PDF Solutions Inc (PDFS) 2012 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 Saturday, June 30, 2012. (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 performances, growth rates, and demand for its solutions.

PDF's actual results could differ materially. You should refer to the section entitled "Risk Factors" on page 10 through 16 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2011 and similar disclosures in subsequent SEC filings.

The forward-looking statements and risk statements 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 President and Chief Executive Officer, and Greg Walker, PDF's Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone. PDF Solutions continued making strong progress towards our goal of being pervasively applied to leading-edge logic manufacturing and generating gainshare from our clients' successful yields. In the second quarter of 2012, we achieved revenue of $22.5 million, non-GAAP profit of $0.22 per share, and GAAP profit of $0.16 per diluted share.

On the new business side, we successfully closed contracts for the following, all with existing clients. An enterprise-wide agreement covering 32-nanometer, 22-nanometer and 14-nanometer to use PDF technology across the process life cycle from R&D through production control, an extension to an existing enterprise agreement to expand technology applied to additional derivative notes for 28-nanometer and a ramp for 20-nanometer as it transfers from R&D.

A contract for 28-nanometer DFM engagement for a foundry, two contracts for an existing 32-nanometer yield ramp client that allows for additional manufacturing facilities to deploy our characterization vehicle infrastructure.

These contracts demonstrate foundries are using PDF Solutions' characterization and vehicle technology across the IC process life cycle to improve the yields and manufacturability of their designs and processes. The enterprise-wide agreement demonstrates the value PDF solutions can provide in R&D, transfer and ramp and manufacturing, as well as later-stage manufacturing. This is the second such agreement PDF has entered into during the last year.

The extension of the enterprise agreement that was signed in a prior quarter and the 28-nanometer DFM engagement speak to the opportunity that clients have to benefit from PDF solutions for ramp and characterizing DSM rules and process design kits for each customer's specific version of a node.

Finally, the last two agreements point to how our characterization vehicle infrastructure is increasingly being used beyond the initial achievement of yield, to match those results across multiple facilities. Collectively, these agreements increase our future gainshare opportunity.

As the industry is moving past the 28-nanometer ramp and looking forward to the 20-nanometer and 14-nanometer ramps, we are seeing a growing opportunity for electrical characterization in part due to the increased process and design complexity, new materials and device structures, challenges with process windows, and challenges in using conventional yield improvement technologies.

Customers tell us that our Characterization Vehicle infrastructure provides a comprehensive electrical characterization of the defects, both the hard defects -- which are often seen at inspection -- as well as the parametric defects, which are undetected by visual inspection.

Ultimately, what works or fails electrically is what matters. We anticipate that customers in PDF Solutions will find new applications of our Characterization Vehicle infrastructure that are important to secure their yield ramp success.

A bit surprising to us was that gainshare results in Q2 improved significantly again. The primary driver for this improvement was increased volumes in yield on the leading edge as well as increased volumes at more mature nodes. Although we continue to expect gainshare to grow year over year, as leading edge volumes increase, we also expect volatility quarter over quarter.

As electrical characterization becomes essential to ramping new products and processes, we continue to see strong interest from the fabs and logic designers for our Characterization Vehicle technology. However, we are mindful of the cyclical nature of the chip industry. So, while we see opportunities to continue to grow both our solutions and gainshare revenue, we'll be cautious as we make investments to disproportionately grow earnings with increased revenue.

We will continue to refrain from providing specific quarterly guidance and focus as we have on long-term profitable growth. Thank you for your time and attention. Now I'll turn the call over to Greg, who will discuss in detail our financial results for the second quarter. Greg?

Thanks, John. As a reminder, in addition to using GAAP results when evaluating PDF's business, we believe it is also useful to consider our results using non-GAAP measures. In this case, non-GAAP measures exclude stock-based compensation expenses, amortization of expenses related to acquired technology and other intangible assets, restructuring charges, and their related tax effects as applicable.

You can access the earnings press release that contains the reconciliation of non-GAAP to GAAP results in the investor section of our website located at PDF.com.

Now, let's turn to the review of the financial results. First, let me cover some highlights for the quarter. As John stated, total revenues were $22.5 million with a GAAP net income of $4.8 million. This resulted in an EPS of $0.17 per share for basic shares, and $0.16 per share for fully-diluted shares.

Net income on a non-GAAP basis totaled $6.4 million or $0.22 per share, per diluted share. Cash increased by approximately $4.6 million during the quarter and on a GAAP basis cost of sales and operating expenses were $17.1 million, an increase of $225,000 from last quarter.

Overall, we are very pleased with the strong improvement in revenues, earnings, and cash for the quarter. Now, let's look at revenues in a little more detail.

Total revenues of $22.5 million for the first quarter were up 9% as compared to $20.6 million in the prior quarter. Total revenues were comprised of design to silicon yield solutions, or solutions revenues, of $13.8 million and gainshare revenues of $8.7 million.

Gainshare revenues increased for the quarter by $1.5 million or 20% sequentially and solutions revenues for the quarter increased by $406,000 or 3% sequentially. Our gainshare revenues for the quarter as a percentage of total revenues increased to 39% from 35% in the prior quarter. As John has indicated, the significant improvement in our gainshare revenues was due to increases in volumes and yields at our customers on the leading edge nodes as well as increases in volumes on the more mature nodes.

The total number of customer contributing to gainshare revenue in the quarter was eight, an increase of two over the prior quarter, as two existing customers began generating new gainshare revenues.

During the quarter we added four new solutions contracts including our second enterprise agreement and one extension to an existing solutions contract. In the quarter, 12 engagements with a total of 7 different customers each contributed at least $150,000 of solutions revenue. Our top-10 customers represented 91% of total revenues in the quarter. Three of these customers contributed revenues greater than 10% each for a total of 71%, compared to three customers contributing 76% in the prior quarter.

On a geographic basis, Europe accounted for 34% of total revenues, North America represented 33%, and Asia accounted for 33%.

Moving on to cost of sales, cost of sales for our solutions revenue was $8.9 million for the quarter, an increase of $178,000. Due to the higher gainshare contribution, second quarter gross margin increased to approximately 60% compared to 58% last quarter. Non-GAAP gross margin was 63% for the quarter compared to 60% last quarter. As a reminder, GAAP includes stock-based compensation, amortization of acquired intangibles and restructuring expense of the San Jose Headquarters Facility once again.

Our total GAAP operating expenses were $8.2 million, or approximately 36% of total revenues, compared to $8.1 million or 39% of total revenues in the prior quarter. R&D expenses totaled $3.3 million, or 15% of total revenues for the quarter, compared to $3.2 million in the prior quarter. SG&A expenses totaled $4.7 million or 21% of revenues compared to $4.9 million or 24% of revenues in the prior quarter.

Looking at total operating expenses and cost of sales together, on a non-GAAP spending basis, total spending for the quarter was $15.5 million versus $15.7 million in the prior quarter. This slight decrease in spending is the result of one-time savings recognized during the quarter of approximately $500,000 being partially offset by increased investments in personnel resources to support our growing solutions engagements.

Due to the effect of favorable foreign currency fluctuations partially offset by a loss on auction rate securities, other income and expense was $155,000 of income compared to $142,000 of expense in the previous quarter.

The income tax provision increased quarter-by-quarter to approximately $639,000 to a total of $808,000 for the quarter. In general as a reminder our tax provision is primarily comprised of foreign withholding taxes on sales.

Total cash for the quarter was $50.2 million, an increase of $4.6 million over the prior quarter, primarily driven by cash generated from operations of $6.9 million being partially offset by cash used in investing and financing activities.

During the quarter, the company repurchased 266,600 common shares for approximately $2 million.

DSO for the quarter including unbilled receivables was 109 days compared to 123 days outstanding in the prior quarter. Of the total accounts receivable of $27 million, only 4.5% was more than 30 days past due at quarter end. Of those amounts more than 30 days past due at the end of the quarter, only $280,000 remains outstanding as of today, the majority of which is related to delays due to Chinese currency controls.

DSO for billed accounts receivable excluding unbilled was 76 days compared to 91 days in the previous quarter. Head count at the end of Q2 was 335 total employees, compared to 323 at the end of Q1. The majority of this increase in head count was in our solutions organizations.

In conclusion, the overall financial results for the quarter led by extremely strong gainshare revenues were very good. The company has continued to effectively manage its spending while at the same time increasing revenues and strengthening the balance sheet. Going forward the financial performance of the company will be strongly impacted by gainshare revenues which in turn are dependent upon a small number of foundry customers and their respective demands from their end customers.

This concludes the review of the financial results for the quarter. Now I will turn the call over to the operator for Q&A. Operator?

(Operator Instructions) Our first question comes from Tom Diffely.

Yes, good afternoon. Quick question on the gainshare side first. Did you say the strength was both the leading edge and the trailing edge, or was one of those in particular stronger than the other?

Yes, they were both actually strong in the quarter, Tom. We expected the leading edge to be strong. We're a little bit surprised that the trailing edge was as strong as it was.

Yes, and I know, I mean we're hearing from a lot of other companies that there's a bit of softness right now for just the core semi market.

Exactly.

So, has that, did that trail off at all towards the end of the quarter or the start of this quarter slow?

Did not seem to be, and we've been monitoring it this quarter. So far, it looks pretty reasonable but it's yeah, we were quite surprised. We thought it would be soft, and it wasn't. So yes, so as you know the general sentiment is this third and fourth quarter are supposed to be relatively soft in terms of utilizations in the factories, hence Greg's comments at the end of his prepared remarks that we don't fully -- if that could happen for us as well. We hadn't seen that yet, it's been actually quite good. Obviously the gainshare number was good this past quarter, so, and it wasn't just the leading edge guys.

Okay, and that business is typically one quarter in arrears. Does it you know, match up with just one quarter, is it a little more, a little less, than one quarter?

It can be left in one quarter in arrears because it's the production, it depends on when the production quarter ends relative to the representing quarter, the reporting quarters.

Okay. And then you talked about how at the leading edge, obviously, the volume and yield but there's no reason to believe that on the yield front things wouldn't be progressively getting even better so it's really just volumes that would impact it?

Generally speaking yes, that's true.

Okay. And then you talked a little bit about increasing the head count for the growing solutions engagements. How do you view the design to silicon portion? Is that kind of a slow growth avenue over the next year or so while really the most of the meat comes from the gainshare acceleration?

That would be yes, that's how we look at it.

Okay, and then I'm just kind of curious what the scalability of that business is, if it's purely head count or if it's just a combination, go ahead?

Yes, it's a really good question, Tom. If you look at the -- by my prepared remarks, we didn't really talk about electrical characterization. When we sit down and talk with the accounts, what they really value is the Characterization Vehicle infrastructure, so it's the test vehicles, the testers and the software that gets all that information out of there. The people are really kind of, they help the customers get value out of it, much like the way an inspection company would have field application engineers helping the customers get information off of a bright field inspector.

They really fill that role greatly for PDF. Over the last year or two, year-and-a-half, we've seen the number of testers, the number of vehicles, the number of wafers the customer has been running on our infrastructure, go up really substantially. I mean, we had customers, we had two or three testers as part of the engagement, and have eight or nine or ten of these things to characterize just the incremental what we say CV's as a short cut for Characterization Vehicle, to keep up with the CVs that the customers are running to characterize their process windows.

So, we -- what the customers I think value is the overall solution. The people are very instrumental in getting information out of that system. I think much the way for the inspection folks, you know. That said, we hire on a kind of annual cycle so in Q3 is when we hire, we tend to hire for our back office and Japan and China. We had anticipated a certain level of attrition in China because the market has been, the employment market's been relatively high. We've seen very little attrition in this past year, so you'll see hiring grow in this quarter and third quarter. That's really generally speaking more about kind of the cyclone which we hire relative to the overall employment market that we work in both in China and the states, but disproportionately China.

Okay. And if you assume that the number of customers remains constant what is the node-to-node growth you typically see in the design to silicon line item?

Yes, you know, that actually gets to my prepared remarks about the incremental engagements. The customers used to just use Characterization Vehicles for the first version or flavor of the node, so 28-nanometer, you know, most of the foundries have three or four or five flavors these days. They all say they're going to have, every time we introduce another, they say we're going to have fewer flavors, and by the time the node gets to volume they have more than they had the previous generation or at least as many.

In the past you would do a vehicle set for that initial node, and then they would use that for all the derivatives as well. The processes are getting so subtle the customers are coming back and asking for CVs for the derivative nodes as well, and that was a couple of the engagements that we referred to in one of the -- the extension enterprise agreement, and that's why we've been putting in place these enterprise agreements. Because it gives the customer the ability to come back and request incremental CVs and then that improves, then we charge them incrementally fixed fees for that.

Generally speaking, we get already kind of all of the flavors in a node under the base contract from a gainshare perspective. It does help the customer, though, get better yields on those derivatives and had some more volumes so it does have a secondary or knock-on effect on gainshare, and from our standpoint what we saw kind of at the 40 node was our costs on the fixed-fees were going way up because customers were asking for derivatives, and we needed a mechanism to be able to charge for that. That's what these enterprise agreements have really been helping with.

Okay. I mean, the fact that these enterprise agreements essentially lock up these customers over a multi-node period, did you have to give up something, kind of a package deal, to get them to sign these agreements or is it within their best interest as well?

You know, generally speaking if you look at the kind of overall improvement in our financials as the enterprise agreements have kind of started to generate and contribute to our business, I mean I think you could infer from that that these are obviously strong contracts for PDF. We're always careful about, or mindful about, making sure we provide tremendous value for the account relative to what we charge, and I think you recognize that our wafer fees are in the tens of dollars per wafer, typically in the gainshare contracts when you work it all out.

At 20-nanometer, just the depreciation of metrology and inspection is expecting to be somewhere around $530 or $540 per wafer, so when you look at the number of yield points the customer can find on our solution, and effectively what they're paying per wafer on the price per yield point, we think it's a very, very strong value for the accounts and I think the accounts are recognizing that, and that's probably creating the umbrella under which we're selling these enterprise agreements, more than it is somehow us finagling or being flexible around terms in the agreements. We really can't afford to do that. We need to get paid for the value we deliver.

Okay. And then another question on the yields on the gainshare side, so, typically when you get to a certain yield then you start to get a royalty after that. Does the yield percentage go down from node to node because it gets a lot more difficult, or are they pretty stable? Get above 85% or whatever the number is?

So, the defect densities that we typically target to are relatively stable. There is some -- the number of complex layers goes up, so sometimes there's some relief there in terms of the actual yield. But in the end, what we've learned about in this business is the customers need to be node-over-node competitive with respect to the previous node. So, if you have a node that is not cost-competitive compared to, if 20-nanometers is cost competitive relative to 28-nanometer, you can be as clever as you want in terms of the wafer fee calculation and the volume won't show up there. So, ultimately, we need to work with the accounts to get to economics that make sense node-over-node, and the volume will show up, and then we need to make sure that we then participate in that fairly for the delivery of the value.

Okay, and the last question, is there any 20-nanometer in the gainshare at this point? Or, is it still 32 and above?

Primarily 32 and above.

Okay great, thank you.

Your next question comes from the line of [Steve Balman].

Good afternoon, guys.

Hi, Steve.

Hi, Steve.

Congratulations on a good quarter. I want to just talk a little bit more about kind of the gainshare commentary that you guys made on a forward-looking basis, and I understand that you don't want to give guidance, and you made some -- I think the words that you used about expecting volatility in gainshare revenue but expecting year-to-year growth. If my notes were good, that was similar language to what you used last quarter and you obviously had a very, very good quarter of gainshare. Is my recollection correct?

Yes, Steve, probably I didn't actually edit the words when I took last quarter's (laughter) and used it to be candid, so you might find that they're exactly identical, actually.

Okay, that's helpful in thinking about it, so, I understand the sentiment but it's somewhat close to boilerplate almost. Though I understand that you guys are saying that it's not going to be a smooth ramp in gainshare.

Yes, I mean, look. Last quarter what we were thinking was -- jeez, if it was flat, or it went down a few-hundred-K, would people all of a sudden get upset? Our model showed it going up actually last quarter, right? We thought Q2 would be greater than Q1. I put those commentaries in there, but it still surprised us. It was up, and that's why our words here were, it's surprising. Because I find management tends to take credit for every time it goes up, and then of course distance themselves from any time something goes away, right? That wouldn't be genuine.

If you think about our business on that part of it, we can control the long term because it's about how well we execute, but the quarter-over-quarter stuff there's just a level that if it's up 500,000 over our model, we really can't take credit for that because it's not us.

Right, right.

And when it's under $500,000 it's easy to get blamed and kicked to the side of the road because investors tend to do that to you, but at the end of the -- I don't really feel all that badly about that level of volatility in the number when it's at this level of total contributions to the business's revenue. It'd be a different story if it was $1 million or $2 million I would give a (expletive) about, plus or minus $500,000 -- ooh, I shouldn't have said that, but plus or minus $500,000.

But I think you understand what we're trying to communicate.

Yes, I think, yes.

You generally expect it to go up. We can't tell. Please don't get over excited about an extra $500,000 above where you thought it would be or an extra $500,000 below where you thought it would be. Don't infer too much from it.

Good, yes, I hear you and I understand that. Just to ask another question on gainshare quickly, the number of customers, that went up I think two in the quarter, so two more customers contributed to the gainshare, do I have that correct?

Yes, that's correct.

Okay, and those are presumably then the new customers, so those could be customers at the leading edge nodes rather than customers at the trailing edge nodes?

One was actually a relatively trailing edge customer, but it was a new node for them. But it was an engagement that we had worked on in the past, it was a more mature node, but for them it's their leading edge node.

Okay but they're still ramping there, right, so? So John, if I understand you guys' business correctly, things ramp up over time, right? So the first quarter that a customer contributes at a given node is likely not to be their greatest quarterly contribution, it should go up over time.

Generally speaking, correct.

Okay, great. That's it for me, thanks very much. Great performance. Thanks, guys.

Thank you.

Thanks.

Your next question comes from the line of Andrew Weiner.

Hi, good afternoon, John and Greg.

Hi, Andrew.

Hi, Andrew.

Hey. So, focusing a little more on the gainshare component, at the leading edge it's been well-reported that some of your customers and subsequently their customers are ramping a series of new products where they've been arguably capacity-constrained, or will be capacity-constrained at the leading edge, for fall or winter product releases. So, to what extent do you think you saw that strength in the second quarter results, or is that something that you're seeing ramping sort of throughout the year?

Yes, I think generally the shortage is at 28, and that's a good question. Tom touched on this too, right? We expect the 28 to start contributing to us in the second part of this year and early next year, and there's some other products that have been announced that are on 32 that we expect to contribute in the second part of the year that we would hope would provide some additional benefits to us, especially as you get out into 2013, right? We are always a bit skeptical because of the way we recognize revenues on the [ramps] and some of these things as well as people's timings on ramps can slip a quarter.

So, when we've built our models for the second half of the year, we've been very conservative internally about our estimates about when they'll start contributing meaningfully. So, that's the positive piece, that would tend to make the number go up. We are concerned about the general utilization that the let's say 65-nanometer node, and could that put some pressure on some of the older contracts to come down in the second half of the year? And therefore, you have to backfill that loss if that were the case, if their utilizations came down. That's why we put the commentary in Greg's script about hey, look you know, there's a volatility and there's certainly sentiment out there that the second half is going to be soft.

We, as you are alluding to, we don't expect that softness to be very much at the 28-nanometer node.

Secondly, sort of along those same lines, one of the large [fabless] companies publicly disclosed a plan to use four different foundries at 28-nanometers and in past calls you've talked a little bit more about what's been sort of an expanding opportunity to work directly with the fabless. Can you perhaps elaborate on the strategy there?

Yes, so, what we're seeing -- this is actually a little bit from my prepared remarks too, these derivative versions of the process, a lot of larger fabless really want specials or slight modifications to the general foundry offering. Those have a subtle but significant impacts on yields and the effective performance that they can achieve from the technology. So, characterizing those derivatives and the way the design uses those derivatives is becoming a bigger and bigger opportunity for us and for the industry overall. Each part of that equation, the fabless and the foundry, take responsibility for some of the results there.

So, if you listen to my remarks, I said that one of the customers was -- to validate the PDK and the design rolodex. That's really about supporting one of these customer-specific versions of a node, and the promise that the manufacturer makes about being able to achieve performance of transistors and interconnect elements.

On the other side of that, we're seeing and we've had in the past quarters and we expect to talk about it in the future on one of our next quarters, design organizations are using our vehicles to look at how their design is using that PDK and really validate that they can build, that their parts are stable in that technology. And we've had a number of those over the past couple of quarters, we expect Q3 actually to be a very good quarter for us from DFM standpoint.

Those DFM contracts with the [fabless], those have been growing year over year with us. We expect 2012 to be kind of a record year in terms of the number of those engagements we'll sign, and those run across almost all the foundries in the world at the leading edge, I think all the foundries in the world at the leading edge.

Okay great. Second, the third question I had was, the process control manufacturing sort of solution or software platform that we'd had sort of installed the beta on and sort of had some initial results, can you update us on sort of the progress with that as well as sort of the opportunities for commercializing that product more broadly?

Yes, thank you. So, yes, it's a good follow-up question. So, we achieved our first beta, we have that customer now asking us for more on that, and we will work through that with them throughout the remainder of the year. We believe that there is upside there, and in fact they're asking for an integrated solution, coming back and saying gee, we really like it when it's integrated with the overall solution business and maybe has some more elements that are like the gainshare portion of it.

We also have been doing a couple of other things, taking our very strong relationships with customers and using it in our yield rep engagements to help find signals. Now, we've been doing that in a couple of the leading-edge 32 and 28s and we visited with accounts certainly, I was out seeing some accounts in the last month or two. I heard really positive feedback from them about what they're able to find in terms of yield signals. One of the customers told us -- hey, 40% of what you showed us turned out to be real, and you know, I know that isn't -- in academics that'd be an F but in the land of inspection if 5% of what you show on defects turns out to be real, that's a home run.

So, at 40% it's so much better than what people find off in-line capabilities. It's not even close, and we have a roadmap to make that better. So, they were very impressed with what they see. We believe this is an incremental opportunity for us.

Where it has already paid off you know, in 2008 and 2009 if you remember those conference calls, and certainly I do as I have some scars remnant from them, we saw the downturn. We had a number of existing customers at 65-nanometer that were on traditional yield ramp engagements, and we were quite afraid that since those had about three-year tails on them and we were in going into a very long downturn, we were afraid of, we would lose a year on a 65-nanometer ramp which would be a third of the opportunity.

So, we sat down with those customers and actually delivered an earlier version of that software, it was a very, very early version of it. And for that extended out the gainshare tails on those contracts, and actually one of the contracts that contributed most strongly in Q2 was that 65-nanometer contract because of the yield where FDC's solution and the benefits that they were getting from it.

So, you know, in the 2008 timeframe that was probably one of the better decisions that we made was going to some of the very old [IDMs] and saying, here's an incremental capability that'll let you get more efficiency out of this facility, why don't you deploy it, now by the way let's extend out the gainshare period substantially since you don't have money to pay for it today. That really has paid up big time for us.

So, as we look at these successes inside our yield ramps at 32 and 28, and customers really liking what they see, we're looking for ways that we can deliver this to improve the gainshare opportunities as it comes and still overall, when they look at the yield points they're getting from PDF, these will be the best deal yield points they have relative to any other way any hardware-based way of getting at yield.

Okay great, thank you.

(Operator instructions) At this time there are no more questions. Ladies and gentlemen, this concludes the program, thank you.

Thanks.