PDF Solutions Inc (PDFS) 2015 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 Tuesday, September 30, 2015.

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 the PDF 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 12 through 18 of PDF's annual report on Form 10-K for the fiscal year ending December 30, 2014, and similar disclosures in subsequent SEC filings.

The forward-looking statements and risks stated in this conference call are based on information available to PDF today. PDF assumes no obligation to update them.

Now I would like to introduce John Kibarian, PDF's President and Chief Executive Officer; and Greg Walker, PDF's Chief Financial Officer.

Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone. Today I will start our discussion with a brief summary of our third-quarter results. Then I will provide some perspective on the semiconductor environment and PDF Solutions' performance to its strategic directions. Next, turn the call over to Greg, who will walk you through the financial results in detail. We will then take your questions.

In Q3, we continued the strong bookings performance for our solutions business that we have seen in the prior quarters this year. Non-GAAP solutions revenue increased 25% during the quarter. This was driven by growth in our Exensio Big Data solution. Gainshare revenues, at $6.6 million, however, declined by 27% when compared to Q2. As we have stated before, Gainshare revenues are directly related to wafer production volumes shipped by our large customers. As a result, they can be highly volatile; and this year has been adversely affected by significant declines in volumes at the 28-nanometer node.

While utilizations declined at some factories more than others, it was evident across the majority of our foundry customers' base, and seems to be consistent with reported utilizations across the industry. While we continue to remain positive on 28-nanometer over the long-term, and eventually expect volumes to recover, until our customers can increase their utilization rates for their 28-nanometer production facilities, our Gainshare results will remain volatile.

Looking at other advanced nodes, our key customers made good progress on their 14-nanometer ramps. And we should start to recognize 14-nanometer Gainshare in Q4. This bodes well for good 14-nanometer Gainshare in 2016.

As you probably are aware, we manage our business based on our financial model that focuses on solution revenue alone for funding the lion's share of our expenses. Looking at solutions bookings and revenue, both for the quarter and the year, we are very pleased with the results. While Q3 bookings were very strong for our growing software business, we also saw solid bookings for our expanding solutions business in Asia. Additionally, much of this new business was booked across a variety of process nodes, ranging from advanced development work at 10 nanometer to mature nodes as large as 90-nanometer.

The major contracts signed in the quarter included: a new technology development engagement at the 10-nanometer node with an existing foundry customer; a new technology development engagement at the 28-nanometer node at a new foundry customer in Asia; a multi-element engagement that included Characterization Vehicle's and delivery of our Exensio Big Data solution for a more-than-more foundry in Japan; a new license of our Exensio-Control software for the next phase of fab expansion for a large foundry customer in Asia, targeted for future 10-nanometer production; additional new software license purchases and extensions of our Exensio Big Data solution at 13 customers; and software and support maintenance renewals at nine Exensio customers.

Last quarter, I pointed out three key trends in the semiconductor industry that are critical to PDF. These are: the proliferation of new derivative nodes driven by more-than-more applications of ICs; the shift of investment and development activity within the semiconductor industry in Asia, and specifically China; the technical and economic challenges of in-line process controls for leading edge processes, i.e., those at 16-nanometer and below.

I went on to state that adjusting the ramifications of these three trends would be the key focus of our overall business strategy, resource allocation, and investments for the foreseeable future. Everything that we have experienced during the last quarter is convincing us that we are on the right track. The types of engagements where we are seeing the highest value for both our customer and PDF are those engagements where combining our capabilities in big data, electrical characterization, and inline process control.

These multi-element transactions are being driven by customers having to deal with issues created by these key trends. The rapid expansion of investments in China's semiconductor market is accelerating the needs of these customers to address these trends quickly.

With the addition of Exensio-Test and Syntricity, we are extending our reach into the OSAT and test market. This allows us to more effectively address the needs of our fabless and IDM customers, and deliver on our promise of the virtual IDM.

Each quarter this year, I have provided an update about our design for inspection, sometimes referred to as DFI solution. As a reminder, design for inspection solves the ever-increasing challenge of inspecting production chips for electrical defects. Conventional inspection allows you to see a visual difference in patterns on a chip. However, many electrical faults are not visually inspectable, and things that appear to be visually different may not result in a chip failure.

Design for inspection changes the entire paradigm for inspection, by placing small on-chip instruments in the empty space in a product design. To read these on-chip inspectors, PDF Solutions has been developing a new machine which charges these inspectors and reads the electrical responses. A typical product wafer will have 5 billion to 10 billion of these instruments. Our Exensio Big Data analytics software can then identify the failing instruments and provide a yield signature for that wafer.

We have reached a number of significant milestones in the past quarter. First, we had another test chip tape-out with DFI instruments. Second, our lead fabless customer taped out two 14-nanometer complete product chips with DFI. Each has over 7 billion instruments per wafer. These were our first product -- full production chips. Third, we received wafers from two factories, one of which was at 10-nanometer, and successfully used our beta tool to read the instruments' electrical responses.

Over the next quarters, we look to increase our demonstration activity with fabs, as well as have more fabless customers include DFI on their test chips and product chips. We believe we are on track to start having business impact with DFI by the end of 2016, with the aim to expand the business in 2017.

In summary, our Q3 results and level of business activity confirm that we are continuing to drive the adoption of our solution at the leading-edge nodes while expanding into solutions for more mature nodes and derivatives, commonly referred to as more-than-more. Moreover, with our test solutions, we are expanding our value proposition to our fabless and IDM customers by addressing their controlled needs, based on and leveraging the process control platform we have built for foundries.

We had success in closing our business in Asia and, in particular, in China this past quarter. Finally, we are reaching significant technical and market milestones, with design for inspection as our fabless customers expand our deployment of on-chip instruments, and we demonstrate the capability of our systems to the market. In summary, we believe we have focused PDF Solutions on the opportunities and challenges in the industry that are significant and valuable.

Now I will turn the call over to Greg to 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 nonrecurring items, stock-based compensation expenses, and amortization of expenses related to acquire technology and other intangible assets 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 nonrecurring items, depreciation, amortization 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 investor section of our website located at PDF.com.

Now let's look at the financial results. Total GAAP revenues for the quarter were $23.9 million, resulting in GAAP net income of $1.5 million, and GAAP EPS of $0.05 per fully diluted share. Revenues on a non-GAAP basis totaled $24.4 million, with non-GAAP net income of $5.8 million or $0.18 per fully diluted share. Cost of sales and operating expenses together were $21.2 million on a GAAP basis, and $17.7 million on a non-GAAP basis, which represents an increase in non-GAAP spending of approximately $1 million over Q2.

Moving on to revenue details, as stated above, total GAAP revenues for the quarter were $23.9 million, which were reduced by approximately $500,000 of non-GAAP deferred license and services revenues related to the Syntricity acquisition. Total non-GAAP revenue of $24.4 million for the third quarter were $1.2 million higher than in Q2.

Total non-GAAP revenues were comprised of design-to-silicon-yield solutions or solutions revenue of $17.8 million, and Gainshare performance incentive or Gainshare revenues of $6.6 million.

Our top 10 customers represented 89% of total revenues in the current quarter. One of these customers contributed revenues greater than 10%, for a total of 60% as compared to two customers and 70% in the prior quarter.

Looking at solutions revenue in more detail, 14 project-based engagements contributed at least $100,000 of solutions revenue in the quarter, two more than in the previous quarter. Additionally, the total number of software customers increased during the quarter to 86 from 51 in Q2. Overall, solutions revenue, at $17.8 million, was $3.6 million higher than in the previous quarter. This quarter-over-quarter increase primarily reflects strong organic growth in our software business, plus the addition of software revenues from the acquisition of Syntricity during the quarter.

Gainshare revenue for the quarter was $6.6 million, a decrease of $2.4 million from the prior quarter. As John stated, this decrease was primarily driven by a decline in 28-nanometer volumes at several of our foundry customers. The total number of node sites -- which we define as individual fab and process node combinations -- contributing to Gainshare revenue in the quarter was 17, the same as in the prior quarter.

On a geographic basis, North America accounted for 54% of total revenues, which is up 5% over the prior quarter. Europe accounted for 26% of total revenues, a decrease of 6% from the prior quarter. And Asia accounted for the remaining 20% of total revenues, an increase of 1% over the prior quarter.

Moving to expenses, cost of sales for the quarter was $10.3 million on a GAAP basis, which was approximately $360,000 higher than in the previous quarter. This increase in GAAP cost of sales was driven by higher headcount as a result of the Syntricity acquisition; increased stock compensation expenses; and amortization of acquired intangibles from the Syntricity acquisition.

GAAP gross margin was 57%, the same as in the previous quarter. On a non-GAAP basis, cost of sales was $9.1 million, which was approximately $160,000 higher than the previous quarter. This increase in non-GAAP cost of sales was principally driven by the higher headcount due to the Syntricity acquisition.

Total GAAP operating expenses, at $10.9 million, were approximately $1.3 million higher than the last quarter, and approximately 46% of total revenues, which is 4% higher than last quarter. R&D expenses totaled $5.2 million, approximately $700,000 higher than the prior quarter. And R&D expense as a percent of revenue was 22% in this quarter, compared to 19% in Q2.

SG&A expenses totaled $5.7 million or 24% of total revenues compared to $5.2 million and 22% of total revenues in the prior quarter. Included in SG&A for Q3, on a GAAP basis, is approximately $670,000 of acquisition-related expenses. This overall GAAP operating expense increase was primarily driven by compensation expenses related to headcount increases in our R&D and sales and marketing organizations.

On a non-GAAP basis, looking at operating expenses and cost of sales together, total spending was $17.7 million versus $16.7 million in the prior quarter, an increase of $1 million. And as I stated earlier, this was principally due to compensation expense related to increased headcount.

The GAAP income tax provision for the quarter was $1.3 million, which reflects an effective tax rate of 46% compared to 42% in the prior quarter. This rate increase is due to the recognition of approximately $600,000 of nondeductible acquisition-related expenses, and the decrease in this quarter's actual pre-tax net income due to lower-than-expected revenue from Gainshare without a corresponding decrease in cash taxes. As we have stated before, our cash taxes are primarily comprised of foreign withholding taxes; and, therefore, did not reduce during the quarter. Overall, our full-year outlook for the GAAP income tax provision rates is projected to be in the 39% to 41% range.

Of the $1.3 million of tax provision in the quarter, approximately $1 million represents cash tax liabilities. This represents an effective cash tax rate for the quarter of 36% of pre-tax GAAP income. For the full year, we still expect cash tax rate to be in the range of 20% to 22%.

GAAP net income of $1.5 million for the quarter resulted in GAAP EPS of $0.05 per fully diluted share compared to $2.1 million and $0.07 in the prior quarter. This reduction in GAAP EPS and net income is related to the reduction in Gainshare revenues and the one-time costs incurred for the Syntricity acquisition.

EBITDAR, which I defined earlier, as also defined in our press release, was $7.4 million in the quarter as compared to $7.2 million in the prior quarter. EBITDAR per fully diluted share was $0.23 compared to $0.22 in Q2.

On a non-GAAP basis, net income was $5.8 million, and non-GAAP EPS was $0.18 for the quarter compared to $5.9 million and also $0.18 in the prior quarter. Total cash at the end of the quarter was $126.3 million, a decrease of $5.4 million when compared to cash at June 30.

Cash generated from operations during the quarter was $5.3 million. And approximately $500,000 of cash was received related to stock option exercises and ESPP shares during the quarter. This cash generation was offset by $5.2 million paid for the Syntricity acquisition, $4 million of stock repurchases, and $1.6 million of fixed-asset purchases mainly related to our tester programs and design for inspection initiatives.

As mentioned above, the Company repurchased approximately 317,000 shares of its common stock for $4 million. After these Q3 repurchases, up to $15.4 million remains available for use by the Company under its Board-approved stock repurchase program.

Trade accounts receivable DSO was 76 days for the quarter compared to 81 days in the previous quarter. Trade accounts receivable balance at the end of the quarter was $19.9 million, a decrease of approximately $800,000 from the previous quarter. The unbilled Accounts-Receivable balance was $12.6 million, an increase of approximately $900,000 over the prior quarter. Of the $32.5 million of total receivables outstanding, approximately $700,000 or 2% was more than 30 days past due. Since the end of the quarter, $1.7 million has been collected to date. Total DSO for the quarter, including unbilled receivables, was 124 days compared to 127 days in the prior quarter.

Headcount at the end of Q3 was 391 compared to 360 at the end of Q2. This headcount increase primarily reflects the impact of the Syntricity acquisition and hiring in the R&D organization.

In Q3, we continued to see strong solutions business activity on a worldwide basis. Much of this improvement is in sales of our Exensio Big Data solutions and continued new business in Asia. Overall, we remain positive regarding the solutions business for the remainder of the year.

In regards to Gainshare revenue, we expect 28-nanometer volumes to remain depressed for the rest of the year. As John indicated, the 14-nanometer ramp at our major customers is proceeding well, and we expect to see our first Gainshare revenues from this node in Q4.

Now we will turn the call back over to operator for Q&A.

(Operator Instructions). Jon Tanwanteng.

I just wanted to focus on the solutions revenue. Could you break out how much Syntricity added, and if you pulled in anything for future quarters at all? The numbers are pretty strong.

Yes. I think when we announced the Syntricity acquisition, and talked about it, we were saying we were expecting approximately $800,000 or so for the quarter in revenue, depending on the exact date of closure, because you only get a prorated portion of the quarter. And we were in that range.

Okay. And can we expect that degree of strength in solutions to continue as we head to the next quarter?

What I would say is for the full year, we expect the strength. Quarter-to-quarter variance is too hard to call, because we don't know where percentage of completion revenue is going to end up.

Okay. And then just from a higher perspective, is the strength of solutions indicative of more Gainshare strength down the line?

Obviously, that's the goal. Right? So we engage in these activities to drive Gainshare and future revenues on these accounts.

Okay, great. And on the Gainshare side, 20-nanometer obviously is not doing so great. Do you have any visibility as to when that may start to recover?

No. We went through this year expecting it to improve in the second half. And obviously with these Q3 results, it degraded from the first half to the second half; which I think the industry overall is starting to figure that out, as we go through the year. I think in the summer, it started becoming more evident.

We don't have great visibility about when it turns up, in part because the parts that drove volumes in 2014 will not be the parts that drive -- designs that drive volumes in 2016. I think a lot of the mobile communication devices in computing will move on to 14-, 16-nanometer in 2016. And that will be the next wave of parts that drive the volume in 28-nanometer. And that's harder to forecast when new designs hit success.

Okay, thanks. And then just on the 14-nanometer node, can you give us a little more color on the competitiveness of your customers' products in that arena? We have seen some media reports on just the way the Apple iPhone processors have been supplied, and the performances and thermal differences between them. How much of what you guys do is responsible for that difference in performance, or maybe what it didn't do for your customers?

Yes. So, of course, we've got to be careful about talking about any specific customer because they are under NDAs. But our vehicles do characterize parametric variability. We have seen parametric variability, as you go down in nodes, become a bigger and bigger and more important contributor to the overall performance and yield of the parts.

We have provided, as part of that, a design for manufacturability, a solution we call Templates. I expect later on this year, or early next year, to be talking a little bit about the success our customers have had on parametric variability that has employed a design for manufacturability solutions on these nodes, and have gotten phenomenal parametric behavior. But design has a big impact on parametric yields.

I don't know the specifics about that design. But mileage those typically vary when it comes to design elements. With our Template solution we have seen great results, but I imagine a design that uses more varying layout styles will see a lot more variability.

Okay. And maybe just a little bit more color on the dissolved partnership and what that means for your business.

So that's a great question, Jon. So earlier this past year, we acquired the assets of Salland, which had software products in the test area; very good products that had a lot of market share in the mixed-signal analog market. A lot of our existing customers for Exensio, previously, our data power customers, were Salland customers as well.

One of the things that we saw a right away with that product, like many small software companies, is they can't make the investment in the product that you need. They can do something really cool in code, and then they need to make sure it works on all the tester platforms.

Salland has -- because of its business with Qualcomm, Broadcom, most of the major fabless companies -- it has tester platforms that it uses to develop software programs for those customers. And we are working with Tessolve in first part to improve the software function on the existing customer platforms. And, secondarily, Tessolve has 800 engineers working with all the largest test and assembly houses around Southeast Asia, and has a bigger number of employees than we have, even. And we are working with them really to do sales channels for the OSATs in that part of the world, a part of the world that we don't typically have PDF folks today.

Have you seen any traction from that so far, or is it too early to say?

I think it's a little bit too early to say on the traction. We certainly have had joint customer meetings as a result of our engagements with them, and there definitely seems to be interest in our products. And in terms of the software, I think we do see big improvements. And our customers have told us they see a huge change with the Salland technology as part of PDF, and now Exensio-Test, than it was when it was a small independent company.

Okay, great. Thank you very much.

Tom Diffely, Davidson.

So just getting back to the Gainshare drop-off, how much of that do you believe is just the number of units going down, versus a transfer from 28 to 14 nanometers, and then the lag between when you get the royalties that 14?

It's a great question, Tom. We know some of the end customers that drove that decline. And at least, in one case, they are not really up on 14 yet. So we do believe it was truly an inventory correction for probably one of the bigger customers that contributed to that volume decline.

We know we have active activities on 14-nanometer, and we expect them to start driving volume in 14-nanometer as we get into 2016. But I don't think they were so much of it. The other big driver on the 14-16 node so far has been the application processors that go in the Galaxy and iPhone launches. That shift has already happened from 28-nanometer over a year ago. So we believe this is primarily around inventory and weakness in some of the fabless customers' products in a couple of the end markets.

Okay. And even though some of your customers' customers have these take-or-pay contracts, you don't see any kind of uptick in the fourth quarter from that?

Well, the take-or-pay, we think, has driven kind of a floor level of volume at at least one of our customers. And we believe that is providing some level of demand inside the factories. It's the more classic fabless customers who don't have those arrangements that buy wafers on demand, where we see the weakness.

Okay. And then if you look at the -- how to phrase this -- the Gainshare producing foundry capacity out there for you, has that gone up this year? Or how is the total capacity of your Gainshare potential?

That's a great question, Tom. So I think there's a couple things -- a lot of our foundry customers, their expansion in 14-nanometer or FinFET nodes is a new foundry capacity. So they build an entirely new shell. They may do some startup of 28-nanometer in that shell, but it quickly shifts onto the FinFET node, because the tooling set is designed to that.

The IBM types, or kind of the hybrid IBM foundry types -- sometimes they repurpose 28-nanometer capacity into advanced nodes. And we know that at least one of the technology leaders is doing that, right, where they are repurposing the capacity. When you repurpose the capacity, the unit volume tends to go down. In other words, factory that could produce 58,000 wafer starts at 28-nanometer will not produce 58,000 wafer starts at 14-nanometer, because the total number of processing steps goes up.

So I would say, for most of our customers, the newer nodes are greenfield capacity, with one particular exception. We believe that a lot of their new capacity at 14-nanometer has come at the expense of their 28.

Okay. So if the foundries all produce at full capacity, or were producing at full capacity today, would you have record royalty revenues?

Yes. If everything were full right now, we would be blowing the doors off.

Okay. Well, I'll look forward to that next year. So on the Syntricity acquisition, we talked about the $800,000 in the quarter. What is the average quarterly run rate?

Probably a little bit higher than the $800,000 is what we are taking over.

And then, Greg, when you look at the OpEx structure right now, post-acquisition, does that feel like a structure that's going to be roughly the same going forward?

I would say certainly within 5% to 10%, up or down, on the stand-alone Syntricity resources. When you look at the combined companies, we will be making additional investments. Hard to say whether, at that point in time, are we hiring new Syntricity or new PDFs. They are basically combined at this point in time.

Okay. And last, Greg, when you talked about -- I think it was $1.6 million for some test equipment, is that not totally part of R&D?

Depending on what stage the development on that hardware is, it can be either R&D or cost of sales. So if we have a completed design we are in production on, we are just building new equipment; like a new tester that is already in the field, that would go against cost of sales.

Okay. Would you expect to have a significant ramp in tester equipment expenses for the next few quarters, as you build up your DFI?

Yes. It will be referred to as something other than tester; but, yes, in the same line.

Okay. All right, thank you.

Brian Freckmann, LS Capital.

Greg, can you please repeat your commentary, if we are going to call it for the fourth quarter, in regards to design-to-silicon? I wasn't quite sure what you are insinuating as to the run rate from the third quarter.

For one thing, as you know, we don't really give our quarterly guidance or expectation. So we reiterated the fact we are expecting the full year to be strong. As far as what the next quarter will be, it's too hard to call an exact number, even within our range, because there's a lot of variability driven by the percentage of completion recognition, depending on how much work against our customers' timetables actually gets done.

So there's quite a bit of variance there. But overall, yes, we are three quarters into the year. We know what that is. And, overall, we feel good about the full-year number, which implicitly says, we feel reasonably good about the quarter. Will that be up or down from this quarter? There will be variance around that. Can't say.

Any way to even just give us a range of the variance, in your view? Is it 10%, 20%? This is certainly a benefit to the upside, a big number. And I think just trying to make sure fourth quarter is in line.

So what we have said before is we expected the year-over-your growth to be in the 5%t o 10% range, closer to the high end of that range. We would certainly reiterate that guidance. So that's a way to figure out kind of bottom end of the range.

Okay, okay. Okay, that's good. And then just in looking out at the Gainshare business, for trying to look at calling a bottom here -- which I think, John, it sounds like you are actually kind of positive on this quarter, versus last quarter. Assuming an equal number of 28-nanometer business, if we take into account 14-nanometer, is the expectation that Gainshare should be up in the fourth quarter, just kind of directionally?

Yes. So if 28 volumes do not erode further, then with 14-nanometer adders we should see an improvement in Gainshare. I think that's good; it's out of new capacity. But like we said, we are still -- 28 is murky to us right now. We are trying to keep -- we expected Q3 to be an improving 28-nanometer quarter when we got into Q1, and it turned out not to be.

So with that caveat, should 28 stay at the same level it's at right now, with 14 adders, we should see an improvement. If 28 erodes more, then it's going to eat into the gains that we are going to get off 14.

Okay, okay. And then did I hear this right, Greg, where you are saying your non-GAAP revenue was $24.4 million?

Correct.

Okay, okay. Non-GAAP revenue, okay. And then finally, is there any way to think about, if we bundle -- I know DFI is not for a little while -- but some of the, let's call it, newer initiatives, whether it's big data within the design of silicon business disaggregate to two, say, core legacy PDF and design-to-silicon. Help us understand what benefit -- and you guys have talked about these new initiatives for quite some time. I think some of us would like to begin to see, hey, this revenue generated a certain percent, potentially, of the design-to-silicon business. We are getting rewarded for things we have been investing in for the last few years. Any way to break that out?

It's hard to do, Brian, because if you look at, for example, the more-than-more foundry in Q3, it's an integration of CVs and the big data solution, right, and how much of it you attribute to each. What I think you can look at it as the growth in the solutions business is greatly due to the new technology. So if you look at year-over-year growth, it's mostly off the new products and new solutions that are making us more relevant to the mature nodes, to the fabless companies, to their test control problems, et cetera.

And you were right; there is really no revenue. In fact, all designed for inspection is right now is a drag on earnings, because we are making that investment now. So it's not contributing to the top line.

But the majority of the growth year-over-year is related to that, the new investments. And moreover, if you look at the capital equipment industry, it was really dependent on advanced nodes. Most of the capital equipment industry this year has seen not a lot of growth in selling new equipment. And typically our business has really -- the solutions part of the business has correlated with when capital goes into factories. And when the Gainshare has typically moved with the application of that capacity; typically, much after the capital equipment folks see their revenue from installing equipment.

And what has been interesting for us this year is our business on the solutions side has been going up strongly while the capital equipment business, which was really tied to the advanced nodes, has not in going up as strongly. And I think that really speaks to how we are decoupling the solutions business from the leading edge, really very -- some of it was about 10-nanometer this past quarter, but not the lion's share of it.

So I think that should give you comfort that the investments we are making are going in the right direction. But it's hard to peel it out. And frankly, when inside the company people want to -- how valuable is my product versus that product? My recommend to them is what's more valuable, your heart or your lungs? I don't see anyone living without a heart and a lungs, so we are not going to live as a company without a heart and a lung. So let's not talk about how much you get versus how much the other guy gets. That's my mother and apple pie little [spiel].

Okay, okay. And then finally, just on DFI, have you guys come to a conclusion on how you are going to be charging for that?

No, we are really not ready on that yet. But we are getting -- for the first time, we are starting to get measurements. And we are starting to see the kinds of problems that we can see for customers, and we are really excited about it. We are seeing subtle leakages that are typically very hard to see on inspection. A lot of our fabless customer friends says, detect the undetectable. And we really are seeing things that are undetectable on inspection. So it's really quite complementary to the inspection capacity that's out there. And I think it will be very valuable for customers. But how we price for it, we still don't know yet. We want to get more data.

Okay, okay, but you are -- sounds good. And then maybe since I don't (inaudible), the $4 million and buyback on a $15 million total, given what looks like a pretty strong 2016 for 14-nanometer, I'm curious what has been the rationale for $4 million versus, let's say, $10 million or at the level you guys are buying, what has been the rationale to do $4 million versus a much larger amount?

This is Greg. I think two things: one is, there's a limit on how much we can buy just based on the last 30-day average trading, and so forth. So that limits us somewhat. Two is, you don't want to go in where you are moving the market. So we are careful about that. And three is, really at the Board level there's still enough discussion going around about how aggressive to be on buybacks that we are taking a relatively cautious approach to how we do that.

Okay, thanks for the color. Appreciate it.

(Operator Instructions). Gus Richard, Northland.

Can you give me some color? What was software revenue in the quarter?

We don't separately disclose that. So part of that is due to the fact that a lot of the deals are combined. It gets very gray as to what's software versus what's IYR type of work. I think John was talking about one transaction where we got a combination of almost everything we do in the deal. So for that reason, we have not separately identified the software business. And at this point in time, we don't have a plan to.

Okay. Would it be fair to say that about, oh, I'd say, 20% of the revenue from design-to-silicon solutions was software? Is that a ballpark, and it's growing as a percent?

I hesitate to say whether that's ballpark or not because of the crossover between the two. Depending on what allocation methodology I use on some of these deals, I can come up with wildly different answers.

I think, Gus, to get at the question, I think the way you might want to think about it and the way, certainly, we think about it, the value of the software that's being delivered in the solution is a greater and greater percentage of the total business. And that is giving us efficiencies in that we are able to deliver more value to the customer without growing the field at all. In fact, our field -- the number of consultants or field folks in the organization has been around 70 folks. And it continues to be at that level.

Yet, as you look at the design-to-silicon-yield solutions revenue, it's up substantially over where it was, let's say, a few quarters ago on the same field expense. And we are trying to improve that.

What I really liked about the Syntricity business was they were delivering software as a service. Right? And so we want to find more ways to serve the customer, where we drive value to the customer that doesn't involve headcount. And I think that's what you are seeing in the numbers. But how to split back out is very hard to do. The Syntricity thing -- do you call that service? Do you call that software? Certainly it's software-enabled service.

Okay, I get it. And I think you announced two contracts, one for 10-nanometer design-to-silicon solutions with an Asian customer. Did you recognize revenue in the quarter from that contract, or is that to come?

I think that was from the foundry customer. We didn't say what part of the world it was from; and that, we did recognize revenue in the quarter. And the other was on control.

Okay. And I think you had also a 28-nanometer customer, I think you said, in China? (technical difficulty)

That was in China. We did recognize some revenue from that customer.

Okay, perfect. Thank you.

Andrew Wiener, Samjo Capital.

Good afternoon. Greg, first I just wanted to clarify something. The guidance on solutions for the year is 5% to 10% growth, and I think you said you are very comfortable with the high end of that. And that backs out the first-quarter contribution from the payment from the customer, from the contract issue from last year. Correct?

Correct.

Okay. Secondly, John, over the last couple of quarters -- this is a little bit of a follow-up to Tom's question earlier -- you've talked about your ability to get in with some customers in Asia, and particularly in China. Perhaps you can talk about how you see, over the next couple of years, that adding to the Gainshare potential for the Company?

Sure. Actually, in our prepared remarks, Andrew, we refer to it as Asia because right now the business we talked about the past quarter was for a company that was headquartered in China. But we also see a lot of our Taiwanese customers making expansions into China. So broadly, greater China -- we see a lot of activity. Foundry capacity is going in there, greatly at the 28-nanometer node initially. And we believe there are some R&D activity that we are seeing in FinFET nodes. We see that part of the market wanting to move very fast on buildout of capacity, and bring up, and a needing to get to worldwide competitive status quickly.

In that regard, I think we have a wonderful offering for them, because we have a proven infrastructure on these advanced nodes from development design for manufacturability to process control and production control. So we are -- we started out about a year ago making introductions. We did some pilots in the first part of this year. This contract we signed in Q3 is the first conversion of a pilot into a contract. And we anticipate others as we go through the remainder of this year, and into next year.

Our activity started first with the fabless entities, and we see good activity there. We believe that will be the way that China moves into the leading-edge nodes. We will start with the fabless and system companies -- or has started, I should say. And then it will also permeate to the foundries. And we believe PDF could be a very important bridge between those fabless and system companies and the foundries themselves.

When you look at their plan in aggregate -- and I realize this is not a forecast of your results, per se. But if you think about nodes and you think about wafers per month under contract, or something like that from a Gainshare perspective, if they were to execute against their stated plans, what does that do to the overall number of potential wafers that you are entitled to, you would potentially be entitled to Gainshare on, if you wanted to look out two or three years?

Yes. So of course you know they are stated is about 60% of what their funds are putting -- what the China government is investing is going into the [fine] manufacturing. And 40% goes into design, test and assembly. If you took the numbers that they are quoting, and they are gargantuan numbers, right, in the tens of billions of dollars, and put 60% of that into capacity and take all of these things that they are forecasting and to put it into volume, yes, then it would dwarf the amount of capacity that we have under contract today, should we then capture that business.

So I think you've got to take a -- certainly, we take a healthy dose of realism, right? And say, okay, we have to be careful about how excited we get about this. This is certainly the potential for a lot of capacity to go in there. And if they spend the money they say they are going to spend on capacity on the front end, primarily at 28 and below, it represents a tremendous opportunity for us, and an opportunity that would be as large or much larger than the factories that we have under contract today.

And when I think about your business model, are you generating enough solutions or design-to-silicon revenue at this point in China, where you are recouping your cost of capital there? Or are you still in the investment mode in China?

It's a great question, and one we asked ourselves earlier this week. And we haven't gotten the math done yet. We are just saying, okay, let's go back and look at what our investment has been on the pilots so far. And now that we're starting to sign contracts, how is this going to look over the next twelve quarters -- that we turn the corner, and we are still on invest mode? We got to China in 2006. Right? We made a decision to go to China in 2005. We got there in 2006. And we invested in and engineering team there. We now have 120 folks in China, almost -- I don't know what that works out to be. It used to be 33%, but slightly less than that of the company.

So we have been investing a very long time in China. So we are not impatient. At the same time, I think we are now starting to turn the corner. I don't think we are very -- we are not very many quarters away from that being a meaningful part of our business.

Also, as a follow-up, you referred to a foundry that's perhaps a hybrid IBM who was transitioning 28 to 14. From the standpoint of how we think about that as being a placement versus incremental, they have actually been running, I believe, at very low levels of utilization for a number of quarters now. So to the extent we start seeing 14-nanometer revenue from that customer, it's fair to say, versus our current rate, that it would be largely incremental?

That's correct.

Okay. The next question I had was, again, you historically have said that design-to-silicon pays the bills, and Gainshare is where the profitability comes in. However, to the extent that software is an increasing portion of the design-to-silicon revenue, and it's being sold not just to foundry customers but for foundry customers for which we have an integrated solutions contract and get Gainshare. But I believe it's also being sold to foundries where we don't have a Gainshare contract, as well as it's being sold pretty broadly now to fabless -- should we expect, over time, that the design to solutions business actually runs profitably and is incremental to the profits of Gainshare?

Well, you could have been in the meetings earlier this week, Andrew. Yes, it's actually something we are trying to model out. We've got two competing things there. Most of the business is ratable, so you make investment in the field. To see that business, you book a couple-million-dollar contract, and you see in that quarter maybe $100,000 to $200,000. So we are trying to -- in the field, as we we're doing the strategic planning, was reporting on where they saw the business opportunity around the world, in terms of Exensio Big Data. And it was quite a number of potential business, potential clients, the customers, on a variety of all of our geographies -- Asia, Europe, US.

And so we were trying to balance our investment levels to get at that business, versus the profitability we drive off that business, and understand a little bit about that trade-off. If you go to the steady-state, yes, our goal and our reason why we started making this investment is we want to drive profitability off design-to-silicon solutions business, irrespective of Gainshare. We want to get to a model eventually where that covers not just our expenses and our investments, but also drives profitability.

We are not there yet, obviously. And we don't know quite how long it's going to take us to get there. Because, as I said, we're balancing investment in the channel versus immediate return. And we are trying to understand that. But for sure, that is the reason why we made that investment.

And then my last question is, if I was trying to -- and then I will pass it on to the next person. If I wanted to try to figure out the profitability of classic PDF, including software, and break out the spend on design for inspection, which really is a new opportunity to which there's no revenue attributable today. What percentage of the operating expenses would you say is attributable to the DFI initiative?

I would certainly think it would be no more than 5%, at this stage, of our total spending, and probably in that range. Yes. That's as a percentage of revenue.

Yes, I thought that was a little bit more.

Yes, sorry. As a percentage of revenue, it would be no more than 5%, higher on total.

I think another way to look at it is the majority of the growth in the R&D line has been design for inspection. So if you compare 2014's spend level with 2015's spend level, the majority of that design for inspection, there was some design for inspection in our 2014 number. And there was even some in our 2013 number. There was some very, very early [are] in our 2012 number. But the majority of that growth has been design for inspection-related activity.

Thank you.

Mike Cotogno, Cardinal Capital.

Just one quick one -- on the Gainshare revenue, if we went back a year or so, my guess is that 28 was probably a nice slug of the composition of the Gainshare revenue. Right now in the current quarter, or the most recently reported quarter, obviously things have fallen off. Is it safe to say that 28 is less than 50%? Or can you give us a rough range of where you think that's playing out right now?

Gainshare is -- 28 is still the majority of the Gainshare revenues. But just the total amount has fallen.

Okay. Thanks.

At this time, there are no more questions.

Okay. Well, thank you very much for your attending the call today. We look forward to talking with you after the end of Q4. Have a great day.

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