Pdf Solutions Inc Q3 FY2021 Earnings Call

Good day. Thank you for standing by. Welcome to the PDF Solutions’ Third Quarter 2021 Conference Call. At this time, all participants’ lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session for which instructions will be given at that time. I would now like to hand the call over to Joseph Diaz of Lytham Partners. Please go ahead, sir.

Thank you, operator. And thanks to all of you for joining us today on this call. We appreciate your time and your ongoing interest in PDF Solutions. As the operator indicated, my name is Joseph Diaz, I’m with Lytham Partners, we are the Investor Relations consulting firm for PDF. If you do not yet have a copy of today’s press release, it’s available on the Company’s website at pdf.com. Some of the statements made during this conference call will be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding PDF’s future financial results, performance, growth rates and demand for its solutions. PDF’s actual results could differ materially. The forward-looking statements and risks referred to on this call are based on information available to PDF today. The Company has no obligation to update them. You are advised to refer to the section entitled Risk Factors on the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020 and similar disclosures in subsequent SEC filings. With that, I would like to introduce John Kibarian, PDF Solutions’ President and Chief Executive Officer. He will be followed by Adnan Raza, Executive Vice President and Chief Financial Officer. At the conclusion of management’s prepared remarks, we will open the call to your questions. Let me now turn the call over to John Kibarian, President and CEO of PDF Solutions. John?

Thank you for joining us on today’s call. If you have not already seen our earnings press release and management report and 10-Q for the quarter, please go to the Investors section of our website, where each has been posted. I will start the discussion by providing commentary on the third quarter. From there, I'll provide our impression of the semiconductor industry and conclude with our expectations for PDF’s business for the remainder of the year before handing the call over to Adnan for a more detailed financial update. Highlights for the third quarter demonstrate the progress the PDF team has made over the last few years. As we've discussed over many quarters, some significant legacy Gainshare contracts ended in the first half of this year. This meant that Q3 for us could have been a challenging quarter. That said, by the second quarter of this year, we had expressed confidence that given a strong bookings and valuable nature of our analytics business, we anticipated that Q3, despite the Gainshare headwind, would be up modestly in terms of revenue versus Q2. Now, with the third quarter behind us, we can report that the company achieved record revenue, with meaningful quarter-over-quarter growth. Despite the significant drop in very high margin Gainshare revenue, we also saw improvements in our gross margins and net margins. This is due to achieving more scale under our Analytics subscriptions. As a result, even with the headwind of decreasing Gainshare, we made progress toward our target gross margins. Turning to bookings, the third quarter was particularly strong and exceeded even last year's third quarter bookings. As some of you remember, it was one year ago that we closed the Advantest partnership, and with it a $50 million contract. At the time, we reported that it was a remarkable quarter, as the partnership had taken years of meaningful discussions to bring to fruition. We communicated then that we did not expect to meet or exceed the previous performance level for a while. Exceeding the previous bookings milestone in just four quarters speaks of demand for our products and services. When we consider all of these factors, we believe that from a financial metrics perspective, this quarter has demonstrated that the company's transition to analytics will lead to improved growth and financial leverage as we bring the business to scale. Now, let me provide a little more detail about the bookings in the quarter. Our bookings in Q3 timely came from Analytics. We had a strong quarter in Exensio bookings, with the majority of Exensio bookings on a dollar basis continuing to be from customers moving to the cloud. This included another eight-figure cloud bookings, as an enterprise customer moved from on-premise to cloud deployment in order to leverage the benefits of Exensio’s big data storage and end-to-end performance. This quarter also included a Tier 1 auto supplier that renewed its initial Exensio cloud deployment, as it expands the use of silicon in the electrification of car drivetrains. As semiconductors become more critical to automobile manufacturing, we are seeing manufacturers look to use Exensio's capabilities to improve visibility in their technology and supply chain. We also had strong Exensio bookings from front-end fabs deploying Exensio process control, as the demand for additional fab capacity drove further deployments of Exensio. Building with the demand for semiconductor capital equipment, we experienced another quarter of strong Cimetrix runtime license bookings, as equipment companies ordered Cimetrix connectivity and equipment control software licenses to ship with their products. As I discussed earlier, Yield Ramp revenue was down significantly as legacy Gainshare contracts completed. While we're not emphasizing integrated Yield Ramp contracts, we have started to see some increases in the volume reports from customers including Chinese fabs where we are seeing significant equipment installs. We anticipate modest improvements in integrated Yield Ramp revenue going forward. Lastly, as some of you may remember, we reported a quick-start Analytics contract signed in Q2. We completed the follow-on multiyear contract in Q3. This contract includes the use of our characterization systems for electrical test, a DFI e-beam system, and Exensio systems including our DFM software. As a result, we began shipment of our PD fast testing eProbe DFI measurement systems to their facility. For customers innovating on the leading edge, speed comes from having huge relevant datasets to be able to see failures at the parts per billion level. We believe that our DFI and CV systems provide the largest datasets, which enable superior learning using our Exensio Analytics software. Our DFM capabilities allow our customers to anticipate how improvements in manufacturing will impact future products, which is particularly important for foundries that must support a rich set of designs. With strong bookings spanning our Exensio Cimetrix conductivity characterization vehicles and DFI systems, the third quarter demonstrates that PDF’s broad value and strategic relevance across various industries from high voltage power IC manufacturing to the most advanced process technology development, from equipment companies to system manufacturers, PDF’s manufacturing analytics platform is becoming ubiquitous in the IC industry. Now, let me turn to our perspective on the IC industry and expectations for the fourth quarter. The industry continues to operate at a high level for manufacturing and R&D. Maximizing existing operational effectiveness, as well as developing new products and processes, is critical to the industry in this setting. As a result, customer interest in our products and solutions remains strong. We are pleased with the progress in the first three quarters of the year in making PDF Solutions the manufacturing analytics platform for the industry. This enables us to build recurring revenue streams to provide greater visibility and predictability to our financial results. Finally, I want to thank our employees for nimbly supporting our customers and continuing to innovate in the COVID-19 environment. Now, I'll turn the call over to Adnan for a review of the financials. After which, we will open the call up to your questions.

Thank you, John. Good afternoon, everyone. Good to speak with you again today. And I hope all of you and your families are keeping safe. We are pleased to review the financial results of the third quarter and to bring you up to date on the progress of the business. We posted our earnings release and management report under the Investor Relations section of our website. Our Form 10-Q has also been filed with the SEC today. Please note that all of the financial results we discuss in today's call will be on a non-GAAP basis and a reconciliation to GAAP financials is provided in the materials on our website. Financial results for the third quarter 2021 continued the strong momentum of the first half of the year. Third quarter total revenue was $29.6 million, up 28% from the comparable quarter last year and up 8% on a sequential basis from Q2 2021. Analytics revenue was up 90% to $27.2 million in Q3 2021 versus $14.3 million in the third quarter of last year and was up 39% sequentially from the prior quarter this year. While we do not expect this level of Analytics growth next quarter, based on continued strong bookings we expect year-over-year revenue and backlog to continue to grow this year. For the quarter, Analytics represented 92% of total revenue. IYR revenue for the quarter was $2.4 million versus $8.8 million during last year's third quarter and represented approximately 8% of total revenue for the quarter, as some of the IYR contracts came to the end of their Gainshare period. We expect that IYR revenue will pick up marginally in coming quarters for the reasons John highlighted in his prepared remarks. The IYR component of our business is lumpy by its very nature. And as we have previously stated, if customers want to engage in IYR in a meaningful way, that's a benefit to PDF shareholders, we will certainly work with them. Our transition to become the leading analytics software provider to the global semiconductor supply chain is continuing at a very consistent pace. And we expect that to carry on going forward. Booking momentum remained strong. Our bookings for Q3 exceeded the extraordinarily successful bookings of Q3 of last year when Advantest became a customer. For the nine months through Q3 2021, our bookings have now exceeded the bookings for all of prior year 2020, which in itself was remarkable booking growth year. Backlog at the end of the third quarter totaled to $181 million. On a sequential basis, that represents an increase of 30% from the $139 million the prior quarter. Notably, compared to the third quarter of 2020, our backlog is up 60% on a year-over-year basis. Our strong bookings growth and sizeable ending backlog sets a meaningful base for total revenue growth into 2022 and beyond. Our cost of sales and operating expenses for the quarter were essentially flat on a sequential basis compared with the second quarter of 2021. While we have a strong focus on managing expenses, we will make the necessary investments to enhance our technological capabilities and competitive positions. This quarter, we were able to expand gross margins to 66% and continue our progress towards the 70% gross margin goal we shared in our fall 2019 Analyst Day. We were also able to deliver $2.4 million of operating income this quarter, compared to the almost breakeven operating income last quarter. We're pleased with the positive $0.09 of non-GAAP EPS reported this quarter as a result of the strength in our revenues and management of expenses. We're also profitable on a non-GAAP net income basis for the nine months of 2020. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of approximately $141 million, compared to $139 million for the prior quarter, and no debt. Cash flow from operations for the third quarter was positive $4 million. We have also generated $3.8 million of cash flow from operations on a year-to-date basis. We expect to end the year with another continued year of operating cash flow generation. Our business continues to be strong across all sectors. We expect full-year 2021 total revenues to grow on a year-over-year basis near the top end of the previously communicated 20% to 25% range. We also expect full-year 2021 Analytics revenue to grow on a year-over-year basis more than 50%. We feel that we're well positioned for 2022. With that, I'll turn the call over to the operator to commence the question-and-answer session.

Your first question comes from the line of Blair Abernethy of Rosenblatt Securities.

Just wondering if we could talk a little bit about, with the growth that you're seeing in the Analytics business, the Exensio platform, just what are you doing on the go-to-market side in terms of your plans for the balance of this year and looking into next year? Are you ramping up your sales rep capacity? Are you looking at partnerships? Just kind of want to get a sense of what you're doing to continue that momentum?

Thank you, Blair. So partnerships are very important. The Advantest partnership has demonstrated that. And we do see other partnerships out there that we've been working on for quite a while that we believe at some point over the next few quarters will come to fruition in different ways. As we've moved more and more users of Exensio onto the cloud, there's a lot we can do to make it easier for them to use Exensio with all the other systems and hardware that they need to operate in order to get produced chips. So, when it's an on-premise system it’s very difficult to do because every customer deploys in different ways. As they move to our cloud solution, it's much easier to help them be more productive with the platform. So partnerships are very important. As well as to your point around building out our channel and our ability to reach more customers, we had the benefit of having been in business for a long time and kind of grown Exensio over many years kind of organically, over 130 Exensio customers out there, are substantially more than that now. And we're able to go back to them and move them, we don't feel any of them are fully penetrated, moving them from using parts of the platform to using the broader session of the platform. The first step again for that is to move them to the cloud, where we can then upgrade them with more modules and more capability quite comfortably. So those two areas, moving into the cloud and partnerships are the two biggest things we're doing, Blair, and then subsequently, more investments in the channel and more applications on the platform.

Your next question is from Tyler Burmeister of Craig-Hallum.

Hey, guys, this is Tyler on behalf of Christian. Thanks for letting us have a couple of questions. John it’s great to hear that your quick start contracts complete in the quarter and you signed an additional multiyear contract with a customer, I think you said. I was just wondering, any additional color you could give us there on maybe the size of that contract, the timing, near-term, long-term of it, any additional color there would be great? Thanks.

Sure, Tyler. Yes, we were happy to sign that contract as well. As you can imagine, based on the components of the technology, it pretty much includes many of the components of PDF, with the exception of Cimetrix, it includes Exensio, the ease-in capability and electrical test characterization of vehicles, the Exensio DFM modules as well. So it's a very big set of technology and all-encompassing departments. So as you can imagine, contract wise, it's one of the larger contracts we've done on a subscription basis. It's multiyear, with a minimum of a couple of years of extensions. So it's quite substantial in that regard as well. That gives a lot of time to really have the customer get value out of systems and then deploy it more broadly. We, of course, hope to build on this with this customer as well as others, because we feel the platform is quite valuable. And with the investments now going on in the leading edge, we believe it's quite an opportunity for the solution.

That's great to hear. And then this year, a very strong year for your Analytics business, going to grow over 50%. But you also have seen some record bookings heading into next year. Would it be fair to assume you're going to continue to be able to grow the Analytics business ahead of what I think is 20% CAGR target in the next year?

Yes. It’s a great question, Tyler. We're doing our strategic planning now. As we get into 2022, we will provide our perspective on growth rate. We had said at Analyst Day that we thought Analytics would grow 20% and the business would asymptotically approach 20% as Analytics makes up the majority of the business now you can see in Q3 Analytics was 92% of the total business. And we're giving guidance that the growth for the overall company would exceed between 20% and 25%, close to the higher end of that range. So obviously, we're kind of already a little bit beyond where we previously expected the business to be. But we're going to go and look at how the remainder of the year works on what we think the future looks like. Obviously, the industry overall is very robust. That would give us some confidence, but we need to see the details of how things work before we kind of say anything more.

Your next question is from Gus Richard of Northland.

John, congratulations on the large contract and Exensio deal as well. I'm just wondering if I can dig into that contract a little bit. Can you give us any color on the sort of the split between DFI, CVs and Exensio on that contract?

Yes. I don't know how we would go about doing that, Gus. I mean the reality is it was a bundle of all those things. Obviously, from a cost standpoint, if you look at our cost to deploy, the DFI has the biggest costs and the machine is the most significant, but I think in terms of value, it’s a more judgmental thing. I think what the customer is buying is an integrated solution that really helps them get technologies developed more robustly and more to a higher level of manufacturability quicker. So it's hard to say, what's the piece that really makes a difference?

Let me try it this way. In the contract, how much of it is recurring and how much of it was like an upfront placement into DFI, use it like…?

It's all recurring, Gus. It's a subscription paid over multiple years.

So all the pieces?

Correct.

Okay. And is it reasonable to assume it was similar in size to the Advantest deal?

Gus, we are really not disclosing a specific number. I mean, obviously, it's a significant deal, right? So, but the specific number we haven't disclosed.

In relation to the IYR business, it appears that Gainshare has reached a low point and, with volume expected to increase going forward, are there any other contracts that might be expiring soon that could have a significant impact?

No, we don't really at this time.

And then the last one for me. Are there any fixed fees remaining in the IYR left? Or is it just one Chinese foundry or is that it or are there more?

That's a good point, Gus. If you remember in the second quarter of this year, we did sign a relatively large multiyear fixed-fee contract that goes out over four years. That is included in that number as well.

Okay. It was a fairly substantial sequential decline in that business. And I'm just sort of was there a lot of fixed fee revenue in the second quarter?

No, it was a couple. The number of contracts actually expired at the end of Q2, so on the Gainshare side. So Gainshare fell off pretty substantially. I mean there was some drop-off in fixed fee revenue, not because contracts ended, but just the percent completion, ability to actually deploy vehicles and things to that account. So it was some small amount of revenue decline quarter-over-quarter on a fixed fee basis due to just deployment capabilities, primarily in China, but the majority of that decline was in number of not just one, but a number of Gainshare contracts coming to their end.

And then the final one for me. Given the large contracts in the quarter, is there any incremental operating expenses required to support the new contracts that are starting to deploy?

Yes, I mean, our expenses, we expect that we've brought them to the right level. In going from now into Q4, we expect there may be a slight increase in some of those expenses. But hopefully, our revenue is also maybe flat to slightly up. So we'll manage the expenses along with those revenues. But it's good to have this problem that we have, as we have more customers to meet demand for both on the Analytics side, as well as the continued engagements from the past on the IYR side that we just talked about.

I think specific to your question, Gus, the capability required to meet that large contract is in place.

Your next question is from Gary Schnierow of RiverPark Funds.

Following up on Gus’ question, absent that big quick start contract, your core Exensio business, I'm assuming that still grew quarter-over-quarter?

In a way that we are very pleased about. We don't disclose the numbers. But on a percentage basis, yes, it would annualize to a number well ahead of our 20% that we’ve talked about.

And can you talk about your CapEx in the quarter? It looks like you stepped that up significantly. What that is and why you felt doing that?

Yes, I mean, as John explained, we had the big contract. And as I think he was being asked about what are the different components of that contract, you obviously heard him talk about different machines we have as well. So, some of the machines that we have in our lab as we start to get them ready for customer shipment, there will be some upgrades that we have to do on those machines and predominantly that's what drove the increase. From time to time, we will also be updating these machines as you know this number was more like around 500 for Q1 and Q2 but markedly lower compared to last year, which was also lower. So every year we have started to bring that number down. But as we get ready to ship machines or do some special projects for customers, sometimes in our lab, we will from time to time be spending to upgrade the different hardware pieces.

Also, as we deploy DEX nodes across that environment, you'll see us have CapEx tick up for hardware that we place at OSATs too, which I think this past quarter was a small piece of that number. But I believe in Q4, there'll be another piece also with that.

So when you're saying about getting the equipment ready, it sounds like the CapEx step-up is not just for the quick start contract but getting equipment ready in anticipation of other contracts or in hope of other contracts. Is that fair?

Yes. There’s equipment purchases mainly related to electrical tests on the ease-in side for the IYR contract and some other expected activities. While I’m not certain about Q3, I know we’ve made some purchases and I can’t recall the exact timing for computing support for DEX nodes at specific OSATs. All these factors contribute to that total, and I don’t believe any single item stands out significantly.

Let me ask it a different way. Is part of the CapEx to have additional eProbe machines?

We have additional eProbe machines, Gary, but it may be to replace some components on the eProbe machines for new applications that we're developing. So in that terms, it could have involved it. But it's not just for specifically for machine shipment to clarify. Probably that machine has very little CapEx associated with it at all.

Your next question is from Corey Tobin of William Blair.

I just want to come back to the sequential increase in Analytics revenue; it's a real nice move up. Is this a new baseline we should think about? Like is the $27 million we saw this quarter the majority of it recurring, and therefore we should expect to see to grow up that $27 million as we move ahead into Q4 and into 2022?

Look, I mean, our focus has been to continue to transition the business towards analytics and that too on multiple prongs, not just the Exensio software, but also on the other pieces within analytics. So yes, we're starting to feel comfortable with this level of Analytics revenue.

Meaning that’s we should build off it from here. There's not a ....

That's right. And look, I mean, precisely to help you all think about how to model this is kind of why we put some of those thoughts around what we expect the total revenue to be doing for this whole year, near the 25% range that we had prior communicated as well as the Analytics business. So hopefully, when you go back into the math, you'll see that we're saying that for one quarter left, the numbers will support the similar levels of Analytics revenue or slightly up.

And the contract value that you mentioned, the large contract. That's a TCV value, that's the total contract value or is that the annual contract value?

I think we reported the total, but we haven't disclosed a specific value or the total contract value. However, on both an annual and multiyear basis, it’s a very substantial contract in those contexts if you examine it.

And I guess you were referencing the 8 figure bookings you talked about…

Eight figures, that is total contract value for the Exensio project.

That’s a TCV number, okay. Congrats again. Thank you.

Your next question is from Orin Hirschman of AIGH Investment Partners.

Thank you. AIGH Investment Partners. And again, congratulations, I'll add to that, that really seeing the breakthrough numbers here. In terms of a very large contract, is that total contract value reflected in the bookings this quarter or only part of it?

The parts that are non-cancelable. So, yes.

Okay. Just in terms of general trends, if I asked you, yield improvements and automation in general versus smaller lines becoming more critical, and you becoming more critical for that, what's driving this? Because this is kind of turning explosive on you, which you have been hoping for, for the last few years. What are the drivers here?

Thanks, Orin. Yes. What's really exciting right now is that, as you mentioned in your question, we have evolved from focusing mainly on a very limited number of advanced node customers. In this quarter, we secured several significant contracts with companies involved in trailing edge technologies, particularly in high voltage applications and microcontrollers. Additionally, we remain highly relevant to leading edge companies, as demonstrated by a substantial contract that followed our quick-start initiative. Our analytics are now in demand across a wider spectrum of companies, as investments are being made not only in leading edge technologies but also in new developments and capacity for trailing edge nodes. For instance, companies like the Tier 1 auto supplier are increasingly dependent on silicon for critical components, leading them to seek out Exensio Analytics. This quarter highlighted the broad nature of our business.

Just two follow-ups. Just on that drivetrain application, you'd never necessarily think that a company like that might think it's not a normal bouncy type of situation. You'd never think of them thinking so deeply about analytics for a better yield. Is it more than that? Is it without analytics, yield is poor? What is it? Why would they even think of that?

Yes. The electrification of cars makes high voltage transistors extremely important as they determine quality, fire risk, reliability, and the lifespan of the vehicle. Therefore, the manufacturing of these components is crucial. We've observed that chip companies are moving into wafer production, with one company announcing its own wafer manufacturing. Companies that traditionally operated with 200 millimeter manufacturing are advancing to 300 millimeter, and firms like DENSO and Bosch are developing fabs and enhancing their high voltage silicon capabilities due to the significant value it brings to vehicles. While you may not immediately use ADASH, there are regulations concerning the adoption of electric cars. The market is evolving rapidly. Exensio Analytics offers a robust means to achieve the highest standards of quality, operational efficiency, and yield. This capability is valuable for many of our existing customers, and we're also attracting new customers, such as auto suppliers aiming to enter the Tier 1 auto industry and venture into the silicon market to gain more control over their future.

Out of curiosity, if you can say those two power names that you mentioned existing customers and/or new customers?

Probably, we're always careful about who we say is our customer. But suffice it to say, we've always sold first to top tiers of every market we get into typically.

A question about silicon carbide; silicon carbide requires significantly more testing, is very delicate when handling super high voltages, and involves difficult tests. Much more rigorous testing is being carried out. Is there a specific module for that? Is it more challenging, so it’s not a key factor for new power customers?

That’s a great insight. Yes. It is an area that we have capability on Exensio test, and they have very complex burn-in and test process. We have in Exensio unique modules that are able to load that data and align it and analyze it. And that has been something we've been piloting with those customers today; there's not an important part of our revenue. But we believe it will more and more be an important part of our revenue because of exactly the hot points you highlighted in your question.

Last comment. On one of the previous calls, you’ve given a number just to give an indication of what kind of data points at Analytics and data points are being pulled in every day by your customers. And I forgot the number; it was an astounding number. As you're transitioning almost from being associated with the semi-cap space, which isn't the best place to be right now, by the way, and maybe for the next few years, but there's more here where once in a while people are actually thinking a lot of the SaaS name finally. You probably process more data points than many SaaS companies do at this point, and certainly more mission critical in a way. Is it impossible to give out for giving out some metrics in some creative nice way that people will be able to understand just what type of incredible processing that you are doing for these customers?

Yes, that's a great point. We are monitoring the volume of data being transferred into Exensio clouds for our core customers. As you mentioned, several customers have transitioned to Exensio on an enterprise level. We anticipate that many of these customers will be fully operational soon. This process takes several months because they also want to upload historical data into both the cloud and on-premise systems. Throughout 2020, we will begin to share the size of the Exensio cloud database, which is expected to reach multiple petabytes of data processed daily. Your observation is accurate; the daily numbers are indeed substantial. While there may be numerous large datasets in the cloud, our focus is on mission-critical manufacturing data, which represents a significant volume of information we handle for our customers. Much of this data originates from external sources, including suppliers, foundry tests, and assembly processes. Therefore, we are creating a complex framework to support our customer base.

And if I may just one last question and I'm sorry I'm taking so much time. But just in terms of being able to cross-utilize what you learned across customers, I believe that you are able to do that obviously anonymously. If that is the case, is at some point will you become almost like a must-have because they want, they need that cross-analytics in order to get the best bang for the buck?

Yes, "must-have" is a very strong term, and I always approach it with caution. However, the point you raise is important. In our customer contracts, we do retain the rights to use the data to improve our algorithms, which ultimately benefits them by helping them uncover insights more effectively. The larger the dataset we have to work with, the better our algorithms perform for our customers overall. We aim for our platform to become the most effective analytics tool in the industry. I am cautious about using the term "must," but we do agree with your general perspective. Whenever I meet with operations executives from the fabs, often through Zoom, they express a desire for our algorithms to detect subtle quality issues more quickly and efficiently. They want to avoid having to explain problems to their customers that could be embarrassing, and they expect our software to catch these issues. Therefore, they want us to refine our algorithms just as you described, which we hope will enhance our significance to them.

No questions at this time. I would like to turn the call over to John Kibarian, CEO of PDF Solutions, for closing remarks.

Thank you for participating in our Q3 call. We look forward to talking with you again soon. Stay safe and have a great day. Goodbye, everyone.

This concludes today's conference. Thank you for participating. You may now disconnect.