PDF Solutions Inc (PDFS) 2013 Q3 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 third fiscal quarter ending Monday, September 30, 2013. 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 release, it has 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 Factor on pages 10 through 16 of PDF's Annual Report on Form 10-K for the fiscal year ended December 31, 2012, and similar disclosures and subsequent SEC filings. The forward-looking statements and risks stated in this conference call are based on information available to PDF today. PDF assumes no obligation to update them.

Now, I'd like to turn the conference over to John Kibarian, PDF's President and Chief Executive Officer, and Greg Walker, PDF's Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone.

Overall, the third-quarter of 2013 was another strong quarter for PDF Solutions. During this period we saw continued growth in the adoption of our yield management solutions across both fabless and foundry markets. These results highlight the opportunities open to the Company as the semiconductor market moves to more advanced technologies such as 3D transistors and multiple patterning processing. PDF Solutions continues to play a key role in the characterization of these new technologies across the major foundries.

From a financial perspective in the third quarter we achieved revenue of $25.5 million and non-GAAP profit of $0.27 per share. Additionally, we had another strong quarter for cash generation. These results reflect the growing importance of PDF Solutions at the fabless foundry boundary and the successful implementation of our technologies by our clients to accelerate process yield ramps and product availability. In a moment Greg will go into more details of our third-quarter financial results.

On the new business side, we have the following engagements to report, all with existing clients. An R&D engagement for 14-nanometer technology development, a 14-nanometer yield ramp engagement, a 20-nanometer DFM engagement, which is an extension of an existing integrated yield ramp engagement, and a new DFM engagement with a fabless client. These engagements are indicative of the growing trend by our customers to leverage the Characterization Vehicle technology and services across the entire process life cycle thereby improving yields and manufacturability of their designs and processes.

Our two 14-nanometer engagements are based on the extensive deep capability that PDF has gained on the 16, 14 nanometer processes across the industry as a whole. Between our foundry, IDM, and fabless engagements, we have Characterization Vehicle infrastructure at work on five different companies' FinFET technologies. As a result, PDF Solutions has developed extremely strong characterization capabilities and models for these nodes. This improves the positioning of our DFM solution for our key fabless clients as well.

The other two engagements evidenced the continued traction in growing business results in DFM. As the foundries are developing new nodes, the complexity of their design rules and the rate of change to those design rules is greater than the industry has ever experienced before. We believe these semiconductor trends will continue to expand the opportunity for our DFM solutions. Overall, the new business activity was strong and consistent with our strategy of providing more value across the fabless foundry interface.

Gainshare revenue results for Q3 were weaker than Q2. The majority of this decline was due to lower volumes at one major foundry client. Due to the timing of revenue reporting in this particular case, Q3 gainshare revenues are reflective of this client's Q2 sales volume. Although we did see an increase in their 28-nanometer volumes, these gains were not large enough to offset the volume reductions at their more mature nodes. Given the timing of their end-customer product transitions, we expect that their 28-nanometer volumes will start to catch up and then exceed the previous node volumes over the next few quarters.

Overall, we continue to expect gainshare to grow year-over-year as leading edge volumes continue to increase. As we have stated in the past, there's always the possibility of gainshare volume and revenue variability quarter-to-quarter. Although there are a variety of opinions about the strength of the semiconductor industry for the remainder of 2013, our belief is that PDF will continue to outperform the industry for the year.

As electrical characterization becomes essential to ramping new products and processes, we continue to see strong interests from the fabs and logic designers for our technology and solutions. 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 will be cautious as we make investments to continue to disproportionately grow earnings with increased revenue.

Thank you for your time and attention. Now I'll turn the call over to Greg. He will discuss in detail our financial results for the third 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 other non-GAAP measures. For internal purposes, the Company focuses on non-GAAP net income and EBITDAR. Non-GAAP net income 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.

Additionally, the income tax provision has been adjusted in our non-GAAP net income to reflect cash tax expenses only. EBITDAR is equal to earnings before income tax, adjusted to exclude depreciation, amortization, restructuring and stock-based compensation. You can access the earnings press release that contains a reconciliation of EBITDAR and non-GAAP net income to GAAP results in the Investors section of our website located at pdf.com. Now let's turn to a review of the financial results.

Total revenues for the quarter were $25.5 million, with a GAAP net income of $4.8 million. This resulted in GAAP EPS of $0.15 per fully diluted share. Net income on a non-GAAP basis totaled $8.6 million or $0.27 per fully diluted share. Total cash increased by $8.5 million during the quarter. For the quarter, cost of sales and operating expenses taken together were $17.7 million on a GAAP basis and $15.8 million on a non-GAAP basis, which is an increase in non-GAAP spending of approximately $170,000 over Q2. Overall, we are very pleased with the continued strength in the total revenues, earnings and cash for the quarter.

Moving on to revenue details, total revenues of $25.5 million for the third quarter were up approximately $700,000 as compared to $24.8 million in the prior quarter. Total revenues were comprised of design-to-silicon yield solutions or solutions revenue of $17 million and gainshare performance incentive or gainshare revenue of $8.5 million.

Our top 10 customers represented 92% of total revenues in the current quarter, slightly higher than Q2. Three of these customers contributed revenues greater than 10% each for a total of 75%, as compared to 73% in prior quarter. On a geographic basis, Asia accounted for 46% of total revenues, up 15% from the prior quarter; North America accounted for 30% of total revenues, which is down 14% from the prior quarter and Europe accounted for the remaining 24% of total revenues, down 1% from the prior quarter.

Looking at solutions revenue in more detail, 13 engagements with a total of nine different customers, each contributed at least $150,000 of solutions revenue. Overall, solutions revenue at $17 million was an increase of $2 million over the prior quarter. This increase was driven primarily by the closing of the contracts for our new 14-nanometer R&D engagement that John mentioned.

Gainshare revenue, as stated earlier, was $8.5 million, a decrease of about $1.4 million compared to Q2. As John mentioned, the majority of this decline was due to lower volumes at one major factory client. In this case, Q3 gainshare revenues are reflective of their Q2 sales volumes, and related Q1 and Q2 production volumes. The total number of customers contributing to gainshare revenue in the quarter was 9, the same as the previous quarter.

Looking at expenses, cost of sales for the quarter was $10.5 million on a GAAP basis, which was $755,000 higher than prior quarter. This increase was driven primarily by previously deferred project costs on the new 14-nanometer R&D engagement, all of which were recognized this quarter. GAAP gross margin was 59% compared to 61% in the prior quarter, reflective of the mix shift between solutions revenues and gainshare revenues in the current quarter.

Our total GAAP operating expenses were $7.2 million or approximately 28% of total revenues, compared to $7.6 million or 31% of total revenues in the prior quarter. R&D expenses totaled $3.4 million, compared to $3.2 million in the prior quarter, R&D expense, as a percent of revenue, was 13% for both Q2 and Q3. SG&A expenses totaled $3.8 million or 15% of total revenues, compared to $4.4 million or 18% of total revenues in the prior quarter. This decrease was primarily related to timing based increases in audit and tax service fees being more than offset by compensation expense reductions.

On a non-GAAP basis, looking at operating expenses and cost of sales together, total spending was $15.8 million versus $15.6 million in the prior quarter. Non-GAAP total expenses were higher compared to Q2 due to the previously mentioned deferred project cost recognition offset by lower compensation expenses. Other income and expense was an expense of $283,000, compared to an expense of $76,000 in the previous quarter as a result of euro-based foreign exchange losses.

The GAAP income tax provision for the quarter was $2.6 million, which reflects an estimated tax provision rate of 35.4%. Of this $2.6 million, approximately $800,000 represented cash tax liabilities. This represents an effective cash tax rate for the quarter of 10.8%. Our cash tax liability decreased from the prior quarter by approximately $570,000, primarily related to favorable changes in our state apportionment and deductions related to employee stock compensation. For the remainder of the year, we expect our cash tax rate to be in the range of 15% to 17% of pre-tax net income, and the GAAP tax rate to be in the 37% to 38% range.

Quarterly GAAP net income of $4.8 million resulted in EPS of $0.15 per fully diluted share, which was equivalent to the prior quarter. For the quarter, non-GAAP net income was $8.6 million compared to $7.7 million in Q2. On a non-GAAP basis, earnings per share was $0.27 per fully diluted share, an increase of $0.02 per share over the prior quarter. EBITDAR, which I defined earlier and is also defined in our press release, was $9.8 million compared to $9.4 million for the prior quarter. EBITDAR per fully diluted share was $0.31 per share compared to $0.30 in the prior quarter.

Total cash at the end of the quarter was $85.2 million, an increase of $8.5 million compared to June 30. This increase was driven by strong accounts receivables, collections, and proceeds from stock option exercises, partially offset by purchases of fixed assets, primarily related to our proprietary testers. Cash from operations was $6.6 million.

Trade accounts receivable days sales outstanding was 74 days for the quarter, a three day improvement as compared to the previous quarter. This improvement in DSO was facilitated by strong collections executed within the quarter. Unbilled accounts receivable for the quarter was $7.5 million, an increase of $1.9 million over the prior quarter, and was primarily due to the percentage of completion revenues recognized on our new 14-nanometer R&D engagements.

Total DSO for the quarter, including unbilled receivables, was 101 days compared to 98 days in the prior quarter, an increase of three days, and once again this was primarily related to the timing of billing under the 14-nanometer R&D engagements.

Headcount at the end of Q3 was 369 people worldwide, compared to 357 at the end of Q2. This growth was primarily related to increases in our cost of sales organizations in China and Taiwan, and our R&D organization in Germany. As with last quarter and last year, the overall financial results for the quarter reflect continued strength in our core business and our ongoing attention to spending levels.

As part of our attention to spending levels, we've structured our discretionary variable compensation plans, such that expense related to these plans is directly tied to the Company performance in any given period. Management practices, such as this compensation policy, allow the Company to continue to effectively manage its spending, while growing revenues, providing increased income leverage and a stronger balance sheet position.

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?

Thank you, Mr. Walker. Ladies and gentlemen, (Operator Instructions) Tom Diffely.

Good afternoon. First a question on the design to silicon side of the business, is there some way you can give us a relative view of the size, and revenue potential of the different types of engagements, the DFM engagement versus the yield ramp versus the R&D development?

Yes, I think the R&D and the yield ramp engagements are similar sized. Typically, they are multi-year engagements, and the fixed-fee portions are in the multi-millions of dollars. They'll run for one to three years, so roughly you can kind of do the math, you say it's somewhere between on the short-end four-ish million dollars, on the high end, $12 million or $15 million over a two to three year time period.

The DFM engagements tend to be smaller. As we've said before, the fixed fees on those -- in the one-ish million dollar range, plus or minus a little bit, sometimes $2 million depending on the time period that they represent the vehicles et cetera and the content that's provided. And of course typically the majority of the wafer fees come from the factory engagements, so there are wafer fees associated with some of the DFM engagements particularly around production control, [scribe] testing, et cetera.

Okay.

So generally speaking the yield ramp and R&D engagements are the ones that really -- are the ones we tend to focus on. They drive the majority of the wafer fees (multiple speakers).

And when you look at the actual -- the revenue from that, is it percentage of completion or milestones or equal payments?

[Revenue] is generally percentage of completion.

Okay. And so that can vary from time to time as far as two projects can have different revenue streams?

Yes, that's true. And generally speaking, there is a lot upfront because that's delivery of vehicles and systems. So you've got more percent completion typically at the beginning of an engagement than the end.

Okay. And then when you look at some of the future growth coming from the fabless group, that's more on the DFM side, so maybe more smaller projects going forward?

Yes. Generally speaking, that's true, Tom. I mean, what we've noticed and if we look at this quarter as one of -- another example of it, the foundries, themselves, last quarter in the enterprise agreement, when the foundries started funding along the DFM specific to their high-valued accounts, this was another example for a foundry that wanted to make sure a specific product was going to hit the time to market window that they fund the DFM that had both improved fixed fees as well as improved wafer fees associated with it.

And so they're starting to get to be bigger and more -- the numbers I gave you is kind of a historical look, and getting to be better as, I think, customers and I alluded to this in my prepared remarks, right, the specific design rule changes and all the interactions between a particular product or family of products in the technology are becoming more important for bringing up these leading-edge products. Overall, they're growing and improving in size and value to the customer.

Okay. And then from this [day], margin profile of the different programs all fairly similar?

Yes, fairly similar. Arguably, the DFM a little bit better on the fixed-fee gross margins.

Okay, all right. And then, John, you referenced the dual decline in the gainshare portion of the business and you said that the ramp of that one customer of 20-nanometer should, and this part I didn't quite hear, did you say that you expect that royalty revenue rate to go back up again from here just based on 20-nanometer ramping faster than the rest of the business was falling down?

Yes. We get paid when they ship to their customers. So sometimes at the beginning of a product introduction, they build a lot and don't ship, so you'll see the volumes come down on other nodes as they fill up the factory on the new node. But those wafers don't get counted until another quarter later.

Okay. Is this similar to what we saw with another customer about a year ago?

Yes.

Okay, all right. And then, Greg, you mentioned on the SG&A, the step-down in the operating expense there, that it was due to a timing. Does that mean it was essentially the delta there was pushed out to the fourth quarter?

No. Actually, if you go look at how we have to recognize expense on audit fees and tax advisory service fees, in the old days we used to basically take those expenses ratably across the year. With the current accounting rules, you have to recognize them as they're incurred and you tend -- they tend to be lumpy throughout the year.

So if you look at Q1 was very high, Q2 was very low, Q3 is kind of in the middle, but when you compare Q3 to Q2, it's an increase over a very low Q2, and then Q4 also tends to be fairly high. So basically, it's just timing effects. The full-year number is actually right on where we expect, because we negotiated that upfront two years ago. So the fees that we're seeing are right on our forecast, they're just timed slightly differently.

Okay. So if Q3 is, I think, it was up Q2 from that point of view, but you still had a pretty big drop sequentially. Maybe what's the component [was then]?

Yes, and that really is related to our compensation expenses, particularly related to the variable compensation structure that we have. As we've talked in the past, a large component of our compensation in any given period is variable tied directly to the -- basically tied to gainshare so that contributes a large portion of the EBITDAR. But basically, when you see gainshare drop, our variable comp will drop with it, such that we can maintain our leverage of net income on a non-GAAP basis.

Well, based on that explanation, do you expect that compensation to go up next quarter?

Well, let's put this way, I hope it goes up.

How we motivate everybody.

As a member of the SG&A team, I seriously hope it goes up.

Okay. And at some point as -- obviously when you negotiate with customers, it takes a while to get all the contracts in place and stuff. At some point, do you think there will be some kind of a lump sum catch-up with some of your larger customers?

As far as fixed fee solutions?

[No, it's for] the gainshare from your products that have been produced over the last year that have come up on your lines that you worked on.

Yes, we think there will be some of that. We don't get as much information out of our customers on their end customer product ramps as we'd like. But we do see those effects flow through every now and then. And we could well see something like that happen sometime between now and Q2 next year.

Okay. And then finally, Greg, you talked about the tax rate, the 15% to 17% on a cash basis and 37%, 38% on a GAAP basis, is that a tax rate that you think is kind of just good going forward beyond just the next quarter?

No, I think the cash tax rate will come up. We're actually going through analysis right now, to say, where we see a significant difference between the cash and book tax rate throughout all of next year. Theoretically, they should approach each other, but the gap will never completely close, because you always are putting in some new timing differentials, and tax credits. So I would -- we haven't done the projected rate for next year, but it will be above the rate we're at right now. My guess is it probably would be in the low-to-mid 20s for cash tax next year.

And that's just the [easing] up of NOLs?

Yes, NOLs and other credits.

Okay. All right, thank you.

(Operator Instructions) At this time, there are no more questions.

Great. Thank you, everyone.

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