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PDFS > SEC Filings for PDFS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for PDF SOLUTIONS INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In some cases, you can identify forward-looking statements by terminology such as "may," "could," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential", "target" or "continue," the negative effect of terms like these or other similar expressions. Any statement concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible actions taken by us or our subsidiaries, which may be provided by us are also forward-looking statements. These forward-looking statements are only predictions. Forward-looking statements are based on current expectations and projections about future events and are inherently subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those anticipated or projected. All forward-looking statements included in this document are based on information available to us on the date of filing and we further caution investors that our business and financial performance are subject to substantial risks and uncertainties. We assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risk factors set forth at the end of Item 1A included in this Quarterly Report on Form 10-Q.

Overview

We analyze our customers' IC design and manufacturing processes to identify, quantify, and correct the issues that cause yield loss to improve our customers' profitability by improving time-to-market, increasing yield and reducing total design and manufacturing costs. We package our solutions in various ways to meet our customers' specific business and budgetary needs, each of which provides us various revenue streams. We receive a mix of fixed fees and variable, performance-based fees for the vast majority of our yield improvement solutions. The fixed fees are typically reflective of the length of time and the resources needed to characterize a customer's manufacturing process and receive preliminary results of proposed yield improvement suggestions. The variable fee, or what we call gainshare, usually depends on our achieving certain yield targets by a deadline. Variable fees are currently typically tied to wafer volume on the node and size of the manufacturing facility where we performed the yield improvement solutions. We receive license fees and service fees for related installation, integration, training, and maintenance and support services for our software that we license on a stand-alone basis.


Industry Trend

We believe that logic foundries invested in leading edge nodes and capacity in 2010 and 2011, even though utilization rates fluctuated in both 2011 and 2012. This investment trend resulted in an increase in our business and improved results of operations in 2011 and 2012 to date. We may experience fluctuations in our results of operations in the future if there is continued consolidation of foundries and fabless companies around the world, any major new foundries enter the market or any of our manufacturing customers experience a decrease in orders.

Generally, the demand for computing, mobile computing and consumer electronics continues to drive technological innovation in the semiconductor industry as the need for products with greater performance, lower power consumption, reduced costs and smaller size continues to grow with each new product generation. To meet this demand, IC manufacturers and designers are constantly challenged to improve the overall performance of their ICs by designing and manufacturing ICs with more embedded applications to create greater functionality while lowering cost per transistor. As a result, logic manufacturers have migrated to more and more advanced manufacturing nodes, capable of integrating more devices with higher performance, higher density, and lower power. As this trend continues, companies will continually be challenged to improve process capabilities to optimally produce ICs with minimal random and systematic yield loss, which is driven by the lack of compatibility between the design and its respective manufacturing process. We believe that as volume production of deep submicron ICs continues to grow, the difficulties of integrating IC designs with their respective processes and ramping new manufacturing processes will create a greater need for products and services that address the yield loss and escalating cost issues the semiconductor industry is facing today and will face in the future.

Financial Highlights

Financial highlights for the three months ended September 30, 2012 were as follows:

Total revenues for the three months ended September 30, 2012 were $22.6 million, an increase of $5.6 million, or 33%, compared to $16.9 million for the three months ended September 30, 2011. Design-to-silicon-yield solutions revenue for the three months ended September 30, 2012 was $15.3 million, an increase of $1.4 million, or 10%, compared to $13.9 million for the three months ended September 30, 2011. The increase in Design-to-silicon-yield solutions revenue was primarily due to more services performed on revenue-generating projects during the period. Gainshare performance incentives revenue for the three months ended September 30, 2012 was $7.2 million, an increase of $4.2 million, or 139%, compared to $3.0 million for the three months ended September 30, 2011. The increase in revenue from Gainshare performance incentives was primarily the result of a higher number of projects reaching performance measures for achieving gainshare and higher wafer volumes at customers' manufacturing facilities.

Net income for the three months ended September 30, 2012 was $5.0 million, compared to net income of $0.6 million for the three months ended September 30, 2011. The increase in net income was primarily attributable to an increase in revenues and a more favorable product mix with relatively flat operating expenses, lower foreign withholding taxes and a foreign withholding tax refund benefit recognized in the period.

Net income per basic and diluted share was $0.17 and $0.17, respectively, for the three months ended September 30, 2012 compared to net income per basic and diluted share of $0.02 for the three months ended September 30, 2011, an increase of $0.15 and $0.15 per basic and diluted share, respectively.

Cash, cash equivalents and investments increased $4.6 million from $46.8 million at December 31, 2011 to $51.4 million at September 30, 2012, primarily due to an increase in cash from operating activities during the period.

Financial highlights for the nine months ended September 30, 2012 were as follows:

Total revenues for the nine months ended September 30, 2012 were $65.7 million, an increase of $16.6 million, or 34%, compared to total revenues of $49.1 million for the nine months ended September 30, 2011. Design-to-silicon-yield solutions revenue for the nine months ended September 30, 2012 was 42.5 million, an increase of $5.0 million, or 13%, compared to $37.5 million for the nine months ended September 30, 2011. The increase in Design-to-silicon-yield solutions revenue was primarily due to more services performed on revenue-generating projects during the period. Gainshare performance incentives revenue for the nine months ended September 30, 2012 was $23.2 million, an increase of $11.6 million, or 100%, compared to Gainshare performance incentive revenue of $11.6 million for the nine months ended September 30, 2011. The increase in Gainshare performance incentives was primarily the result of higher number of projects reaching performance measures for achieving gainshare and higher wafer volumes at customer manufacturing facilities.

Net income for the nine months ended September 30, 2012 was $13.3 million, compared to net loss of $(0.2) million for the nine months ended September 30, 2011. The increase in net income was primarily attributable to an increase in revenues and a more favorable product mix, a decrease in operating expenses, lower foreign tax withholding taxes, and a foreign withholding tax refund benefit recognized in the period.

Net income per basic and diluted share was $0.47 and $0.45, respectively, for the nine months ended September 30, 2012 compared to net loss per basic and diluted share of $(0.01) for the nine months ended September 30, 2011, an increase of $0.48 and $0.46 per basic and diluted share, respectively.


Critical Accounting Policies

There were no significant changes in our critical accounting policies. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011. The following is a brief discussion of the more significant accounting policies and methods that we use.

General

Our discussion and analysis of our financial conditions, results of operations and cash flows are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The most significant estimates and assumptions relate to revenue recognition, stock-based compensation and the realization of deferred tax assets. Actual amounts may differ from such estimates under different assumptions or conditions.

Revenue Recognition

We derive revenue from two sources: Design-to-silicon-yield solutions, which include services and software licenses, and Gainshare performance incentives.

Design-to-Silicon-Yield Solutions - Revenue that is derived from Design-to-silicon-yield solutions comes from services and software licenses. We recognize revenue for each element of Design-to-silicon-yield solutions as follows:

We generate a significant portion of our Design-to-silicon-yield solutions revenue from fixed-price solution implementation service contracts delivered over a specific period of time. These contracts require reliable estimation of costs to perform obligations and the overall scope of each engagement. Revenue under project-based contracts for solution implementation services is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting. Revenue under certain time-based contracts for solution implementation services is recognized under the proportional performance method. Losses on solution implementation contracts are recognized in the period when they become evident. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated. If we do not accurately estimate the resources required or the scope of work to be performed, or do not manage the projects properly within the planned period of time or satisfy our obligations under contracts, resulting contract margins could be materially different than those anticipated when the contracts were executed. Any such reductions in contract margin could have a material negative impact on our operating results. On occasion, we license our software products as a component of our fixed price service contracts. In such instances, the software products are licensed to customers over a specified term of the agreement with support and maintenance to be provided at each customer's option over the license term. The amount of product and service revenue recognized in a given period is affected by our judgment as to whether an arrangement includes multiple deliverables and, if so, our determination of the fair value of each deliverable. In general, vendor-specific objective evidence of selling price ("VSOE") does not exist for our solution implementation services and software products and because our services and products include our unique technology, we are not able to determine third-party evidence of selling price ("TPE"). Therefore, in such circumstances, we use best estimated selling prices ("BESP") in our allocation of arrangement consideration. In determining BESP, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. We typically arrive at BESP for a product or service that is not sold separately by considering company-specific factors such as geographies, internal costs, gross margin objectives, pricing practices used to establish bundled pricing, and existing portfolio pricing and discounting. After fair value is established for each deliverable, the total transaction amount is allocated to each deliverable based upon its relative fair value. Fees allocated to solution implementation services are recognized using the cost-to-cost percentage of completion method of contract accounting. Fees allocated to software and related support and maintenance are recognized under software revenue recognition guidance.


We also license our software products separately from our solution implementation services. For software license arrangements that do not require significant modification or customization of the underlying software, software license revenue is recognized under the residual method when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable, (4) collectability is probable, and (5) the arrangement does not require services that are essential to the functionality of the software. When arrangements include multiple elements such as support and maintenance, consulting (other than for our fixed price solution implementations), installation, and training, revenue is allocated to each element of a transaction based upon its fair value as determined by our VSOE and such services are recorded as services revenues. VSOE for maintenance is generally established based upon negotiated renewal rates while VSOE for consulting, installation, and training services is established based upon our customary pricing for such services when sold separately. Revenues for software licenses with extended payment terms are not recognized in excess of amounts due. For software license arrangements that require significant modification or customization of the underlying software, the software license revenues are recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting, and such revenues are recorded as services revenue.

Gainshare Performance Incentives - When we enter into a contract to provide yield improvement services, the contract usually includes two components: (1) a fixed fee for performance by us of services delivered over a specific period of time; and (2) a Gainshare performance incentives component where the customer may pay a variable fee, usually after the fixed fee period has ended. Revenues derived from Gainshare performance incentives represent profit sharing and performance incentives earned based upon our customers reaching certain defined operational levels established in related solution implementation service contracts. Gainshare performance incentives periods are usually subsequent to the delivery of all contractual services and therefore have no cost to us. Due to the uncertainties surrounding attainment of such operational levels, we recognize Gainshare performance incentives revenues (to the extent of completion of the related solution implementation services) upon receipt of performance reports or other related information from our customers supporting the determination of amounts and probability of collection. Gainshare performance incentives revenue is dependent on many factors which are outside our control, which can include among others, continued production of the related ICs by our customers, sustained yield improvements by our customers, and our ability to enter into new Design-to-silicon-yield solutions contracts containing provisions for Gainshare performance incentives.

Stock-Based Compensation

Stock-based compensation is estimated at the grant date based on the award's fair value and is recognized on a straight-line basis over the vesting periods of the applicable stock purchase rights and stock options, generally four years. As stock-based compensation expense recognized is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

We have elected to use the Black-Scholes-Merton option-pricing model, which incorporates various assumptions including volatility, expected life and interest rates. The expected volatility is based on the historical volatility of our common stock over the most recent period commensurate with the estimated expected life of stock options. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted to employees. The interest rate assumption is based upon observed Treasury yield curve rates appropriate for the expected life of stock options.

Income Taxes

We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. Changes in the net deferred tax assets, less offsetting valuation allowance, in a period are recorded through the income tax provision in the consolidated statements of operations. During the year ended December 31, 2008, we concluded that a valuation allowance was required based on our evaluation and weighting of the positive and negative evidence. We continued to carry a valuation allowance against our U.S. and certain foreign deferred tax assets as of September 30, 2012 and December 31, 2011. See Note 9 to the condensed consolidated financial statements for further discussion. If in the future, we determine based on our future profitability that these deferred tax assets are more likely than not to be realized, a release of all, or part, of the related valuation allowance could result in an immediate material income tax benefit in the period of decrease and material income tax provisions in future periods. A continued improvement in the Company's financial performance and expected future results could result in a reversal of the valuation allowance in the near future.

Our income tax calculations are based on application of the respective U.S. federal, state or foreign tax law. Our tax filings, however, are subject to audit by the respective tax authorities. Accordingly, we recognize tax liabilities based upon our estimate of whether, and the extent to which, additional taxes will be due when such estimates are more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. To the extent the final tax liabilities are different than the amounts originally accrued, the increases or decreases are recorded as income tax expense or benefit in the consolidated statements of operations.

Recent Accounting Pronouncements and Accounting Changes

See Note 2 of "Notes to Condensed Consolidated Financial Statements (Unaudited)" of this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements and accounting changes, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.


Results of Operations

The following table sets forth, for the periods indicated, the percentage of
total revenues represented by the line items reflected in our condensed
consolidated statements of operations:

                                               Three Months Ended               Nine Months Ended
                                                  September 30,                   September 30,
                                              2012             2011           2012             2011
Revenues:
Design-to-silicon-yield solutions                  68 %             82 %           65 %             76 %
Gainshare performance incentives                   32               18             35               24
Total revenues                                    100 %            100 %          100 %            100 %
Costs of design-to-silicon-yield
solutions:
Direct costs of design-to-silicon-yield
solutions                                          42               45             41               44
Amortization of acquired technology                 -                1              -                1
Total costs of design-to-silicon-yield
solutions                                          42               46             41               45
Gross Profit                                       58               54             59               55
Operating expenses:
Research and development                           14               20             15               22
Selling, general and administrative                20               25             22               29
Amortization of other acquired
intangible assets                                   -                -              -                -
Restructuring charges (credits)                     -                -              -                -
Total operating expenses                           34               45             37               51
Income from operations                             24                9             22                4
Interest and other income (expense), net           (1 )              1              -                -
Income before taxes                                23               10             22                4
Income tax provision                                1                6              2                4
Net income (loss)                                  22 %              4 %           20 %             (0 )%

Comparison of the Three Months Ended September 30, 2012 and 2011

                                             Three Months Ended September 30,            $             %
Revenues                                        2012                  2011            Change         Change
(In thousands, except for percentages)
Design-to-silicon-yield solutions          $        15,305       $        13,903     $   1,402             10 %
Gainshare performance incentives                     7,246                 3,036         4,210            139 %
Total                                      $        22,551       $        16,939     $   5,612             33 %

Design-to-Silicon-Yield Solutions. Design-to-silicon-yield solutions revenue is derived from services (including solution implementations, software support and maintenance, consulting, and training) and software licenses, provided during our customer yield improvement engagements as well as during solution product sales. Design-to-silicon-yield solutions revenue increased $1.4 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to an increase in fixed fee integrated solutions, the result of higher field utilization in the period due to increased business activity. Our Design-to-silicon-yield solutions revenues may fluctuate in the future and are dependent on a number of factors, including the semiconductor industry's acceptance of our products, the timing of purchases by existing customers, and our ability to attract new customers and penetrate new markets including photovoltaic and LED, and further penetration of our current customer base. Fluctuations in future results may also occur if any of our significant customers renegotiate pre-existing contractual commitments due to adverse changes in their own businesses or, in some cases, take advantage of contractual provisions that permit the suspension of contracted work for a period if their business experiences a financial hardship.


Gainshare Performance Incentives. Gainshare performance incentives revenue represents profit sharing and performance incentives earned based upon our customers reaching certain defined operational levels. Revenue derived from Gainshare performance incentives increased $4.2 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase was primarily the result of a higher number of projects reaching performance measures for achieving gainshare and higher wafer volumes at customers' manufacturing facilities. The revenue from Gainshare performance incentives was generated from eight customers and ten engagements for the three months ended September 30, 2012 and seven customers and seven engagements for the three months ended September 30, 2011. Our Gainshare performance incentives revenue may continue to fluctuate from period to period. Gainshare performance incentives revenue is dependent on many factors that are outside our control, including among others, continued production of ICs by our customers at facilities at which we generate gainshare, sustained yield improvements by our customers, and our ability to enter into new Design-to-silicon-yield solutions contracts containing provisions for Gainshare performance incentives.

                                              Three Months Ended
                                                 September 30,               $             %
Cost of Design-to-Silicon-Yield
Solutions                                     2012           2011         Change         Change
(In thousands, except for percentages)
Direct costs of design-to-silicon-yield
solutions                                  $    9,457      $   7,650     $   1,807             24 %
Amortization of acquired technology                 -            156          (156 )         (100 )%
Total                                      $    9,457      $   7,806     $   1,651             21 %

Costs of Design-to-Silicon-Yield Solutions. Costs of Design-to-silicon-yield solutions consist of costs incurred to provide and support our services, costs recognized in connection with licensing our software, and amortization of acquired technology.

Direct Costs of Design-to-Silicon-Yield Solutions. Direct costs of Design-to-silicon-yield solutions consist of services costs and software license costs. Services costs consist of material, labor, overhead costs, and stock-based compensation charges associated with solution implementations. Costs include purchased materials, employee compensation and related benefits, travel and facilities-related costs. Software license costs consist of costs associated with licensing third-party software sold in conjunction with our software products and expenses incurred to produce and distribute our product documentation. Direct costs of Design-to-silicon-yield solutions increased $1.8 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. The increase was primarily due to an increase . . .

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