PDF Solutions, Inc.
Q3 2016 Earnings Call Transcript

Published: 28 Oct 2016

[Operator:]

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. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session for which instructions will be given at that time. [Operator instructions] As a reminder, this conference is being recorded. If you have not yet received a copy of the corresponding press release, it has been posted to PDF's website at www.pdf.com. Some of the statements that will be made in the course of this conference are forward-looking, including statements regarding PDF's future financial results and performance, growth rates and demand and solutions. PDF's actual results could differ materially. You should refer to the section entitled Risk Factors on pages 12 through 19 of the PDF's Annual Report on Form 10-K for the fiscal year ended December 31, 2015 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 Mr. John Kibarian, PDF's President and Chief Executive Officer and Greg Walker, PDF's Chief Financial Officer. Mr. Kibarian, please go ahead.

[John Kibarian:]

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'll provide an update on Design For Inspection. Finally, I will turn the call over to Greg, who will talk you through the financial results in detail. We will then take your questions. We had a strong recovery in our Gainshare revenue in Q3. Gainshare revenue was $8.7 million an increase of 42% when compared to Q2 2016. Both 14-nanometer and 28-nanometer nodes increased Gainshare revenue in the quarter. 28-nanometer volumes increased in most of our customers fabs. We experience increased 14-nanometer volume at existing 14-nanometer and our second 14-nanometer customers started to generate Gainshare. We expect 14-nanometer wafer volumes and accordingly Gainshare 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 there will be appropriate 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 cost related to the deployment of our DFI systems, higher subcontracting and consulting costs and the timing of the current season in the quarter. Now turning to our solutions business in detail, we are continuing to expand our customer based 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 at a high level in China as we work with the 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 to 28-nanomter Yield Ramp engagement with the leading IDM. A 10-nanometer Yield Ramp engagement with the leading Chinese fabless semiconductor company and Exensio yield deployment at a foundry and China to complement their earlier deployment of Exensio control. And Exensio yield deployment of the large system company and an FEC 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 the handful of companies tied primarily to the bring up of new leading edge node in fab in the large fables customers that use those nodes. PDF business was the leading knife-edge at the chip industry with the 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. Contract 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 a lot of fabs, OSAT, fabless and system companies to optimize their manufacturing over the life of production. Many of the Exensio deployment this quarter or for companies who have no interest or use of leading edge processes. We are very excited about the market standards of our new solutions in the customer base. Finally, each quarter, I provide an update about our Design For Inspection solutions referred to as DFI. As a reminder, Design For Inspection saw the ever increasing challenge of inspecting production chips for electrical defect. Conventional inspection allows semiconductor companies to see visual differences in patterns on a chip. However, many electrical faults are not visually detectable any more. PDF Solutions’ DFI technology is design 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 on our second customer. The tool is generating useful measurements for the every search 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 the detection and control of our electrical defects. Our early successes at our customers’ facilities are validating, I believe 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 chips CV instruments that work with the design community to deploy the CV instruments inside the fables company’s chips. During the quarter, six additional products and test chips tape out with DFI including the design. We now have over 50 products in test chips tape out with DFI. We are pleased with the continued interest we see from the fables 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 1st. We are looking forward to seeing many of you there and providing additional insight into PDF Solutions. As I mentioned earlier in this 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 fables interface to more broadly across many nodes, further down to supply chain to the OSAT and to the system company who are more and more developing around chips. We are excited to share with our stockholders our perspective on our businesses evolution and all reasons where the opportunity learned 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.

[Greg Walker:]

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 non-recurring items, stock-based compensation expenses and amortization of expenses related to acquired technology and other intangible assets and also 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 non-recurring 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 Investors section of our website located at pdf.com. Now, let's turn to over to 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 Gainshare performance incentive or Gainshare 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. Gainshare 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 Gainshare with 16 up by three over the previous quarter which also included the addition of 14-nanometer Gainshare 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 revenue, 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 cost 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 revenue. 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 cost, lower deferral of project costs in Q3 than in Q2 and increase in depreciation due to 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 pre-tax 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 with respect to non-GAAP earnings. At this point in time we are still working with our external pack devices 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 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 $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 used primarily related to our DFI program. 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 increase in Gainshare 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 contract and with spread across a large portion of our customer based. Of the $51.7 million of total current and long-term receivables, approximately $1.9 million or 4% was age 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 1736 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 increase 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. 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 Gainshare revenue. However, we still expect total Gainshare 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 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 previously stated we expect our capital spending to increase by $10 million for the year, and this is 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 a result of investments the company has made over the last several years. These investments are consistent with the company's business model and 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 in November 1st. If you are unable to attend the presentations will be webcast and available on the Investor Relations page on our website. Now, I'll turn the call back over to the operator for Q&A. Operator.

[Operator:]

Thank you Mr. Walker. [Operator Instructions] Your first question comes from the line of Jon Tanwanteng from CJS Securities.

[John Kibarian:]

Hi Jon.

[Jonathan Tanwanteng:]

Hi, how are you doing guys? Thanks for taking my question. Can you walk through the flow through to PDF from the new wafer supply going between global and AMD, what that specifically means for Gainshare?

[John Kibarian:]

Wafer supplies do you mean with global and AMD, I think there is a couple of points. One, there is a commitment in terms of what they are going to purchase next year, some of that is opaque to us to calculate all that document, but of course since the primary AMD production is 28-nanometer or 14-nanometer those are wafers when that is materialized that will become more transparent to us. We expect that given AMD success in the marketplace on their more recent - that their volumes overall and global foundries specifically will be up substantially over 2016 levels. Secondly, they may have mention to AMD’s interest 7-nanometer, I think on the press announcement or 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 through 7-nanometer and AMD is probably - but the potential of being significant customer of global foundries at 7-nanometer as well.

[Jonathan Tanwanteng:]

Great that’s helpful. And given the strong early response and the deliveries you have done so far. Can you tell us about the market for the Gen-1 DFI machine is shaping up. Heading to 2017 what you think demand may look like from other foundries through the year?

[John Kibarian:]

That’s another great question Jon. We are kind of working that out right now. We believe that as we have done a number of tape outs. But the operation that, the generation one machine goes up, which is really electrical characterization primarily on the test chip or test chip that run in this scribe line next two products. We have been able to see the customer’s find signals with the system. Even notwithstanding a relatively small amount of the area on the wafer. So we are starting to believe there is an application here, we don’t know the exact side, but we think there is at least 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 are 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 the voltage contrast. We believe that types of voltage contrast in conjunction with the test vehicles is a more efficiently to get a chunk of that market. And therefore, we think that DFI in the eProbe-150 could get at some part of what is the voltage contrast market today. And that market today is a sizable, I mean already bigger than PDF is today.

[Jonathan Tanwanteng:]

Okay, great. And just a progress update on the Gen-2 machines and the earliest potential delivery day on that?

[John Kibarian:]

Yes. We are going to talk about that again also on the Analyst Day, but we remain on-track for completing that program and making deliveries in 2017.

[Jonathan Tanwanteng:]

Okay, great. And just maybe more high level commentary. Earlier this year we saw IDM inspection company bought for a fairly [indiscernible] by SML. How should we think of the read through to your business and what you are doing with DFI and how that technology similar or actually better or how it differs from what was bought?

[John Kibarian:]

Sure. I think I'm familiar with what you are referring to. Electron beams systems are used to do many types of measurements inside a fab. One of the measurement, there is some review, there is fine feature scanning. One application is voltage contrast that is the application that is the most similar to PDFS and that it give you some kind of electrical information. What we are doing that’s different and putting something on the chip some IP on the chip that you scan that specific IP and since that IP is sensitive to 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 a nano probe or have gone in probe 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 in the customer base to have a voltage contract on electrical measurement is becoming more needed because of the use of 3D structures in semiconductor. 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 you know 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 3D production techniques in the chip manufacturing.

[Jonathan Tanwanteng:]

Got it, thank you. we will see you guys at the Analyst Day.

[John Kibarian:]

Thank you.

[Gregory Walker:]

Great. Take care Jon.

[Operator:]

And your second question comes from the line of Tom Diffely from DA Davidson.

[Thomas Diffely:]

Yes, good afternoon. So you talked a little bit about these increase in the cost in levers around DFI deployment, I'm curious it seems like you should also be showing a little bit of cost increase for all of your activities in China. You may just talk a little bit about what kind of leverage you get with your current set up there and what kind of cost maybe have to be laid in eventually toward that growing market.

[Gregory Walker:]

Yes, when we look at China, we are trying to hold pretty much to the same margins we are looking at on a worldwide basis. These are primarily fixed fee projects at this point in time with wafer fee tail at the backend, 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 negative but not significantly. I think we have talked in the past about 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.

[Thomas Diffely:]

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

[John Kibarian:]

So it’s a good question, we have a relatively large office in Shanghai we have had, we 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, maybe – talk 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 very well positioned there. We every year in the summer hire new people in China, it's usually on the order of about 15% of the staff. We did that this summer as well we are now somewhere over a 140 folks in China, 160 I guess the number is. And that maybe being only slightly modulated because of the activity in China. You know we serve our customers on worldwide basis with our staff from around the world, and I mean kind of your specific comment around PhDs. We hire the smart people no matter where they are in the world and we have 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 it’s from a different part of the world. We always have people there who speak Mandarin and who work locally, but the matching up of PhD and geography isn’t something that we are smart figure out to do, we just hire smart people whoever they are.

[Thomas Diffely:]

Okay, that’s great, because there are so many new potential customers or just start but there touch via a little bit bigger ramp, it sounds like you are kind of the ahead of the curve there?

[John Kibarian:]

Yes. Thank you. You are right, there is a lot of that business activity. There are a lot of hiring that goes on associated with that, this is something we have been doing for 10 years.

[Thomas Diffely:]

Great. And then when you look at the new royalty streams coming in at 14, 20-nanometer. On the 14-nanometer you said your second customer, was there any a bit of catch-up kind of revolver around that initial start of that royalty stream or is that kind of steady state?

[John Kibarian:]

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

[Gregory Walker:]

Correct.

[Thomas Diffely:]

Okay. And same thing on the new 20 side?

[John Kibarian:]

That’s correct.

[Thomas Diffely:]

Okay, great. And then just a final question. When you look at the model in general, you ramped up the DFI. Is that going to taking kind of step function higher when the 250 gets up and running, just see the market?

[John Kibarian:]

You are talking about revenues or expenses?

[Thomas Diffely:]

I’m sorry. On the cost side, yes.

[John Kibarian:]

I suspect we will have cost associated with our initial department on the 250s as well. And it’s been early for us to kind of guess estimate how much different that will be within in our 150 initial costs. So how far is the guess, I mean yes, I would say the guess is going to be higher and if you are going - surprised right.

[Thomas Diffely:]

Okay. Thank you.

[Gregory Walker:]

Thank you, Tom.

[Operator:]

And your third question comes from the line of Brian Freckmann from LS Capital.

[Brian Freckmann:]

Hi guys. How are you?

[Gregory Walker:]

Good Brian. How are you doing?

[Brian Freckmann:]

Good. And just sort of following up on Tom’s question a little bit. As I sort of look at number 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 in the 20s, as a percent of sales and then 25%. I guess and went up $5 million last year up $6.5 million through nine-months and going on the way at about $8 million. Is there a way for you guys to sort of 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 or what as you guys sort of start to move to the 250. What is the steady state run rate for R&D for 2017 and how should we think about that. If you can give us a little bit more clarity that would be great. Obviously it looks like you sort of taking about $0.17 to $0.18 of earnings and put it into R&D. And so just trying to think about how we can kind of recover that or what it should you look at next year?

[John Kibarian:]

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 in the bombs to get the most effective use. And quite honestly a lot of that is build and feedback coming from the customers about what types of issues are their biggest to worries. So we continue to have some development expense on that, but that will actually start to flatten out and then wane away overtime. 250 is still in a very aggressive build up, we see that carrying on, its continuing to probably grow through the end of 2017 when we start to move out of the lab and into actually deployment 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.

[Brian Freckmann:]

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 10% customers, what was that this quarter.

[Gregory Walker:]

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

[Brian Freckmann:]

Thank you. Thanks guys.

[Operator:]

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

[John Kibarian:]

All right. Thank you.