Good day, ladies and gentlemen, and welcome to the PDF Solutions, Inc. Conference Call to discuss its financial results for the Second Quarter ended Sunday, June 30, 2019. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. If you have not yet received a copy of this 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 demands for its solutions. PDF's actual results could differ materially. You should refer to the section entitled Risk Factors on the pages through 12 to 21 of PDF annual report on Form 10-K for the fiscal year ended December 31, 2018, and similar disclosures in subsequent 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 turn the call over to John Kibarian, PDF's President and Chief Executive Officer; and Christine Russell, PDF's Chief Financial Officer. Mr. Kibarian, please go ahead.

Thank you, and welcome, everyone. If you have not already seen our earnings press release and management report presentation for the second quarter, please go to the Investors Section of our website where each has been posted. Although our total revenues were up only slightly, our results this quarter show the progress towards our objective to be the provider of choice for end-to-end analytics and manufacturing control to the semiconductor and electronics industry. Our results reveal the ongoing evolution from being important to our customers and ramping leading edge logic nodes to being even more valuable for controlling quality, reliability, yield and operational effectiveness across the lifetime of semiconductor production. This is leading to a growing customer base. In the past, our focus on ramping leading-edge logic resulted in only a handful of customers driving the majority of our revenue. This caused our business to be tied closely to the investment cycle on leading-edge logic. Our business is now driven by analytics. We have over 130 customers that make everything from leading-edge logic to high-voltage discretes, mixed signal, memory and systems. The emphasis on analytics has grown our available market and will create more predictable results for PDF. We characterize the value we bring to the industry as foresight, that is the ability to monitor what is happening in production and convert this into useful information for predicting and preventing fabrication pumps. We're uniquely able to do this because our measurement tools, databases and analytics software span the whole supply chain, from wafer manufacturers to foundries, OSATs, IDMs and fabless to the systems. Let me touch on four highlights from the second quarter that demonstrate our continued progress. The first highlight is the extensive number of cloud and machine learning pilots we are doing. Over 25% of our top 20…

Thank you, John. Most of you will have seen our financials in our earnings release. In addition, we posted a management report in the Investor Relations section of our website. The report has financials and comments regarding the results of PDF for the quarter. So I'll focus my comments on a few key areas. All of the financial results that we provide on this call are on a non-GAAP basis, which excludes stock-based compensation, amortization of intangibles and onetime and restructuring charges. Please refer to our press release for our GAAP results and GAAP to non-GAAP reconciliation. Before I go through our analysis of our line items, I want to summarize what we consider to be key numbers for this quarter. We want to ensure that important underlying trends are clear. To us, the key takeaways in our financial results are these: First, while our cash balance declined during the quarter, we generated operating cash of $5.1 million and the major use was the stock buyback of $3.8 million. Equally important, we held cash constant before the repurchase, while still funding our CapEx investments, which included the StreamMosaic acquisition and the continuing work on our eProbe 250. The second key takeaway is that we are primarily a software analytics business now. Analytics revenue grew by over 10%, sequentially, continuing a trend of steady growth. As John mentioned, analytics was over 70% of our solutions revenue. With that summary, let's now look at the key items of the financial statements in more detail, starting with revenue. Second quarter revenue of $20.6 million was up slightly, sequentially. In general, revenue behaved as we anticipated, as our model continues to evolve towards the analytics. Analytics revenue comprised of Exensio software and DFI grew quarter-over-quarter. Our efforts revolve around driving the growth of analytics.…

[Operator Instructions] Our first question comes from the line of Jon Tanwanteng from CJS Securities.

Hi good afternoon guys. Thank you for taking my questions. Maybe can you first provide an update on the growth rate of Exensio software, maybe on a year-over-year basis? And secondly, maybe an update on the expectations for the amount of series 150 and 250 machines, that you hope to be shipping this year and next, given that you're ordering more long lead time parts?

Sure. So as I said in my prepared remarks, Jon, our analytics revenue was up 40% year-over-year and over 10%, sequentially. As far as we go we recorded long lead item parts, right now we have the ability to ship one more eProbe 250. We ordered the ability to be able to ship a couple more than that as we get out into 2020. We would expect to be able to shift these first machine, maybe, by the end of this year or early next year, and the remaining machines sometime in next year. As far as 150s, we are not building any more of those. We have a handful of them that we use from a development standpoint, demo standpoint and we do -- we are shipping one to customer developing more mature technologies in China.

Okay. Great. And then are you winning any more customers with DFI that were not historically yield ramp customers or winning back ones that may have stopped using, I guess?

Yes. In fact, all of the DFI accounts are, basically -- have not been yield ramp customers. So the first customer as well as the ones that we're doing demos now, including the memory one, they're all -- were not yield ramp customers. One was a yield ramp customer a number of years ago, I should correct myself.

Okay. Great. And then in the quarter because I'm not sure if you addressed this or not. Did you make or did you receive any make-whole or new solutions payments from global foundries in the quarter? And do you expect any more in the coming quarters?

We are receiving regular quarterly cash payments throughout the remainder of this year. So we receive cash every quarter. And in Q1, we did recognize revenue, and not because we received the cash, but we recognized revenue because we had PLC hours that we actually had earned and completed. And so don't expect any additional revenue from the cash payments, but we will regularly be receiving the quarterly cash payments through the end of this year.

Okay. Great. What was the size of those? And kind of what was the expectation for the rest of the year?

It's approximately somewhere around $2 million a quarter.

Okay. Great. And then, John, just a little more color on your expectations for Gainshare going through the rest of the year, and maybe, split between 28 and 14, and below?

Yes. I think I still believe that 2019 Gainshare will be consistent with 2018 Gainshare. The majority of that is still coming through 14-nanometer, we do see some 28-nanometer, there's been – that bounces around a little bit better in Q2 over Q1 and 28. And as we get out beyond next year, we believe we will look as we get to the end of this year half, 14-nanometer and 28 and move on, but we believe it's above the long-lived node, at this time left on this contract.

Okay, great thank you.

Our second question comes from the line of Tom Diffely from D.A. Davidson.

Yes, good afternoon. First a question on the cost structure. It looks almost like you're transferring some people from COGS into OpEx? Or is it a separate group of people that is making that transition?

Well, actually, what's happening is our classic business, our IYR business, that was really the business where we took most of our cost reductions and so that would, naturally, reduce the cost of sales. Those people were primarily a fixed expense in cost of sales. But as that business moved towards declining, those people were either redeployed or we did have a risk as well. So that is a natural reduction of the cost of sales. And then the offset to that is our new product, the analytics business has higher gross margins. So there's not the kind of labor involved or consultative approach that is more costly.

That's a – I think, Tom, you noticed, we have added people in the sales and marketing of Exensio, and to a lesser extent DFI, but primarily Exensio. And we continue to see opportunities to expand our ability to sell in market Exensio. As we said, we have a very large installed base of Exensio out there that are becoming aware of what Exensio can do today. So we will – we do make continued investment in the field. Some of that was transferring folks, but a lot of that was hiring new folks.

Okay. That's good to know. All right. And then sticking to Exensio, you said that of your 130 customers, most or all of them only have a partial solution set. What is the opportunity just with the existing customer base?

We believe that – as I'm highlighting that one example, we believe we can more than double the annual run rate in a number of the top 20 customers of cross-selling them additional modules across our traditional capability, moving to the cloud does provide additional growth beyond that.

Okay. And that was the question too, you talked about the cloud providing better performance. Maybe just a little more color on that?

Yes. So Exensio has worked with a conventional relational database for you as customers either buy from us or from typical Rdb suppliers database and build out, usually, a fairly sizable amount of hardware. And when they go and move Exensio to Cassandra, Exension now comes shipped with a Cassandra database which is a non-traditional database, the same database that's used by the internet suppliers, you need to refactor the entire hardware stack. And for most of – many of our customers they found, it's better to do that with our cloud offering because it gives them better scalability, far better performance for the same hardware dollar spend, but the spend is very spent very differently. And then that allows them to benefit from Spark, which is in-database analytics, and that's how they really get that kind of factor of 30 performance benefit. It's the combination of faster storage, retrieval, but available through Cassandra and a much faster in database computation in Spark, which parallelizes the analytics as well. And it's just much easier to doing that on the cloud where all of the hardware is new and constantly refreshed and then scaled to the customers' incremental needs and demand.

Okay. That's interesting. Okay. Great. So the only question is, you're given the collections issue during the quarter, are you still expecting growth in the solutions business for the year?

We're expecting growth in the solutions business, primarily, from Exensio and DFI, especially in the analytics business. We do believe we have opportunities for the yield ramp business, particularly, in the Asia region, but we don't forecast that at this point, and we take it when it looks like it's attractive for us.

Okay. And then on the eProbe 250 side, are you currently demoing with the logic and memory customer in-house? Or do you have a system on site?

Yes. That's a very good question. So when we are -- we will not put a machine at a customer site without a contract that has payments associating with it. So demos are them shipping wafers to us. We have now, I think, 4 companies, a couple of them in leading edge logic, one in memory and one in something different that is shipping wafers to us for the purposes of us demonstrating capability in our facility in Milpitas.

Okay. And so the parts for one more tool, that's an addition to your demo tool, then?

Yes, I think – well, hopefully, if you have an opportunity to come to our Analyst Day, you'll get to see the R&D tool, the demo tool and some fraction of produced tool. And you can see what they look like.

Okay. Great. And then finally, what is left on the buyback authorization?

Let's see, there was $25 million authorized, and we have spent around $7 million of that. So we have plenty of room within the authorization to continue the repurchase program.

Great, okay, thank you.

And our next question comes from the line of Gus Richard from Northland.

Yes, thanks for taking the questions. Just help me understand on the solutions revenue's down $3.3 million, sequentially, and $1 million, I understand, is the lack of payments from your Asian customer. What else declined in that? Was that fixed fee business?

Yes, so if you remember, there was – in 2018, we stopped percent completion on a 7-nanometer development program and therefore, we had that depressed solutions revenue in Q4, I think, in part Q3 and Q4 of last year. In Q1, when we and the customer agreed that the work was complete, that then gave us a catch-up payment of over $3 million associated with that percent completion. So that drove up that revenue. So when you take out the puts and takes on the IYR revenue, but mostly takes, the growth in analytics was, as Christine said in her prepared remarks and mine also, well over 10% quarter-over-quarter.

Okay. I was under the impression that load through other income, but I was mistaken, sorry. And then in the yield ramp engagements you're looking at currently, are those consistent with classic yield ramps? Or are those going to be just sell the tools and let the customer go on? Can you give a little more color on how those will be structured going forward?

Yes, that's a great question, Gus. So yes, in the yield ramp business, I mean, when we traditionally delivered the vehicles and the systems, recognized revenue on a percent completion for the fixed fee portion of the business and then enjoy the royalty or getting share on the back end once the customer went to manufacturing. As we found the time to volume, particularly in some of the newer markets, is very long and our risk on that is high. And historically, this was the driver for our business. So we had to be really focused on driving the Gainshare revenue. As we brought the business to being primarily analytics, this is a lot less strategic for us and we look at this more opportunistic. So we'd like to see – we are looking to see more of the revenue upfront paid out ratably on a subscription basis as well, but with no risk on results or volume, with a few exceptions.

Okay. And that would be recognized ratably over the life of using these tools?

Probably, I'm not right, over the life of using the systems.

Right. I'll make one little additional comment there, as we actually, on subscription licenses, recognize 15% upfront, and then the remainder of it is ratable. That's under ASC 606.

Right. Okay. Got it. And then there was some talk around [indiscernible] was viewed developing DFI structures to, for lack of a better term, a health monitor for chips in the field. And I was just wondering if you could add a little color to that? And again, how you would monetize that capability?

Yes, So that is not related, if I try to see the capability, but we have built structures and put them in this guideline for years. Customers are starting to ask us to put that inside the product line and then make that available through conventional product test, in other words, through the J-tag, and eventually, downstream while the product is in the field. Now that we have Exensio test, we have ways of collecting that data for the customer because that test sits as an agent on the tester, and we didn't have that capability, let's say, a few years ago. This is, again, because packaging technology is getting a lot more complicated and there's a lot of – customers have been telling us they test that wafer sort, the chip looks fine, they put a bunch of stuff in the package, they test it, and stuff doesn't work, and they can't figure out why has the silicon shifted in its performance? As you thin silicon, the amount of strain in the silicon changes, and hence, the device characteristics shift, et cetera. I can go geek off on that for a long time with you, some time, Gus. But the reality is, being able to monitor later stages than wafer sort is becoming valuable to the customer, and customers even express the desire to be able to monitor that silicon performance while it's in the field as well. And this is an activity we've got going on with one customer we're doing some tape-outs right now. And we expect to expand that as we get out into next year.

And our final question comes from the line of Christian Schwab from Craig-Hallum.

What drove the upside in Gainshare this quarter?

The volumes were up quarter-over-quarter.

By who?

Actually, it was broad-based, primarily at 14, a little bit of 28 as well.

Okay, Okay, Okay. So last quarter, you said that Gainshare would be down in 2019 from 2018 now, given the strength, which must have, maybe, surprised you now expect Gainshare to be flat year-over-year, 2018 and 2019, is that correct?

Roughly, yes.

Okay. And then how should we be thinking about, given the drop-off in the solutions business this quarter, how should we be thinking about that on a year-over-year basis?

We believe solutions will also be up modestly.

Okay. Solutions will be up modestly and Gainshare will be flat. Okay. So then – which is fine – so after we leave 2019 what is your multiyear, not to steal anything from your Analyst Day, but what is your kind of multiyear outlook? Do you still expect Gainshare to be a growth business or modestly go away over time? And in the Solutions business to be the big grower over time? I'm just trying to figure out how we make a bunch of money again, to the bottom line as a company.

Yes. So you're right. You don't want to steal our thunder for the Analyst Day, Christian. But yes, I think you've already kind of walked on to it, right? Over time, we do expect Gainshare to be around for a few meters because the contracts have a few more years on that. It will slowly roll-off. So as we look out over our longer time period. We believe that, by and large, the business will be driven by the analytics business, which will be primarily on ratable time-based license in SaaS subscription. As Christine mentioned in her prepared remarks, we believe that, that business will approach gross margins that are typical for a company like that in the 70% to 80% range. And you can work that out at scale as that business grows. We grew 40% year-over-year. If you look at Q2 of this year versus Q2 of last year, right? As that business grows, we anticipate that being actually more substantial than our historic company peak has done in the past. And then focus on

And then, how are you changing the pricing in order to get 80% gross margins on that product now?

Yes. So that category had very reasonable gross margins, Christian, it was just always a very small part of revenue, right? Because solutions has the analytics revenue as well as the percent completion on the yield ramp business. The percent completion, if you go back two years ago or three years ago, yield ramp business was the vast majority of the solutions revenue and it was at a much lower margin than the analytics business was. You roll forward a couple of years, the analytics product is now the vast majority of the solutions revenue, as we said up well over 7%, and is at a higher margin.

And Christian, this won't surprise you to hear this, but the cost of sales for delivery software is substantially lower than the cost for delivering consultative IP as was our classic IYR business. So that is a big component of the improvement in gross margin going forward.

Okay. And then when would you expect on [Audio Dip] logical to assume you could see 70% to 80% gross margins at some point? Have you done that math?

Okay, so I think sometimes you get a sense of that, Christian, we'll go over where we see our long-term model, wonder what timeframe, I think, that's going to be.

Great, awesome. Thank you, no other questions.

[Operator Instructions] Your next question comes from the line of Tom Diffely with D.A. Davidson.

Just a quick follow-up question. So of the 70% of the business that is analytics, is that all ratable at this point? Or is some of it old style?

There is still some perpetual licenses on some legacy contracts, but the vast majority of license revenue is ratable. There's also managed services for our cloud customers where we manage the database-related technology, which is sort of also, typically, ratable.

Okay. And was the entire analytics business, that was up 40% year-over-year? Or just the Exensio part?

The entire analytics business was up 40% year-over-year. The individual products within that were also all by and large very healthy.

Yes. So for your future reference, whenever we refer to analytics that's comprised of both DFI and Exensio.

Okay, thank you.

Thank you, ladies and gentlemen. If there are no more questions at this time. I would now like to turn the call back over to John Kibarian, CEO.

Thanks, everyone. We look forward to seeing you on our Analyst Day on October 15. Take care.

Ladies and gentlemen, this concludes the program. Thank you for joining us today.