PDF Solutions, Inc. (PDFS) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the PDF Solutions, Incorporated Conference Call to discuss the financial results for the fourth quarter and full year ended December 31, 2011. [Operator Instructions] As a reminder, this conference is being recorded. If you have not yet received a copy of the corresponding press releases, they have 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 in -- 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 9 through 15 of PDF's Annual Report on Form 10-K for the fiscal year ended December 31, 2010, and similar disclosures in subsequent SEC filings. The forward-looking statements and risks stated in this conference call are based on information available to PDF today. PDF assumes no obligation to update them. Now I'd like to introduce John Kibarian, PDF's President and Chief Executive Officer; and Greg Walker, PDF's Chief Financial Officer. Mr. Kibarian, go ahead, please.

Thank you, and welcome, everyone. PDF Solutions made strong progress in 2011 towards our goal of being pervasively applied to leading edge logic manufacturing and generating gainshare from our client's successful yields. In the fourth quarter of 2011, we achieved revenue of $17.6 million, non-GAAP profit of $0.12 per share and a GAAP profit of $0.07 per share. For the full year, we achieved revenue of $66.7 million, and a non-GAAP net profit of $0.26 per share and a GAAP profit of $0.07 per share. I am pleased to say that this was our second consecutive year of GAAP profitability. We believe this is clear evidence of our commitment to conserve spending policy that has been closely aligned to our revenue opportunities. On the new business side, activity in the fourth quarter was very strong, as we anticipate on last quarter's call. And we successfully closed the following business, all with existing clients. In a reserved contract for 14-nanometer process R&D, an extension to an existing contract for 22-nanometer process R&D, an extension to an existing 32-nanometer yield ramp, a contract for a 29-nanometer process R&D, an extension to our fabless company's 28-nanometer DFM contract, a commercial license for a beta copy customer of our next-generation YieldAware process control software, and lastly, a single contract for yield ramps of a client 32, 28, 22 and 20-nanometer processors. This last contract replaced an extended prior agreements from some of those nodes in facilities and added additional nodes in all facilities at which these processes are run. This resulted in a larger, more comprehensive implementation of PDF's integrated solutions across the client's organization. As a result, we'll be able to drive more value with this client with better ramp, which will benefit their business as well as ours. The beginning of this benefit was already evident in their manufacturing and our gainshare results in Q4 2011. The 20-nanometer R&D engagement I listed is yet another contract and a key collaboration between a number of logic manufacturers of this node. This 20-nanometer collaboration as well as our 22-nanometer and 20-nanometer engagements demonstrates the continued trend of process developers applying PDF Solutions' Characterization Vehicle to optimize the design rules and technology definition. This is another extension of PDF's value across the process life cycle and a form of DFM for technology development. Sequential increases in solutions and gainshare revenues, coupled with continued spending discipline, resulted in our generating $2.2 million in cash from operations in Q4. For the year, we generated approximately $8.2 million from operations. As I said at the beginning of this call, our primary goal this past year was to make PDF's yield ramps pervasive leading edge logic, execute well for our clients and position ourselves to generate future gainshare from these facilities. As you may remember, to achieve this goal, we had 5 priorities for the year. First, drive adoption of our technology in logic manufacturing and the fabless customers across the manufacturing process life cycle. During the year, we signed engagements with logic manufacturers at nodes from 45-nanometer to 14. These engagements include, DFM, yield ramps and process control solutions. Between our DFM engagements and our direct work with foundries, PDF Solutions' Characterization Vehicle test chips will run at all major foundries in 2011. As a result, PDF's unique resource as our characterization of leading edge silicon across the entire industry is unparalleled. In particular, the value of our solution to fabless clients has started to be publicly recognized. In the third and fourth quarter of this past year, AMD referred to PDF Solutions on their earnings call as an important partner in driving their manufacturing efficiencies. In our strategy of helping our foundry clients achieve great operating results, our CD infrastructure and DFM solutions are becoming more recognized capability for both the factories and the fabless design teams using them. The second priority in 2011 was achieving our yield targets with our clients to maximize gainshare results. We made good progress on this during the year. For example, in Q4, we started to see gainshare contribution from those below 40-nanometer for the first time. Achieving our yield targets means that our clients are experiencing improved manufacturing execution in part by using PDF's characterization and RAM capabilities. Our third priority for the year was to drive adoption of our DFM solutions at fabless clients. We already mentioned the work with our clients and the value AMD has recognized. During the year, we signed a number of DFM engagements and laid the groundwork for further expansion in 2012. In particular, as fabless companies begin manufacturing a 28-nanometer, our process control solutions, which leverage our proprietary Characterization Vehicles implemented in products' guidelines are beginning to demonstrate value. As 28-nanometer volume picks up in 2012, we anticipate this capability becoming an important part of PDF Solutions' valued proposition to fabless, augmenting the DFM solutions that clients engage prior to tape out. Our fourth priority for the year was to continue deliver our solutions to markets adjacent to our logic manufacturers, such as LED, solar, wafer and memory manufacturing. As I mentioned in the third quarter call, during 2011 we successfully expanded on the relationship with our first LED manufacturer that we began in 2010. One of the features of the next generation process control software I mentioned earlier, is more cost-effective deployment for our YieldAware process control capability to these adjacent markets. We expect to see continued traction in logic and adjacent markets for this technology in 2012. Finally, our fifth priority for the year was to remain committed to prudent spending. During 2011, we grew our designer silicon revenue by 20% while our cost of sales increased only approximately 10%. We are pleased with this margin expansion. Our strategic direction in 2012 will remain largely unchanged from 2011. While we will increase our focus on achieving our yield targets as it sets the stage for client satisfaction and future gainshare. In 2012, we anticipate the overall chip industry will continue to grow with logic manufacturers seeing more growth than the industry overall. In 2011, our business, in particular our solutions revenue, which is an indicator of future gainshare, grew faster than the overall logic industry. Adoption of the leading edge nodes where a few yet -- is particularly well positioned will continue to be the most exciting part of logic manufacturing business. In these nodes, yield ramps, DFM and process control will be critical issues for IT manufacturers and fabless companies. As a result, while we will continue to refrain from providing specific quarterly guidance and we may see ups and downs quarter-over-quarter, we expect to continue to grow our solutions revenue in 2012 at our level that is fast [ph] in the overall logic manufacturing industry. Further, we believe Q4 foreshadowed a return to more consistent growth in gainshare results as the investments we have been making on the leading edge nodes with our clients start bearing fruit. Finally, due to our continued focus on conservative spending, we anticipate that our earnings growth will be greater than our revenue growth on a percentage basis. Thank you for your time and attention. Now I'll turn the call over to Greg, who joined PDF just about 3 months ago as our new CFO. We are pleased to have him as part of our team. Greg will discuss in detail our financial results for the fourth quarter and fiscal 2011. 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 non-GAAP measures. In this case, Non-GAAP measures exclude stock-based compensation expenses, amortization of expenses related to acquired technology and other tangible assets, restructuring charges and their related tax effects as applicable. You can access the earnings press release that contains a reconciliation of non-GAAP to GAAP results in the Investor section of our website located at pdf.com. Now let's turn to a review the financial results. First, let me cover some of the highlights of the quarter and for the year. As John stated, total revenues were $17.6 million for the quarter, with a GAAP net income of $2.1 million. This resulted in an EPS of $0.07 per share for both basic and diluted shares. Net income on a non-GAAP basis totaled $3.3 million or $0.12 per diluted share. Cash grew by $1.9 million during the quarter. Cost of sales and operating expenses were $15.5 million, an increase of approximately $100,000 from last quarter. Looking at the full year, total revenues were $66.7 million with a GAAP net income of $1.9 million as compared to prior year total revenues of $61.7 million and GAAP net income of $22,000. Resulting EPS of $0.07 for both basic and diluted shares on a full year basis compared to $0.00 per share last year. Net income on a non-GAAP basis totaled $7.4 million or $0.26 per diluted share compared to $7.8 million or $0.28 per diluted share last year. This reduction was due to an increase in tax provision of approximately $1.1 million, which more than offset an increase in pretax non-GAAP income of approximately $700,000. Cash and cash equivalents grew by $7.9 million during the year with $8.2 million being generated by operations. We are very pleased with the improvement in our pretax earnings both on a quarter and a full-year basis and our strengthening balance sheet. We continue to investigate strategies to mitigate the impact of foreign withholding taxes on the results of the company going forward. Moving on to revenues. And for the quarter, total revenues were $17.6 million in the fourth quarter, were up 4% as compared to $16.9 million in the prior quarter and up 9% compared to $16.2 million for the same period last year. Total revenues were comprised of design-to-silicon-yield solutions revenues of $14.2 million and gainshare revenues of $3.4 million. Yield solutions revenues for the quarter increased $300,000 sequentially or 2%, and gainshare revenues increased $400,000 or 13% sequentially. The increase in yield solutions revenue was due both to new engagements and extensions of existing engagements with existing customers. The increase in our gainshare revenues was principally generated by the inclusion of the new process node and related wafer volumes at an existing customer. Gainshare revenues for the quarter as a percentage of total revenues were 20% as compared to 18% in the prior quarter. During the quarter, we continued to observe further concentration as the leading foundry manufacturers within the marketplace. Reflecting this market trend, the total number of customers contributing to gainshare revenue in the quarter fell to 5 down from 6 in the prior quarter. Offsetting this effect, however, the total number of gainshare eligible process nodes and related wafer capacity at those 5 customers is continuing to increase both on a quarterly basis and an annual basis. During the quarter, we added 2 new contracts, 4 extensions to existing contracts and a significant new software license contract. In the quarter, 14 engagements spanning 7 customers contributed at least $150,000 of revenue. Finally, our top 10 customers represented 88% of total revenues in the quarter. 3 of these customers contributed revenues greater than 10% each. This was the same number as last year and the same number as the fourth quarter last year. I'm sorry, same number as last quarter and the same number as fourth quarter last year. On a geographic basis, Asia accounted for 31% of total revenues, Europe represented 26% and North America accounted for the remaining 43% of total revenues. Moving on to cost of sales. The total cost of our yield solutions was $8.2 million, an increase of approximately $400,000 as compared to prior quarter. Fourth quarter gross margin as a result was slightly lower at approximately 53% compared to 54% last quarter. Non-GAAP gross margin was 57% for the quarter compared to 58% last quarter. Our total GAAP operating expenses were $7.2 million or approximately 41% of total revenues compared to $7.6 million or 45% of total revenues in the prior quarter. R&D expenses totaled $3.1 million or 17% of total revenues compared to $3.4 million in the prior quarter. SG&A expenses totaled $4.1 million or 23% of total revenues compared to $4.2 million in the prior quarter. Other income at $282,000 was favorable when compared to $201,000 in the previous quarter. Worth noting, the income tax provision decreased quarter-to-quarter by approximately $840,000 and by approximately $230,000 as compared to the same quarter last year. In general, our tax provision is primarily comprised of foreign withholding sales tax -- withholding tax on sales. As mentioned earlier, we strengthened the balance sheet during the quarter, primarily as a result of our positive operating cash flow. Cash from operations was approximately $2.2 million. During the quarter, the company also repurchased $440,000 in stock, which was partially offset by $240,000 in employee stock option exercises. Headcount at the end of the quarter was 319 people worldwide compared to 321 people at the end of Q3. That concludes the review of the financials for the quarter. Now I will turn the call over to the operator for Q&A.

[Operator Instructions] Your first question comes from Tom Diffely.

Maybe, first, a couple questions on the model itself. The tax decrease that we saw this quarter, is that something that's sustainable or is that just a one-time item that we go back around $1 million going forward?

I would say that, that model, one-time item depending on the revenue mix in any particular given quarter between those revenue subject to foreign withholding tax and domestic revenues, primarily. So as that mix may shift, you would see the tax provision it's right now shift and potentially increase or decrease. Our goal, we're looking at ways to which we may be able to mitigate some of those impacts, but at this point in time, we don't have anything specific identified.

Okay. Are you subject to the benefits from R&D tax credit if it comes back?

Yes.

Okay. And then also, I'm looking at the operating expenses, the reduction you saw quarter-over-quarter, is that just that control of discretionary spending or is there a headcount reduction that went along with that?

I would say that those are actually somewhat related. We had some legal expenses that were significantly reduced. We are managing the headcount very tightly. So I'd say there's some onetime items in there, but at the same time, we're trying to manage the run rate as well as we can.

Okay. I mean, do you look at those being kind of a starting point for the run rate going forward or did the one-timers bring it below, what you would think it'd be a normal run rate?

I would say the one-timers probably brought it down a couple $100,000 of what would be a starting run rate for 2012.

Okay. And then John, looking at the nice uptick in the gainshare portion. So was all of that driven by the new -- I think it was 40-nanometer or sub 40-nanometer gainshare coming out or was there some older stuff that came back as well?

It was the sub 40-nanometer stuff compensating for what was then lower in some of the legacy stuff. We do things that as we go through 2012 some of the legacy stuff may do better. Our Q4 was not a great quarter for the legacy stuff.

Great, okay. But those contracts haven't come to an end. It's just a matter of utilization rates?

Right.

Okay. And then when you look at the top line, the design-to-silicon business based on kind of the book that you have, would you expect that to continue to go up as well or have we got to a plateau in this, your consulting part of the business?

Yes, it's the overall solutions are sort of consulting and some software solution revenue in there. In general, we expect that. As I said on my prepared comments, we expect that portion of the business -- the overall business and that portion of the business to continue to outgrow the overall growth in logic industry. So we do expect that number to continue to grow.

Okay. And then getting a little more, I guess, kick from the gainshare, in addition to that?

Exactly.

Okay, great. All right. When you look at the adjacent markets, right now, it's pretty slow. Do you see it being a meaningful portion? I know, you're going to probably get some pretty nice ramps here coming up on the new nodes. I'm just curious if those adjacent markets come into play it all this year?

We do expect them to come into play this year but not relative to the amount of the increased growth that we expect in the logic industry. We think they'll still be dwarfed. Sort of the -- can try to be a very good piece of business for PDF in 2012. The growth will continue to be further penetration as the logic customers move to the advanced nodes, more investment in advanced products and processes, bigger facilities, running more wafers on the advanced nodes, contributing bigger gainshare, that's going to be the big driver. That's the headline story for PDF this year.

Yes, yes, okay. And then you mentioned too, some increased emphasis on the DFM solutions going forward at 28 below. How big do you see that as part of the, I guess, the top line? Is that something that once a fab is up and running, the homes [ph] like maintenance were going forward or is that something that ramps up initially with the yield and then tailors off?

Yes, that's a good question, Tom. So we continue to have customers engage with us pre-tape out where the DFM that we -- mostly business that we saw in 2011 towards the end of the year. Fabless customers start to use our scribe line, and I think what they recognized was how very tight the profits windows are for these advanced nodes and as you know, some of them are now on wafer buys. And on the wafer buy basis, you are going to need to understand what is the variability the technology is able to hold and how does that relate to your product yields. So we're encouraged that there may be an application of our scribe solutions for the fabless accounts as they test the wafers themselves, and then in some ways understand the process windows that the manufacturers are actually delivering for them. And we started getting some of that business in 2011 with all the fabless comps, and we saw some good data coming off those vehicles. I mean, we're hopeful that there's an opportunity to expand that in 2012.

Okay. And then you talked about a multi-generation contract. I guess, I'm just kind of curious, insight of a customer, how active are they at multiple nodes at the same time? Is there one that completely dominates your work there? Or are there separate groups at all working at their own node and it's a lot of work on each node at the same time?

That's a great question. I think, every generation, the technology developers tell you they're going to do one version of the process for that node. HPM was the definition default founded standard technology on 28-nanometer. Then the reality is the fabless companies have tremendous leverage and they need specials, and so you start seeing the polysilicon versions, the version of polysilicon, the versions of super high performance and medium high performance. And you start seeing more and more and more derivatives, and the layout optimizations that each of the major companies is using is unique. But foundries may have heard us now from multiple ones, telling us you need vehicles for each of the specific flavors of the node. And from our standpoint, that means they may need more than what we originally allotted for. So we need to have a way of scaling the amount of capacity they needed from us in terms of capability, funding that could be incremental fixed fees, and then enjoying the wafer fees that, that would represent. So overall, encompassing engagements, which is what we did in this case with this one account. Because of all the nodes and all the flavors gives them the ability to apply that to whichever one of the flavors that are there. From our standpoint, that means that we get paid on all flavors the way it takes specific test vehicles or not and all facilities. So for us, it has an advantage of de-risking the nodes, which is very significant for us. And for them, it gets them PDF characterization for all of the fabless accounts. And we hear consistently fabless guys, prefer our vehicle, they prefer the data that comes off our vehicles as an understanding of the manufacturability of the fit between the specific technology choices they are making and the ones the manufacturers are making.

Okay, great. And then are you seeing any kind of migration from all the spend [ph] what you're doing to your customers, other product lines like the memory side?

Yes. Still primarily focused on the logic side of the businesses across the customer base. We do from time to time see opportunities in memory, but we haven't given it a lot of focus yet. That may change as we go through 2012. But right now, 2012 will all be about logic.

Your next question comes from Adam Fisher [ph].

AMD talked a lot in both their Analyst Day and on their calls about increased yields that GLOBALFOUNDRIES particularly. Can you talk at all, though, how we might have played a role in that? Their discussion of our technology and their call has kind of coincided with an increase in their yield seemingly?

Yes. Thank you. Yes, so I'll try to take that question. I mentioned it also in our call. We are very pleased, I guess, at some levels for fabless guys, it's better if they don't mention PDF in their call, that means they're not talking about manufacturing they're talking about product. But as you've probably seen on many of the calls, for the fabless industry, yields on 32 and 28 are hard to achieve. AMD talked about how using our Characterization Vehicles and our technology could help them build a tighter relationship with their key supplier and result in better yields in Q3. They said this was the way that they had already put in place to improve their manufacturing. And then after their fourth quarter, they said that they had improved manufacturing as a result of applying our technology to that ramp. For us, that's just a super nice endorsement of how Characterization Vehicles and the PDF technology can help bridge the gap between manufacturers and designers. I think they mentioned us in both cases because there is a cause and effect there.

And I think historically, our relationship with AMD's have GLOBALFOUNDRIES had been mostly in Asia. My understanding is AMD's volumes generally come out of the Dresden facility, which GLOBALFOUNDRIES has kind of discussed being kind of, I think, 30,000 to 40,000 wafers a month capacity. Is that all incremental capacity to us as we go forward with that relationship?

Yes. Obviously, AMD is using up the liability of light interest [ph], and that is incremental capacity to us as we go out to 2012.

And your expectation as if they'll use us on additional nodes going forward?

It always comes down to achieving great yields for accounts when they achieve great yields, when they -- since they're getting great yields as a result of applying here, they tend to apply your technology on more product lines, future products, et cetera. So we would -- our expectation, as we said in our prepared remarks, is to drive even further, to achieve customer's yields this year. And we expect that as we've always seen when customers get great yields from us they repurchase.

The second part of my question has to do with our large Asian customer who discussed -- who just finished building a fab in Texas. And I believe they've talked about being in full capacity there. My understanding is that as their wafer volumes, their increase are gainshare should kind of commence, certainly increase, is that -- is that a fair assessment?

Yes, that's a fair assessment.

Okay. So can you discuss at all kind of on a percentage growth basis? We touched x number wafers in 2011, how many we could potentially touch given our current customers in the new capacity that's come online over the last couple quarters that we're now touching kind of what the percentage growth would be?

That's a great question, Adam. I don't -- we don't have the number off the top of our head. As we said in our prepared remarks, right, we've made a lot of investments in the leading edge with a number of companies that have been investing very significantly in our capital in the leading edge over the last couple of years, and we anticipate that bearing fruit for us. As we go into 2012, the exact amount of fruit and how significant it's going to be, it's really hard for us to quantify it right now. They certainly built a lot of capacity. I mean, the capacity builds at least a couple of our customers has been quite substantial. So we anticipate that, meaning that there's a lot more wafers that we are going to be cutting [ph] wafer use from or gainshare from in the 2012 time period and the 2011. But we don't know that we have a specific number to say, it's any percent out.

Okay. Can you talk at all about, you mentioned a software contract with -- for next generation, I think, YieldAware. Can you -- you sounded significant, but can you certainly elaborate a little bit the significance of that product, the significance of a customer adopting kind of it this early in the life cycle, et cetera? And maybe give whatever detail you can around the kind customer it was?

Yes. So with the customer that's in the alive [ph] area, in the image center area, actually. And that customer has been a customer of ours over years. And we said, an existing customer, primarily in the logic manufacturing area. What we see more and more, as more and more [ph] moves from scaling it's purely with the graphics to scaling and technologies start having more and more unique materials, unique capabilities, et cetera. Your ability to control a manufacturing facility based purely on looking at inspection data or visuals doesn't give you a lot of indication about the actual control. It gives you one piece of information. We made an investment. We thought it was coming back in 2005, started making investments in 2006, and the first set of engagements with the logic manufacturers where the investments were very high, we could charge an awful lot for the deployment of the solution, and really it was a very human-intensive deployment to get the system up and running and be able to make some small impacts. We use that to understand how to make the system more deployable, more efficient in the way it ran less human intensive on a deployment. This new -- the other process control solution is our kind of next, our third evolution in this field. And here's the case where we've got a customer signed up today, because I think they recognize how important it is in the image sensor market. And we're doing a deployment going, I think quite smoothly and much less intensively from a human capital standpoint. That's why, as I said in my prepared remarks, we feel like we have an opportunity to expand the number of places we can deploy the solution and the number of different end markets where we think this kind of capability would be valuable. Still hard for us to kind of put a number on what the opportunity is and how much we can get out there. But when we made this investment, we worked a lot with the gain system guides on their businesses, and one of the things they always told me about being efficient in manufacturing was we gave them an efficiency to dial up how much of the market. If you can sell an X-box to pay a little money, you can get a lot of them out there and then make the money off the title. For us, we're trying to make our deployment as efficient as possible, so we can really understand what's the market opportunity. We'll have our deployment was self-centered, there's risk in taking on adjacent markets.

Does the new solution open up new opportunities for you? The lower capital and person -- people intensivity of it? Does it open up some opportunities that we may not have had up to this point?

Yes, that's our expectation. And we're measuring it's engagement pretty heavily to see exactly what the deployment cost is for us. And it's been substantially less so far. We feel pretty good about it, very good about it.

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