John Kibarian - President and CEO Greg Walker - CFO.

Jon Tanwanteng - CJS Securities Tom Diffely - DA Davidson Drew Fanberg - Pennington Capital Gus Richard - Northland Rob Ammann - RK Capital Andrew Wiener - Samjo Capital.

Good day, ladies and gentlemen, and welcome to the PDF Solutions, Inc., Conference Call to discuss its financial results for the Fourth Quarter and Full Year ended Wednesday, December 31, 2015. At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session for which instructions will be given at that 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 the 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 12 through 18 of PDF's Annual Report on Form 10-K for the fiscal year ended December 31, 2015 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 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 review of our previously stated plans for 2015 and then give you an overview of our business and performance to plan in the fourth quarter and full year of 2015.

I'll then talk about our plans for 2016 and review how some of the major activities we're seeing in the overall semiconductor logic market may impact us. Greg will then walk you through the financial results in detail and give some comments on our 2016 outlook. We'll take your questions after that.

We began 2015, with a plan to achieve four strategic objectives. First, execute on key 14 nanometer ramps to maximize our Gainshare potential. Second, establish PDF Solutions as the integral part of the Chinese semiconductor ecosystem. Third, make major strides on delivering our Big Data Analytics product Exensio across the semiconductor supply chain.

And fourth, accelerate the development in market adoption of our new Design for Inspection solutions or as we called it our DFI system. The business activity in the fourth quarter in the year demonstrates the success we've achieved on this plan.

As to 14 nanometer, during the year we successfully enabled two key customers to reach production capability and booked our new 14 nanometer engagement. Also as we anticipated we received the first 14 nanometer gain share in Q4.

Highlights of 2015 for China business include, a 28 nanometer yield ramp engagement with a leading foundry in China which we signed in Q4. A 28 nanometer R&D engagement with another Chinese foundry which had been signed earlier in the year.

A 28 nanometer DFM engagement with a leading fabless company signed in Q4 and an Exensio Big Data engagement with a leading foundry in China signed in Q1. Additionally, we are engaged in many pilot projects and other sales activities in China. Other activity in the fourth quarter additionally included the following contracts for our base business.

A 7 nanometer R&D engagement with a foundry client and a 14 nanometer DFM engagement for a fabless company. Regarding our Exensio Big Data platform objective, we closed over 50 contracts in the fourth quarter alone and over 200 for the year.

We successfully acquired Syntricity which enabled us to extend Exensio to a SaaS model and acquired the assets of [Stallion] software which extended Exensio modules into test. We now have over 90 Exensio customers. We estimate that over 10,000 engineers are currently using Exensio and that over 10,000 manufacturing tools are connected to the platform.

Our Exensio customer base includes foundries, fabless, IDMs, test and assembly houses and equipment vendors. For 2016, we anticipate further growth in Exensio across the semiconductor industry supply chain. We also made great progress in our fourth objective for 2015, DFI.

During 2015, we completed design, development and build out of our initial DFI tool and related IP. Additionally, we demonstrated our ability to inspect and analyze results from actual wafers for both fabless and foundry customers.

The first major fabless company that take out multiple chips based on our Template DFM layouts and embedded over 7 billion on-chip-DFI instruments, successfully achieved foundry base line yields on their first wafers out.

This outstanding achievement demonstrates our chips based on the combination of DFM Template layouts and DFI came up the yield curve faster than other chips in 14 nanometer production. PDF's value proposition of providing our virtual IDM experience resulted in starts to bring out better yields and better parametric performance.

Further in 2015, we placed DFI instruments on 19 tape-outs at four major foundries and have received back expected demo wafers from three of those foundries. We have demonstrated the ability to perform electrical inspection and the technical viabilities of our DFI solution.

We have in effect brought the benefits of electrical characterization to in-line inspection. In summary, we executed well on all of our 2015 strategic objectives and have strongly positioned the company for 2016 and beyond. For 2016, we'll focus on the following strategic objectives.

First, continue to deploy our yield ramp solutions for leading edge fabless and foundries, which in 2016, we anticipate will expand into 10 and 7 nanometer with early technology development work on 5 nanometer. We will continue to drive our yield ramps on 28 and 14 nanometer.

We believe 10 and 7 nanometer are really somewhat of a combined node much like 20 nanometer and 16 nanometer. 10 and 7 nanometer [become] a much more important part of our solutions business during the year while 14 nanometer volumes grow and drive Gainshare revenues.

The second strategic objective for 2016, is to drive adoption of DFI by increasing the number of chips with our on-chip instruments by installing early tools at multiple fabs and demonstrating benefits, while continuing development of our system. Our DFI investments during the year will increase significantly as we get closer to market release.

Last year we said, we anticipated that DFI would have small revenue impact late in 2016 and more material impact in 2017. As we begin 2016, we maintain this positive outlook. Third, extend our overall business activity in China supporting the entire semiconductor ecosystem. Our activity in China, in 2015 sets us up well for a great 2016 and beyond.

As way of background I should point out that 2016 is our 10th anniversary in China. More than 38% of our employees are based there and we're initially focused on our back office analytics. Late in 2014, we expanded our focus in China to become the cornerstone of silicon characterization for the Chinese semiconductor customers.

It has been well covered in the Trade Fest that China has committed to invest in leading edge silicon starting with 28 nanometer. We are uniquely positioned to support China's desires in semiconductors with our strong local engineering team and worldwide proven IP systems and software.

Our fourth and final objective for 2016 is to further assist our fabless and foundry customers in applying Exensio our Big Data Analytics platform to maximize their production efficiency. To some of these customers, we'll couple Exensio with our Characterization Vehicle test and other IP to further optimize their production.

For foundries we call this combination of CVs and Exensio for production control, [indiscernible] [FPC]. We expect further adoption of the solution in 2016. From an industry perspective, we are excited to see the beginning of 14 nanometer volume and we anticipate those volumes building throughout the year.

While 28 nanometer volumes stabilized in Q4, we remain cautious of our 28 nanometer volumes in 2016. However beyond 2016, we see many reasons to be positive on 28 nanometer volumes and our related Gainshare as we have a number of foundry customers that are just beginning their journey on 28 nanometer [indiscernible].

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 an increased PDF value and make 2016 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 2015.

Greg?.

Thanks John. As a reminder, in addition to using GAAP results when evaluating PDF's 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 some nonrecurring items, stock-based compensation expenses and amortization of expenses related to acquire technology and other intangible assets and their related tax effects as applicable. Additionally, the income tax provision has been adjusted in our non-GAAP income to reflect cash tax expenses only.

EBITDAR is equal to earnings before income tax adjusted to exclude nonrecurring items, depreciation, amortization and stock-based compensation. You can access the earnings 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 GAAP revenues for the quarter were $24.1 million resulting in GAAP net income of $2.8 million and GAAP EPS of $0.09 per fully diluted share. Revenues on a non-GAAP basis totaled $24.5 million with non-GAAP net income of $5.7 million or $0.18 per fully diluted share.

Cost of sales and operating expenses together were $20.7 million on a GAAP basis and $17.7 million on a non-GAAP basis. For the year, total GAAP revenues were $98 million resulting in GAAP net income of $12.4 million and GAAP EPS of $0.39 per fully diluted share.

Annual revenues on a non-GAAP basis totaled $98.9 million with non-GAAP net income of $25.6 million or $0.80 for fully diluted share. Annual costs to sales and operating expenses together were $78.7 million on a GAAP basis and $69.2 million on a non-GAAP basis.

Moving onto revenue details, as stated earlier total GAAP revenues for the quarter were $24.1 million. This was higher than the previous quarter by approximately $200,000. Total non-GAAP revenues of $24.5 million for the fourth quarter were approximately $100,000 higher than Q3.

Total non-GAAP revenues were comprised of Design-to-silicon-yield solutions or solutions revenue of $14.7 million and Gainshare performance incentive or Gainshare revenues of $9.8 million. Our top 10 customers represented 85% of total revenues in the current quarter.

Two of these customers contributed 10% or greater revenue for the quarter for a total of 66% as compared to one customer and 60% in the prior quarter. Looking at solutions revenues in more detail, 16 project-based engagements contributed at least $100,000 of solutions revenue in the quarter, two more than in the prior quarter.

Primarily as a result of Q3's strong software revenue performance, Q4 solutions revenue at $14.7 million was $3.1 million lower than in Q3. Gainshare revenue for the quarter was $9.8 million, an increase of $3.2 million over the prior quarter.

The total number of node sites which we define as an individual fab and process node combination contributing to Gainshare was 18. On a geographic basis, North America accounted for 44% of total revenues which is down 10% from the previous quarter.

Europe accounted for 28% of total revenues, a decrease of 2% from the prior quarter and Asia accounted for the remaining 28% of total revenues, an increase of 8% over the prior quarter. Total GAAP revenues for the year were $98 million. This was lower than the previous year by approximately $2.2 million.

This variance in year-over-year revenues was generated by a reduction in Gainshare revenues of $13.3 million, related to depressed 28 nanometer volumes offset by an $11.1 million increase in solutions revenues primarily driven by growth of our Exensio Big Data Solutions.

Total non-GAAP revenue of $98.9 million for the year were approximately $1.3 million lower than in 2014. Total annual non-GAAP revenues were comprised of Design-to-silicon-yield solutions or solutions revenue of $64.8 million and Gainshare revenues of $34.1 million.

Moving to expenses, cost of sales for the quarter was $10.1 million on a GAAP basis, which is approximately $200,000 lower than in the previous quarter. This decrease in GAAP cost of sales was primarily driven by one-time hardware costs recognized in Q3 that were not repeated in Q4.

GAAP gross margin was 58%, as compared to 57% in the previous quarter. On a non-GAAP basis, cost of sales was $8.9 million, which was $200,000 lower than in the previous quarter. This increase in non-GAAP cost of sales was principally driven by the previously mentioned hardware costs in Q3.

Non-GAAP gross margin was 64% as opposed to 63% in the previous quarter. Total GAAP operating expenses at $10.6 million were $300,000 lower than last quarter and 44% of total revenues down 2% from last.

R&D expenses totaled $5.4 million, $200,000 higher than the prior quarter, R&D expense as a percent of revenue was 22% in the quarter which was the same as Q3. SG&A expenses totaled $5.2 million or 22% of revenue compared to $5.7 million and 24% of revenues in the prior quarter.

The overall GAAP operating expense decrease was primarily driven by the reduction in acquisition-related expenses as compared to Q3 partially offset by increased R&D expenses primarily driven by new hires.

During Q3 2015, PDF completed its acquisition of Syntricity Inc., a industry-leading hosting solution for characterization yield management and that drove the acquisition costs. On a non-GAAP basis, looking at operating expenses and cost of sales together, total spending was $17.7 million, which was flat compared to the prior quarter.

Cost of sales for the year was $39 million on a GAAP basis, which was $700,000 lower than in the previous year. GAAP gross margin for the year was 60%, which is the same as in 2014. On a non-GAAP basis, cost of sales for the year was $36.8 million, which was $2.4 million higher than in the previous year.

Non-GAAP gross margin for the year was 63%, which is 3% lower than in 2014. Total GAAP operating expenses for the year at $39.7 million were $7.1 million higher than last year and 41% of total revenues, up 8% from last year. R&D expense for the year totaled $19.1 million, $5 million higher than in the prior year.

R&D expense as a percent of revenue was 20% for the year, which is up 5% from last year. SG&A expenses for the year totaled $20.6 million or 21% of total revenues, compared to $18.5 million or 19% of total revenues in the prior year. In 2015, the SG&A expenses included on a GAAP basis $1.2 million of acquisition-related expenses.

The overall GAAP operating expense increase was primarily driven by increased investment in R&D related to our DFI initiatives and acquisition-related expenses. On a non-GAAP basis, looking at operating expenses and cost of sales together, total annual spending was $69.2 million, which was $7.4 million higher than in 2014.

The GAAP income tax provision for the quarter was $620,000, which reflects an effective tax rate of 18% compared to 46% in the prior quarter.

This rate decrease is primarily due to the reinstatement of the federal R&D tax credit program, which allowed the company to benefit in the current quarter from credits related to the full year of 2015 for qualifying R&D activities. Cash tax liabilities for the quarter were $1 million.

This represents an effective cash tax rate for the quarter of 30% of pre-tax GAAP income. As we have stated before, our cash taxes are primarily comprised of foreign withholding taxes. For the year, GAAP income tax provision rate was 36% compared to 34% in the prior year. The cash tax rate for the full year was 22% compared to 17% in 2014.

GAAP net income of $2.8 million for the quarter resulted in GAAP EPS of $0.09 per fully diluted share, compared to $1.5 million or $0.05 per share in the prior quarter. This increase in GAAP EPS and net income is primarily related to the increase in Gainshare revenues in Q4.

GAAP net income of $12.4 million for the year resulted in GAAP EPS of $0.39 per fully diluted share compared to $18.5 million or $0.58 per share in the prior year. This decrease in GAAP EPS and net income is related to the decrease in full year Gainshare revenues and also one-time costs incurred for the Syntricity acquisition.

EBITDAR, which I defined earlier and is also defined in our press release, was $7.5 million in the quarter as compared to $7.4 million in the prior quarter. EBITDAR per fully diluted share was $0.23 the same as in Q3. EBITDAR for the year was $32.5 million as compared to $40.5 million from the prior year.

EBITDAR per fully diluted share for the year was $1.01 compared to $1.27 in 2014. On a non-GAAP basis net income was $5.7 million and non-GAAP EPS was $0.18 for the quarter compared to $5.8 million and $0.18 in the prior quarter.

For the year, non-GAAP net income was $25.6 million and non-GAAP EPS was $0.80 compared to $33.9 million and $1.06 in the prior year. This reduction in non-GAAP income is primarily related to the year-over-year decrease in Gainshare revenues and increased investments in R&D.

Total cash at the end of the quarter was $126.2 million which is a slight decrease of $100,000 when compared to cash at the end of Q3. Cash generated from operations during the quarter was $6.5 million representing an increase of $1.2 million over the prior quarter.

This cash generation was offset by $4.9 million of stock repurchases or 450,000 shares and approximately $1.2 million of fixed asset and intellectual property purchases mainly related to our tester and DFI initiatives. As mentioned earlier, the company repurchased 453,000 shares of its common stock for $4.9 million.

After these Q4 repurchases, up to $10.5 million remains available for use by the company under its current Board approved stock repurchase program. Included as the use of cash from operations, we also repurchased $800,000 of additional shares to cover employee taxes on restricted stock grants released about 69,000 shares.

For the full year the company spent $14.5 million on repurchasing 1.1 million shares under the Board approved program and additionally spent $1.8 million on a 133,000 shares to cover employee taxes on restricted stock grants released. Trade accounts receivable DSO was 83 days for the quarter compared to 76 days in the previous quarter.

Trade accounts receivable balance at the end of the quarter was $22 million, an increase of approximately $2.1 million over the previous quarter. The unbilled accounts receivable balance was $11.5 million, a decrease of approximately $1.1 million from the prior quarter.

Of the $33.5 million of total receivables, approximately $76,000 or less than 1% was more than 30 days past due. Since the end of the quarter, $4.3 million has been collected. Total DSO for the quarter, including unbilled receivables, was 127 days compared to 124 days in the prior quarter.

Headcount at the end of the year was 390 compared to 391 at the end of Q3. Looking at 2016, we expect the growth rate of Solutions revenue to be greater than 10% year-over-year driven by increasing demand for our Exensio Software Solutions and the continued expansion of the Asia's semiconductor market and in particular the Chinese market.

For Gainshare, we remain very cautious with regards to 28 nanometer volumes for the year. While we expect overall Gainshares to increase during the year, driven by the build out of the 14 nanometer volumes, the magnitude of this increase maybe negatively impacted by the lagging recovery in the 28 nanometer node.

From a spending standpoint, we expect that 2016 R&D expenses and related cost of sales will increase by more than 30% as we take our DFI initiative from development to commercialization. Additionally capital equipment purchases should also step up substantially as part of the DFI initiative.

As we've stated before, we expect first revenues from DFI before the end of 2016. In regards to other operating expenses, they will reflect the full year of the impact of the Syntricity acquisition. Finally, we expect our full year GAAP tax provision rate to be between 38% and 40% and cash taxes for the year to be in the range of 24% to 26%.

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

Operator?.

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

Are you starting to see any rebound or backfill at all at the 28 nanometer node and then was the strength in Gainshare in the quarter all 14 nanometer?.

The growth was primarily 14-nanometer. We'd really gone into quarter expecting 28-nanometer in Gainshare volumes to grade Q3 over Q4 and that didn't happen..

Okay.

Not as I was expecting on 28?.

Exactly..

And then can you talk about the new 10 and 7 nanometer engagements, are any of these with the client that you had a dispute with in 2014 or perhaps have you made [volume] penetration in clients where you haven't historically done at all?.

So I think we always are very careful about talking about who customers are because we have to abide by our confidentiality agreements with customers. The 10 and 7 nanometer engagement was with an existing customer. There were other contracts particularly in China that were with growing customers..

And then just Greg on the R&D comments, I just want to clarify, did you see you expected to be up 30% year-over-year the R&D expense?.

At least..

Okay got it.

Just remind me also what is the remaining share repurchase authorizations and if it's fair enough that I guess they are at [10% of the cash]?.

Yes. I believe its 10.4 million but let me validate that for you, only 10.5 million remaining..

It's all annual?.

Yes. No other updates on cash plans at this point in time..

Your next question comes from the line of Tom Diffely from DA Davidson. Your line is open..

First on the Gainshare side, for the 14 nanometer Gainshare in the quarter, does that represent some catch up from previous quarters as well as if it's just kind of ongoing level?.

No. that's just the ongoing level..

Okay.

And some of these customers have been doing gains with our 14 nanometer for several quarters, how does that play out as far as the royalty show up?.

As we've talked about, to effect one of the contracts the first Gainshare quarter was measured in Q3 and invoiced in Q4 and then six or so years of that contract represents some Gainshare starting in that quarter. So in shares the prior production was lost..

And then on the 28-nanometer side is it the fact that the previous 20-nanometer capacity has been partially moved to 14-nanomter or is that 28-nanometer capacity still there and just underutilized, how would you characterize it?.

Yes. It's different for different customers. So I think you can really take into three buckets, Tom. So the folks that have a Gate-Less 28 it's alternative to kind of the industry standards. They're seeing demand for their High-K technology.

On the Gate-First technology we see that is very spotty in terms of the number of designs that have been put to that. With respect to one of the customers that has a Gate-First technology, a lot of their 28-nanometer capacity was retargeted to 14, but they still have some capacity in 28-nanometer.

And in the case of other customers they have a combination of Gate-First and polysilicon and we watch those two closely to see what the demand is for each one of those..

Okay.

And over time would you expect some of the overt designs to migrate down to the 28 or do you expect some of those 28 to get migrated down actually to 14?.

I think for the customers that are primarily in the foundry business usually they don't migrate capacity. More often than not that capacity is last, so the 28 foundries generally speaking, the last planer on node factories.

And if you remember the 0.18 micron node, eventually the foundries repurposed that to 0.15, 0.13 but it is pretty much the last 200 millimeter aluminum node. We believe 28 nanometer capacity for the most past is the last planer node, right, so you'll see it repositioned for FinFET technology -- I mean for FD-SOI technology.

In one customer's case in tweaks on 28 slight shrinks, parametric tuned version, the foundries have now HPM, HPC, HPC+, many versions that are slightly improved. We anticipate that happening. But we don’t expect any more capacity being transitioned from planer to 3D technology, other than the one case that we saw in this past year.

Did that answer your question?.

Yes.

And then when you look at the 20 nanometer down the road when the capacity comes back or when your royalties comes, is the biggest driver for you just the ramp up of the newer largely Chinese Asian customers or do you think that this existing capacity gets fully utilized again in some point in the future?.

We anticipate the capacity that exists being utilized both on 28 and derivative nodes like FD-SOI. We also see an awful lot of capacity going in Taiwan and in China on the second wave foundries and that represents a pretty big slug of volume.

Should they complete their shells primarily targeted -- the shells are completed, complete the capacity build out, primarily targeted 28-nanometer. So 28-nanometer for us, we still see a number of years of meaningful Gainshare.

And so 2016 is really those newer customers are still kind of coming up on the volume, so we don’t expect to see -- we’ll see some Gainshare from them in 2016, more as we got out to ’17 and beyond.

And we also expect the customers that have -- will have more capability still available to pickup as we get through design wins, which will take a good part of '16 and really build into '17..

Okay. And then the last question on 28.

You mentioned, it sounds like the 28-nanometer did not do grade as fast as you thought it was in the fourth quarter and I guess that means you are expecting a bit of drop off here, then in the first or sometime this year?.

It’s a great question Tom. We proved to ourselves that we weren't great forecasters in Q4, because we expected it to go down and it didn’t really. And so when we had modeled out in Q4, we’d modeled out to state the depressed levels throughout the first part of 2016 as well.

And now how do you change your model based on sort of one data point putting it in line [to on the one]. So we decided to just remain cautious with respect to the 28 and watch how that goes out throughout the year. We’ll figure out more over the next couple of quarters. We don’t have control over that..

Okay. And moving over to Exensio.

When do you think this becomes a meaningful part of the revenue stream and at that point what does it do the margin structure?.

I think as we went through '15, it was becoming more meaningful and significant. As we go into '16, I think you will start to see it becoming a more dominant part of the overall margin picture on solutions.

Offsetting that will be as we move more and more work to the China and Asia markets, you typically don’t see as great a margin there as you would on the rest of the world. But yes, as we move into 2016, the Exensio business becomes a very material part of the business..

And I think one way to think about it Tom, if I can add a little bit color to that. Gainshare was down, like $14 million year-over-year and gross margins were basically flat. Normally, if we were to lose $14 million of Gainshare revenue replace it with solutions revenue, you wouldn’t hold margins..

Okay..

So that’s one way, you can go back and do your own modeling on that bigger shift of stuff out..

Okay. And then finally Greg on the R&D increase this year the 30% plus.

What kind of linearity are you looking at for that?.

My model, which is no more accurate that anybody else's, because these brand new development projects, they can go in spurts and fits. But I have a fairly aggressive ramp up in the first half of the year and then flattening a little bit in the second half..

Okay, great. Thank you..

Your next question comes from the line of Drew Fanberg from Pennington Capital. Your line is open..

Hi guys. Just one question for me. On -- you have quite a bit of cash on the balance sheet. Now you have a little bit leftover on the current buyback program.

But can you comment are there any future plans to return capital to shareholders in terms of either dividend or more [in that ballpark]?.

Yes. I think, the amount of cash -- the amount left open on the buyback maybe somewhat misleading. We’ve never actually gone through a period where we haven’t had an open buyback.

So while this one will expire and set to expire in 2016, we will announce another buyback on the heels of -- slightly before it will expire which will refresh the amount of buyback we will put in place in 2016 and beyond..

Okay. Thanks..

Your next question comes from the line of [indiscernible]. Your line is open..

Hi John, hi Greg.

Can you guys characterize your DFI solutions, what fits in the inspection ecosystem and also talk about how you’re going to sell it if there is Gainshare prior to that?.

Sure Gary, thank you. [indiscernible] if I have to answer that question has been, can we characterize which is I guess part of our business, so we have to answer that question. So where does it fit in? what we believe we are doing is bringing an electrical measure in line.

So it doesn’t directly replace what they do, but it gives them a new piece of information we believe related to electrical performance on the part and to some extent potentially reliability metrics. With new 3D structures the way layers interact becomes more and more important.

Conventional inspection kind of lets you look at the in-layer behavior, but doesn’t give you a good way of demonstrating how that layer is interacting the layers below it. And they are really targeting this application to looking at the interaction between the layer that is just incomplete with the layers below it.

To look for defects that are basically covered and/or interactions of layers. In terms of the business model we really are still exploring that, so it's hard for us to go and say, what the business model will be for it.

We do anticipate that the business model will somehow be ratable and be proportional to the amount of information in a way that system is used. However we don't know it, because there is an element that's the machine that has a lot of it, which is the IP and software.

Without a signed contract, because the market also accepts the way that we're thinking about going to the market, it's probably speculative for us to say that's where we're going actually price it and bring it to market..

Okay.

You mentioned that you have I think 19 tape-outs for DFIs?.

That's correct..

So what does that mean as opposed to being in market and those being contract -- revenue generating gains possibly ratable accelerated contracts?.

Yes. So, I just wanted to, so I didn’t bring out -- point out. I think we did something like 80 tape-outs last year in 2015 on test on CVs. So we tape-out more than a vehicle a week. Every vehicle, every chip in the world has dummy shell. Test vehicles, product chips, every chip in the world does.

What we started doing with our fabless customers and our foundries, is going back and saying, look this dummy shell, it's going to be wastage space, let's use it productively and we started putting wherever we could given engineering constraints and timing, et cetera.

We started putting on chip instruments inside shells for both test vehicles, fabless customer's test vehicles and fabless customer's full products. It's like putting an instrument then inside potential customer's foundries.

Then our fabless customers are able to go back to the foundries and say, oh, these instruments are running in your factory, we'd like to see how they perform and we're able to then take wafers, bring them to our lab here in California, [excite] those instruments with our own tool, read the results, use the Exensio Analytics Platform to characterize how that wafer behaved and report that information back to the fabless and foundry about how you can get a better characterization of the design process interaction with this technology.

So, for us they are at this stage like selling tools. Because they are our way of marketing what this capability can bring to people and given we do so many tape-outs that pretty much all the foundries in the world every year and as I said, many more than one a week, we always have an opportunity to in effect market the solution.

For that [matter] we have the capacity to address the opportunity [indiscernible]..

Got it, thanks. And switching to your Gainshare, can you characterize -- a few years back, I think you had a few peak quarters of $12 million of Gainshare and at that time I think that was on 12 engagements and today you're at 18 engagements, but I don't know, you're defining engagements differently.

So how -- on the 18 engagements today and everything which is because of that, volumes of customers, can you talk what the dollar amount of Gainshare would be compared to the $12 million on 12 engagements a few years back?.

It's a difficult thing to say. Given our conservative view of the 28 nanometer volumes, we are modeling numbers that are not as high as that in any given quarter for the year. I won't give you -- we don't give guidance. So I won't go beyond that..

I think, Gary's question is a question is if the foundry factories fills up….

Then we'd be above that number..

We'd be well above the previous peak..

Right.

And then can you give -- I assumed you're going to say that, but can you give us a little bit more clarity? I mean, if it's 18 engagements versus 12 engagements and I'm guessing your economics are better and the volumes are bigger that an engagement, a single engagement today is better than a single engagement three years ago, is that fair?.

Yes. Generally, I think, we don't mention the number, but we look at that just as a number of wafers out there in the factories and what -- if the factories produced at full capacity, what would the dollars that would come out of each of the factories be and that's our kind of way of modeling it.

When you look at over to that model the number of potential wafers out -- efficient wafer out has grown. So I think the peak you're referring to is a 2014 peak.

So the number of wafer -- the factory capacity has grown over that time period for the most part and so therefore the total potential volume that's represented and the Gainshare that resulted from it, is up substantially. I don't know the exact multiple of where it is over the previous peak, but it's a pretty sizable growth..

Okay great. Thanks guys..

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

You've mentioned you have 19 tape-outs with DFI, how many customers do that represent?.

I think it's somewhere around 5% or 6%, 5% of these..

Okay. And then in the Solutions business can you give a little bit of color.

Right now you've got a number of contracts, how many are at 10-nanometer and below? How many are at 14 and how many are at 28?.

We generally won't specify those numbers..

You are talking about Gainshare or Solutions?.

Solutions..

Yes. I mean we have multiple contracts at 10 and 7. I think it probably is the most clarification we would give you. In our older contracts at 45 and 32, are starting to roll off..

That's Gainshare though. He is expecting Solutions..

Well yes, yes..

I will do it..

Yes. I was just looking at Solutions..

We have got still substantial -- there is as you can in the quarter, we're still signing contracts at 28 nanometer. I think one of the points that -- we've been maybe not doing a great job of communicating to the community. The 28 and 14 ramps are beginning to look at China and parts of Asia now, so those are all starting all over again.

So you are going to see us has activity on 28 and 14 for a number of years beyond this point. That said there is a number of activities going on in 10 and 7 as well. So the number of nodes that will be engaged in 2016, '17 and '18 is a very broad number of nodes..

And then I didn't catch the Gainshare at 28, was that up, down or sideways for the quarter?.

It is primarily sideways for the quarter..

Okay.

So it is as stabilized but you do expect the kind of stabilized to be weak through '16?.

That's how we're modeling it. The answer is we really won’t know until we get into the year..

And then just real quick, your Solutions business dipped in the quarter quite a bit and you are guiding for the year to be up 10% or greater and I just want to sort of understand what do you expect that ramp to look like in '16 in terms of your Solutions businesses? Going to be a steady increase or -- and what do you see out there to give you comfort that you're going to have a pretty good step up in the run rate of Q4?.

Yes. So to answer the first question, will it be a steady increase? No. Historically our Solutions business is fairly choppy and moves up and down quarter to quarter. Two reasons for that, one is that on the yield ramps solutions side, those are percentage of completion contracts generally.

They tend to have very lumpy revenue recognition as different parts and deliveries on individual contracts are made and how much effort you put forward to complete those.

And then on the software side, we're coming from a software business, the Exensio business that historically had a significant portion of revenue that was perpetual and the annual maintenance renewals related to that.

While that is shifting more towards a ratable model and in some cases even a hosted model, there are still quarter-to-quarter impacts on occasion where you will get lumps of revenue coming in either catch up on maintenance or a mix of perpetuals.

And in those cases, the combinations of those two can generate you non-material -- I mean material variances quarter-to-quarter. If you look at the Q3 to Q4 variance, that's exactly what happened.

In Q3 we had a very strong software quarter as some existing contracts that were fairly substantial actually got to revenue recognition that had been under some services that was being performed. And then in Q4, those contracts are not there. You're on your regular steady base.

So that dropped off and that's what drove most of the variance from Q3 to Q4. We'll see that kind of activity up and down all throughout the year. But the overall direction is one where we're pretty comfortable that will be up at least 10%..

And you have another question from the line of Jon Tanwanteng from CJS Securities. Your line is open..

Can you clarify that up 10% in the Solutions business, does that include the lump sum you received in Q1 of '15 or is it up 10% from that or are you actually backing that out when you calculate?.

Yes, that's a very good question. I would count that as up 10% from the absolute number including the $6 million..

Your next question comes from the line of Rob Ammann from RK Capital. Your line is open..

Yes.

Just a clarification on expense growth, that 30% is that just R&D or was that 30% growth in R&D and cost of goods sold?.

That’s just R&D..

Just R&D. Okay, okay, great. And then past 2016 is that a level that you think a plateau is going to hold there or is there a chance it steps down.

How do you view it longer term?.

I don’t think, it will step down significantly, but it will flatten out as we move out of '16, this is R&D expanding into '17..

Okay, okay. And then the increased CapEx, the data was about somewhere around $5 million or so.

Is that something that you see a couple of million extra or any way to size that a little bit?.

Yes. I would expect it to be a higher growth than we saw in '15 and it could be materially higher..

Okay. Thank you..

Your next question comes from the line of Andrew Wiener with Samjo Capital. Your line is open..

Hi. Good afternoon guys.

With respect to 14-nanometers did you have one customer recognizing -- in recognized revenue and Gainshare or is it two on the Gainshare side?.

It was one in the past quarter..

Okay. And then when you look at the second customer.

Do you have an estimate at this time, when you’d expect to see first revenue from it?.

We expect it in 2016, Andrew, but timing is always hard to think when they first start shipping for revenue. We believe they are at strong enough yields too..

Okay. In your beginning comments, did you say, I may have misheard.

But did you say that you have added another 14-nanometer customers from sort of development deal?.

That is correct..

Okay.

So that will make three customers for 14-nanometer at various stages?.

That is correct..

Okay. With respect to the 28-nanometer and 14-nanometer ramps in China, in Taiwan. To what extent -- Greg you had talked about potential margin pressure on Solutions because of they are -- sort of their willingness to pay for so I guess labor and that type of [sales].

Is there a learning curve though you benefit from, from the previous 28-nanometer ramps that you did for the customers that might allow you to have greater efficiency or productivity in getting customers in China [up and running]?.

Andrew, I think the vehicles and systems, I think my choice of words was worldwide proven IP and systems. And I think there is tremendous benefit for our customers there and everywhere that our systems are proven against -- we’ve run vehicles in every 28-nanometer node in the world and [per se] the 14-nanometer, 16-nanometer node in the world.

So there is a lot of solidity in the structures and the capability, which does drive benefit to them and some efficiency to us.

But they all make different tool choices and different materials choices and people -- you’ve got to run the program to the one in characterized that we -- ours have [voted] to run up an engagement is relatively consistent across the customer base.

A lot of that will be served out of our China office and obviously over time we have some efficiencies there..

And then with respect to expense, you are obviously mentioning 200 odd contracts for the year again 90 plus customers, which obviously means more than one contract per customer.

Perhaps you could talk about how deeply you have penetrated within the existing customers from an Exensio perspective and what is opportunity there for you to expand that business within the existing customer base?.

Sure Andrew. So we [indiscernible] penetration is reaching. Almost only a handful of customers have the broad solution with the full analytics capability across all of the data types. And those are by and large the largest [indiscernible] and then giving ourselves the ability to demonstrate the other capabilities that are out there.

So we believe that the customer base itself is a big up-sell opportunity, a significant part of our go-to-market strategy..

Okay. Greg and then as a follow-up to the CapEx question.

Do you expect particularly in the back half for the year, the CapEx associated with DFI, will it be reactive to customer demand or do you anticipate the need to build tools in advance of getting interest in orders?.

Andrew this is John. So, some of it is early build out of initial tools for our lab and demo capabilities for second generation tooling. Some of it is for customers.

So, obviously if we don't see success throughout the year we would sell some of that build out, but as we said in my prepared remarks, we feel comfortable about achieving our goals of seeing customer impact by the end of 2016, financial impact than in 2015 and so with more material on '17.

So we would need to prepare and enhance that a little bit, which is what we built into our operating plan..

Okay, great, thank you..

Your next question comes from the line of Tom Diffely from DA Davidson. Your line is open..

Yes, just a quick clarification here. So, if a lot of the increase in R&D is for data tools.

Greg, could you put that in inventory instead of R&D?.

The R&D expense is not really for the tools, you would see that more in our capital line. There are some parts that get expensed that don't have commercials capability or things like that. So it wouldn't be in inventory, these would be in capital or in -- for the moment or in R&D expense and both of those will be going up..

Okay, that helps. Thank you..

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

Thank you..