PDF Solutions, Inc.
Q3 2007 Earnings Call Transcript

Published: 1 Nov 2007

[Operator:]

Good day, ladies and gentlemen, and welcome to the PDFSolutions Inc. conference call to discuss its fiscal results for the thirdfiscal quarter ended Sunday, September 30, 2007. (Operator Instructions) If youhave not yet received a copy of the corresponding press release, they have beenposted to PDF’s website at www.pdf.com. Some of the statements that will be made in the course ofthis conference are forward-looking, including statements regarding PDF’s future financial results and performance growth ratesand demand for its solutions. PDF’s actual results could differ materially. You should refer to the sectionentitled risk factors on pages 11 through 19 of PDF’s annual report on Form10-K for the fiscal year ended December 31, 2006 and similar disclosures insubsequent SEC filings. The forward-looking statements and risks stated in thisconference call are based on information available to PDF today. PDF assumes noobligation to update them. Now, I would like to introduce JohnKibarian, PDF’s President and Chief Executive Officer; and Keith Jones, PDF’sChief Financial Officer. Mr. Kibarian, please go ahead.

[John K. Kibarian:]

Thank you and welcome, everyone. For the third quarter of2007, PDF Solutions is reporting total revenue of $24.1 million and non-GAAPnet profit of $0.19 per share. Gain share was $6.8 million. All of theseresults are in or above the ranges we provided in July. Keith will talk more about these results and our guidancegoing forward in a few minutes. Let me start by sharing some highlights of the quarter.First, overall we had a strong bookings quarter for new and extendedengagement. We closed the full contract for the 45-nanometer yield aware FDC engagementwe announced as an LOA last quarter. Additionally, we closed four new engagements

[Keith A. Jones:]

Thank you, John and good afternoon to everyone. Let me againstate that this presentation and our press releases issued earlier todayinclude references to certain non-GAAP financial measures. The press releasescontain a reconciliation of such measures to the most directly comparable GAAPmeasures and you may access the press releases and reconciliations in theinvestor section of our website located at www.pdf.com. Revenue for the third quarter ending September 30, 2007,totaled a record $24.1 million, an increase of 24% and 2% when compared to thethird quarter of last year and last quarter respectively. These results werewithin the range we provided in July. Compared to the third quarter of 2006,improvement was the result of increases in both design-to-silicon and yieldsolutions and gain share. Compared to last quarter, the improvement was theresult of an increase in gain share more than offsetting a small decline indesign-to-silicon yield solutions. We are pleased that gain share was again at record levels,meaningfully over the guidance for the quarter as forecast for generally low customerproduction volumes plus adjusted upwards at the end of the quarter as wereceived final customer production data. Design-to-silicon yield solutions revenue totaled $17.3million for the third quarter, an increase of 50% from the comparable periodlast year and a decline of 3% from last quarter. Integrated solutions revenueincreased 46% from the comparable period last year and 2% from last quarter. Standalone software license sales continue to show weaknessand evidence of volatility, declining 75% and 46% from last year and lastquarter respectively. Standalone software sales will continue to be volatilebecause new engagements also include services utilizing design formanufacturability and intellectual property and process control software. As John discussed, bookings for the quarter were verystrong. We closed a full contract from our LOA from last quarter and closedfour new engagements with new and existing customers in both logic and memorymarkets. We also signed further extensions to earlier memory and yield awareFDC engagements and signed an evaluation agreement at 45-nanometers for a pdBrixengagement. During the third quarter, 14 integrated solution engagementsfrom 13 customers each contributed approximately $150,000 or greater inrevenue. This represented a net increase of one in the number of engagementsand an increase of two customers during the quarter. Gain share revenue for the third quarter totaled a record$6.8 million, a 55% increase versus the comparable period last year and a 16%increase from last quarter. Gain share revenue was generated from sevencustomers and 10 engagements, an increase in one engagement during the period. Gross margin for the third quarter of 2007, excludingstock-based compensation and amortization of core technology, was 68% of totalrevenue, an increase of 67% during the third quarter of 2006 and anas-forecasted decrease from 72% from last quarter. The increase from last year was a result of modestlyimproved service margins on integrated solutions, partially offset by a smalldecline in combined higher margin gain share and software sales. The declinefrom Q2 2007 was expected as a result from lower margins on integratedsolutions. Total operating expenses, excluding stock-based compensationexpense and the amortization of acquired intangible assets, were $13.6 millionfor the quarter, up approximately $3.2 million or 31% from the third quarter of2006, but down $413,000, or 3% from last quarter. The increase from last year was due to increases across allfunctional areas, primarily the result of our acquisition of SI Automation inOctober 2006 and Fabbrix in May of 2007, as well as the opening of our officein China in late July 2006. The decrease from last quarter is the result of loweroutside sales commissions and trade show costs, partially offset by the firstfull quarter of expenses from our Fabbrix acquisition. Research and development expenses, excluding stock-basedcompensation, totaled $8.5 million for the third quarter, an increase ofapproximately $2.5 million, or 42% from the third quarter of 2006, and anincrease of approximately $273,000, or 3% from last quarter. The increase from last year was primarily the result of theacquisition of SI Automation on October 31, 2006. The increase from the last quarter was primarily theresult of increased personnel related costs in off-shore locations, variable compensationaccruals, and increased travel, partially offset by a decrease in the use ofoutside development resources. Selling, general and administrative expenses, excludingstock-based compensation, were $5.1 million during the third quarter of 2007,an increase of approximately $700,000, or 16% from the third quarter of 2006,but a decrease of approximately $686,000, or 12% from last quarter. Theincrease from the comparable period last year was a result of increasedexpenses associated with our acquisition of SI Automation and expensesassociated with opening the office in Korea, partially offset by reduced outsidesales commission and legal costs. The decrease from last quarter was primarily the result ofdecreases in outside sales commission, travel and trade show expenses,partially offset by variable compensation accruals. Reiterating the statement made in our press release, inaddition to using GAAP results in evaluating PDF’s business, management alsobelieves it is useful to measure its results using a non-GAAP measure of netincome, which excludes stock-based compensation expense, amortization of acquireintangible assets, the write-off of in-process research and development, andthe related tax effects. Non-GAAP net income for the third quarter ending September30, 2007, totaled approximately $5.3 million, or $0.19 per share, at the upperend of the range we provided in July. This compares with non-GAAP net income ofapproximately $3.6 million, or $0.13 per share, for the comparable period lastyear and non-GAAP net income of approximately $5 million, or $0.17 per share,during the second quarter of 2007. On a GAAP basis, including amortization of stock-basedcompensation and acquired intangible assets, we reported a net loss for thequarter of approximately $939,000, or $0.03 per share. This net loss included$4 million in stock-based compensation and amortization of acquired intangibleassets. Turning to our balance sheet at September 30th, total cashdecreased to $50 million, a decrease of $4 million during the quarter. Operatingactivities generated $3.2 million in cash during the third quarter. Capitalexpenditures used approximately $278,000 during the quarter, while $2.7 millionwas used to complete the cash portion of our acquisition of Fabbrix, whichoccurred in late May 2007. Employee stock plans generated $280,000 in cash and $4.5million was used to complete our previously authorized $10 million sharerepurchase. During the period, we repurchased approximately 437,000 shares atan average price of $10.18 per share. Our accounts receivables increased $286,000 to $32.6million, as a modest revenue increase was partially offset by our strongcollection effort. The aging and collectability of our receivables remains veryhealthy. Now turning to guidance, I will again state that some of thestatements made in the course of this conference call, including the ones thatwe are about to make with respect to Q4 of fiscal year 2007, areforward-looking. These statements include expectations about our futurefinancial results and performance, growth rates, the success of any businessobjectives, product and service features and introductions, client products anddemand for PDF design-to-silicon yield solutions. PDF’s actual results could differ materially. You shouldrefer to our current SEC filings and understand that the forward-lookingstatements made during this conference call are based upon informationavailable to PDF today. We assume no obligation to update them. For the fourth quarter of 2007, we reiterate the guidance weprovided in our outlook press release earlier today. Total revenue is expectedin the range of $24.5 million to $26 million. Gain share revenue in the fourthquarter is expected to be in the range of $6 million to $6.5 million, ascustomer current volume projections reflect a small decline in gain share fromlast quarter. Earnings for the fourth quarter are expected to include atax benefit of approximately $1 million due to the final utilization of taxcredits during the year. Non-GAAP earnings per share for the quarter isexpected to be in the range of $0.20 to $0.22 per share. Assuming we achieve the middle of the ranges provided in thefourth quarter ending December 31, 2007, revenues for the year would total$95.2 million and non-GAAP EPS would total $0.71 per share, increases ofapproximately 25% and 61% over fiscal year 2006 respectively. With that, I would like to turn the call back over to theOperator to open the floor for questions.

[Operator:]

(Operator Instructions) Our first question comes from DennisWassung.

[Dennis Wassung -Canaccord Adams:]

Thanks. Good afternoon. A couple of questions; first, John,I was wondering if you could go over a little more detail on the newengagements you signed. I just wanted to be clear on it. It sounds like youclosed the LOA from Q2 and then you signed four new additional engagements, andtwo of those are memory. Is that correct?

[John K. Kibarian:]

Two are memory, one is logic yield ramp, that includes alsopdBrix. One is a 65-nanometer DFM engagement with a fabless customer, and thenthere were a series of extensions on existing engagement, an extension onexisting yield aware FDC engagement, and on a memory engagement. And then therewas a small 45-nanometer evaluation engagement for pdBrix with an existingcustomer.

[Dennis Wassung -Canaccord Adams:]

Okay, so it sounds like pdBrix was involved in two of thetransactions at this point?

[John K. Kibarian:]

Yes.

[Dennis Wassung -Canaccord Adams:]

Okay, so one was an evaluation and another one is a45-nanometer logic?

[John K. Kibarian:]

Yes.

[Dennis Wassung -Canaccord Adams:]

Okay. Can you give any other detail about some of thesecustomers -- geographical locations or --

[John K. Kibarian:]

I think I said four continents, and then I thought tomyself, you know, I’m not sure there were four continents. I think it’s Asia,Japan, U.S.,and Europe. I guess we have promoted Japan to acontinent. I think it’s four geographies is probably what we should have said. I think with the memory accounts, we’ve been very carefulnot to say exactly which continent they are from, as you would guess prettyquickly who they were. I think there was meaningful business in all fourgeographies. I don’t know that we are going to go into much more detail thanthat.

[Dennis Wassung -Canaccord Adams:]

Were the memory engagements all DRAM at this point, or wasthere any Flash involved?

[John K. Kibarian:]

That’s correct. They were all DRAM at this point.

[Dennis Wassung -Canaccord Adams:]

Okay, and when you look at the revenue line here, theintegrated solutions line was only up $300,000 in the quarter, but you signed alot of new deals here. How do you think about that as you go forward? Theguidance would imply that there is at least a reasonably sizable increase hereinto Q4. Were a lot of these deals signed later in the quarter or did you nottake a lot of revenue here from these contracts? Is that the right way to thinkabout it?

[Keith A. Jones:]

Dennis, your assumption is correct. Quite a few of theengagements were signed fairly late in the quarter, and as you know, the impactfor revenue would be not as great in the current period, but some of theengagements, we did have a meaningful contribution in the quarter, some of thelarger engagements. However, typically when we had talked about the size of andlength of our projects for our yield ramps, we had typically talked aboutapproximately a six quarter service offering. For DRAM, they are a little bitshorter than that for our memory offering, so the total amount of the fixedfees might be a little bit different but the overall margin contributions andwhat not are fairly healthy. So from a -- taking a look out, this is all part of what wehad forecasted for our guidance earlier on and we had already baked thisassumption into our forecast.

[Dennis Wassung -Canaccord Adams:]

Fair enough. And when you look at the size of these fourcontracts you signed in the quarter, are these traditional size, typicalrevenue contribution type contracts to you guys?

[John K. Kibarian:]

The DFM one is -- the DFM ones tend to be a little bitsmaller on the fixed fees. The ramp ones are pretty much typical.

[Dennis Wassung -Canaccord Adams:]

Okay, perfect. And last question for me, I guess, on thegain share side of it. Obviously had a great number here on the revenue side.The number of contracts involved, the number of customers involved here, prettymuch the same. I guess one contract is higher. Do you expect to see that thosenumbers shift at all as you go into Q4 and into next year, or are you juststarting to see a lot more content coming through your existing customers andcontracts at this point?

[John K. Kibarian:]

I think we are modeling that it is a similar number ofaccounts and contracts. We do see with things like 55-nanometer, the ramp hasbeen pushed out. The volume has been pushed out quite a bit. We originallythought that would be an ’07 activity. If you look at all the talk from thefoundries, it’s really late ’07, ’08. So a lot of our expectations on theseimprovements have been the dollar amounts coming out of fabs going up. In the quarter, we did complete a number of engagements andthat’s why I was saying we, even in Q2 or Q3, we achieved our measurementquarters, and those are very important because they establish the percentachievement that we achieved with the account and has the dollar per wafer thatwe can achieve with the account. Some of those accounts we completed the engagement. We donot forecast wafer volumes yet but do anticipate them to start sometime in ’08.I know that those don’t show up on our financial results, but it’s really quiteimportant for our business in the future and also our teams to know that we hita high percentage of our goal and hence will establish a good wafer fee at thataccount for the out quarters.

[Dennis Wassung -Canaccord Adams:]

So those are contracts you were alluding to when you weresaying you were coming at better-than-expected yield rates and getting betterdollar per wafer?

[John K. Kibarian:]

There were some contracts -- those customers were already involumes, so those did impact our Q3 gain share. There were other contracts thatthose customers were not in volume yet and they are not forecasted to be involume in our Q4 forecast, but we would hope that they turn into volumesomewhere in ’08.

[Dennis Wassung -Canaccord Adams:]

Okay, and a last quick one on that gain share side; howwould you describe the technology node contribution in there? You mentioned65-nanometer volume coming in later than expected. Is that what’s driving someof the higher volumes and higher dollars you are seeing now? Are you startingto get the contribution from 65 or is it still 90 driven?

[John K. Kibarian:]

We still see good contribution from 90-nanometer, quite goodcontribution. We do see 65 picking up. But I think it’s both nodes reallycontributing at this point.

[Dennis Wassung -Canaccord Adams:]

Thanks, guys.

[Operator:]

Our next question comes from Matt Petkun.

[Matt Petkun:]

A lot to go through, but a nice quarter, obviously,especially on the new engagement side. So just to be clear, including the dealthat you announced on the last call, there were five new engagements. Is thatright, John?

[John K. Kibarian:]

Four new engagements, Matt.

[Matt Petkun:]

And then one LOA?

[John K. Kibarian:]

Five engagements and an evaluation, if you will, so five.

[Matt Petkun:]

Five if you include the eval?

[John K. Kibarian:]

Correct.

[Matt Petkun:]

I thought you maybe said that one of the new deals in thisquarter was actually an LOA that you signed but the engagement hasn’t formallybegun. Is that right?

[John K. Kibarian:]

No, I’m sorry. I started off by saying the LOA that wetalked about last quarter, that converted. We weren’t including that in thefour.

[Matt Petkun:]

Right.

[John K. Kibarian:]

And in the four, there was one LOA for 55-nanometer R&Dengagement for DRAM, and the others were all contracts.

[Matt Petkun:]

So when do you expect that 55-nanometer to convert -- nextquarter?

[John K. Kibarian:]

It converts in the next quarter.

[Matt Petkun:]

Okay, so if we exclude LOAs all together, and we include theone that converted this quarter, there were four new engagements in thequarter, or three if you exclude the 45-nanometer assessment. Is that correct?

[John K. Kibarian:]

No. If you want to include the one from last quarter and youwant to exclude the pdBrix evaluation, there would be five including the LOA,which is at 55-nanometer. If you want to exclude that LOA, then there would befour. Our way of counting is to count the LOA that converted intoa contract as a Q2 engagement, and then we count the four including the LOAfrom this quarter, although the contract, the remainder part of the contractwill be finished in Q4.

[Matt Petkun:]

Understood. Either way, it’s -- the two to three that you’vetalked about meeting on a quarterly basis.

[John K. Kibarian:]

That is correct, Matt. It depends on where you want to --you know --

[Matt Petkun:]

Yeah, I understand that, and of those, how many -- let’sexclude the LOA from last quarter. Of the new engagements or LOAs, how many newcustomers again?

[John K. Kibarian:]

One new customer.

[Matt Petkun:]

One new customer. The other question that I had, Keith, wason -- I just have an awfully hard time and I can’t be the only one, estimatingyour non-GAAP tax benefit every quarter. I now a lot of that is coming from taxcredits. What do you expect for 2008 in terms of what you’d be using for a non-GAAP taxnumber?

[Keith A. Jones:]

Candidly, Matt, we’re actually taking a look at our forecastfor the year and at this point in time, we’re not in a position to give outthat forecast. But rest assured when we discuss it in January, we’ll give youappropriate guidance.

[Matt Petkun:]

Okay, and of the $2.1 million pro forma tax credit that yourecognized this quarter, how could you compare that to a cash receipt for PDFSolutions? Because you are not purely offsetting taxes that you paid on a GAAPbasis.

[Keith A. Jones:]

I think the short answer to that is that it’s an asset, ifyou will, that in the future when our profitability increases, obviously thenthere will be a tax liability. Instead of writing a check, those creditsrealize and that reduces the amount that we have to pay. So the effect of thatis ultimately a cash savings to PDF.

[Matt Petkun:]

Okay, but I mean, I don’t see that on the balance sheetanywhere. Is that correct?

[Keith A. Jones:]

You would see that on the balance sheet within the line itemfor our deferred tax assets and then also look in the line item for our othercurrent assets, which has a deferred tax asset as well.

[Matt Petkun:]

Okay, they aren’t NOLs though, correct?

[Keith A. Jones:]

No, they’re not. They are much better than NOLs.

[Matt Petkun:]

Right. Just your deferred tax asset line item, it wasn’t upthat much sequentially so I’m trying to correlate the two numbers.

[Keith A. Jones:]

We actually build in that to the rate over the year, so youare not [inaudible].

[Matt Petkun:]

Okay, then, just my final question; John, it’s prettyexciting to see the pdBrix technology being employed in these new engagements.Can you talk about what that means from a revenue opportunity standpoint or isit more just attracting customers in new areas where they might not have beeninterested in engaging with you in the past?

[John K. Kibarian:]

I think it’s a revenue opportunity for us. Let me be clearabout this -- so when we purchased pdBrix, when we looked at the customer sidewe said if you look at these new technologies there is a difficulty inachieving a good shrink with these new technologies and getting good performancecharacteristics. We thought pdBrix offered a lot of value for that and it wasalso really critical to have good characterization technology. As we spoke on the call, we started in the process lifecycle on the yield ramp and we felt that if you looked back up during thedevelopment of process and the design rolls and the development of a chip, youcould really do a lot to affect the overall cost structure of the design orproduct. And pdBrix is really a big part of our way of achieving that. Itshould create for us, over time, a longer payment on our wafer fees; betterwafer fees and give us basically more introduction into the product team in theaccounts.

[Matt Petkun:]

The new engagements that incorporate the pdBrix, will thosehave wafer fees associated with the use of the pdBrix’s technology or just onthe traditional IOIR side?

[John K. Kibarian:]

For them to be able to use the pdBrix part in productionthere is a separate term for that and there is a wafer fee for that.

[Operator:]

Our next question comes from the line of Mahesh Sanganeria –RBC Capital Markets.

[Analyst for MaheshSanganeria:]

This is Casey calling in for Mahesh. A couple of quickquestions. If you could step back a little and look at the overall picture, canyou share your thoughts on the market for new products as we go from 65 to 45nanometers?

[John K. Kibarian:]

I’m sorry, for the yield products or for the market ingeneral?

[Analyst for MaheshSanganeria:]

The market in general.

[John K. Kibarian:]

The market in general, new products. Yes, I think that’s areally good question. We see the memory folks marching down the nodes prettymuch on a very standard pace. When we saw our 45-nanometer business, we feelthat there’s some key early products that go into the node quickly; the gamessystems, the baseband systems, the FPGA and to some extent the graphicsproducts. Then there seems to be more of a lull between that firstwave of products and the subsequent, more broad use for products that havegenerally lower volume characteristics, but more product mix or more tape-outmix. We see that trend continuing aswe’ve gone from 90-nanometer to 65-nanometer to 45-nanometer. Also, when we’ve seen which customers achieve volume andsometimes not our customers, in the logic business with the advent of some ofthe newer producers like Chartered, there’s more viable suppliers on theleading edge silicon and there is a lot of competition in markets likebaseband. We’re seeing the winners of the designs, i.e. the system companies,who Nokia selects or who Motorola selects, et cetera, affect which factoriesget the volume. It is kind of two stages removed.

[Analyst for MaheshSanganeria:]

As a follow-on to that, do you guys feel that as apercentage of development dollars, the 45-nanometer in the memory spacereceived more dollars for even improvement, both early on as well as duringproduction than what you guys saw for the previous nodes?

[John K. Kibarian:]

The general things that customers tell us is the cost tobring up a new technology goes up about 35% generation over generation, so inother words whatever they spent on 65-nanometer, they’ll need to spend about35% more than that on 45-nanometer. That seems to continue. I think we don’tsee, really, a change in that. Some of the things we’re doing with pdBrix and some of thethings we’re doing with yield aware FDC are trying to help the customers slowthat rate of increase and also slow their rate of increase in productioncontrol costs. Net, I think the costs generally continued to scale up. Ofcourse, the number of transitions or shift per centimeter also scale up at asteeper rate, so the benefit is generally still there for the account.

[Analyst for MaheshSanganeria:]

So is it fair to then assume that on a multi-year basis,that 35% increase in your revenues is a rough ballpark to begin?

[John K. Kibarian:]

They generally introduce the technology every two years, twoto two-and-a-half years. The time lag between the cost of 45 versus the cost of65 so that cost, I think you would probably look at a longer horizon on theircosts going up, probably every couple of years, to get to that 35% number. Now how that affects our revenues I think is a differentball of wax. I think if you look over the past four years, we’ve grown atgreater than a 20% compound annual growth rate, which would be a little bithigher than that number would imply.

[Analyst for MaheshSanganeria:]

Switching gears a little bit, can you talk about incrementaldollars that you plan to get from your engagement with Magma, and the potentialfor future engagements with other companies?

[John K. Kibarian:]

After our second quarter conference call, we announced thatwe were working with Magma on a product for yield simulation that was based onour wireless technology and their quartz technology. We have not forecastedrevenues for that product until that product is successful in its beta sites. Ithink that market is a very new market, and we haven’t speculated much on whatthe total opportunity is for that product offering. We do, from time to time, identify design automation toolsthat would benefit from our yield models and yield simulation, and we look atways to leverage the design automation company’s channels for that and createrevenue streams. That’s been something that’s been a part of our strategy onlyover the last couple of quarters, and it’s really too early for us to forecastwhat we’re going to generate revenue-wise.

[Keith Jones:]

So we’ve been fairly conservative in building that into ourmodels; actually not including that, but it’s part of our long-term strategy,obviously.

[Operator:]

There are no further questions at this time.

[John K. Kibarian:]

The third quarter was a good quarter for PDF Solutions andsets the foundation for better results in the future. We are pleased thatclients see promise in our new offerings. We are also pleased with our abilityto expand ourselves in the DRAM market. Finally, our share performancedemonstrates the results our clients are achieving with the application of ourtechnology. These three points reinforce that we are on the right track. Thank you for joining our conference call. Goodbye.