometer node, I think if you listen to the calls between the capital equipment folks and some of the manufacturers, you hear a dichotomy about the effectiveness of that node. I think in the end, you're going to see that the first -- the latter part of this year and the early part of next year will be a struggle, and we expect the volume on 28 nanometer, 32 nanometer to really pick up more toward Q2 and beyond. And it would have then a one quarter-ish delay on average for us from the 32 nanometer, 28 nanometer wafer fees. The majority of the growth we expect in wafer fees for us Q4, Q1 had always been, even when we went into this year, expected to be on 45 nanometer, 40 nanometer incremental facilities and capacity coming on line.

And so if there are some starts and stops over the next quarter or two, does that actually increase the opportunity for your design-to-silicon business then?

Yes, I think in general we found that customers, as they've gone through and recognized the value of characterization, the incremental business for us at nodes that we thought were done from a selling and design silicon solutions contract, has increased. If you think about our Q2 last year, this year, I am sorry, just 90 days ago, we had announced that we signed a 40 nanometer and 45 nanometer engagement with an existing account. And that's a classic case where accounts recognize the value of characterization as they transfer nodes and bring up new flavors around the world.

We expect that with 28 nanometer, 32 nanometer, we are a continued stream of incremental opportunities into 2012.

And do you expect LED to be a meaningful part of the business next year?

No, not yet. We're quite encouraged. It was a bit surprising to us. We certainly didn't forecast that happening as quickly as it had. We are exploring that as we go through our strategic plan for 2012, but we go into the year right now with -- we go into our planning right now for 2012 with our original intent that the lion's share of our revenue growth and the lion's share of our revenue will come from logic manufacturers and their associated fabless clients.

And then moving to the model, when you look at the OpEx reduction over the last quarter, is that -- were those just variable costs, or has there been a structural change to the operating expenses?

Tom, this is Mike. There have not been structural changes in a meaningful way to the operating costs. We did end up with some benefits this quarter that did bring the expenses down, and they were offset by one-time effects last quarter. So the reality is the last quarter was a little bit higher than we would have expected because of those one-time charges. And this quarter we did end up with some benefits in addition to not having to record those.

So you would probably look at normalizing the last couple of quarters to get a sense of where the expense run rate is.

And then same question on the stock-based comp on the non-GAAP stuff.

Right. We did have an exceptional charge in there last quarter of about $300,000, so if you actually look at the stock-based comp, it came in at total of about $1.2 million versus $1.5 million last quarter. So I think that would reflect somewhat the run rate. We have not been issuing stock option grants this quarter. So the reality is until we start issuing new grants, we will probably see that number remain pretty much in the current range.

Okay. Thanks for your time.

Andrew Weiner.

So, in response to the last questioner, you described that the expectation for Q4/Q1 of increasing gain share is going to be driven largely by, I guess, greater utilization sort of on legacy engagements and incremental facilities starting to come on likely at 45 nanometer, 40 nanometer. Did I hear that correctly?

That is correct, Andrew.

Which do you expect to be the greater impact?

I think the majority of what we expect is 45 nanometer, 40 nanometer.

Is the greater impact going to be from incremental actual facilities, i.e. lines that we weren't benefiting from prior, or is it just utilization rates going back up in the near term?

Our model says the incremental facilities are relatively substantial for us because we have a couple of facilities with a couple of the customers that we never used to get wafer fees before. We're just starting to get them now, and so we expect it to be a good part of it.

That said, sometimes customers change around their manufacturing plants, and stuff that was supposed to go to one facility gets pulled back to the other facility, and the new node goes into the new facility. So, if it goes as we expect and we've been told by our customers we expect it to be primarily new facility -- the majority of the new facilities.

And that leads to a second question, and I know we've talked before about this and I was hoping maybe you could provide a little more color, particularly as some of these new facilities and new nodes come online, I know you guys internally try to calculate some form of gain share backlog or gain share potential related to nodes for which you've been designed in and lines for which you've been designed in. Is there a relative metric you could provide as to what that backlog or pipeline looks like versus perhaps where it was two or three years ago when you began this transition to a more foundry-centric model?

Yes, we've talked about that before on the call. And, in fact, we're going through our planning for 2012 right now, and we always go back and re-update that model to try to understand.

In general, it seems to be growing pretty substantially as the customers that we have under gain share contracts do have a number of new facilities that are there now tooling out. We still don't have a lot of confidence in the way we compute that number. We went back and reran the numbers for the times we had it in the past and tried to figure out where our errors have been.

In general, it seems like it's going substantially -- you can think about the IBM alliance, which I think everyone knows is a very important part of our customer base, and just say, okay, the alliance is CapEx. Over the past couple of years, most of which is really not online and contributing to gain shares, specially in 2011 CapEx, is collectively the largest foundry spend in the industry right now. If you can take Global Foundries plus Samsung, plus IBM, that's more CapEx than any other single foundry in the world.

So you can get kind of a measure that way. We've used that as a rough metric. They have, by and large, been doubling their leading-edge capacity. Samsung certainly has already. Global Foundries has been on path to do that as well. So you can get a sense that that would reflect roughly what our backlog would look like.

But I want to make sure that I'm sort of clear in understanding it because I think that's one of the things that people struggle with is, all of that capacity for which has driven these solutions engagements over the last year and is the source of your enthusiasm about PDF's both positioning and this transition to the foundry model, very little of that has actually yet shown up in the gain share line.

Yes, under -- well over 50% of that capacity has shown up in our gain share line so far.

And secondly, you talked about demand for solutions continuing to be strong, and there were a number of nice engagements in the quarter. I think in past quarters you've characterized it as that the demand or bookings have been running at a rate that would support sometime in the not-too-distant future the solutions business being at either peak or above peak levels. Could the same -- does that characterization still hold? Has there been a pause based on the macro environment? It sounds like demand still is relatively strong.

Demand is still relatively strong. It's a very lumpy business, Andrew, as you know, from a bookings standpoint. So I think one of the engagements we referred to as an early start agreement for a 32-nanometer yield ramp, that bookings value is relatively small in the quarter. The subsequent engagement that we expect to book would be relatively substantial.

And so the big fee backlog that would build as a result of that would be pretty significant. So timing is always everything. Is that a Q4 sign? Is that a Q1 sign? That would have a big indication of how much backlog we built 2011 over 2010. But I think, nevertheless, if we look at the remainder of fixed fee backlog, it continues to grow.

Can you also maybe elaborate a little bit on the LED sort of the accounts under that relationship? Perhaps maybe you can give some color around what you're able to demonstrate on the early part so far with that customer that would make them want to expand their relationship and perhaps how that might translate into validating this as a potential another market -- real market opportunity for the Company?

Sure. Yields for LED systems, especially for the higher end systems, are -- it is still relatively low. The industry is ultimately in its nascent state.

That yield has to do with multiple elements to the manufacturing process. Unlike the chip industry, where the majority of the yield is, loss occurs in the wafer manufacturing, and the package and assembly and test tend to be relatively efficient parts of the industry. The LED market -- the LED manufacturing process -- after the LEDs are made on a wafer, just like in a chip business, their dye has been put into systems, and then there is loss there. And the final performance is really understood quite a bit later in the manufacturing.

So being able to understand the relationship between the position of a LED on the wafer when it was manufactured versus how it ended up being downstream is a challenging problem. Our systems from a yield standpoint because they had really actually been born out of the analog industry, which in its early days had very similar characteristics, it turns out to be seemingly well suited. I think that's what excited that customer. I think that is what got us the repeat business with that customer.

You know, going from there to value-based business models -- and this is why I flinched on -- not flinched, I just basically said we don't expect it to be significant in 2012 when Tom asked me the question. I got a lot of gray hairs on my head for the ones that stayed in my head in figuring out how to get a value-based business model to work in the logic business. And I'm not willing to say that we now know because we have something that's technically useful for an account and they seem to value it to the tune of millions of dollars that we really understand how to make that into a good, scalable, repeatable business for the industry. We are encouraged by the technical results and the fact that the customer has come back to the well. I think that's a good sign, but that doesn't build you a plant in 2012.

So we're going to keep scratching at it. We think there's an opportunity there. We're excited about it, but we are not forecasting it.

Thank you.

At this time, there are no more questions. Ladies and gentlemen, this concludes the program. Thank you.