PDF Solutions Inc (PDFS) 2014 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the PDF Solutions Incorporated conference call to discuss its financial results for the second fiscal quarter ended Monday, June 30, 2014.

(Operator instructions)

As a reminder, this conference is being recorded. If you have not 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 Factors on pages 11 through 17 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2013, and similar disclosures in subsequent SEC filings. The forward-looking statements and risks stated in this conference call are based on information available to PDF today. PDF assumes no obligation to update them.

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

Thank you and welcome, everyone.

The results for the second quarter were mixed, with lower solutions revenue partially offset by continued strong Gainshare performance. For both the quarter and the first half of the year, Gainshare revenues were stronger than originally expected. We always remind you that we will likely experience quarter-to-quarter volatility in revenues. In this case Q2 results were lower than Q1.

Our business model, which aligns PDF's revenue to customer wafer volumes, is designed to offset this technology bookings variability on a long-term basis. Despite the softness in Q2 revenues, we have reason to remain optimistic about our projections that we would outgrow the overall logic market on an annual basis.

During the quarter, we closed the following engagement and orders, both with existing and new clients. A 10 nanometer DFM engagement with established client, an amendment to a 14 nanometer engagement adding additional capability, and a significant software contract for dataPOWER, part of our [accent seal] yield management solution with an analog integrated device manufacturer.

While the quarterly bookings were adversely affected by timing and contract executions, the technical challenges presented by advanced nodes continues to drive the growing need for PDF Solution's technology at our customers, both fabless and foundry. This is evidenced by our first 10 nanometer engagement with the fabless company, as compared with our previous 10 nanometer engagements, which had been with process R&D organizations. We now have had multiple 10 nanometer tapeouts across several customers, further extending PDF's leadership in electrical characterization.

The quarter-over-quarter solutions revenue decrease was due to delayed signings of two contracts. We look at this as a bookings timings issue, since for both contracts, we have been delivering characterization vehicles and systems prior to signings. These systems are being successfully used at our customers.

The situation is similar to last year. If you remember in Q3 last year, we closed a contract for an R&D engagement, having already delivered our characterization vehicles and systems for multiple quarters. Because costs for that activity were deferred, there was a relatively large one-time quarterly revenue catch-up for that engagement.

While this drove volatility quarterly, on an annualized basis it had no impact. In this case we have two contracts where we have been delivering our infrastructure for multiple quarters. Our logical characterization is vital to see defects which limit the ramps and is integral to our customers' activities.

As a result, we believe we are in a similar situation as last year. Closing these contracts will result in the catch-up of revenue.

Updating our view of the logic business environment. As we have stated since last year, the technical need for electrical characterization continues to build. 28 nanometer volumes remain mostly strong, as evidenced in our Gainshare.

Foundries are racing to demonstrate their first FinFET node in production, which is driving strong demand for electrical characterization. Foundries are accelerating their activities at 10 nanometer, we believe in part, to gain engagement with critical fabless customers.

Given the increased importance of these customers, we do see wins and losses causing ripples in foundry capacity schedules. While this can cause short-term pressure for our customers, over the long term, it increases the value of our characterization, as it is the lingua franca between designers and fabs.

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 with 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 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 income to GAAP results in the Investor section of our website located at www.pdf.com.

Now let's turn to a review of the financial results. Total revenues for the quarter were $24.6 million with a GAAP net income of $4.7 million. This resulted in GAAP EPS of $0.15 per fully diluted share.

Net income on a non-GAAP basis totaled $9 million, or $0.28 per fully diluted share. Total cash increased by $5.9 million during the quarter. Cost of sales and operating expenses together were $16.9 million on a GAAP basis, and $14.5 million on a non-GAAP basis, which is a decrease in non-GAAP spending of approximately $1.5 million from Q1.

Moving on to revenue details, total revenues of $24.6 million for the second quarter were $2.5 million less than in the prior quarter. Total revenues were comprised of design-to-silicon-yield solutions, or solutions revenue, of $13.1 million, and Gainshare performance incentive, or Gainshare revenue, of $11.5 million.

Our top 10 customers represented 93% of total revenues in the current quarter. Three of these customers contributed revenues greater than 10% each for a total of 76%, as compared to 77% in the prior quarter.

Looking at solutions revenue in more detail, 11 engagements contributed at least $100,000 of solutions revenue in the quarter, compared to 13 engagements in the previous quarter. Overall, solutions revenue at $13.1 million was $1.8 million lower than in the prior quarter. This decline was the result of one engagement transitioning from solutions to Gainshare status, and the completion of the 10 nanometer technology development agreement during the quarter.

Additionally, two advanced node engagements, which we began project work on several quarters ago, did not complete the signature process prior to the quarter end. As we have stated before, working in advance of contract execution has been a standard business practice with our customers for several years. Had both of these contracts been executed prior to quarter end, solutions revenue would have been significantly higher.

Gainshare revenue for the quarter was $11.5 million. This result was approximately $650,000 lower than in the prior quarter, primarily driven by lower 28 nanometer volumes at one customer, partially offset by increased volumes at other customers. The total number of customer sites contributing to Gainshare revenue in the quarter was eight, which is the same as in the prior quarter.

On a geographic basis, Europe accounted for 44% of total revenues, which is up 6% from the prior quarter; North America accounted for 41% of total revenues, down 1% from the prior quarter; and Asia accounted for the remaining 15% of total revenues.

Moving to expenses, cost of sales for the quarter was $8.8 million on a GAAP basis, which was $859,000 lower than in the previous quarter. This was primarily driven by lower accruals for performance-based compensation and vacation. Additionally, we increased our deferral of specific project costs related to the previously mentioned engagements.

As of the end of the quarter, the total accrual for these deferred project costs was $1.9 million. GAAP gross margin was 64%, the same as in the prior quarter. Total GAAP operating expenses, at $8 million, were flat with last quarter and approximately 33% of total revenues, up slightly from last quarter.

R&D expenses totaled $3.3 million, compared to $3.6 million in the prior quarter. R&D expense as a percent of revenue was 14% in this quarter, compared to 13% in Q1.

Similar to cost of sales, the decrease in R&D expenses was primarily driven by lower accruals for performance-based compensation and vacation. SG&A expenses totaled $4.7 million, or 19% of total revenues, compared to $4.3 million, and 16% of total revenues, in the prior quarter.

The increase in SG&A expense was primarily due to significantly higher stock-based compensation expenses, related to the accelerated vesting of options for two departing board members. This was partially offset by lower accruals for performance-based compensation and vacation.

On a non-GAAP basis, looking at operating expenses and cost of sales together, total spending was $14.5 million, versus $16 million in the prior quarter. Non-GAAP total expenses were lower compared to Q1, primarily due to the previously mentioned decreases in accrued performance-based compensation and accrued vacation.

The GAAP income tax provision for the quarter was $3 million, which reflects an estimated tax provision rate in the quarter of 39.2%. Of the $3 million, approximately $1.2 million represented cash tax liabilities. This represents an effective cash tax rate for the quarter of 15%.

Our cash tax liability decreased from the prior quarter by approximately $400,000, primarily due to lower foreign withholding taxes in the quarter. For the full year of 2014, we expect the GAAP tax rate to be the range of 37% to 39%, and the cash tax rate to be the range of 16% to 18%.

GAAP net income of $4.7 million in the quarter resulted in a GAAP EPS of $0.15 per fully diluted quarter, compared to $6.3 million, or $0.20, in the prior quarter. On a non-GAAP basis, net income was $9 million and non-GAAP EPS was $0.28 for the quarter, compared to $9.5 million and $0.30, respectively.

EBITDAR, which I defined earlier, and is also defined in our press release, was $10.6 million as compared to $11.5 million for the prior quarter. EBITDAR per fully diluted share was $0.33, compared to $0.36 in Q1.

Total cash at the end of the quarter was $106.9 million, an increase of $5.9 million when compared to March 31. This increase was driven by strong accounts receivable collections, and proceeds from stock option exercises, partially offset by stock repurchases and purchases of fixed assets, primarily for our proprietary testers. Cash from operations during the quarter was $6.3 million.

During the quarter, the Company repurchased approximately 24,000 shares of our common stock under our board-approved stock repurchase program for a total of $437,000 at an average price of $18.11 per share. There was also a $2.2 million cash impact for shares that were repurchased at the end of Q1 but did not settle until Q2.

Trade accounts receivable DSO was 76 days for the quarter, the same as in the previous quarter. Trade accounts receivable balance at the end of the quarter was $20.5 million, a decrease of $2 million. The unbilled accounts receivable balance was $10.2 million, an increase of $242,000 over the prior quarter.

Of the $30.7 million in total receivables, $746,000, or less than 3%, was more than 60 days past due. The majority of this past-due amount is related to normal delays caused by remittance restrictions of the Chinese government. Total DSO for the quarter, including unbilled receivables, was 114 days, compared to 109 days in the prior quarter.

Headcount at the end of Q2 was 362 worldwide, which was flat when compared to Q1. Although revenue results for the quarter were adversely impacted by timing delays on contract execution, as we have stated previously, we will not compromise the integrity of long-term contracts in an effort to achieve quarterly revenue results. We are pleased with the continued growth in our cash and the results of our cost management activities.

This quarter demonstrated the effectiveness of our performance-based business model, which allowed us to substantially offset the impact of the delayed revenues on profitability during the quarter.

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)

John [Pennewick].

Can you provide some more detail on the relative size of the two contracts that got pushed out?

We can't disclose the detail but if you look at the deferred costs and our normal margins you can get kind of to an estimated size.

Do you still expect the solutions business to be kind of that single digit growth over a four-quarter rolling basis that you mentioned last call?

Yes, that still remains our full-year expectation.

Just a little more clarity on the transitions that have occurred with Samsung and Apple. What can we expect over the next three or four quarters in terms of Gainshare impact? And do you expect other customers, other foundries, to back fill that capacity?

We can never talk about specific customers and their end customers just due to confidentiality agreements that we sign. I think this quarter was indicative of one customer's volumes going down at 28 and others picking up volume, and muting out some of the impact of that transition, that particular customer.

As I said in my prepared remarks, we know that there is a lot of jockeying between the individual big consumers of silicon and the producers of silicon. And we expect that to continue back and forth for the next couple of years.

And in terms of that next couple of years, what do see past the 20 nanometer node, especially at 14, how confident are you that your customers can gain share in that node?

I think if you look at the comments that TSMC made about the node transitions, I think they were very vocal about their share being eroded in 2015 time frame, they think they're going to come back with share in 2016. Our customers are the beneficiaries of that share degradation, so I think that they're probably a better indicator of how share shifts and what they say, because they obviously track this very closely too.

Tom Diffely.

First, John, maybe give us a little but more on the software business that you're starting to do more of now. The software contract -- customer types you are attracting and what the long-term possibilities are for the business?

We have had, over the years, a yield management system that was primarily based on dataPOWER and FTC solutions. We integrated those into -- pretty much built them from the ground up, again, in 2009-2010 timeframe, started releasing it in 2011 and 2012, a package we called Exensio. We started with some customers outside of logic image sensor was one of the first customers, and we've been going out systematically to logic customers and now non-logic customers, and demonstrating the capability, the ability to use these types of systems to drive variability. They are systems that allow for big data, and in other words, non-relational databases as well as relational database information in them.

We believe that this is an important part of process control for anything that's electrically -- sensitive to electrical behavior, logical parametric behavior, hence analog image sensor, even advanced logic is becoming greatly electrically controlled. And the business models -- in this case it was a part of a solution, it was a TBL, so the revenue impact in the quarter was pretty de minimis, if anything. But over time it provides a nice piece of business for us.

And when you look at the next few years, is there a benefit to merging the electrical data that you provide with optical or e-beam data that other people provide? (Multiple speakers) between the two?

Yes, when you try to look at things in line, the modes that people have to provide are becoming very sophisticated. The ability to see a defect is very difficult. You are using pretty advanced signal processing algorithms after you shine the laser on the wafer at some point.

So you need to know what's electrically really a short or an open, or how it behaves electrically because that ultimately is that affects circuit behavior. So, really, most of the customers that use our characterization vehicle and collect electrical data, one of their key applications is to calibrate and correlate that with their inspection data to get an inspection recipe that will let them see them what they see electrically.

Almost all of our customers use our vehicles to tune their inspection systems. And going forward, we see more and more applications of combining CVs, or characterization vehicles, with inspection. It's been a big part of our R&D over the last year and we expect to be a growing part of the value we can bring our customers.

And then when you look at the big expected ramp here of 14 nanometer FinFET over the next couple years, and every time I go to a new node there's a lot of challenges, but it seems like people are talking more about how these challenges may be a little tougher than we've seen in the last couple of node transitions. That being said, do you think that there is potential risk that perhaps your Gainshare portion gets pushed out as yields take a little longer to achieve in this node versus previous nodes?

We always build models based on when we expect the industry to achieve each of its targets. If you look at the 20 nanometer node, just based on where we expect customers to be, they're about on our schedule. Our schedule that we build internally is probably a little bit more conservative than what the foundries go out and communicate.

We are tracking the FinFET nodes pretty closely. They are about on the schedule that we expected them to be on, which again, as I said, would be probably further behind where we expect the customers to be. We, as we have said many times we expect 2014 to be a 28 nanometer volume year for us, it has been so far this year and we expect it to continue to be.

2015 will be a 20 nanometer node in terms of Gainshare production as well as 28. And we expect, really, FinFET production to impact Gainshare most materially in the 2016 timeframe, and we still have that expectation at the tail end of 2015 and mostly 2016.

So would you also expect further growth in 28 in 2015 as well in addition to the new emerging growth of 20?

We do expect volumes to grow in 28 over the next couple of years, we are watching closely how pricing on a wafer -- how wafer pricing goes as 28 matures. So far pricing has been pretty reasonable. We don't know how it's going to change over time.

And then do you expect any seasonality in the Gainshare part of the business on a go-forward basis? As you get more exposed to a couple of large customers, does that impact how normal seasonality typically reacts?

We had expected, as we said back in February or January that we expected the first half of the year to be weaker and the second half of the year to improve. As I said in my prepared remarks, actually, the first half of the year was better than what we had modeled. So it's been less seasonal than we expected it to be.

We have not really changed our estimates for the second half of the year in our own modeling. So if that were to hold up it would be less seasonal than we had expected. In general, 28 nanometer is broadening out in terms of the number of customers that are consuming that node. And as a result, it is seemingly becoming more flat.

Do you feel like customers typically add capacity in the first half of the year? Or is it really just when the yields get to certain levels and just so happens it was first half floated this year?

I don't know that we have real insight on that one.

I'm just curious if your seasonality is based on actual when your customers produce chips, or just some other dynamics as far as node transitions and when you would (multiple speakers) yields.

It's pretty much when they ship wafers.

Greg, you are starting to build a pretty nice cash balance here, I'm curious what you think the necessary level of working capital is and what some plans are beyond that.

Yes, you know, we talk about this with most of the investors and we certainly talk about it with the management team and the Board. I think not much has really changed in our view of the cash position even though we are building.

We do have a Board-approved shareholder repurchase plan. We will go execute it against that to the extent that we can, given the volume restrictions and market opportunities. But our full goal there is to try to offset to the greatest extent possible the dilutive effects of our employee compensation programs.

Beyond that, we are still evaluating potential uses for our cash and any parts of our balance sheet as we move into some more investment phases around long-term R&D. So we're looking at potential licensing, all the way to potential acquisitions although we don't really have any specific acquisitions on the table at this point in time. But those types of things get reviewed all the time.

We have been approached by multiple investors on potentially looking at other ways to return cash to investors and we do evaluate that. So these are activities that get talked about at every Board meeting. But at this point in time, we have not launched any specific activity, other than the stock repurchase program.

Do you foresee any kind of bump in either capital spending or people investment over the next few quarters or year that would require a little extra money?

We have been working on some things in the last four or five quarters that may result in an increase in capital spending on some new types of hardware and the impact that would have on our customers' ability to control their line. So we have nothing that we could communicate in terms of what it would be and it seems to be relatively modest right now. But that's one of the avenues that we are looking at, and in the end it is ways of growing the value that we can bring our customers and hence the residual value of Gainshare in the contracts.

And then finally, Greg, when you look at the model and you -- there are times when you have to push out revenue a quarter or two based on timing of contracts, does that have any impact at all on the model itself? Are there any inefficiencies that are more time-sensitive? Or you need -- well, the end of the year, would that model be the same with or without those pushouts?

Yes, that is our sense right now is that this really is just timing. Now what will be interesting as we -- assuming these contracts go into place and we get caught up there, going forward, I think that all of the customers are going to be under pressure, particularly at 14 and some of the 10s to push schedules.

So we may see some of the workloads get more front-end loaded than the original estimates of the contract. So that may push revenue a little more forward. But overall, no, we have not really changed our expectations on a full-year basis at all.

(Operator instructions)

Steve Baughman.

Greg, I just wonder if we can return to this deferred contract cost, I want to make sure got the numbers right. Can you just walk us through again, or walk me through again, what the deferral was, what the total amount was?

Yes, what we said was our total deferred project cost on the balance sheet at the end of the quarter was $1.9 million. The vast majority of that is related to the two specific engagements I talked about.

And so it sounds like if we just take the normal gross margin on service engagements of, call it low 30s or mid-30s, then that sort of implies that there was roughly $3 million of revenue that was deferred in the quarter?

Actually if you look at the margins it's probably higher than that, but you have got to model that for yourself.

I guess the next question would be, just, you obviously talked about what you guys are doing with the cash. I think you were little bit more aggressive last quarter in buying back stock, am I remembering correctly and can you remind me where you bought stock back last quarter?

Yes, we bought back stock last quarter, and I don't remember the number of shares, I would have to get back to you on that. But yes, it was larger buybacks at slightly higher prices. Hang on one second I've got it right here. So 170,000 shares last quarter, approximately.

So it's opportunistic, we look at the market, we look at what's going on in the trading, we look at the short interest. We look at all those things, and basically it is at John's discretion with my advice as to when we go into the marketplace. And we also have to be careful not to trade over the top of any of our Board members or things like that. So when we have windows we will go forward if we think it's at the right time.

The last question, and John, this comes up all the time, and I'm going to ask you to go through it again. You frequently made reference to your guys' growth relative to the overall growth of the logic industry, and it sounds like you still think you can outgrow the logic industry in 2014. What kind of bogey are you using for the overall industry when you make that comment?

Bogey, can you define what you mean by bogey?

Just hurdle rate, what are you saying that the overall industry is growing at?

I guess that's a golf -- anyway, I think we believe that the logic business is low to mid -- I think that the logic business is in the mid to upper single digit numbers. We believe that means we will outgrow that. That means we expect to be in the double-digit growth rates. How much above that depends a little bit on our customers' volumes.

And obviously I know that your math skills are far superior to mine so you fully understand that that implies that you have a really big sequential growth in the second half, at least from where you guys were the second quarter.

That's correct.

Andrew Weiner.

I just wanted to clarify a couple of things. Following up on the prior question there. When you talk about outgrowing logic industry, we are talking about total company revenues, correct?

Yes.

And Greg, when you earlier said, and I just want to be clear, that the expectation was that solutions for the full year would still grow based on current expectations?

Yes, in the low single digits.

Which, just doing the math, would require averaging around $17 million quarters in solutions. You did 61 last year and you did 28 year to date. So you would need at least 33.7 just to break even in the back half of the year.

Correct.

The other question, John, I wanted to clarify is you said that the Gainshare exceeded your expectations for the first half of the year. But you haven't seen anything that has made you change your expectation for the back half of the year. Did I hear that correctly?

That's correct.

So if I looked at the year as a whole on a Gainshare perspective, if the back half were to play out as you see it today, it would be, as a whole, ahead of what you would expect it coming into the year.

Correct.

And my last question, I guess I was hoping to get an update on some of the advanced R&D you were doing in process controls, sort of where that stood and how you're thinking about it from a potential timeline for commercialization.

Yes, Andrew, we do expect to make more meaningful communications about that in the second half of the year. We just didn't feel we were ready to do that in this call.

(Operator instructions)

And there are no more questions in queue.

Okay. With that we will conclude the call. Thank you, everyone.

Thank you. This does conclude today's conference call. We ask that you now disconnect.