John K. Kibarian - President and Chief Executive Officer Gregory C. Walker - Vice President and Chief Financial Officer.

Jason M. Ursaner - CJS Securities, Inc. Gus Richard - Northland Securities Thomas Diffely - D.A. Davidson & Co..

Good day, ladies and gentlemen, and welcome to the PDF Solutions Inc., Conference Call to discuss its financial results for the Fourth and Full-Year ended Wednesday, December 31, 2014. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session for which instructions will be given at the time.

[Operator instructions] 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 10 through 16 of PDF’s annual report on Form 10-K for the fiscal year ended December 31, 2013 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 would like to introduce John Kibarian, PDF’s President and Chief Executive Officer and Greg Walker, PDF’s Chief Financial Officer. Mr. Kibarian, please go ahead..

Thank you, and welcome, everyone. Today, I will start our discussion with a brief overview of the fourth quarter and full-year of 2014 for PDF, followed by a review of some of the major activities in the overall semiconductor logic market. Greg will then walk you through the financial results in detail and give some comments on our 2015 outlook.

We will take your questions after that. The fourth quarter was a strong quarter for PDF, closing out what I would call the mixed year overall. While the Company’s achieved successes in many key areas, our overall financial results were adversely affected by our failure to close during the year two key contracts with one of our major customers.

As you’re probably aware this issue was successfully resolved during early Q1 of this year. Greg will provide some detail on the financial aspects of these contracts. One of these contracts was for an early research and development and the second for Yield Ramp.

As we stated in our press release on January 7, the year end contract includes gainshare and a rate inline with the value of the technology and services the company delivered. As a result, we see this as a success for the customer and PDF.

We maintain ongoing engagements with that customer and work with them in three-way situations with our mutual fabless customers. Turning to a summary of the business for 2014.

During the year, we brought in the adoption of our solutions for yield enhancement by spending our engagements with many of our current customers, while also signing engagements with new customers.

Additionally, we saw significant interest in demand for our design for manufacturability solutions such as our Direct Scan Characterization Vehicle test chips, our XScribe Characterization Vehicle test chips and our DFM templates.

As a result PDF is instrumenting more wafers and products with our characterization intellectual property across more foundries and technologies than anyone else in the world. Our foundation products for manufacturing production control continue to gain momentum with multiple deals signed during the year for our YieldAware FDC and Exensio products.

Additional our advanced development efforts for electrical characterization and inspection in [hematology] continue to make significant progress. Finally, driven by the growth of 28-nanometer capacity at our major customers our gainshare revenue grew by nearly 20% year-over-year.

During the fourth quarter, the company closed the following significant agreements. A YieldAware process control engagement with an existing foundry client to support their use of our Exensio FDC solution for advanced nodes across multiple sites. An extension and expansion of a significant IYR engagement with an existing client for advanced nodes.

Our new template DFM engagement at 14-nanometer with an existing client, a pilot project with a new foundry client for our integrated year end service at multiple nodes.

A large software license and support agreement with a new client for yield management module of our Exensio big data analytic solution and three software license and support agreements with existing clients for Exensio FDC solution.

As we entered 2015, PDF Solutions and technologies continue to be accepted by large portion of the industry as the standard for bridging the gap between fabless chip design and foundry manufacturing enabling the virtual IDM.

Today, our Characterization Vehicle infrastructure is in place at all major logic foundries and use at many of the top 10 fabless companies. Further interest and adoption continues to build around our Exensio System for big data analytics and control, which integrates a number of legacy products into a single unified system.

Now, turning to the industry as a whole, volume production at 28-nanometer node remains very strong and the industry is currently ramping up volume production at 20-nanometer node. However, the introduction of the 16, 14 node is less clear. As discussed in multiple annual reports in earnings releases of the capital equipment suppliers.

There appears to have been a pause or slowdown in the ramp up and build out of 16, 14 production capacity. Additionally, there is a great deal of speculation as to both the timing and supplier allocations of new products to be introduced by the major fables and system companies.

The combination of these two factors is creating a great deal of uncertainty around the introduction of the 14, 16 node. From our perspective, we see continued improvements in FinFET yields with some products achieving at least functionally which are typical for early volume ramp.

However, our experience from past nodes has us modeling across this volume ramp, because many factors contribute to the timing. In 2015, the 28-nanometer and 20-nanomenter nodes will be the dominant contributors to production volumes at the leading-edge foundries.

As we stated before the technical requirements of these multiple advanced nodes including early development of 10-nanometer continue to be a significant challenge for both fabless and foundry suppliers.

This complex environment continues to presents PDF with many new opportunities and challenges as new solutions are required to effectively manage Yield Ramp and production process control. PDF Solutions has a long history of inventing new products for yield characterization and were added again.

Over the past few years we have been developing new capability in our advanced research. As we progress through 2015, we will step up our level of investment particularly in the area of development in order to bring some of these new solutions to market. We see 2015 as a transformative year with our industry.

The introduction of new products and technologies and the rapid growth of new market such as China will be disruptive across the industry as a whole. In order for PDF to continue to its success we must position ourselves at the forefront of these changes.

I want to thank our stockholders, customers and employees for their support of the company over the past years. I look forward to working with you all to deliver and increase PDFs value and make 2015 and beyond even better. Now, I’ll turn the call over to Greg, to discuss in detail our financial results for the fourth quarter and 2014.

Greg?.

Thanks, John. As a reminder, in addition to using GAAP results when evaluating PDF business, we believe it is also useful to consider our results using other non-GAAP measures. For internal purposes the Company focuses on non-GAAP net income and EBITDAR.

Non-GAAP net income excludes nonrecurring items, stock based compensation expenses and amortization of expenses related to acquired technology and other intangible assets and their related tax effects as applicable. Additionally, the income tax provision has been adjusted in our non-GAAP net income to reflect cash tax expenses only.

EBITDAR is equal to earnings before income tax adjusted to exclude nonrecurring items, depreciation and amortization and stock-based compensation. You can access the earnings the press release that contains a reconciliation of EBITDAR and non-GAAP net income to GAAP results in the investors section of our website located at PDF.com.

Now let's turn to a review of the financial results. Total revenues for the quarter were $26.1 million with a GAAP net income of $5.8 million. This resulted in GAAP EPS of $0.18 per fully diluted share. Net income on a non-GAAP basis totaled $9.1 million or $0.29 per fully diluted share.

Cost of sales and operating expenses together were $18.3 million on a GAAP basis and $16 million on a non-GAAP basis, which is an increase in non-GAAP spending of approximately $671,000 over Q3. For the year, total revenues were $100.2 million and non-GAAP net income was $33.8 million.

Moving on to revenue in more details, total revenues of $26.1 million for the fourth quarter were $3.7 million higher than in the prior quarter. Total revenues were comprised of design-to-silicon-yield solutions or solutions revenues of $13.9 million and gainshare performance incentive or gainshare revenue of $12.2 million.

Our top-ten customers represented 94% of total revenues in the current quarter. Three of these customers contributed revenues greater than 10% each for a total of 84% as compared to 81% in the prior quarter.

Looking at solutions revenue in more detail, nine engagements contributed at least $100,000 of solution revenue in the quarter, two less than in the previous quarter. Overall, solutions revenue of $13.9 million was $3 million higher than the prior quarter.

This increase reflected the expansion and extension of a significant advance node IYR engagement with the major customer and the ramp up of a new 14-nanometer template engagement, also in the early yield target achievement at a 20-nanometer engagement.

Gainshare revenue for the quarter was $12.2 million and increase of $617,000 over the prior quarter. The total number of customer sites contributing to gainshare revenue exceeding $100,000 in the quarter was eight compared to seven in the previous quarter.

For the year, total revenues were $100.2 million as compared to a $101.5 million in the prior year. Of the $100.2 million of total revenue $47.4 million was gainshare revenue, which compared to $39.7 million of gainshare revenue in 2013. This reflects a year-over-year growth rate of 19%.

Increasing capacity and volumes in the 28-nanometer node drove materially increases in our gainshare revenues across our major customers. On a geographic basis, North America accounted for 49% of total revenues which is up 2% from the prior quarter.

Europe accounted for 39% of total revenues down 2% from the prior quarter and Asia accounted for the remaining 12% of total revenues the same is in the prior quarter. For the year, North America was 45% of total revenues, Europe represented 40% and Asia accounted for the remaining 15% of total revenue.

Looking at expenses, cost of sales for the quarter was $9.5 million on a GAAP basis which is $2.1 million lower than the previous quarter. This was primarily driven by the recognition of $1.9 million of impaired deferred project costs in Q3. As a result GAAP gross margin was 63% for the current quarter, compared to 48% in the prior quarter.

Total GAAP operating expenses at $8.8 million were approximately $906,000 higher than the last quarter and approximately 34% of total revenues down 1.4% from last quarter. R&D expenses totaled $3.8 million, approximately $432,000 higher than the prior quarter. R&D expenses as a percent of revenue was 15% in the quarter the same is in Q3.

SG&A expenses totaled $5 million for the quarter, or 19% of total revenues compared to $4.5 million and 20% of total revenues in the prior quarter. The overall increase in total operating expenses was driven by performance base incentive compensation programs, timing of expatriated expenses and increases to reserves.

For the year, GAAP gross margin was 60% compared to 61% in the prior year. On a non-GAAP basis, looking at operating expenses and cost of sales together total spending was $16 million versus $15.3 million in the prior quarter.

As stated earlier, this was principally due to performance based incentive programs timing expatriated expenses and increases to reserves. For the year, total non-GAAP spending was $61.8 million compared to $63.1 million in the prior year.

The GAAP income tax provision for the quarter was $2.2 million which reflects an effective tax rate of 27.8% compared to 40.9% in the prior quarter.

This reduction in the effective tax rate was principally driven by the recent reinstatement of the 2014 Federal R&D tax credit program which allowed the company to benefit in the current quarter from credits related to full-year 2014 R&D activities. For the full-year of 2014, the GAAP tax rate was 34% compared to 33.2% in the prior year.

Of the $2.2 million of GAAP tax provision in the quarter approximately $1.1 million represented cash tax liabilities. This reflects an effective cash tax rate for the quarter 14.3% of pre-tax GAAP income. This compares to Q3 cash tax rate of 26.5% this decrease in cash tax rate is once again due to the benefit of the R&D tax credits mentioned earlier.

For the full year of 2014, the cash tax rate was 16.5%. In regards to 2015 tax rates we expect our GAAP tax provision rate to be in the range of 38% to 40% and our effective cash tax rate to be in the range of 22% to 24% for the year.

GAAP net income of $5.8 million for the quarter resulted in GAAP EPS of $0.18 per fully diluted share compared to $1.8 million and $0.05 per share in the prior quarter. GAAP net income of $18.5 million for the year resulted in GAAP EPS of $0.58 per fully diluted share compared to $20.9 million and $0.67 per share in the prior year.

On a non-GAAP basis, net income was $9.1 million and non-GAAP EPS was $0.29 for the quarter compared to $6.3 million and $0.20 respectively. For the year, non-GAAP net income and EPS was $33.9 million and a $1.06 per share respectively compared to $33.8 and a $1.08 per share in the prior year.

The change in the cash tax rate for the year accounts for the $0.02 per share reduction in non-GAAP EPS. EBITDAR, which I defined earlier and is also defined in our press release was $10.8 million in the quarter as compared to $7.6 million for the prior quarter. EBITDAR per fully diluted share was $0.34 compared to $0.24 in Q3.

For the year EBITDAR was $40.5 million and a $1.27 per fully diluted share as compared to $39.7 million and a $1.26 per share in the prior year. Total cash at the end of the quarter was $115.5 million, a decrease of $657,000 when compared to September 30.

This decrease was primarily due to $6 million of delayed customer payments the majority of which have now been collected in January of 2015. Cash used in operations during the quarter was $730,000 once again affected by the delayed customer payments.

Trade accounts receivable DSO was 98 days for the current quarter compared to 72 days in the prior quarter. Trade accounts receivable balance at the end of the quarter was $28.1 million an increase of $10.4. The unbilled accounts receivable balance was $9.7 million, an increase of $250,000 from the prior quarter.

Of the $37.8 million of total receivables only $176,000 or less than 1% was more than 60 days past due. Total DSO for the quarter including unbilled receivables was 132 days compared to 110 days in the prior quarter. Headcount at the end of Q4 was 359 worldwide which was slightly down when compared to the end of Q3.

This concludes the review of the financial results for the quarter and the year. Now looking forward to 2015 as we stated on our Q3 2014 earnings call, we expect the company to grow revenue during 2015.

We expect higher than normal growth in our solutions revenue driven by the impact of the previously mentioned delayed contracts which were agreed upon in Q1 of 2015. As you are aware we expect these two contracts to contribute $6 million to our solutions revenue in Q1 of 2015.

Additionally, we will reflect approximately $1.9 million of previous impaired cost of sales related to these contracts in our Q1 2015 non-GAAP results.

In regards to gainshare revenues, given the uncertainty around the introduction and ramp up of the 16 and 14-nanometer process node, we are somewhat more cautious in regards to our expected level of growth. In total however, we expect our overall revenue growth in 2015 to exceed the industry growth rates.

Now I will turn the call over to the operator for Q&A. operator..

Thank you Mr. Walker [Operator Instructions] our first question comes from the line of Jon Tanwanteng from CJS Securities. Your line is open..

Good afternoon. This is Jason Ursaner calling in Jon Tanwanteng..

Hi Jason, how are you?.

Good. It seems like there has been a lot of movement recently in terms of some of the business wins at the leading edge among some of the key foundries and you mentioned some of these uncertainties surrounding the 14-nanometer node transition.

Just wondering at a high level – how you see this dynamic of shifting business among the foundries affecting your company..

Yes hi, this is John. Yes I think obviously we collect – gainshare from some of the foundry companies and not all of them. so depending on how volume ends up, we participate in that volume that ends up in our partners and we don’t when it doesn’t end up at one of our partners.

So it seems that the companies that we work with have gainshare on the FinFET node in comparison to the 20-nanometer node, at least they claim not. And if that’s true then that would be very positive for us, as we said in my prepared remarks until you see the volumes actually materialize folks can make big claims.

So we need to take away and see on this..

Okay, and maybe just following up on that. You had mentioned that 20 to 28-nanometer node is sort of the dominant contributor in 2015, but to the extent your partners are winning share at 14-nanometer and are starting to reach functionally yields where we could see a ramp.

How would you put the gainshare potential for maybe 2015, but more importantly fiscal year 2016 and beyond into context..

Yes, that’s a good question. So our model high is always been the FinFET volume is a 16 story, even if you go back two or three quarters ago we’ve been saying this for quite a while. It’s the kind of when we put our perspective out there in this call it’s no different than it’s been over the last few quarters which is we believe it is a 16 story.

We believe the volume on that node will be substantial and that would be a very good thing for us.

If that’s true, as we said in these prepared remarks 28-nanometer remains an important node and well even in 2016 continue to be an important node for the industry overall and for our gainshare and well actually four year right, so it’s an important node for us even on the going forward basis, right.

But the 14, 16 node we expect to start contributing gainshare potentially in 2015 and certainly much more materially in 2016 being substantial contributor there..

Okay, and in the design solution segment I think I heard you say $6 million of catch up revenue in Q1, but maybe excluding the catch up payments, just how should investors be thinking about expectations for revenue growth in the design solution section going forward?.

Yes, this is Greg, kind of consistent what we’ve looked at in prior years excluding this one time catch up in Q1, we would see the solutions business outside of that being kind of a mid to single-digits kind of growth rate in normal times.

That’s somewhat limited because it does work kind of an in/and out module where you have new deals coming in as older node deals are dropping off. So there is overall growth there, but it’s not significant, you are not going to see 20% or 30% growth rates there..

Okay, and looking at your capital structure between the net cash on the balance sheet and free cash flow just what do you see as your priorities for excess cash and how are you thinking about acquisitions versus share repurchase versus other alternatives?.

Yes, we have a lot of discussions internally and actually quite a few externally with our investors regarding this question, because we do generate cash and we continue to expect to be able to do that. When we discuss this topic with our board. Our board is fairly clear on how we should be prioritizing or look at this.

Our number one goal is to accelerate to enhance our ability to bring out our new technologies and that will play a significant role and where the company goes as we progress into the late teens. Anything that we can do from a capital structure standpoint to enhance our ability to do that will be our number one priority.

That could range from purchasing capital equipment, licensing technologies all the way through acquisitions and we do consider all of those. Beyond that then we hire more open to other ideas. We do have approved stock repurchase program which we’ll be backing and executing against as we go throughout 2015.

And then we are looking at all the time what to do beyond that. We don’t have any decisions on that, but it’s an active discussion point at the board..

Okay, great. I appreciate all the details, thanks..

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

Yes, good afternoon. Greg, just a quick follow-up in your comments on the designed silicon portion. For a while now we’ve been talking about low-to-mid single-digit growth in that space. But I’m curious now we had a bit of an artificially low level in 2014, because of these builds.

Are you talking about modest growth of the lower level?.

Yes, I think it’s still modest growth and probably would be in the upper end of our range most likely, but it would still be fairly modest growth outside the impact of the $6 million catch up, but it would probably be higher than our normal year, but still within a range..

Okay, and that’s mainly because one of these larger customers is not as active on a go forward basis, as they had been in the previous years..

Yes, I think that’s a reason to only way to think about it..

Okay, and then you also talked about you are growing the industry, what is your current view of the industry growth this year?.

Well, there is a lot of different views out there, we basically kind of look at what a multitude of people are saying. I’ve seen overall semiconductor numbers in the mid-to-high single-digits.

I’ve seen speculations on foundry growth between high single-digits and low double-digits, but I think centering somewhere in that 5% to 10% range is probably a reasonable approach..

Okay, all right.

And then when you are cautious this year, and you won’t expect in the FinFET rev to happen until 2016 anyway, what is the incremental piece of cautiousness in your voice I guess?.

Yes, I don’t – hi, this is me John. We don’t – there is nothing really more incremental we just thought there was an awful a lot of confusion out there about it never happening or being quite negative, we think there will be a ramp in FinFETs this year.

We are muted about how big that ramp will be I think than a fair number of people, but at least we see there are yields on parts and those parts are making their way through - there will be yields and there will be a ramp in FinFETs this year, how big we don’t know.

We have them saying forever that 2015 will mostly be 28 and 20 and maybe some small amount of 14 contributing. That’s what we’ve been trying to communicate today..

Okay, to that end have you seen any additional capacity been added at 20, 28 because of the slowdown in the FinFET ramp?.

We are starting to see the second tier foundries add capacity or plan capacity in 28-nanometer and we do think actually that continues to represent a good opportunity for us. So in this year the bulk of our gainshare is kind off of our first year 28-nanometer manufactures with some growing portion coming from kind of the second tier folks.

We expect as we go out into the future there are more business opportunity for us on 28-nanometer as continued gainshare to first tier and growing opportunity at the second tier producers..

Okay, and so over the last quarter or two - you have been more actively engaged with so called second tier players?.

Yes, I think yes we’ve been thinking if you look at my prepared remarks we do mention, we see a fair amount of opportunity in the new markets..

Okay, and you specifically mentioned China I believe outside of I guess one of the bigger players there, are you seeing an expansion to multiple potential customers in the regions?.

Yes, what we see in China first and foremost is the fabless and we’ve had a lot of activity with them, they are consuming silicon and conventional foundries at this point. And we see them as a growth opportunity for our DFM solution as well including our scribes and Direct Probe Characterization Vehicles and templates.

We are seeing now multiple factories in China on 28-nanometer, 40-nanometer - it is the largest player in China as well as new entrants there and I think you are probably aware of some of the Taiwan foundries now expanding capacity in China as well and we see all of those as a meaningful opportunities for us..

Okay, at some point you think software will become a big enough component to breakout?.

At some point in time I would expect that yes..

Okay. And then also Greg, you talked about an effective tax rate of 22% to 24%.

What would that be if the R&D tax credit came back again?.

If the R&D tax credit comes back, we would probably see that rates drop by at least a couple of points. There was a bigger impact this year, but we would see at least a few points. Yes..

Okay.

And then finally it sounds like you are going to make some more investments this year what's your view of OpEx over the next several quarters?.

Without giving specific guidance, yes we are definitely going to step up our investment in the development side of R&D as we're moving projects out of kind of early research phase into taking it to actual market introduction stages.

I would classify that as probably a 5% to 10% higher increase than we were talking about before, so you know I think many people have modeled it in the 15% to 20% growth, I would probably add five points to that..

Okay. All right. Thank you very much..

Your next question comes from the line of Gus Richard from Northland. Your line is open..

Hi, thanks for taking the question. Can you sort of for the year for 2014 kind of give a split between gainshare revenue from 28, 20 and maybe more mature nodes..

Yes, I believe if you give me one second, I believe that gainshare from the 28, 32-node contributed north of 84% in the year and….

The rest is….

Yes the rest is just either older nodes, we have immaterial amount on other nodes at this point in time. So it’s really 28, 32..

Okay, got it and you expect that volume to continue to grow and your customers to benefit as more people come up on 28..

Yes..

All right and then, I think you talked a little bit about some new contracts, could you just swing back and go through that discussion again, it sounded like you have a new pilot program and another new customer ramping..

Yes. Gus this is John.

So I spoke of a yield where engagement – that’s was with the existing client across multiple factories, and extension expansion of a yield ramp engagement with again our existing client and a new template DFM engagement again at 14-nanometer with an existing client, those for the new activities there was a pilot with a new foundry Yield Ramp across multiple nodes that is a new client.

We expect that to expand in 2015, and then software license and support agreements for Exensio with also a new customer. And then there were three existing customers all from expanded software licenses and agreements for FTC solution rather substantial..

And then just one final one for me when you look at you know sort of what you wrote-off at the end of the third quarter in terms of the contracts you are working on. And then look at the revenue recognizes at delta between what’s wrote-off and what you are recognizing, what makes up the difference between those two numbers..

I think your question is we wrote-down about $1.9 million in Q1 we are going to recognize about $6 million is that your question?.

No, I think in the original press release in September you said that you are going to miss like $10 million to $12 million in revenue.

Because you couldn’t get the customer design and then when you put of a press release in early January indicated that the revenue was going to be $6 million for the first quarter and I was just wondering what’s the delta between those two numbers, what you are going to recognize in revenues….

Right, so agreement we reach with customer meant that we were no longer require, we got a fixed revenue per wafer. We no longer needed to achieve targets.

And as a result incremental fixed fees work to achieve those targets they did not contract us for and we did not generate that revenue, I would explain that difference of about $5 million - middle of $10 million to $12 million and 6 million. From our side we took out any risk on yields on the FinFET node with that manufacturer..

Okay got it..

We take out risk we are done, risk they say is that incremental revenue that incremental cost..

Okay got it. So effectively you just took out your risk when they start ramping FinFET wafers should get paid and….

[Indiscernible].

Yes, okay got it. And then I am sorry to ask one more question.

In terms of that can you give any color around what royalty rate will be on that customer at 14-nanometer on the one we have a gainshare, is it inline with historics?.

Its not inline with historics, it is however inline for the amount of the technology that was delivered. Because the contracts were stopped at the point they were not a 100% of the schedule deliveries of the IP was made. So the royalty rate was reduced by a proportionate amount..

Can you handicap that in terms of percentage or historic..

Well, I think if we use the kind of ratio of the reduction in the fixed fees and apply that to kind of our standard royalty rate you get – you would be in the ballpark..

Perfect, that makes conclusion. Thank you so much. End of Q&A.

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

Thank you..