PDF Solutions, Inc. — Q3 2015 Form 10-Q
Business and period: The company provides semiconductor design-to-silicon-yield services and software, earning fixed-fee revenue and variable Gainshare incentives tied to customer performance. This unaudited report covers the three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $23.9m | $22.4m | $73.9m | $74.1m |
| Gross profit / margin | $13.6m / 57.1% | $10.8m / 48.2% | $45.0m / 60.8% | $43.9m / 59.3% |
| Operating income / margin | $2.7m / 11.3% | $2.9m / 13.1% | $15.8m / 21.4% | $20.1m / 27.1% |
| Net income / margin | $1.5m / 6.3% | $1.8m / 7.9% | $9.6m / 13.0% | $12.7m / 17.2% |
| Diluted EPS | $0.05 | $0.05 | $0.30 | $0.40 |
| Operating cash flow | Not separately presented for the quarter | $22.1m | $27.8m |
Revenue mix: Q3 design-to-silicon-yield solutions revenue increased 59% to $17.2m, while Gainshare revenue fell 43% to $6.6m. For the nine months, solutions revenue rose 27% to $49.6m, but Gainshare declined 31% to $24.3m. The company attributed the Gainshare declines mainly to lower volumes at older 32nm and 28nm nodes.
Cash, liquidity and obligations: Cash and equivalents were $126.3m at September 30, up from $115.5m at year-end 2014. Working capital was $151.5m. Nine-month free cash flow, calculated as operating cash flow less capital expenditures, was approximately $18.0m; investing cash use was $9.2m, including $5.2m for the Syntricity acquisition. Financing cash use was $2.0m, including $9.6m of share repurchases. The company reported no undisclosed borrowings or debt; it had $2.97m of non-current liabilities and repaid $0.35m of long-term obligations assumed in the acquisition. Management said available cash and expected operating funds should cover requirements for at least 12 months.
Changes, outlook and notable matters
- Q3 revenue increased 7%, but nine-month revenue was essentially flat. Nine-month net income fell 24%, reflecting higher operating expenses and lower Gainshare revenue; operating expenses rose to $29.1m from $23.9m. Q3 net income also declined despite higher revenue, principally because operating expenses increased.
- Gross margin improved year over year, partly because 2014 included a $1.9m impairment of deferred pre-contract costs. The 2015 nine-month solutions revenue also included $6.0m recognized upon signing two contracts with one customer, an item investors may wish to assess for recurrence and timing.
- On July 17, 2015, PDF Solutions acquired Syntricity for approximately $5.2m net of acquired cash, adding hosted characterization and yield-management software. The purchase included $0.75m held in escrow and up to $2.5m of contingent payments. The company recorded $0.475m of employee-related post-acquisition expense and $0.588m of acquisition costs; acquired intangible assets were $5.0m.
- No formal financial guidance is provided. Management expected 28nm capacity utilization to remain low through the rest of 2015, potentially weighing on Gainshare revenue. It cited continued investment in leading-edge foundry nodes as an opportunity. Research and development and selling, general and administrative costs may fluctuate with hiring, product development and selling activity.
- Customer concentration is substantial: Customer A represented 60% of Q3 revenue and 52% of nine-month revenue, and 70% of gross receivables at quarter-end. Management noted customer contract changes or suspension of work could affect results.
- Tax matters include $10.5m of unrecognized tax benefits, a continuing full valuation allowance on excess California R&D credits, and an ongoing New York tax audit. No material litigation loss was accrued. Disclosure controls were assessed as effective, with no material change in internal control reported.
Important facts for investors to verify
- Whether declining older-node volumes and low 28nm utilization continue to reduce Gainshare revenue, and how much future revenue depends on the largest customer.
- The nature, billing and collectability of the $6.0m recognized upon signing two contracts, along with the sustainability of solutions revenue growth.
- Cash conversion and working-capital quality: accounts receivable declined, but unbilled receivables were $11.7m; confirm billing milestones and collections.
- Syntricity earn-out terms and remaining expense exposure. The filing gives differing earn-out end dates: July 17, 2017 in the acquisition note and June 30, 2016 in MD&A.
- Potential tax exposure, including the New York audit, unrecognized tax benefits and California R&D credit valuation allowance.