Good day, ladies and gentlemen, and welcome to the PDF Solutions Incorporated Conference Call to discuss the Company's Financial Results for the third quarter ended September 30, 2020. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to Joe Diaz of Lytham Partners. Thank you. You may begin.

Thank you, operator and thanks to all of you for participating on today's call. We appreciate your time and your ongoing interest in PDF solutions. As the operator indicated, my name is Joe Diaz. I'm a Managing Partner of 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 is available at the company's website at www.pdf.com. Some of the statements made during the course of 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 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 PDF's Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and similar disclosures in subsequent SEC filings. The forward-looking statements and risks stated on this conference call are based on information available to PDF today. The company assumes no obligation to update them. Now, I'd like to introduce, John Kibarian, PDF Solutions' President and Chief Executive Officer, who will be followed by Adnan Raza, Executive Vice President and Chief Financial Officer. John, the floor is yours.

Thank you for joining us on today's call. If you have not already seen our earnings press release and management report for the third quarter, please go to the Investors section of our website where each has been posted. We hope that you and your families are staying safe, and we appreciate your taking time to join us today for our commentary about the third quarter financial results. After summarizing the business in the quarter, I will use some time today to provide more detail about our marketing and engineering activities in the quarter, with a highlight on our Advantest partnership. I will conclude with our impressions of the semiconductor industry before handing it over to Adnan for the financial update. Highlights for the third quarter validate our long-term strategy. We continued with strong bookings particularly in China. We had a slow start for the year in China, as did most everyone due to the effects of the pandemic, but we did see some renewed activity starting at the end of the first quarter, increasing in the second quarter and building even more in the third quarter. The strength in China includes yield ramp solution for foundry, as well as Exensio contracts for our fabless entities. From a product perspective, there was a strong business activity for Exensio in the quarter, with continued high level of interest in our cloud solution. Contracts closed in the quarter for customers making everything from advanced ADAS chips to power MOSFETs and novel switches. The customer list included equipment companies' foundries, fables, IDMs, system companies and a Tier one automotive supplier, all of whom found Exensio Analytics frequently on the cloud, provided them with the insights they need to manufacture more effectively. As for DFI, we work closely with fabless and foundry customers on…

Thank you John. Good afternoon, everyone and nice to be speaking with you again. I hope all of you are keeping safe in the current environment. As I mentioned in the last call, we at PDF continue to operate in the spirit of connected while apart with some of our offices around the globe reopening this quarter while other employees continue to work from home. We are learning to thrive in this environment, closing deals and growing the business. We will share some of that progress with you today. Please note that all of the financial results we discuss on today's call will be on a non-GAAP basis and the reconciliation to GAAP financials is provided in the materials on our website. We have posted our earnings release and a management report in the Investor Relations section of our website. To start with the business update, we continue to make the strategic transition to an analytics company as communicated during our Investor Day last year. Analytics as a percentage of our total company revenue has gone from 45% in 2018 to 58% in 2019 to 64% on a last 12-month basis through Q3 of this year. For Q3 itself, analytics was 62% of revenues and 65% of revenues for year-to-date 2020 period. We're delighted with the ongoing transition of PDF to an analytics company. Our bookings for the third quarter of 2020 came in at a record level with the quarterly bookings this quarter comfortably exceeding the total bookings for the full year of 2019. Compared to Q3 of 2019, which interestingly was the strongest bookings quarter for 2019 itself, our Q3 2020 bookings came in very strong as well even without the Advantest deal. Recall that our bookings for the first six months of 2020 were already more than…

[Operator Instructions] Your first question comes from the line of Tom Diffely from D.A. Davidson. Your line is now open.

Yes. Good afternoon. Thanks for taking my question. John, first I'm curious about the deal that you talked about, that you decided to do with an IYR contract, instead of turn to a subscription. It seems like, that's opposite of what we've been seeing over the last year or so and kind of counter to the long-term plan of the company.

Yeah. When we made the plan, we did say, we would from time-to-time still do yield ramp contracts if we felt, the economics looked to be good. It's a customer that at 28-nanometer finally started ticking up volumes. As I said, it's a Chinese entity. And when we looked at their projections on 14 and the economics that were there, we actually felt it was a better deal for us over the long-term the economics return would be larger. As we sized up the situation, we do feel that, because some of the challenges that have gone on for Chinese suppliers or Chinese users of silicon over these last couple of quarters, the focus on manufacturing in China has picked up. And we feel better about the time horizon on this contract, from a gain share standpoint. If you go back a year ago, we were pretty negative on volumes materializing there. I think this has greatly changed over the last let's say, three to six months and hence our change with this customer. We will not do this in general, in the customer base. There are a very small set of customers for whom, we would take a gain share contract. We think the volumes are more, short than in other places.

Okay. Has your ability to service Chinese customers, changed at all over the last couple of months, when restrictions with Huawei and then with SMIC started to arrive?

Yeah. We have wanted one of our legal team in some of our legal expenses to be very careful about what we do there. And we watch very closely, the rules in the U.S. government. From a yield ramp standpoint, we have an ability to operate there quite well. We do engineering around the world right? So our vehicles are often designed outside the United States, in Taiwan and in Europe. And a lot of our software modules and elements are also primarily non-U.S. origin technologies. The eProbe DFI machine, which is really most relevant to people on the leading edge, we would have some limitations as of now, because it's manufactured, primarily in the states. But for the Yield Ramp and for Exensio, we are operating within the U.S. law, but have fewer restrictions due to the non-U.S. content in the solution.

Okay. That makes sense. And then, Adnan, a couple of questions about the model, first, would you expect to see a rise in the COGS with more cloud spending as the contract with Advantest continues to evolve?

Yeah. I think for the modeling purposes, I mean if you look at the total of cost of sales, R&D and SG&A and I think you can think of it as flat to slightly down. I mean as John alluded, we had special contracts some other region-specific, contract-related expenses and other legal expenses that drove that number a little bit higher than we expected. So I think there's probably a little bit tapering down on the OpEx side and probably just a slight tapering up. Net-net a little bit flat – net-net slightly down is what I would say from a modeling perspective for Q4.

Okay. How big was the legal services – the onetime legal services in the SG&A jump quarter-over-quarter?

Yes. So I don't know if I'd call it all one time but let me just put it this way. I mean the legal expense increase was $0.6 million and it was a variety of things. There were some contracts that we were working for customers in that region. Recognize also that we did the Advantest deal during this current quarter as well. So it's a combination of – it was a combination of factors that led to that higher legal expense which is why when you look at OpEx as a total the thought is that for next quarter is probably going to be down a little bit.

Okay. Great. And then finally John, when you look at the $65 million investment from Advantest what drove that? And was it kind of thought of or earmarked for any kind of specific acquisitions or infrastructure build-out that you need to do?

I think there are a couple of things. On their side they had asked – they are basing their company backbone on their cloud right which is Exensio. So I felt they felt that they wanted to have some investment in PDF some minority share, so that they would participate in the success of PDF overall as they drove business and they are driving business to Exensio and have been quite effective about that. Number two, I think from our standpoint we believe that there is a lot of opportunity similar to Advantest. Customers that need – that are building equipment are being asked to bring intelligence with their machines. And we felt that there was things we could do to grow the platform. That would be good for Advantest and good for the broader market and also continue to make Exensio platform that if you are a fabless or a system company you know that your foundries use it, your equipment suppliers use it. And now you have an ability to really partner across the supply chain. So we thought that it would also give us a little bit more flexibility and latitude as we looked at strategic alternatives. So I think that would probably be how – they looked at it as participating in the upside; we looked at as giving us a little bit more of flexibility in how we looked at alternatives.

Okay. That makes sense and I appreciate the time today.

Thank you.

[Operator Instructions] Your next question comes from the line of Jon Tanwanteng from CJS Securities. Your line is now open.

Hi, guys. Thank you for taking my question. I was just wondering that IYR contract that would have been an analytics one. I'm wondering what it would have looked like in the quarter in terms of revenue and profitability, if it had stayed in analytics subscription?

Yes. So John, it's a good question. If we have taken it as an analytics its gross margins would have been higher we would have put one of the resources that we put to that contract. The revenue dollars, the time period – on the time period duration would have been maybe slightly different. I'm not quite sure how we would have gone and recognized the revenue. It would have been more on a ratable basis. There was a lot of upfront design costs in this case. But that would haven't driven it that much different – some different but not that much but we would have put a lot less cost into that program. And to be candid with you we had invested a little bit ahead of the contract signing with that customer in the first and second quarter, which we wouldn't have put into that as we were looking at our alternatives with them. So probably would have been higher gross margin maybe slightly less revenue.

Understood. And then just in terms of the – you mentioned the nature of the customer. I was wondering how much cushion you gave yourself just in case – it seems like it's more of a traditional contract where you're dependent on their production volumes over a certain time period. I was wondering you did the comparison over either analytics or I guess system.

Yes. That's a great point, Jon. Yes. So it's a 10-year gain share period. That's one of the things that we did. Let's make sure the gains are getting longer. Because what we're learning about China is they start much later than we think. And as we completed some yield ramps on 28-nanometer in 2017 and 2018 and in some of the customers' cases they've not crossed the wafer volume minimums in 2020, right? So obviously the time horizon is a little different than what we're used to in other geographies in the world. So we lengthened the period quite a bit. We also took out a lot of the sensitivity to actual yield performance because we've come to recognize that the actual yield being in production is more important than being cost-effective in that market to some extent it seems like. So we've derisked ourselves from that as well which – and it was – we're starting to recognize that in this changed environment there are definitely winners that are being picked by the government. We felt that we were aligning ourselves with where we think the market is going there.

Got it. That's helpful. And then are there any more potentials like this in the pipeline where the economics look better over the longer-term to do this or...

It would be very few. I mean, you can count on less than – you don't need a handful to count on the ones that we would do this with. Very, very few. And in the China market maybe then and maybe one other probably not. Outside of there there's really only two or three players in the leading edge that we would consider it.

Okay. Got it. And then just going to the Advantest deal and kind of – you've mentioned that you're attracting other companies or the deal that attracted other companies and equipment manufacturers to explore doing the same thing. Are they similar in size and scope with all the Advantest partnership? And I'm wondering, if there's a significant number of them in your pipeline does that change the path on your near-term or medium-term growth rate versus long-term target?

Yes. So we started working with Advantest way back I think the first means in 2017, and then we started doing some actual joint product development work in early -- late 2018 early 2019, right? So you're seeing what is the three years of work. There are other equipment companies we're not, let's say, three years into the relationship we're at that beginning stages. But it's -- I think we're starting to understand the formula. Probably the investment piece is something we probably wouldn't do on a regular basis very much obviously and Advantest is a kind of anchor partnership. So it's a little bit special in that regard. In terms of the sizes of them, I'm sure many of them will start out smaller. And -- but overall, we see quite a significant opportunity in terms of just the number of equipment, particularly in the newer parts of the semiconductor or electronics industry, where software analytics is really just coming into play. So in your advanced packaging and your advanced system manufacturing, we think there's significant opportunities there.

Got it. And then just finally, you mentioned DFI taking a little bit longer than everyone had hoped. I was wondering if you had any expectations for when the next couple of machines might ship and start revenue.

Yes. Yes. It's -- I think that piece of it is, as I said in my prepared remarks, it's taking us longer than we would have liked. We would have liked to have gotten something shipped this year. I think for a number of reasons, it's probably slipping into the first part of 2021. At the same time, we have been working. Maybe partly due to the COVID situation, it's easy to fly wafers around -- a lot easier to fly wafers around than flying engineers around or even for our standpoint even machines. So we've been having customers send a significant number of wafers to us and have been generating revenue on DFI in that way on pilots many of them paid demonstrating capabilities. And it's -- as I've said in my prepared remarks, we believe that's increasing the number of applications viable for the customer base, and which is why we remain very confident about the platform and its potential. But we are behind on, let's say, the ability to get one shipped and installed.

Got it. Thank you very much.

[Operator Instructions] Your next question comes from the line of Gus Richard. Your line is now open. From Northland. Thank you.

Yes. Thanks for taking the question. On the IYR contract, is that for 14-nanometer development?

That's correct, Gus.

Okay. And then, the analytics revenue was down sequentially and kind of a big chunk of that is ratable. Is that a decline in customer rolling off? Is it the fact you took this IYR customer out of that ratable stream and moved it off? Or is it...

Correct.

Okay. So that was -- and how big of an impact was that in terms of percentage?

Yes. It would be meaningful, Gus, probably over 10%.

Okay. And then, thinking about the bookings. Can you help us -- if you back out Advantest so we can just sort of look at the regular everyday business, could you give us a sense of what the bookings have been this year relative to last year?

Yes. Relative to last year, the bookings already -- yes, we said, after Q2 it was already greater than all of 2019. When you add the non-Advantest portion of Q3 on pace with the first half of the year. If we -- it depends on where Q4 works out to be, but it would suggest that even without Advantest the total bookings for the year would be very close to that 2x number if not at that 2x number or greater. But in that same range anyway.

Okay. And just so I'm clear, when you say bookings is that a 12-month basis? Or is that the total value of the contract?

Total bookings value. Total contract value.

Got it, okay. Very good. Thanks so much.

Thanks, Gus.

No questions on queue. I would like to turn the call over back to John Kibarian 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.

This concludes today's conference call. You may now disconnect.