John Kibarian - President and CEO Greg Walker - Vice President of Finance and CFO.

Jon Tanwanteng - CJS Securities Tom Sepenzis - Northland Capital Markets Christian Schwab - Craig-Hallum Tom Diffely - DA Davidson Eugene Fox - Cardinal Capital Brian Freckmann - Lyon Street Capital Andrew Weiner - 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 Saturday, December 31, 2016. 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 earnings press release and the company’s fourth quarter and annual commentary, 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 and solutions. PDF's actual results could differ materially.

You should refer to the section entitled Risk Factors on pages 12 through 19 of the 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 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..

our 14-nanometer IYR engagement for early technology development that also included DFM templates and DFI with a foundry customer in Asia. And to manage to an existing 28-nanometer IYR engagement with the Asian foundry, a 40-nanotmer IYR with an Asian semiconductor company, a 10-nanometer DFM engagement with the U.S.

fabless companies and multiple Exensio contracts with several foundries and fabless companies.

The 14-nanometer contract signed this quarter led the 7-nanometer contract signed earlier in the year with a different customer starts from the early development of the manufacturing node, it includes DFM templates and templatizer software which are being used by the foundry’s internal IP provider and third party IP providers to create foundational logic cells.

Customers are recognizing that IP built from templates demonstrate with manufacturing benefits. In this 40-nanometer program DFI is used to accelerate the early technology development. As we moved through 2016 we started to recognize usage for DFI with the eProbe-150 that we had not foreseen when we began the program.

This has accelerated the program’s early commercial adoption. By including DFI in our customers’ early R&D program we believe we can accelerate their process of development and also validate and demonstrate the on-chip instruments which will be important for mass production control.

This is the third commercial customer of our DFI solution and we continue to discuss the adoption of our DFI solution with several other foundries.

Our Exensio big data analytics solution, in addition to hitting record bookings in the quarter and the year, greatly expanded its customer base, horizontally deep into existing customers and new fabless and device manufacturers as well as vertically into OSATs, and system houses.

Our development of DFI and Exensio have allowed us to create new offerings for our customers that grow our total available market, add more IP hardware and software to our solutions.

As Greg will discuss, this has helped us grow our solutions revenue at a rate faster than the past as well as improved the gross margin of the solutions revenue as customers recognized the value of the high def [ph] margin software, IP and the hardware components of the solutions we are doing.

And total 2016 revenue at $107.5 million was also a company record and represented a 9% increase year over year. This increase in revenue was driven by the strength of our solutions revenue which grew 21% year over year to $77.2 million.

Offsetting this gain was an 11% decline in our Gainshare revenue year over year to $30.3 million due to decline in some consumers’ utilization rate. We started 2016 with four key strategic objectives.

One, deploy our Yield Ramp solution for leading edge fables and foundries which is the timing anticipated would expand during 2016 into 10 and 7 nanometer.

Two, drive adoption of DFI by increasing the number of chips with on-chip instrument measurement structures, installing early tools at multiple fabs and demonstrating benefits, all while continuing the development of our systems.

Three, expand our overall business activity in China by supporting the entire semiconductor ecosystem there, and four, assist our key foundry and fables customers and apply Exensio based solution to improve their operational efficiencies both on new products as well as matured products. We have successfully achieved these objectives.

We are engaged with multiple customers at 10 and 7 nanometer. We began commercialization of DFI and installing two systems in 2016 and closing a contract for a third. There are now over 50 chips that have DFI instruments at multiple foundries. We continue to see great reception at our fables customers for DFI.

We signed multiple engagements with several key Chinese foundries and fabless companies. Collectively these agreements include all our components of our solution, from DFM templates to IYR to Exensio and DFI. And for Exensio our business activities were strong. We now have over 90 customers.

Moreover as a press release earlier in the year with [indiscernible] indicated customers are enjoying the benefits of operational efficiencies on matured product. Our user conference was well attended and the keynote from SPIL demonstrated the benefits of Exensio are being enjoyed across the supply chain.

Finally, for our more than more foundry customers, they’ve benefited from solutions that include CVs and Exensio to improve their manufacturing effectiveness.

All of this activity has served to greatly increase the number of customers utilizing our products and solutions, expand our relevance across the entire lifecycle of nodes and across more of the semiconductor supply chain. We believe this is greatly increasing our addressable market.

Turning to 2017, from an industry perspective we expect to see continued growth of volumes of 14 nanometer. Also we are lucky to see the start of a 10-nanometer production during the year.

The 28 nanometer node will trend up over the long term but would be lumpy during 2017 as some customers are transitioning capacity to newer technology nodes and some Gainshare periods end while new ones start up.

Our 2017 objectives are a continuation of our 2016 objectives as we believe our new products and market expansion represents a multi-year growth opportunity for us. Overall in 2017 we intend to further broaden our IYR customer base and exploit the new Chinese opportunities in logic as well as other process technologies.

Additionally, we intend to expand our Exensio customer base both vertically and horizontally as the electronics industry moves to manufacturing 4.0 by leveraging our big data analytics software capability.

We intend to build on the early traction of our 150 series systems for DFI with further commercialization, then to complete the development of our 250 systems. I look forward to speaking with you during the year and letting you know how we are doing against these goals. I will now turn the call over to Greg.

Greg?.

Thank you, John. For everyone, as John pointed out, we have posted in the Investor Relations section of our website a management report for the quarter and the year which gives detailed comments regarding the financial results of PDF.

Given that I'm going to focus my verbal comments today on the non-GAAP financial results for the year and some key messages reflected in those results. First, as John stated, we had record bookings for both our IYR and Exensio offerings which drove our solutions revenue growth to just under 20% for the year.

Additionally we ended 2016 with the largest solutions backlog in the history of the company. This record performance allowed us to grow our total revenue year over year despite an 11% year over year drop in Gainshare revenues as John pointed out.

Second, beginning in 2013 and ’14 we set out to substantially increase our position within the semiconductor industry in Greater China to take advantage of the growing investments within that geography. Since that time, Asia Pacific has increased from 15% of our total revenue to 42% of our total revenue in [2017].

That's a significant change in the revenue structure of the company. We have seen however on the downside of that an increase in our accounts receivable as the payment periods and collection issues out of China are a little more difficult than in the U.S. or Europe.

Looking at 2014 we began investing in a new technology which we call design for inspection with the goal of significantly increasing our addressable market and extending our relevance throughout the entire node life for any process technology.

Our original plan was to introduce our first generation development platform by 2016 and subsequently introduce our second generation in-line solutions with first commercial shipments in early 2018. Driven by customer demand, however, we were able to commercialize the first generation platform and in fact generated some material revenues in 2016.

During 2016 we were also able to significantly increase the capability of our Exensio solution and expand its addressable market beyond foundries and fabless customers to test an assembly. In order to take advantage of this expanded market we increased our investment in our sales and support teams in the field during the year.

As a result we added many more new customers during the year and expanded the overall marketplace and also expanded our position with existing customers.

Looking at revenue, even though the mix between solutions revenue and Gainshare revenues shifted away from Gainshare by more than 11% since 2013 we've been able to effectively sustain our gross margin levels.

We've been able to accomplish this by improving our solutions margins over that period driven primarily by higher software content in many of our deals which have higher margins.

While our large R&D investment in DFI has limited our profitability over the past two years we have been actively managing our other expenses to offset this impact as much as possible. As a result we have remained profitable during this entire investment period and have not had to utilize a significant portion of our balance sheet cash.

In summary, as John has stated during 2016 we were able to successfully meet the core strategic objectives that we set out to accomplish.

In executing against these objectives we added many new customers through expansion of our Exensio business, significantly grow our position in China, opened up a new market with our DFI solution and developed many solutions for the more than more or older net [ph] process nodes.

We feel that we are well on our way towards achieving our goals of increasingly the addressable market for PDF and significantly reducing our overall business risk particularly as far as customer concentration. In the management report that I referred to earlier, there is a discussion of our 2017 outlook for both revenue spending and spending.

That is available on the website. With that, I will turn the call over to the operator for Q&A.

Operator?.

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

Hi John and Greg, good afternoon. Thank you for taking my questions.

Can I ask -- what do you have built into your 2017 outlook in terms of DFI machines or revenue and if that includes any shipments of the gen-2 machine or not?.

This is John. We do anticipate completing the development of the generation two machine and being in a position to ship it to a customer in the second part of this year but we have not forecasted any revenue associated with the gen-2 machine at this point. All the revenue that we forecast in 2017 is based on the generation one machine. .

And if I can go out a bit further.

Could you -- do you envision growth accelerating meaningfully into 2018 if you are successful with the 250 series machine and how should we think about that from a quarterly run rate in terms of number of machines sold or any kind of metric like that?.

Yes, I think it's a bit early to kind of specify how many machines we expect to sell or install in a quarterly basis but obviously this has been a big investment for us. We do anticipate if we're successful meaningfully accelerating the rate at which we grow the business as you get out in 2018 and beyond.

Greatly in part because of DFI and the solutions that the 250 system will enable. It’s been positive for us, actually the 150 system has enabled a number of very powerful applications for our customers which is why we're generating business and traction from it as well. And we like that to also continue into 2018.

There are some applications towards the 150 we believe that’s particularly well suited -- costs from our perspective are our more modest than the 250 so we would be inclined to continue to use the 150 as we go out into 2018 as well..

And then just switching over to Gainshare side. Your largest customer just announced a 20% increase in their production capacity.

How is that factored into your outlook at all in 2017 and does that impact the Gainshare?.

Customers announce capacity expansions frequently, those usually take two years from when they announce them to when you kind of see first meaningful -- about a year to build the building, some number of months after that to install and then you're getting to about usually three to five [indiscernible] start after that.

So we always look at those things with kind of a very careful eye. It takes quite a while for them to materialize. And the industry we’re in, it's quite cyclical, sometimes before they're able to get those things up and going, something can go awry.

If you look at that -- it’s unrelated to us but if you look at that announcement about the plant in Arizona for Intel that was announced I think multiple times over the last five years. So we are excited about that but we factor pretty cautiously. .

And then Greg, just on the SG&A in the quarter there was a pretty big sequential jump.

Was that all the additional sales you were talking about or is there something else in there that we should be thinking about and is that the run rate we should build from going forward?.

Now the majority of it was related to accelerators being reached by sales guys on their bookings. And it's a one time jump as far as the spike and then will be more of a revenue stable -- revenue driven growth after that. .

Your next question comes from the line of Tom Sepenzis from Northland. .

Hey thank you for taking my question.

But just curious with 90 Exensio customers, can you give us some sensitivity or in terms of the rate contribution in ’16 and ‘17 from Exensio or is that really just being used to bring customers in to your other products?.

John, you want to talk to that?.

Sure. Tom, it’s a long tail on the Exensio customers. So we have customers where the contracts represent millions of dollars per year in revenue for us.

So the bookings may be anywhere from let’s say, $3 million to $5 million on a multi-year time based license, to customers that are using just some small fraction of the system and their annual spend with us is $20,000 or $30,000 a year, I mean it really is quite a wide spectrum and there are a number of customers, as I alluded to in my prepared remarks, foundries who are using a combination of CVs and Exensio to drive manufacturing operations improvements on those like 55 nanometer and 90 nanometer and those are multi-million dollar per year contracts larger than the [indiscernible] they constitute multiple elements.

Collectively it represents a meaningful part of our solutions revenue. And that's why the gross margins are going up. In the case of DFI, DFI ships with an Exensio, a big data module for doing all the analytics. So it's hard to kind of split it out per se. But it is growing as a factor of our solutions revenue, hence the gross margins are going up.

And you could ask, why do we keep around the smaller customers, where we find the smaller customers often get acquired by larger companies and when customers, through this consolidation, our customers look at the -- we now have a much more complicated supply chain, particularly our fabless customers and our analog kind of asset light manufacturing customers, they find that many parts of the organization are already familiar with Exensio and so we've been able to get customers to standardize on our platform in part because many of their acquired elements are already familiar either with Exensio, Yield or Exensio Test or Exensio characterization or one of the modules and we build from there.

We've had during 2016 a number of the bookings were from customers that were merging standardizing on Exensio and increasing the run rate as they deployed it across, they're now larger enterprise..

Great, thank you for the color there.

And then just given the annual guidance that you had on the website, it seems that the return on the investment from DFI is really going to be more of a 2018 event rather than a 2017 event; am I reading that right or is it something that starts to -- this revenue starts to grow a little bit quicker than the operating expenses in the second half of this year?.

Yeah, this is Greg. Go ahead, John..

Yeah, I think, Tom, we anticipate DFI to grow throughout the year in terms of its revenue contribution and be more significant in 2017 than it was in 2016..

Your next question comes from the line of Christian Schwab from Craig-Hallum. .

Hey good afternoon guys. So great quarter. So as we work at the operating expenses, we did $43 million in non-GAAP operating expenses in ‘16. And we talked about low to mid teens revenue growth in ’17. But we thought we would be spending more money.

So is that -- should we think about the growth rate of OpEx to be about half of revenue?.

This is Greg. Without specifically commenting on how much, I think you are right. There is some leverage in the model. What we said was with the exception of the spending on DFI R&D development, because we're still developing the 250 series platform, the rest of the company's revenue -- expanding growth should be commensurate with revenue growth.

What that means is when you look at the field organizations and the cost of sales and the sales expense, those will grow pretty much close to the revenue growth rate but some of the overhead particularly in the G&A organization, things like that won't grow at that rate at all. What that means overall is that spending will grow.

We hope to get a few points of margin leverage at the end of the day, though..

So just to make sure I'm thinking about this correctly so.

If we -- just absolute numbers if we have kind of 14% revenue growth we should have kind of a 7% OpEx growth and we may get a point or two of gross margin improvement?.

Yes..

One to two points of gross margin, perfect.

And then as we look to 2018, I think you guys were discussing that, what should we be monitoring or listening for looking at throughout the course of 2017 for all of us to get increased conviction that the DFI 2 product will create meaningful and measurable revenue in the 2018 and beyond timeframe?.

Let me take that one, Christian. So I think a couple of things. First of all, we've become increasingly more confident that we can drive revenue even off the eProbe 150.

So we expect in 2018 -- 2017 for growing revenue contribution from the 150, we've started setting goals to have those systems driving revenue for this year and being a material contributor. Because of the ratable nature of the DFI business those revenues will, from many cases the customers continue out through 2018 as well.

So we expect that to be a significant fraction of the business. You should be listening to us talking about additional customers deploying DFI on the 150 and expanding the number of 150 systems they have in their facilities, that would be a good indicator through 2017.

Number two, you should be listening for us talking about the number of fabless customers putting content inside their designs, because that is kind of the way that we see the market.

That should propel throughout 2017 and we dissipate expanding kind of the number of fabless customers and IP providers that are using DFI in their design elements, you should be listening for that.

Number three, you should be listening to us talk about the progress we're making on the 250 in terms of being able to complete the development and then start shipping at the end of the year to such customers for the 250 system for applications that the 250 are particularly well suited for.

But that will be kind of a lagging indicator, you want to see those other two indicators before you see that out. .

Was there a fourth or is there just the three?.

That’s it, sorry..

Okay, perfect. So just because there were so many comments, said earlier I get notes [ph] all over.

So remind me right now, how many DFI 150 customers do we have as of today?.

So today there are three -- we signed in the fourth quarter for the third customer on DFI. .

So we have three DFI customers and then remind me of how many fabless content design wins do we have right now today?.

As I said there are over 50 chip -- combination of test chips and full product chips that DFI content in them..

Perfect. Thank you for that.

So as we look to 2018, one other question -- if we didn't have DFI initiative and success in the eProbe 150 et cetera, what would their revenue growth for ‘17 be?.

It's very hard to, one, estimate that because we’re coming off of probably a little bit lower base. But also when you look at these DFI deals in many many cases they are combined deals with IYR and even Exensio in most cases.

When you look at that depending on the nature of that deal a lot of it's reported in the solutions revenue space as opposed to say any standalone DFI, I mean in the IYR revenue space. So it would be really hard to predict that but clearly without DFI our growth would probably be a little bit slower. But you can't really identify that. .

And then just lastly, if given the initial success of the 150 and then the DF2 coming, can you quantify what you think the revenue opportunity could be in a broad range in ’18, ’19, or ’20? Should we be modestly successful or not very successful to massively successful?.

Yeah, that's a great question, because we talked about that at our analyst day back in November and as we -- I think we talked about it, if we're even able to let's say feed the world with on the order of 10 systems, we anticipate that would drive tens of millions of dollars of revenue per year on a ratable basis, and that would greatly improve the gross margins and profitability of the solutions revenue.

Because as we said -- and at the analyst day our DFI 150 based solutions systems generated between 70 to 80 gross margin points today. And we expect that to grow over time. That would be kind of the -- okay, DFI is a very useful tool for customers but it's not a home run. So that’s kind of the low end case.

If you then go back and say okay, DFI is able to be a full in line production control applications for customers and valuable over some number of layers in the manufacturing process, then as we discussed in the analyst day the market opportunity for DFI is many times larger than the businesses today.

And then at what rate do you grow on to that over that, say, three to five year period depends greatly on what the investment levels in the nodes, your ability to penetrate multiple layers. But then that would suggest that DFI would contribute more revenue than the company is today. .

So if one would want to take a multi-year outlook on, on the company not just looking next quarter or next year, we would assume that with the information we have in hand, that we should at least have modest success with the DFI and DFI 2 which should allow us to continue to drive kind of low to mid teens revenue growth.

I don't want to put words in your mouth for it but let's just say for at least the next few years, with the opportunity for gross margins to expand at the same time and should it become a homerun, then it’s a homerun, is that fair?.

Yeah.

So that's a great way to look -- so the way I think about it right because -- if you go way back even to the time we bootstrapped PDF, so I’ve kind of always had this conservative way of looking at things and the excitement that I have about the success in 2016 as I feel pretty good that the kind of where we're going to do better than the bottom case on this, because we see applications where, even the 150 is really valuable for customers, we think it's quite a useful thing, we can get to that case where it’s going to allow us to grow solutions revenue as you said in the mid teens, improve gross margins.

And as we prove out the applications that drive even more usage some of which that are enabled on the 250, some of which we think are even enabled on the 150, we believe we have a chance of growing the business even greater than that.

So for years, if you remember we’ve told the investors solutions is a single digit growth business and Gainshare is a double digit growth business. And that’s what we're really telling you all as we do see really solid growth in the solutions business as well.

We went into 2016 saying it was a mid teens growth year and it exceeded that, if you look at the way 2016 ended from a solutions growth standpoint..

Great, thank you. My last question if I may. On Gainshare you guys talked about revenue increasing greater than 10% in ‘17 driven by the continued ramp of 14-nanometer volumes.

Does that have to do with any expansion of customer base or does it have to do with kind of more of the well tailored graph, production, capacity expansion of your largest customer?.

When we factor in our analysis we always -- and it's part of the reason why we gave the caution on the 28.

We always factor the stuff that is volume expansion of a known facility with one customer -- customers that have already design wins that have been in that factory with qualified deals, we always build that in our modeling and the things which involve start-up of new nodes, start-up of new products, start-up of new facilities, we always discount that greatly.

So our confidence in the year that we would communicate would be based on facilities where we felt the volume was going to grow because they've done the homework in 2016 and before. .

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

Good afternoon. So maybe following on the last few questions on DFI. So John, I think you mentioned that you thought that the 150 had a pretty long life ahead of it, even if the 250 is out in the marketplace.

What is the difference in the type of application you would expect the 150 to be doing instead of the 250? It seems like 250 is just so much faster than it would dwarf the capability of the 150?.

It does, and what we started seeing customers doing in 2016 was we had anticipated that 150 really only being useful for test chips.

Now you say okay, well use it for early R&D, that's why we couple it with the IYR for customers because it gives them a shorter faster learning loop on some of the layers that -- if you want to test electrical you need to process many layers, not on the middle of line you want to kind of learn quicker.

What happened was, customers liked some of those structures, we started seeing ways that we could put them inside the scribe line on their early customer tape-outs. And they were -- the customers at 14, 10, 7, the alignment of the layers becomes a really big challenge.

And the process window, in other words, the tolerance to that alignment is very different depending on the combination of layers. And so with DFI you have a way of electrically measuring the amount of misalignment you've got as well as the width of the process window. We were able to show that it correlates with product yield for customers.

And so now you can take this application and use that data to improve your lithography controls as well as your upstream etches and depositions in terms of widening that process window.

So we start to see production control applications for being able to measure a modest number of test structures in the millions instead of billions, that's actually valuable for customers and -- So now we've got customers that are using that data and entering that into their factory control databases to improve their manufacturing control on their leading edge nodes.

That's kind of what has gotten us to say well there's an application we did anticipate, we didn't think people would be using the 150 on volume production chips, we thought they'd only be using it on test chips. It turns out they can use it on volume chips. .

So is that data more valuable for the foundries for their process or for the fabless guys to try to get the feedback loop for the next design?.

So the test chip work we thought would be useful for the fabless guys and there has been because they learned about specific structures that may or may not be easy to manufacture. So scribe line application that I described is really for the foundry to improve their control. .

So based on that success early on here, would you expect to kind of ramp up shipments of the 150 then over the next year? And if so, are you capacity constrained at all or is it just a matter of educating the customer and what you can do?.

Yeah, so we believe we can keep up with the demand so far on being able to build up the system. A real bottleneck right now on this, we’ve got to design those structures, put them on a customer's chip, collect the data, show them how they can be used for production control, that is -- it is a very powerful way of getting a feedback loop.

I always joke with customers that it seems like we're going around the world proving the physics is the same in every geography.

But as much as I crack that joke, the customers still expect, okay, let's do a pilot, let’s tape-out DFI, scribe line, send it away for the PDF, PDF will test it, in our clean room, show them what they can do and that's again the dialogue on how they could then deploy it inside their facilities.

And we have a number of those ongoing right now with customers and that's really the long lead on how fast we could move in 2017. .

And does most of that work on at the 10 nanometer node right now or is it 14 or how does that change when you go from 14, 10 to 7 as far as the demand for your tools do you think?.

We have activity going on on all of those nodes. We also have some activity with customers on 28 and we have some activity on advanced memory technologies with DFI in discussions with customers and pilots. So we can the application space is broader than just leading edge but we're testing that.

I don't think we have the confidence to say that it is right now, Tom. We’d be very excited if we could prove that it is valuable for a lot of those other non-leading edge nodes. .

And the last question on that, is one tool per fab enough for this type of measurement?.

We don't believe it would be. But we're still early improving that on, that’s not a big -- we set a goal for us internally to prove this year that that's not true, that you need multiple to be able to do this work. But we haven't proven that yet. .

All right. Moving over to China, obviously a big potential market.

So how big is that today for you on the solution side and based on all the incoming inquiries how big do you think that can get over the next couple years as a percentage of your business?.

I think as Greg pointed out in his prepared remarks, Asia overall is comping about 15% of revenues in 2013 to I think 40 something percent in 2016. A lot of that growth is China, Tom. China and to a lesser extent Taiwan.

How big can it be, as I think I said in our analyst day if you just look at the number of opportunities in China and compare it to the yield ramp business we have outside of China, if they actually build out what they say they're going to build out, and I know there's a lot of scepticism in the semiconductor market about whether all these plans are really going to materialize, that opportunity is as big as PDFs.

There's as many fabs as we're collecting Gainshare from today that are being planned. They are greatly at 28 nanometer and below where we think we have a lot of value to offer them and electrical characterization we think is particularly important.

And with their fabless and system companies we've had a lot of activity with Exensio to control their operations. So we see really -- as I said in my prepared remarks we see the entire Chinese semiconductor ecosystem, because it's being built new as if P.D.F.

existed before it greatly existed they can really leverage PDF in ways that it's always been hard for us to slowly convince the U.S. fabless customers how to use PDF more broadly. So we're very excited about that opportunity. We think it could be as big as PDF is, and the growth rates would suggest that it is on track to do that. .

Yes, so I guess if you look at your guidance for solutions for the year in only high single digits when both DFI is ramping nicely in China, is ramping nicely -- is your segment in there that's not doing well that's kind of even related [ph]to early growth rate?.

If you go back to 2016, Tom, this time last year we said we thought it would do a low to middle teens if I remember correctly for 2016. And as you went through the year we became more confident with the bookings and we slowly increased the actual performance and so the solutions revenue growth rate I think was closer to 20%.

As we look out this year, as we talked to all of our team, we see the bookings for this year are looking to be very strong and potentially another great year like 2016 was. But there's always -- our contracts always take a while to negotiate and signing et cetera. It flips one or two quarters and then that greatly changes your horizon.

So at this point of the year, it’s prudent to kind of forecast it to be not as good as growth of 2016, even though as you point out we have a lot of irons in the fire that we believe could make it a better year than 2016. But it's early to say to go in, kind of put a stake in the ground and say it will definitely happen. .

And as far as Gainshare goes for China that will lag a little bit here, maybe a few years out. .

No, we anticipate seeing Gainshare from China starting in 2017. But again because it's new, we tend to forecast that to be a little bit behind what the customers’ owned models would suggest. So we anticipate by the end of 2017 to be collecting Gainshare from our customers in China. .

Okay, and then just to go back to kind of your big picture or long term view, you said earlier that DFI could double the revenue at higher margins than you currently have. Sounds like China could double revenue at maybe slightly lower margins than you currently have.

But net-net I mean the combination of those two pricks is pretty explosive on a multi-year basis..

Yeah, we're very excited about the investments that we've made.

I think if you kind of look back at the materials we prepared for the analyst day, we chose to do the analyst day, then we felt that there was a lot of exciting things going on at PDF and we've made -- we’ve had a lot of very patient investors that have been with us as we made a lot of these investments over multiple years.

And as we’re saying today we're not done with the investments but we're starting to see a lot of the benefits, and you saw that in the ’16 numbers, you’ll see that more in the ’17 and ’18 numbers..

And then just two for Greg. I guess on the downside you said collections in China are a little bit more difficult, little more color on that would be helpful, just to know what kind of risk you might have..

Yeah, when you look at it, number one, just on regular normal business transactions payment terms in China tend to be longer than you would see normally in the U.S. or Europe where you're looking generally in 40 to 45 days. On top of that to date our business in China transacts on a dollar basis.

So all of the cash related to revenue comes back to the U.S. which means you have to go through the currency process in China to get hard dollars out which takes some time.

Now we are looking at, as part of our overall business strategy should we look at changing some of that for part of the revenue streams which would make it easier and mitigate some of that difficulty in getting collections. We haven't seen this impact our actual ability to collect, it just strings out the time.

So we factor that in when we look at cash flows and things like that. It’s just a fact if you're going to transact dollars out of China. It's going to have some sort of extended collection period on it. .

And then the last one is just on the SG&A line that you said you took a little step-function up in December because of payments to sales, is that something that -- it's unclear, does it come back down and then ramp with sales or percentage with sales growth or does it stay at this level and ramp from there?.

No, it should come back down a little bit as we get into Q1 and then ramp from there with sales revenue. .

And then I guess, on the research and development side, is that mainly people cost or are there tools in that you peak at some point later this year after the 250 is out?.

It's actually starting to move from 2015 and ’16 where it was a combination but heavily weighted with people cost to as we go through ’16 towards ’17, it’s going to be more on the third party vendor costs as we're moving from design and engineering to actual prototyping. .

I think it’s just in NRE then?.

A lot of NRE, some capitalized software development and things like that. But we've been saying we expected R&D to increase by 300K to 500K each quarter over the last six quarters or so. I think that by the time we get to the second half of the year that will probably slow a little bit. .

Your next question comes from the line of Mike Cotogno from Cardinal Capital..

Hi, this is Gene Fox in for Cotogno. Just a couple of questions. When it comes to your solutions guidance do you -- it sounds, John, like you probably do a very detailed one and then I would say adjusted based on contracts. But a couple of questions.

Are you assuming more than the three customers for DFI-1 in the guidance? And as it relates to that, when do you get visibility for the year? Is that something that by the middle of the year, do you have enough contracts so you should have a pretty good idea of where you're going to end up?.

Yeah, that's a great question, Gene. So when we built our model and guidance for this year, we assumed no more revenue than these customers, many renewals of these customers would need to do, so the first three systems surviving in the world and that's about it. That of course is not -- we're spending to do more than that.

But as you said when you're in the middle of a pilot in the beginning of the year, you don't want to go and forecast that you're going to be successful and then assume success, we like to be a little bit more conservative.

So as you get through the first half of the year you have better visibility about what you already booked, where you are in negotiations with customers et cetera.

If you kind of go back and look at the transcripts, in 2016 you'll see that the confidence that we were going to do something with DFI in 2016 increased as we started -- we were in fact negotiating those contracts in the first -- the second contract in the first quarter, although it didn’t time for the second quarter.

So our confidence level went up as we went through 2016. We anticipate the same clarity will come in 2017 while we get through the first half of the year.

And remember what we're talking about here is bookings, not so much revenue, right? So rather than you have -- when you make a big booking in PDF, it has a very de minimis impact on that quarter’s revenue typically. So that tends to kind of build a base for the future more than it changes that quarter's numbers. .

So your point, John, is even if as you sign up more customers for DFI-1 there's just a lag between the signing and when you see material economics?.

Yes, you start seeing -- if you look at when we signed up contracts in Q2, it was really Q3 before we started seeing some material economics, it didn't start getting it steady state I think until Q4. It takes a while. It's a very ratable business model. Because it’s of course been built..

Understood.

John, can you give us a little more granularity into where we stand on DFI 250 in terms of update us on sort of what was accomplished in the quarter and maybe a little more granular on what you need to accomplish over at least the first quarter and anything else you're willing to share for the year?.

Sure. Yeah, we anticipate in the first half of the year being able to run -- have the system fully come together, be able to run customers waivers first and then do that work with customers in the second half of the year. So the first half of the year will be mostly with us, by the second half year we start engaging with customers on the 250.

By and large all of the components are built and are being tested in some combination of them being put together and of course the software layer which controls all of that, which greatly benefits from our investments that we've made in the past on the 150 because we use greatly a similar software approach.

So 2016 for those people that came out to our clean room, you would have seen some components, if you were to come into our clean room today you would see what looks like a machine with the skin taken off, because it's no point putting the skins on it, because all the components with the exception of I think one have been put on machine and are being integrated and test with within each other..

So John, does that mean you’ve basically chosen all the suppliers and are we locked in on that or do we still have more work to do?.

We basically have been working with all of the suppliers.

I don't believe there's any real changes going on, and nothing substantial, maybe we’re changing a different wire supplier, screw supplier that I don't know about but for the major components, they’ve all been locked in and their systems have been shipped to us and we're working with them at their facility..

Last question for me, from a technology standpoint, John, what are the big obstacles on the 250 that we need to shove or is it literally just putting it together and making sure it works and it's more of a put it, get it, make sure it does what we say it's going to do as opposed to having to solve problems?.

Gene, from my ten thousand foot level, there's always system integration challenges. I would joke that engineers’ idea of the perfect thirty day team work project is on day one, with the project up into parts come back on day twenty nine and it all comes together.

So there's always integration challenges, I am always nervous about engineers working on big systems to make sure they've kind of gone through all those system choices and those are always the last to resign risk, right? The system itself, without kind of getting into the details that would really kind of tell people how we’re actually getting to kind of a billion instrument measurements and our -- the system itself has a number of components which are very different and we kind of thought of it as it's like an e-beam writer but with a column that is more like a voltage contract machine.

So we've been retiring risks on our ability to achieve the alignment tolerances that we need, and we did a lot of things to make that happen. And we’ve been retiring risk on being able to see a large field of view that we need to be able to make the system get the throughput.

Those are probably the two biggest areas retiring risk on alignment and retiring risk on the ability to be see a large field of view and I know -- I can't really kind of tell you exactly where we are with those things. We are pretty far along on them, though..

Your next question comes from the line of Brian Freckmann with LS Capital..

Hey guys, how are you? I asked -- almost every one of my question has been answered to us, so this is just kind of -- on DFI, I know this is more speculation than anything else.

But in your estimation, you have three wins of customers right now, in 2017 does DFI com from land and expand, do you get multiple orders from certain customers, your best guess, or do you think you grow DFI by getting all new customers?.

It’s a big speculation, we're trying to do both of those things, Brian. I would like it to be successful at both. In other words, expand the number of applications, the number of systems customers, the early wins that we talked, because we’re still early in those customers.

And we certainly don't feel like we're anywhere near penetrated and -- as well as achieve new customers to start deploying their first system. So we would like to do at both of those things throughout the year, which one is handicapping, which one we have a better chance of doing, I don't know that. My guess would be as good as yours. .

So I guess, on that note, maybe better understanding the sales cycle, right? I mean at some point you're midway through the first quarter, you have some estimations of wins and sales cycles.

I guess I was just kind of thinking from that, if you look at the current sales cycle for the 150, is it new, is it or is it current customers?.

Yes, and part of the reason why we talk about the number of fabless customers are the number of designs and of our content. Our biggest channel is the fabless companies, the fabless companies really believe that their designs can make inspection harder or easier.

So they're very willing to put content on their -- technically their test chips first, to make the inspection problem easier.

And they do that with us some time before they even tell their foundry and then after that test chip is taped out, they will go back to the foundry and say hey we put this new design for inspection content on our chip, we'd like you to send away for the PDF, so PDF can show you what it can do.

If you go back and look at our second customer, really that's how we got that customer in 2016. It was a fabless customer that really was the pioneer.

So this is a great thing we should be doing this and included the content on their test chip of that large foundry and then the foundry sent us away where we measured it and we showed the results and then we negotiated a contract. But from that first tapeout to when we got the result, till we signed the contract it was about a year.

So we see the ground by working with these fabless entities and then we go back and harvest when the chips -- when they direct the chips from their foundry to us..

Your next question comes from the line of Andrew Weiner from Samjo Capital. .

Hi good afternoon guys. So following up on that question, I guess the way I would ask it is you have two 250 customers, you've got an order for a third.

What's the current build plan for 2017? How many do you expect to be building or have an inventory, to keep us engaged of sort of what you think the opportunity set is over the next sort of call it twelve to eighteen months?.

Yeah, so we have another six or so that we have built or partially built at this point. We do anticipate at least a couple of them staying in our facility for the purposes of doing further engineering R&D and pilots et cetera, can’t just -- to do some of the work that I described in the last question of Brian.

And we know we have the ability to build more than that [indiscernible]. So that would kind of give you a baseline, Andrew. .

And then second with respect to the fabless, we've had conversations where the sort of the six or seven biggest fabless drive a disproportionate amount of the advanced node volume or wafer purchases and obviously they will have a significantly bigger influence on what foundries will or won't do.

So to what extent have we been successful in getting on chip instruments in those top six or seven fabless?.

I believe right now four of the top six, either on test chips or full product wafers have DFI instruments..

And then just following up I guess on an earlier sort of thought process with respect to the spending this year versus the leverage, Greg, I think you had described at the analyst day getting EBITDA margins back to 40 plus percent, I think it was like 150 or so million run rate or --.

Yes. .

And is the way -- sort of think about that in the context of sort of 2017, ‘18, is that you are ramping the solutions business in China very quickly but you’ll see only a small partial year impact to the Gainshare component but that ‘18 Gainshare in China should grow very rapidly and become a meaningful piece of the overall Gainshare?.

Yeah, I think that's true and you combine that with some level of DFI growth as we go into ‘18, from both the 150 systems which you start to get full year’s worth of revenue off of plus any new revenue coming in from the 250 series. That basically should push you back towards that level we were talking about approaching a 40% number.

Along those lines, I'll make a final comment on ‘16. From the analyst day basically you could see really starting in ‘14 going through ‘18, to get back to the original model where we're going through about a four year investment cycle. At the end of ‘16 we're kind of halfway through that.

I think one of the good indicators of how effective some of the things that we're doing are is to look at one of the things that we often talked about before which was our customer concentration.

And if you look at that and we look at it as the number of customers that are generated -- that are 10% customers and how much of our total revenue are they generating. And if you look at that over time that really kind of peaked in 2014, at nearly 80% of our total revenue was coming from our 10% customers.

If you look at that now as we exit ‘16 that number is down to almost 50%. That is a great widening of the customer base where we're having significant revenues coming out of multiple geographies, multiple customers and multiple technologies now.

So kind of halfway through our investment cycle, we're seeing some very positive results and we're seeing some real impact on that risk position of the company. We've got another two years to get back to where we want to be but we're on that path..

And then just with respect to Exensio, is there a some sort of quantitative measure whether it's growth in bookings or something that would provide a little bit better color as to the rate of growth or the scale of that business?.

Yes, if you recall we used to -- we talked at the end of last year and early this year about over two years being able to double the scale of Exensio from where it was back in 2014 I believe and into ‘15 and we are definitely on track for that.

So without -- we don't talk about the individual revenue levels because so much of the business is mixed with IYR and DFI. But when you look at the bookings levels and how that plays out into revenue streams, we're definitely on track for that kind of growth rate. .

And when you say on track, so that means as you look forward and when you think about the opportunity, do you feel those growth rates are sustainable for the next couple of years despite the larger scale?.

Well I feel that we were talking about a two year doubling -- doubling the scale of the business over two years, we’re halfway through that and we're on track to make that number. .

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

Thank you everyone..