PDF Solutions Inc (PDFS) 2016 Q3 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 third fiscal quarter ended Thursday, September 30, 2016.

(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 factors on page 12 through 19 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2015, 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 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 more detail on our business activity in the quarter. Next, I will provide an update on our design for inspection. Finally, I will turn the call over to Greg, who will walk you through the financial results in detail. We will then take your questions.

We had a strong recovery in our gain-share revenue in Q3. Gain-share revenue was $8.7 million, an increase of 42% when compared to Q2 2016. Both 14-nanometer and 28-nanometer nodes drove the increased gain-share revenue in the quarter.

28-nanometer volumes increased in most of our customers' fabs. We experienced increased 14-nanometer volume at existing 14-nanometer customer, and our second 14-nanometer customer started to generate gain share. We expect 14-nanometer wafer volumes and, accordingly, gain-share revenue tied to them to continue to grow through 2017.

Solutions revenue was $18.6 million, a decrease of 10% over the prior quarter's strong results. Solutions revenue in Q3 increased 8% year over year, and we are now on track for solutions revenue growth rate to be in the upper teens this year.

I will provide more details on our business activity in a minute.

From an overall spending standpoint, during the quarter expenses increased primarily due to an increase in costs related to the deployment of our DFI systems, higher subcontracting and consulting costs, and the timing of accounting fees in the quarter.

Now, turning to our solutions business in detail, we are continuing to expand our customer base into new markets and customers. In our integrated yield ramp solutions, we are seeing strong interest at the 28-, 14-, 10- and 7-nanometer nodes.

In addition, activity remains high -- at a high level in China as we work with a number of new and existing customers. Exensio business continues to grow and facilitate our strategy of extending our customer base across the supply chain.

Select deals closed in the quarter include an extension trade 28-nanometer yield ramp engagement with a leading IDM, a 10-nanometer DFM engagement with a leading Chinese fabless center [country] company, an Exensio yield deployment at our foundry to complement their earlier deployment of Exensio-Control, and Exensio yield deployment at a large system company and an FDC deployment at a new fab at an existing foundry customer.

A few years ago, the majority of PDF Solutions contracts in the quarter would be concentrated with a handful of companies tied primarily to the bring-up of new leading-edge nodes and fabs and the large fabless customers that use those nodes.

PDF's business was the leading knife edge of the chip industry, with a business model that tied our business success to the customers' manufacturing volumes and success over many years. Hence, our bookings would often track with the capital equipment deployment, but revenue would be far more ratable.

Contracts signed this quarter demonstrate that while we continue to participate in the leading edge -- take, for example, the 10-nanometer DFM engagement -- with Exensio and in the future, we hope, with design-for-inspection, we are delivering solutions that allow fabs, OSATs, fabless and system companies to optimize their manufacturing over the life of production.

Many of the Exensio deployments this quarter were for companies who have no interest or use of leading-edge processes. We are very excited about the market acceptance of our new solutions in the customer base.

Finally, each quarter I provide an update about our design-for-inspection solution, referred to as DFI. As a reminder, design-for-inspection solves the ever-increasing challenge of inspecting production chips for electrical defects. Conventional inspection allows semiconductor companies to see visual differences in the patterns on a chip. However, many electrical faults are not visually detectable anymore.

PDF Solutions' DFI technology is designed to change the paradigm for inspection by placing small, proprietary characterization vehicle test structures on-chip in a product design.

In the third quarter, PDF Solutions' second eProbe Measurement system was installed and running at our second customer. The tool was generating useful measurements for their research and development efforts in less than two weeks from the completion of the installation.

Today, we are working with our lead customers to demonstrate that DFI can improve their detection and control of electrical defects. Our early successes at our customers' facilities are validating our belief in the necessity of bringing electrical characterization into the fab from the lab as device structures become smaller and more three-dimensional.

For DFI, it is also critical to develop on-chip CD instruments that work with the design -- and work with the design community to deploy these CV instruments inside the fabless company's chips. During the quarter, six additional products and test chips taped out with DFI included in the design. We now have over 50 products and test chips taped out with DFI. We are pleased with the continued interest we see from the fabless community.

We have also filed more than 50 patent applications to date that cover various aspects of DFI, and we are already starting to receive the first allowances.

Development activities for our second-generation DFI system, the eProbe 250, continue to drive our R&D spending.

Before I turn the call over to Greg, I would like to mention our upcoming analyst meeting in New York on November 1. We are looking forward to seeing many of you there and providing additional insight into the PDF Solutions.

As I mentioned earlier in these prepared remarks, over the last couple of years our business has evolved significantly as we moved from participation primarily on the leading edge at the foundry fabless interface to more broadly across many nodes further down the supply chain to the OSATs, and to the system companies who are more and more developing their own chips.

We are excited to share with our stockholders our perspective on our business' evolution and always enjoy the opportunity to learn from you as well.

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 also their related tax affects 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 turn to a review of the financial results. Total GAAP revenues for the quarter were $27.3 million, resulting in GAAP net income of $1.9 million and GAAP EPS of $0.06 per fully diluted share. Non-GAAP net income was $5.4 million and $0.17 per fully diluted share. Cost of sales and operating expenses together were $24.1 million on a GAAP basis and $20.9 million on a non-GAAP basis.

Looking at revenue details, as stated earlier, GAAP revenues for the quarter were $27.3 million. This was higher than the previous quarter by approximately $600,000. Revenues were comprised of design-to-silicon-yield solutions, or solutions revenue, of $18.6 million and gain-share performance incentive, or gain-share revenues, of $8.7 million.

Our top 10 customers represented 84% of total revenues in the current quarter. Two of these customers contributed revenues of 10% or greater for a total of 50%, as compared to two customers and 52% in the prior quarter.

Looking at solutions revenue in more detail, 18 fixed-fee engagements contributed at least $100,000 of solutions revenue in the quarter, three more than in the previous quarter. Q3 solutions revenue was $18.6 million, including for the first time a significant contribution from standalone DFI. Q3 solutions revenue was $2 million lower than in the previous quarter. Q2 solutions revenue, as you may recall, was positively impacted by a catch-up percentage of completion revenue [issue] recognized on a single contract.

Gain-share revenue for the quarter was $8.7 million, an increase of approximately $2.2 million over the prior quarter. The total number of node sites, which we define as an individual fab and process node combination, contributing to gain share was 16, up by three over the previous quarter, which also included the addition of 14-nanometer gain share from a second foundry.

Also during the quarter, we saw a significant increase in volume at the 28-nanometer node across multiple existing customers.

On a geographic basis, North America accounted for 32% of total revenues, which is down 4% from the previous quarter. Europe accounted for 24% of total revenues, an increase of 3% from the prior quarter. And Asia accounted for the remaining 44% of total revenues, an increase of 1% over prior quarter.

Moving to expenses, cost of sales for the quarter was $11.5 million on a GAAP basis, which was approximately $800,000 higher than the previous quarter. This increase in GAAP cost of sales was primarily driven by higher stock-based compensation expense, larger deferrals of project costs in Q2 versus Q3, increased depreciation expense due to the deployment of eProbe 150 systems and our electrical testers, and also higher compensation expenses in the quarter.

GAAP gross margin was 58%, as compared to 60% in the previous quarter. On a non-GAAP basis, cost of sales was $10.2 million, which was approximately $600,000 higher than the previous quarter. This increase in non-GAAP cost of sales was driven by the same factors as in GAAP cost of sales, with the exception of the higher stock-based compensation expense.

Non-GAAP gross margin was 63% in the quarter, down from 64% in the prior quarter.

Total GAAP operating expenses at $12.7 million were approximately $400,000 higher than last quarter and 46% of total revenues. This is the same as last quarter. R&D expenses totaled $7 million, the same as the previous quarter. R&D expense as a percent of revenue was 26% in the quarter, 1% lower than the prior quarter.

SG&A expenses totaled $5.7 million, or 21% of total revenues, compared to $5.2 million, or 20% of total revenues, in the prior quarter.

The overall GAAP operating expense increase was primarily driven by the timing of annual audit fees in the quarter and third-party consulting expenses.

On a non-GAAP basis, looking at operating expense and cost of sales together, total spending was $20.9 million, which was approximately $500,000 higher when compared to the prior quarter. As previously mentioned, this increase was primarily driven by higher subcontracting and consulting costs, lower deferral of project costs in Q3 than in Q2, an increase in depreciation due to the deployment of our eProbe 150 systems and our electrical testers.

The GAAP income tax provision for the quarter was $1.1 million, which reflects an effective tax rate of 38% compared to 40% in the prior quarter. This rate decrease is primarily due to the recognition in the quarter of a deferred tax benefit. Cash tax liabilities for the quarter were approximately $800,000. This represents an effective cash tax rate of 27% of pretax GAAP income.

Our cash taxes continue to be primarily comprised of foreign withholding taxes at this point in time. As I stated on the last call, the SEC has been clarifying its guidance in respect to non-GAAP earnings. At this point in time, we are still working with our external tax advisors on the impact of these clarifications on our financial reporting. I do not anticipate any reporting methodology changes for the remainder of this year.

GAAP net income of $1.9 million for the quarter resulted in GAAP EPS of $0.06 per fully diluted share, compared to $2.2 million and $0.07 per share in the prior quarter.

EBITDAR, which I defined earlier, is -- and is also defined in our press release, was $7.2 million in the quarter as compared to $7.1 million in Q2.

On a non-GAAP basis, net income was $5.4 million and non-GAAP EPS was $0.17 for the quarter, compared to $5.3 million and also $0.17 in the prior quarter.

Total cash at the end of the quarter was $118.5 million. This represents a decrease of $3.7 million when compared to our cash balance at the end of last quarter. Cash used in operations for the quarter was $1.2 million. The cash impact of fixed-asset purchases during the quarter was $3.8 million. These were primarily related to our DFI programs.

The Company also repurchased about $339,000 worth, or 20,000 shares, of stock during the quarter related to our Board-approved stock repurchase program. Additionally, the Company repurchased $86,000 worth of shares related to employee tax liabilities on RSU grants.

Trade accounts receivable, DSO was 85 days for the quarter, compared to 66 days in the previous quarter. The trade accounts receivable balance at the end of the quarter was $25.5 million, representing an increase of approximately $6.2 million from the previous quarter. This increase in trade accounts receivable was due to the increase in gain-share revenue during the quarter and the timing of new billings for fixed-fee projects.

The unbilled accounts receivable balance, including long-term, was $26.2 million, an increase of approximately $2.8 million over the prior quarter. This increase in unbilled receivables was primarily driven once again by timings of billings on percentage-of-completion revenue contracts and was spread across a large portion of our customer base.

Of the $51.7 million of total current and long-term receivables, approximately $1.9 million, or 4%, was aged greater than 30 days, as compared to $2.6 million, or 6%, in the prior quarter. Since the end of the quarter, $2 million of these receivables have been collected. Total DSO for the quarter, including unbilled receivables, was 173 days compared to 146 days in the prior quarter.

Headcount at the end of the quarter was 433, compared to 412 at the end of last quarter, with most of the increases taking place in Asia.

Now let's discuss the remainder of 2016. As we previously stated, we have been very cautious with regards to 28-nanometer volumes for this year. Given the sequential increases in 28-nanometer volumes we saw during Q2 and Q3, as well as the expansion of capacity at new 28-nanometer customers, we are more confident in our earlier expectation that second-half 28-nanometer volumes would exceed the first half.

We also saw our second 14-nanometer customers start to contribute to our total gain-share revenue. However, we still expect total gain share for the year to be down as compared to 2015.

With respect to solutions revenue for 2016, due to the incremental strength in our solutions bookings as well as upside in DFI, we expect solutions revenue to grow in the upper-teens range for the year versus our prior estimate of mid-teens growth. Therefore, our overall revenue outlook is to outpace the logic semiconductor market and to grow at a rate in the higher single digits for the year.

In regards to spending, as John stated earlier, growing demand for our eProbe 150 systems and accelerating development on our eProbe 250 systems are requiring increased investment levels in R&D and cost of sales both from an expense and a cash standpoint.

We would expect non-GAAP R&D expense to grow by approximately $300,000 during the quarter, and this is in line with our prior guidance.

Finally, as we have previously stated, we expect our capital spending to increase by $10 million for the year, and this was driven by investments in our DFI solutions.

In summary, we have seen a greater diversification in our customer base during the year, both in the number of customers and the geographic distribution of those customers. This diversification has principally been driven by our expansion in new growth markets such as China and the introduction of new technologies such as the Exensio platform for big data and our DFI solutions.

These new technologies expand our customer base across the semiconductor supply chain and extend our market position beyond advanced node introduction into the entire node lifecycles. This progress is the result of investments the Company has made over the last several years. These investments are consistent with the Company's business model of selectively investing in products and solutions to address future needs of the industries.

Our unique position in the industry and insights gained from our electrical characterization data allow us to make these selections in a very effective and efficient manner.

You will hear much more about this business approach during our analyst day presentations on November 1. If you are unable to attend, the presentations will be webcast and available on the investor relations page on our website.

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

(Operator Instructions). Jon Tanwanteng, CJS Securities.

Can you walk through the flow-through to PDF from the new wafer supply agreement between Global and AMD, what that specifically means for gain share?

The wafer supply agreement with Global and AMD, I think, has a couple of points. One, there is a commitment in terms of what they're going to purchase next year. Some of that is opaque to us and factored out of that document. And, of course, since the primary AMD production is 28-nanometer and 14-nanometer, those are wafers that whenever -- when that has materialized, that will become more transparent to us.

We expect that, given AMD's success in the marketplace on their more recent products, that their volumes overall and at GlobalFoundries specifically will be up substantially over their 2016 levels.

Second, they made mention to AMD's interest in 7-nanometer, I think, on the press announcement or in the actual WSA. I can't remember which one it was. And we see that as another positive sign that fundamentally that partnership will continue on to 7-nanometer. And AMD is probably -- the potential of being a significant customer of GlobalFoundries at 7-nanometer as well.

Great. That's helpful. And given the strong early response and the deliveries you have done so far, can you tell us about how the market for the gen-one DFI machine is shaping up? Heading into 2017, what you think demand may look like from other foundries through the year?

That's another great question, John. We are working that out right now. We believe that -- as we have done a number of tapeouts that the application that the generation-one machine goes after, which is really electrical characterization primarily on the test chip or test chips that run in the scribe line next to products. We have been able to see that customers find signals with the system, even though they're scanning a relatively small amount of the area on the wafer.

So, we are starting to believe there is an application here. We think that -- we don't know the exact size, but we think there is at least a handful of systems that we can put in place over the next year, and that would result in meaningful business for us.

In general, we think that when you look at -- we're going to talk next week at the analyst day. If you look at the overall inspection business, there is a meaningful amount of it that is going towards voltage contrast. We believe that [past] the voltage contrast in conjunction with the test vehicles is a more efficient way to get at a chunk of that market.

And, therefore, we think that DFI and the eProbe 150 could get at some part of what is the voltage contrast market today. And that market today is sizable, already bigger than PDF is today.

Okay, great. And just a progress update on the gen-two machines and the expected or earliest potential delivery date on that?

Yes, we're going to talk about that again also at analyst day. But we remain on track for completing that program and making deliveries in 2017.

Okay, great. And just maybe more high-level commentary. Earlier this year, we saw an e-beam inspection company bought for a fairly rich multiple by ASML. How should we think of the read-through to your business and what you're doing with DFI and how that technology is similar or actually better or how it differs from what was bought?

Sure. Yes, I think I am familiar with what you are referring to. Electron beams are used -- electron beam systems are used to do many types of measurements inside a fab. One of the measurements -- there is a SEM review; there is fine-feature scanning. One review -- one application is voltage contrast. That is the application that is the most similar to PDF's in that it gives you some kind of electrical information.

What we are doing that is different is putting something on the chip, some IP on the chip, that makes -- that you scan that specific IP. And since that IP is sensitive to a particular failure mode, you can get better resolution of the electrical signals. Customers that have gone back in, and after finding defects with DFI have gone back in, and nanoprobed or has gone and probed that direct structure, have found that you can see small leakages between neighboring lines that are very difficult to see in any other way.

We think, overall, this interest on the part of the customer base to have a voltage contrast or an electrical measurement is becoming more needed because of the use of 3-D structures in semiconductors. So, now when you scan at the surface, there is so much of the activity is below the surface. You really need to be able to look down. The only way to look down into the wafer is with electrical conduction.

So, we think that we and they speak to that general need in the marketplace. And we think that there is going to be a growing need as you have more use of 3-D production techniques in the chip manufacturing.

Got it. Thank you. We will see you guys at the analyst day.

Tom Diffely, D.A. Davidson.

I guess you talked a little bit about increasing the cost around DFI deployment. I am curious, though; it seems like you should also be showing a little bit of cost increase for all of your activities in China. Can you maybe just talk a little bit about what kind of leverage you get with your current set-up there and what kind of costs maybe have to be layered in eventually to serve that growing market?

Yes, when we look at China, we are trying to hold pretty much to the same margins we were looking at on a worldwide basis. These are primarily fixed-fee projects at this point in time with a wafer fee tail at the back end, very similar to what we have been doing in the rest of the world.

We think that upfront, initially, as we are shifting resources into these new contracts, the matching of revenue and cost might be a little bit negative, but not significantly. I think we have talked in the past about a 1% or 2% impact in any particular quarter. But, overall, once you are in these engagements for a while they will have margins that look pretty much like the rest of the world. So they will scale with solutions revenue.

So, you will see cost increases on the cost-of-goods-sold side, but it will be scaling with the solutions revenue.

Okay. And do you foresee having to hire more of the PC guys going in there to do the consulting evaluation?

It's good question, Tom. We have a relatively large office in Shanghai. We have had -- we had mentioned on one of our prior calls, in May of this past year we celebrated our 10th anniversary in China. And at our analyst day -- going to put a shameless plug in for the day -- we will have our head of our China operation give a presentation about our history in China and what we see in the China market and how we feel we are very well-positioned there.

We, every year in the summer, hire new people in China. It is usually on the order of about 15% of the staff. We did that this summer as well. We are now somewhere of 140 folks in China.

160.

160, I guess the number is. And that is maybe being only slightly modulated because of the activity in China. We serve our customers on a worldwide basis with our staff from around the world. And your specific comment around PhD's, we hire the smart people no matter where they are in the world, and we found that there are smart and creative people all over the world. And they serve our customers all over the world.

So, it's very likely one of our Chinese clients will work with an engineer who has got a PhD but is from a different part of the world.

Okay.

We always have people there who speak Mandarin and who work locally. But matching up a PhD and geography isn't something that we are smart enough to figure out. Okay? We just hire smart people wherever they are.

Okay. That's great. Because there are so many new potential customers there, I just thought that there tends to be a little bit bigger ramp. But it sounds like you are ahead of the curve there.

Yes, thank you. You are right: there is a lot of business activity there and a lot of hiring that goes on associated with that. But this is something we've been doing for 10 years. (multiple speakers).

Great. Then when you look at the new royalty streams coming in at the 14- and 20-nanometer, on the 14-nanometer side, your second customer, was there a bit of a catch-up revolving around that initial start of that royalty stream, or is that a steady-state?

No, I believe that was steady-state. That was just the quarter's production.

Correct.

Okay. And same thing on the new 20 side?

That's correct.

Yes.

Okay, great. Then, I guess the final question is when you look at the model in general, you have ramped up the DFI. Is that going to -- taking a step function higher when the 250 gets up and running just to seed the market?

Are you talking about revenues or expenses?

I'm sorry, on the cost side, yes.

I suspect we will have costs associated with our initial deployments on the 250s as well. And it's a bit early for us to guess or estimate how much different that will be than our 150 initial costs. So, hard for us to guess. It is always safe to guess it is going to be higher.

Okay.

You are only pleasantly surprised, right?

Okay, thank you.

Brian Freckmann, LS Capital.

Following up on Tom's question a little bit, as I look at numbers year over year for the last couple of years, 2015 over 2014, 2016 over 2015, the R&D number obviously steps out that we were in the teens and the 20s as a percent of sales and then 25%. I guess it went up $5 million last year. It is up about $6.5 million through nine months and going on the way to about $8 million.

Is there a way for you guys to characterize -- break that spend out for us so we can better understand it? And then maybe how we think about it going forward? Trying to figure out what components are what. And as you guys start to move to the 250, what is a steady-state run rate for R&D for 2017 and how should we think about that? If you can give us a little more clarity, that would be great.

Obviously you guys have -- it looks like you have taken about $0.17 to $0.18 of earnings and put it into R&D. And, so, just trying to think about how we can recover that or what it should look like next year.

Yes, that's a tricky question right now. I think that when you look at the two programs, while we are deploying 150s in the field at this point in time, we still have R&D dollars being spent on that program as we are tweaking the configurations and the BOMs to get the most effective use. And, quite honestly, a lot of that is built on feedback coming from the customers about what types of issues are their biggest worries.

So, we will continue to have some development expense on that, but that will actually start to flatten out and then wane away over time.

250 is still in a very aggressive buildup. We see that carrying on, continuing to probably grow through the end of 2017 when we start to move out of the lab and into actually deployments, at which point in time some of the expense will shift away from R&D to cost of sales. But at the same time, you will start to see revenues flowing in.

How big that is, we will be going through our planning exercises as we go through the next month to really get a handle on that. But you can expect that it will continue to increase throughout the year.

Okay, thanks. And just quick, I may have missed it, the concentration, Greg, I think you said that in your prepared remarks. What was the greater than -- the 10% customers? What was that this quarter?

Yes, it was two customers greater than 10%, and they represented 50% as compared to 52% last quarter.

Thank you. Thanks, guys.

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

All right. Thank you.