Pdf Solutions Inc Q1 FY2023 Earnings Call

Good day, everyone, and welcome to the PDF Solutions Inc. Conference Call to discuss its Financial Results for the fourth quarter and year-end 2023 Conference Call Ending Saturday, December 31, 2023. As a reminder, this conference is being recorded. If you have not yet received a copy of the corresponding press release, it has been posted to PDF's website at www.pdf.com. Some of the statements that will be made in the course of this conference are forward-looking, including statements regarding PDF's future financial results and performance, growth rates, and demand for its solutions. PDF's actual results could differ materially. You should refer to the section entitled Risk Factors on pages 15 through 29 of PDF's annual report on Form 10-K for the fiscal year ended December 31, 2022, 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 your host, John Kibarian, PDF's President and Chief Executive Officer; and Adnan Raza, PDF's Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you for joining us on today's call. If you've not already seen our earnings press release and management report for the first quarter, please go to the Investors section of our website, where each has been posted. The first quarter was a good start to our year. Revenue remained strong, and we benefited from our newer strategic partnerships as we experienced continued adoption of our end-to-end analytics by our customers. Before Adnan discusses the financials in detail, I have some comments about the events in the first quarter and our perceptions of the market in the second quarter and the remainder of the year. Bookings were light in the first quarter following record bookings in Q4. This is a similar pattern to Q2 of last year, which also followed a strong quarter. Despite the bookings level, activity with customers remained very strong. In the quarter, we started benefiting from our collaboration with SAP. We experienced our first large seven-figure booking for our products that integrate SAP's HANA ERP data with manufacturing analytics data, enabling more accurate and timely applications for operations and finance organizations. Our solutions are designed to enable customers to react more quickly to changing business environments. This product is a result of our collaboration with SAP as well as our acquisition of Cimetrix that we completed about three years ago. The solution provided to the customer includes our Sapience Manufacturing Hub, which enables near real-time connection between ERP, manufacturing, and engineering data, as well as an extensive application that leverages financial, operational, and engineering data. More than this being an important first proof point for our collaboration with SAP, many of our customers are expressing interest in this application. While SAP-generated business was the largest strategic partner-related booking in the quarter, our other collaborations also resulted in bookings and important leads. In total, over 40% of bookings in Q1 were via our strategic partners. This speaks to the value of our collaboration strategy. As the largest independent end-to-end analytics SaaS provider to the semiconductor industry, we are a natural partner. Other significant bookings in the quarter include contracts for leading-edge infrastructure for advanced development, including one with a memory customer. Our memory customers are experiencing a strong correction this year, so we were encouraged to see this customer investing with PDF solutions. Gainshare remained nearly unchanged from Q4 of last year as customers, particularly in China, shipped at similar volumes. Finally, bookings for Cimetrix's connectivity runtime licenses decreased significantly in Q1 versus Q4 as our customers' equipment shipments decreased. This is not surprising given the weakness in the capital equipment market. Overall, with our strong backlog and business model, where most of our revenue is ratably recognized, we continue to deliver strong results in revenue and earnings. We were pleased with the business activity in the quarter as it demonstrates the strength of our business model and partnership strategy. Now let me turn to discuss product development. Beyond the Sapience Manufacturing Hub, we have other new products and capabilities coming up this year. This includes the next advancement in our eProbe DFI tool. As part of the large contract we signed last year, we shipped the first of these advanced tools in April. It is designed for customers ramping three- and two-nanometer technologies, which often include backside power and gate-all-around structures. We are very excited about this milestone. Customers are building more system and package products, targeting end markets where quality is key, such as automotive and data centers. For these customers, it is critical to use more advanced test screening at more test insertion points. We have built Exensio test exactly for this emerging need. This week at Advantest's Voice Conference, we will demonstrate the next set of applications for their ACS Edge box. These applications are designed for customers to deploy machine learning models at scale and benefit from our DEX Data Exchange Network and Exensio cloud platform, managing the required data feed-forward and feedback, as well as model building and model quality monitoring. Overall, from a product release standpoint, we expect the first half of this year to be very fruitful, which we believe will position us to have strong results this year and in the future. One quarter into 2023, the semiconductor environment is unsettled. There has been an inventory correction affecting many of our fabless and IDM customers. This has also generally impacted the foundries, OSATs, and equipment companies that we serve. While the short-term environment is unclear, the long-term drivers for our customers, including increased use of AI/ML, cloud, smart devices, and the electrification of the energy economy, remain in place. These drivers are being amplified by the various government investments in semiconductors we are seeing around the world and the increased diversification of the supply chain that many of our customers are embracing. We remain confident in the outlook we provided earlier this year of overall annual revenue growth for the year approaching mid-teens. We would also like to announce that from October 24 through 26, we will have the PDF users group meeting at the Santa Clara Marriott. As with our pre-COVID event, we will host an Analyst Day on October 24. This gives our customers, partners, analysts and stockholders a chance to see the latest capabilities in PDF and also learn from each other. We hope that you'll be able to attend. I want to thank all the PDF employees and contractors for their efforts this quarter. Now I will turn the call over to Adnan who will review the finances and provide his perspective on our results.

Thank you, John. Good afternoon, everyone. Good to speak with you again today, and I hope all of you and your families are well. We are pleased to review the financial results of the first quarter of 2023. As mentioned, our earnings release and the management report are posted in the Investor Relations section of our website. Our Form 10-Q was also filed with the SEC today. Please note that all of the financial results we discuss in today's call are on a non-GAAP basis, and a reconciliation to GAAP financials is provided in the materials on our website. We are off to a good start with the first quarter of 2023. Total revenues for the first quarter were $40.8 million, up 22% over last year's first quarter and up slightly on a sequential basis as well. Analytics revenue came in at $36.3 million, an increase of 19% year-over-year and also up slightly on a sequential basis. Our year-over-year strong performance is a result of the strength from Leading Edge and Exensio business, offset by some of the equipment shipment trends we saw recently. For our Exensio products, we are benefiting from the recent large deals we spoke about over the last few quarters, utilizing the Exensio platform across manufacturing operations. For our leading-edge solutions, we continue to engage strongly with multiple customers and see opportunities to expand this business. For our Cimetrix products, while we saw a meaningful impact due to the downturn in capital equipment spend, we benefited from our investments in new products such as Sapience Manufacturing Hub. Taken as a whole, we believe our analytics business continues to be strong, exhibiting near or in-line growth to our long-term growth targets. IYR revenue came in at $4.4 million and was up 44% over last year's first quarter. We are pleased that we have been able to rebuild this business over the last 1.5 years to meaningful levels. Our backlog for the quarter ended at a strong $261 million level, though down from $278 million a quarter ago. As John mentioned, our bookings will vary in size from quarter to quarter, and we are encouraged by what we see in our pipeline for the rest of the year. On a year-over-year basis, our backlog at the end of Q1 is up over 30%. Our gross margin for the first quarter came in at 75% versus 69% for Q1 last year and 74% for Q4, as we benefited from incrementally higher revenues and were able to realize savings from lower expense accruals and some cloud spend optimization. Our operating margin for the first quarter came in at 19% versus 11% a year ago and 20% for the prior sequential quarter. On a year-over-year basis, the operating margin expansion was driven primarily by stronger revenue growth, coupled with lower expense growth from our cost of sales and operating expenses. We have improved our margins compared to last year as we reap the benefits of scale in our cloud business, allowing us the ability to apply engineering resources efficiently and more effectively manage cloud spending. Net income for the quarter totaled $7.3 million or $0.19 per share, both essentially similar to Q4; however, meaningfully higher compared to Q1 last year's net income of $3.7 million or $0.09 per share. On a year-over-year basis, our EPS increased by $0.10 per share. Turning to the balance sheet, we have carefully managed our cash position and carry zero debt. We ended the quarter with a cash and equivalents balance of $133.5 million compared to $139.2 million at the end of the prior quarter, with the change driven primarily due to the timing of the payment of accrued employee bonuses and CapEx spend to support the opportunities ahead of us. As we look to the next quarter and the rest of the year, we expect to moderately increase costs for ramped investments to meet the bookings opportunities and customer pilots for a stronger second half of the year. For the full year 2023, we continue to be comfortable with our previously stated revenue growth rates approaching mid-teens on a year-over-year basis. All in all, it was a solid first quarter and positions us well for the rest of the year. We are pleased with the resilience of our business model and the realized and potential value from our strategic partnerships. We also look forward to hosting you all during our planned Analyst Day and PDF User's Group conference starting on Tuesday, October 24. Please look for a save-the-date press announcement later this week. With that, let me turn the call over to the operator for Q&A.

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

Great quarter, everyone. John, could you provide more details about the manufacturing execution systems solution with SAP? Regarding this seven-figure deal, what is the typical selling cycle, and can you share some insights on what the pipeline looks like moving forward?

Thank you, Blair. We have been in discussions and collaborating with SAP for a couple of years on this application. While that period wasn't strictly the selling cycle, it involved designing and developing the software, as well as showcasing it to several early potential customers, including our first customer. The deal was actually closed fairly quickly, aided by their guidance on how to engage in this market segment, which connects us with parts of organizations that have been our clients for years but in a different capacity. The applications leverage real-time data from Exensio to track consumable usage, processing times, and yield at various stages. By integrating this with ERP data and manufacturing execution system data, operations can achieve precise costing models, gaining insights into their costs on a per-product and per-route basis. Additionally, there are other applications that improve the analysis of field returns and economic evaluations. In this initial contract, we sold the costing module along with the base platform that integrates the data for a customer undertaking a significant SAP deployment. We've also engaged with several other customers, introduced to us by SAP and others, who are interested in the same application. Before we started this, we noticed strong demand as we interacted with customers beyond those referred by SAP. There is a consistent request from companies for increased agility, and as the supply chain evolves, the ability to manage operations in an automated, near real-time manner is becoming crucial for our customers. This represents an innovative approach to utilizing Exensio data and the Exensio connection, and we are very pleased with SAP's collaboration in helping us understand and develop this capability.

That's great. Adnan, could you clarify which areas of your spending are expected to increase this year? Additionally, how do you feel about the spending levels for your sales and marketing in 2023, particularly regarding partners and the representative count? What are your plans to continue driving growth in these areas?

Yes, sure. So look, I mean, our number one goal for us is to continue to grow the business. And as we focus on that growth from time to time, and not necessarily matching the revenue that we may realize just because of the accounting principles and function of where the bookings come in, you will see us ramp up the investment. This was true a few years ago, right before we were getting ready for the Advantest engagement. This was true last year and the year before when we were doing some of the leading-edge engagements. So this comment is just similar to those past events that we have seen as well. You're also hearing from us how we feel about the rest of the year in terms of some of the bookings in the pipeline and how that makes us feel good. So some of the comments with regards to increasing some of that spend are related to getting ready to do some of those bookings. As for the sales and marketing spend, this is another area we try to optimize. With the increased revenue and the increased scale that we have, we hope that those margins will improve over time. But we take a close look at that from a quarter-to-quarter basis. Most of our increase, I think we expect would be on the kind of R&D development areas as we ramp up the capabilities of our solution set and platform for serving the customers.

And our next question comes from the line of Tom Diffely from D.A. Davidson.

John, I thought I'd ask you a little bit more about the memory customers. I mean, historically, memory has not been a huge portion of your business. I'm just curious what's driving an increased activity level there.

Thank you, Tom. We have observed this with this customer and others as well. The future of computing involves transitioning memory from a standalone commodity to a more essential component of the computing system. Customers are seeking better statistical characterization of the logic part of memory elements in order to develop more advanced interface capabilities and to effectively characterize and manage them in manufacturing. Historically, the logic segment of memory was constructed with legacy or relatively lenient design rules, which meant that performance was often not very aggressive and it tended to be an afterthought. Now, we see customers increasingly focused on how to better integrate memory with logic to enhance performance. This shift is partly driven by advancements in memory technologies; for instance, with X-stack technologies, having the flash element on one wafer and the logic element on another, bonded together, offers significant opportunities to leverage more advanced nodes and sophisticated logic. This contract is noteworthy as it indicates early interest from customers. As mentioned in my previous comments, this mirrors what we experienced a couple of years ago when we began engaging with new customers around the characterization of this PDK area. It usually leads to a more extensive characterization if we are successful in demonstrating the value of our systems to them. The overarching trend you're inquiring about, Tom, revolves around the fact that memory subsystems are going to become increasingly crucial as computing systems aim for higher performance per watt per dollar. Therefore, regardless of the PDF situation, I believe there will be significantly more reliance on advanced logic and memory subsystems in the future.

Okay. And it sounds like it's a lot more complicated than just going from DDR4 to DDR5 and increased logic, but it's just a lot on the heterogeneous packages that are being put together.

Correct. Yes. You're right.

And then on the automotive side, are you seeing the strength on the power side with silicon carbide or the control side with just the silicon?

In the areas where the most advanced testing operations are being utilized, customers are indeed seeking the highest level of test screening. This is especially evident in advanced driver-assistance systems, as the chips involved are quite sophisticated. They are employing FinFET and lower technologies in vehicles, whereas historically, automotive controllers would utilize much less advanced geometries. The historical timeline for adopting seven-nanometer technology in cars compared to phones would have taken decades; now, it's down to years. The sophistication in testing is particularly noticeable here. We're also observing an increased application of analytics for silicon carbide, which is still in its early stages of development, and the advancement in end-to-end analytics is just beginning to evolve. The first instance of these advanced capabilities appears on the leading edge, where companies attempt to apply technologies that are only slightly behind those used by phone manufacturers, who typically adopt these innovations first. We anticipate that this trend will eventually permeate the automotive market as a whole, leading to a rise in testing sophistication across the sector.

Okay. Makes sense. And then when you see some strength in the data center side, are you starting to see kind of the next generation silicon photonics as well?

We do have some small number of silicon photonics customers on Exensio. I think I alluded to that in one of our previous calls. That part is still very, very nascent, really still in the R&D stages with folks using the system to look at R&D silicon. The data center side, we see an increased number of application-specific chips designed by a broader set of companies than your conventional processor vendors that are driving more use of Exensio. We anticipate that trend continuing as workloads are being moved to more and more specialized logic that drives more complex assembly flows, as well as analytics performed by a class of companies that historically didn't really design their own silicon.

Okay. Very helpful. And then maybe just a quick clarification question. The seven-figure deal with SAP, is that for PDF alone? Or is that a joint venture? How would you describe that?

Yes, that's just for our product. We are available. If you look at the Manufacturing Hub, it is on the SAP website and is a product on the SAP store. When sold in the store, they do receive a commission, which occasionally drives revenue for them, but it is primarily our product.

Okay. Great. And then final question. When you look at the Cimetrix installed base, what is the opportunity for upsell with new products in that installed base?

Yes, that's a great question, Tom. One of the main ideas we had with the Cimetrix merger was to introduce new data types and connectivity to analytics. The SAP opportunity was not originally part of our plans, but it aligns with our goal of bringing new data types into analytics. Additionally, we aimed to provide our analytics products to equipment companies. Larger equipment firms typically earn recurring revenue by offering analytics that enhance equipment uptime, functionality, and consumable use, often tied to significant service contracts. In the Cimetrix installed base, we have a few top companies utilizing our connectivity, but many customers are in the five to fifty range. They seek to generate recurring revenue through analytics or analytics-based services. We are actively developing new analytics products that utilize equipment companies' capabilities to create service offerings, combining our analytics with their data and the infrastructure platform uniting Cimetrix and Exensio. We hope to engage with customers on this as we progress through the year and into the next. This is the second facet of our relationship. The E142 was the first phase focused on traceability, which we have already launched. We are also working on additional products that will help equipment companies establish recurring revenue streams, which is a key goal for many of our clients.

And our next question comes from Christian Schwab from Craig-Hallum Capital.

Good quarter, everyone. I have a quick question about backlog. I understand that most of it should be completed over the next couple of years, which provides good visibility. Do we think that, over time, this will decrease significantly as it's worked through, or do you anticipate maintaining that level of visibility? Specifically, where do you expect backlog to be at the end of calendar year 2023, John?

Yes. I can't provide a specific number for any particular quarter. However, we generally expect growth on a year-over-year basis. The exact performance in any given quarter can vary compared to the previous quarter. This quarter, it's down slightly. We do see many significant deals on the horizon. Timing is always challenging, whether it's in Q3, Q4, or Q1, and that could influence our position at the end of the year. Overall, we typically anticipate an increase year-over-year.

And like John mentioned in his prepared remarks, if I could add a similar pattern to what we saw last year. If you looked at our backlog at Q2 of 2022, it was down compared to Q1. It's more a function of timing of the bookings. We'll always look to annual performance and how we can exceed that year-over-year.

Great. And then, I guess I do have one quick follow-up. Can you give us an update on Advantest and how much pull-through or new opportunities have come from them? What type of level that customer business is ramping to or where you would expect it to ramp the next year or two?

Yes. So it's great. Our first product that we announced with them was dynamic parametric test or DPT. We've come up with a derivative of that. That continues to book, I would say, a couple of times a year, we see incremental bookings from that. That continues to grow. It's an all-ratable business. So obviously, every time we are booking incrementally more, it's layering on more. We've announced five additional products, I think, in Q3 of last year when they announced their Advantest ACS Edge store. Those products are out. We're out doing demos with them on those products with customers and entering in some pilots. We anticipate at some point over the next few quarters, they should start also, like dynamic parametric test, driving incrementally valuable revenue. In the meantime, I think both for Advantest and PDF, our commitment to bringing more advanced analytics to the marketplace, we've helped each other in the market, I would say in different accounts, where their vision with their Edge box and our vision with advanced modeling has been the point for them to sell Edge boxes and the point for us to sell modeling capability, even if it's not directly through the store.

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