Good day, ladies and gentlemen, and welcome to the PDF Solutions Incorporated conference call to discuss the company's financial results for the third quarter ended September 30, 2020. I will now turn the call over to Joe Diaz of Lytham Partners. Thank you. You may begin.
Thank you, operator. Thanks to all of you for participating on today's call. We appreciate your time and your ongoing interest in PDF Solutions. As the operator indicated, my name is Joe Diaz. I'm a managing partner at Lytham Partners. We are the investor relations consulting firm for PDF. If you do not yet have a copy of today's press release, it is available at the company's website at www.pdf.com. Some of the statements made during the course of this conference call will be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, 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 PDF's annual report on Form 10-K for the fiscal year ended December 31, 2019, and similar disclosures in subsequent SEC filings. The forward-looking statements and risks stated on this conference call are based on information available to PDF today. The company assumes no obligation to update them. Now I'd like to introduce John K. Kibarian, PDF Solutions President and Chief Executive Officer, who will be followed by Adnan Raza, Executive Vice President and Chief Financial Officer. John, the floor is yours.
Thank you for joining us on today's call. If you have not already seen our earnings press release and management report for the third quarter, please go to the investor section of our website, where each has been posted. We hope that you and your families are staying safe, we appreciate you taking time to join us today for our commentary about the third quarter financial results. After summarizing the business in the quarter, I will use some time today to provide more detail about our marketing and engineering activities in the quarter with a highlight on our Advantest partnership. I will conclude with our impressions on the current state of the semiconductor industry before handing it over to Adnan for the financial update. Highlights for the third quarter validate our long-term strategy. We continued with strong bookings, particularly in China.
We had a slow start for the year in China, as did most everyone, due to the effects of the pandemic. We did see some renewed activity starting at the end of the first quarter, increasing in the second quarter and building even more in the third quarter. The strength in China includes yield ramp solution for a foundry, as well as Exensio contracts for fabless entities. From a product perspective, there was strong business activity for Exensio in the quarter, with continued high levels of interest in our cloud solution. Contracts closed in the quarter for customers making everything from advanced ADAS chips to power MOSFETs and novel switches. The customer list included equipment companies, foundries, fabless, IDMs, system companies, and a tier 1 automotive supplier, all of whom found Exensio Analytics, frequently on the cloud, provided them with the insights they need to manufacture more effectively.
As for DFI, we work closely with fabless and foundry customers on additional applications that expand the need for the unique measurement capability made possible by our eProbe. We recognize that this investment period for DFI has been longer than anticipated. We see that these additional applications can expand the servable market for the eProbe. Closing milestones and building trust with the foundries is taking time, but we continue to believe in the long-term potential. From a revenue perspective, analytics was down slightly quarter-over-quarter, although up year-over-year, which is largely due to our choice to negotiate a contract as an Integrated Yield Ramp instead of a subscription license. We did this because we believe the revenue opportunity is larger for PDF over the long term.
Despite the slightly dampening effect of this choice in the third quarter, Analytics revenue grew, and we expect it to return to growth targets as we complete Q4 in 2021. As you may remember from our last quarterly call, on July 30th, Advantest and PDF Solutions announced our five-year partnership agreement. This is a significant step for PDF Solutions at a company level, Exensio Analytics at a platform level, and for our cloud offering specifically.
Included in this partnership is a $65 million investment that is now reflected on our balance sheet, a five-year contract to use Exensio as the basis of Advantest Cloud that we believe will result in more than $50 million over its term to PDF, agreements to optimize Exensio's tester agents for the Advantest equipment, and the potential of additional joint development programs to build applications leveraging Advantest's deep understanding and data associated with test and PDF Solutions Exensio Analytics and machine learning. During the third quarter, we kicked off the deployment of Exensio Cloud, and by the end of the quarter, had met the performance milestones that initiate our ability to start to monetize the contract. Ahead of the schedule we had communicated in our last call. While revenue in the third quarter was for just a partial quarter, we anticipate more meaningful contribution over the next quarters.
One reason we believe the partnership with Advantest is so important is that it provides the opportunity for conversations with a wide variety of companies in the semiconductor supply chain, and we hear the same theme from many of them. Users of capital equipment want to get more than just data from their tools. They want intelligence. Customers have already expressed their pleasure that they can get the Advantest applications on the Exensio platform. Over 130 companies use Exensio, many of whom are also Advantest customers. By Advantest using the Exensio platform, mutual customers are able to solve manufacturing challenges by accessing Exensio files and analysis methods. We believe the partnership will only increase the analytics choices available to our customers. Of course, Advantest and PDF remain independent companies, and Exensio continues to work with all equipment types. Overall, we are pleased with the opportunity that Advantest partnership represents.
I would now like to turn to what we're seeing in the industry. There's continued investment in the industry, despite COVID-19 impact on the general economy. Most founders report to us that they are reaching high levels of manufacturing volumes. For example, we are seeing some of the fabs in China report higher utilizations and customers reporting wafer shortages. On that industry footing, we anticipate broad-based interest in Exensio and our analytics products in the fourth quarter. Finally, I want to thank our employees for continued product innovation and servicing customers' complex requirements, even while working from home. Now I'd like to turn the call over to Adnan for review of the financials, after which we will open the call for your questions. Adnan?
Thank you, John. Good afternoon, everyone, and nice to be speaking with you again. I hope all of you are keeping safe in the current environment. As I mentioned on the last call, we at PDF continue to operate in the spirit of connected while apart, with some of our offices around the globe reopening this quarter, while other employees continue to work from home. We are learning to thrive in this environment, closing deals and growing the business. We will share some of that progress with you today. Please note that all of the financial results we discuss on today's call will be on a non-GAAP basis, and the reconciliation to GAAP financials is provided in the materials on our website. We have posted our earnings release and a management report in the investor relations section of our website.
To start with the business update, we continue to make the strategic transition to an analytics company, as communicated during our investor day last year. Analytics as a percentage of our total company revenue has gone from 45% in 2018, to 58% in 2019, to 64% on a last 12 months basis through Q3 of this year. For Q3 itself, analytics was 62% of revenues and 65% of revenues for year-to-date 2020 period. We're delighted with the ongoing transition of PDF to an analytics company. Our bookings for the third quarter of 2020 came in at a record level, with the quarterly bookings this quarter comfortably exceeding the total bookings for the full year of 2019. Compared to Q3 of 2019, which interestingly was the strongest bookings quarter for 2019 itself, our Q3 2020 bookings came in very strong as well, even without the Advantest deal.
Recall that our bookings for the first six months of 2020 were already more than our bookings for the full year of 2019. Q3 alone, including Advantest deal, has also exceeded the full year 2019 bookings. We have more than doubled our 2019 bookings through Q3 of 2020, with a quarter left to go for the year. Strong bookings growth validates our momentum and gives us the ability to make future investments to grow our business. We believe our momentum is a result of our focus and continued investment in the growing segment of our business and the strong recognition that the PDF Solutions name carries as a leading provider of differentiated data and analytics solutions. Turning to revenues. Total revenues for Q3 were $23.1 million, up 8% versus the prior quarter and up 5% versus the same quarter last year.
For the quarter, analytics revenue was $14.3 million, and Integrated Yield Ramp revenue was $8.8 million. Analytics continues to be our strategic focus and evolution for PDF Solutions. Analytics revenue for Q3 grew 13% on a year-over-year basis and was down 5% compared to the prior quarter, primarily due to a new customer engagement in Q3, which we decided to close as an IYR contract instead of a subscription license to capture better long-term economics. It is worthwhile noting that on a year-to-date basis, the analytics business grew 18% year-over-year, validating our comfort with a target long-term analytics annual growth rate of 20%, as discussed during our 2019 investor day.
During Q3, as John mentioned, we also successfully achieved the performance milestones for the Advantest deal, which was booked within the same quarter, allowing us to begin some revenue recognition from that contract this quarter, a quarter earlier than we originally anticipated. We continue to expect Advantest revenues to ramp to a $10 million per year run rate by the middle of next year. As John mentioned, we are benefiting from this relationship via further customer conversations about the opportunities we can bring to both our customers via the Advantest Cloud, powered by PDF Exensio. We are seeing interest from other equipment companies desiring to add that power of Exensio Analytics to their own portfolio of supply chain tools. We are pleased with the performance of our analytics business during Q3 2020, particularly from the growth of our Exensio product line.
With the Exensio Analytics platform, we firmly believe we are offering a differentiated portfolio of products and services to our customers. For Integrated Yield Ramp, our revenue was $8.8 million, which was up 41% on a sequential basis, primarily due to the new IYR contract mentioned earlier, and was down 5% on a year-over-year basis, consistent with our focus of evolution towards an analytics business. For the third quarter of 2020, analytics represented 62% of our total revenues and was 65% of our total revenues on a year-to-date basis through Q3. Overall, the continued growth of analytics remains strong, while our quarter-to-quarter revenues may reflect fluctuations in Integrated Yield Ramp and the impact from ASC 606-based accounting on our revenues.
On the cost of sales and gross margins, consistent with what we mentioned on our last call, we continue to make investments to support the growth of our business. The increased cost of sales spend of $0.7 million this quarter versus prior year was primarily due to increased investment in cloud infrastructure and cloud spend as a result of servicing our customers. These investments support our customer wins, such as the significant partnership we announced in our third quarter with Advantest, which is now contributing to revenue. Our non-GAAP gross margins for the quarter came in at 63%, versus 63% for the prior quarter and 64% for the same quarter last year. We continue to expect to achieve our target long-term financial model gross margin of 70% that we discussed during our 2019 Investor Day.
Now let's look at our quarterly operating expenses, which were up approximately $1.6 million on a year-over-year basis. R&D was down $0.2 million versus the same period of the prior year, primarily due to personnel-related costs. Our SG&A was up $1.8 million versus the same quarter of prior year, which was primarily driven by an increase in legal fee of $0.6 million versus the same quarter of prior year, primarily due to increased legal services, including the Advantest partnership. In addition, SG&A increased due to meaningful sales headcount increases for analytics business and subcontractor costs in the quarter. As John mentioned, we will continue to align our operating expenses and resources with our product roadmap and booking and sales momentum to create a differentiated position in the Industry 4.0 landscape.
In summary, for the P&L, we posted a non-GAAP net profit of $0.1 million and non-GAAP earnings per share of $0.00. On the balance sheet side, cash and short-term investments grew to $168 million at the end of the third quarter versus $100 million of cash for the same quarter of the prior year, or an increase of approximately $68 million on a year-over-year basis, primarily driven by a $65 million increase from the proceeds of the private placement of common stock to Advantest during the third quarter. Kindly note that we invested a portion of our cash in short-term investments of U.S. Treasury bills during the third quarter. You will see our total $168 million of cash in short-term investments show up on our balance sheet in two line items, $118 million of cash and cash equivalents and $50 million of short-term investments.
Our strong balance sheet with no debt and $168 million of cash in short-term investments provides us a very strong opportunity to invest in a variety of initiatives to broaden and deepen the portfolio of products we offer to our customers. Our goal is to be the leading provider of differentiated data and analytic solutions with a broad portfolio of software products and services. We do see potential in the marketplace for new offerings to expand our platform and are pleased that we have the balance sheet strength to make such investments and enhance the long-term value for our stockholders. In summary, we are excited about our continued transition to analytics, the bookings momentum and growth we have achieved this year, the selection of PDF Exensio as a platform of choice for the Advantest Cloud, which started revenue this quarter, and the strength of our balance sheet.
We believe these data points serve as validation of PDF as a leading provider of differentiated data and analytics in the market today, and provides us the strength to make the right investments to enhance long-term shareholder value. At this time, let's open the call for your questions. Operator, please begin the Q&A portion of the call.
To ask a question during the session, please press star one on your telephone keypad. Again, to ask a question, please press star one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Again, to ask a question, please press star one on your telephone keypad. Your first question comes from the line of Tom Diffely from D.A. Davidson. Your line is now open.
Yes. Good afternoon. Thanks for taking the question. John, first, I'm curious about the deal that you talked about that you decided to do with an IYR contract instead of turning it into a subscription.
It seems like that's opposite of what we've been seeing over the last year or so and kind of counter to the long-term plan of the company.
When we made the plan, we did say we would from time to time still do yield ramp contracts if we felt the economics looked to be good. It's a customer that at 28 nm finally started ticking up volumes. As I said, it's a Chinese entity. When we looked at their projections on 14 and the economics that were there, we actually felt it was a better deal for us over the long term, the economics return would be larger. As we sized up the situation, we do feel that because some of the challenges that have gone on for Chinese suppliers or Chinese users of silicon over these last couple of quarters, the focus on manufacturing in China has picked up, and we feel better about the time horizon on this contract from a gain share standpoint.
If you go back a year ago, we were pretty negative on volumes materializing there. I think this has greatly changed over the last, let's say, three to six months, and hence our change with this customer. We will not do this in general in the customer base. There are a very small set of customers for whom we would take a gain share contract, where we think the volumes are more sure than in other places.
Okay. Has your ability to service Chinese customers changed at all over the last couple of months when restrictions with Huawei and then with SMIC started to arise?
Yeah. One of our legal team and some of our legal expenses to be very careful about what we do there, and we watch very closely the rules in the U.S. government. From a yield ramp standpoint, we have an ability to operate there quite well. We do engineering around the world, right? Our vehicles are often designed outside the United States, in Taiwan and in Europe. A lot of our software modules and elements are also primarily non-U.S. origin technologies. The eProbe DFI machine, which is really most relevant to people on the leading edge, we would have some limitations as of now because it's manufactured primarily in the States. For yield ramp and for Exensio, we are operating within the U.S. law but have fewer restrictions due to the non-U.S. content in the solution.
Okay. That makes sense. Adnan, a couple questions about the model. First, would you expect to see a rise in the COGS with more cloud spending as the contract with Advantest continues to evolve?
I think for the modeling purposes, if you looked at the total of cost of sales, R&D, and SG&A, I think you can think of it as flat to slightly down. As John alluded, we had special contracts, some other region-specific contract-related expenses and other legal expenses that drove that number a little bit higher than we expected. I think there's probably a little bit tapering down on the OpEx side and probably just a slight tapering up. Net slightly down is what I would say from a modeling perspective for Q4.
Okay. How big was the legal services, the one-time legal services in the SG&A jump quarter-over-quarter?
I don't know if I'd call it all one time, but let me just put it this way. The legal expense increase was $0.6 million, and it was a variety of things. There was some contract that we were working for customers in that region. Recognize also that we did the Advantest deal during this current quarter as well. It was a combination of factors that led to that higher legal expense, which is why when you look at OpEx as a total, the thought is that for next quarter, it's probably going to be down a little bit.
Okay, great. Thanks. Finally, John, when you look at the $65 million investment from Advantest, what drove that, and was it kind of thought of or earmarked for any kind of specific acquisitions or infrastructure build-out that you need to do?
I think there was a couple things there. On their side, they are basing their company backed on their cloud, which is Exensio. They felt that they wanted to have some investment in PDF, some minority share, so that they would participate in the success of PDF overall as they drove business, and they are driving business to Exensio and have been quite effective about that. Number two, I think from our standpoint, we believe that there is a lot of opportunity similar to Advantest, but customers that are building equipment that are being asked to bring intelligence with their machines.
We felt that there was things we could do to grow the platform that would be good for Advantest and good for the broader market, and also continue to make Exensio a platform that if you are a fabless or a system company, you know that your foundries use it, your equipment suppliers use it, and now you have an ability to really partner across the supply chain. We thought that it would also give us a little bit more flexibility and latitude as we looked at strategic alternatives. I think that would probably be how they looked at it as participating in the upside. We looked at it as giving us a little bit more flexibility in how we looked at alternatives.
Okay. No, makes sense, and I appreciate the time today.
Thank you.
Again, to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Jon Tanwanteng from CJS Securities. Your line is now open.
Hi, guys. Thank you for taking my question. I was just wondering that IYR contract that would've been an analytics one. I'm wondering what it would have looked like in the quarter in terms of a revenue and profitability, if it had stayed an analytics subscription.
Yeah. Jon, it's a good question. If we had taken it out as an analytics, its gross margins would've been higher. We would've put none of the resources that we put to that contract. The revenue dollars, on the time period duration, would've been maybe slightly different. I'm not quite sure how we would've gone and recognized the revenue. Would've been more of a ratable basis. There was a lot of upfront design costs in this case. That wouldn't have driven it that much different. Some different, but not that much. We would've put a lot less cost into that program. To be candid with you, we had invested a little bit ahead of the contract signing with that customer in the first and second quarter, which we wouldn't have put into that, as we were looking at our alternatives with them.
Got it.
Probably would've been higher gross margin, maybe slightly less revenue.
Understood. Thank you. Then just in terms of the You mentioned the nature of the customer. I was wondering how much cushion you gave yourself just in case. It seems like it's more of a traditional contract where you're dependent on their production volumes over a certain time period. I was wondering, when you did the comparison over, either analytic or I guess system.
Yeah, that's a great point.
Yeah.
Yeah. It's a 10-year gain share period. That's one of the things that we did, said let's make sure the gain share period is long enough because what we're learning about China is they start much later than we think. As we completed some yield ramps on 28 nm in 2017 and 2018, and some of the customers' cases, they've not crossed a wafer volume minimums in 2020, right? Obviously their time horizon's a little different than what we're used to in other geographies in the world. We lengthened the period quite a bit. We also took out a lot of the sensitivity to actual yield performance because we've come to recognize that the actual yield being in production is more important than being cost effective in that market, to some extent, it seems like. We've de-risked ourselves from that as well.
We're starting to recognize that in this changed environment, there are definitely winners that are being picked by the government, and we felt that we were aligning ourselves with where we think the market is going there.
Got it. That's helpful. Are there any more potentials like this in the pipeline where the economics look better over the longer term to do this?
It would be very few. You don't need a handful to count on the ones that we would do this with. Very few. In the China market, maybe it is them and maybe one other, probably not. Outside of there's really only two or three players in the leading edge that we would consider it.
Okay, got it. Just going to the Advantest deal, and you've mentioned that you are attracting other companies, or the deal attracted other companies and equipment manufacturers to explore doing the same thing. Are they similar in size and scope at all to the Advantest partnership? I'm wondering, if there's a significant number of them in your pipeline, does that change the math on your near-term or medium-term growth rate versus long-term target?
Yeah. We started working with Advantest way back, I think the first meet in 2017, and then we started doing some actual joint product development work in late 2018, early 2019, right? You're seeing what is the three years of work. There are other equipment companies where we're not, let's say, three years into the relationship. We're at that beginning stages. I think we're starting to understand the formula. Probably the investment piece is something we probably wouldn't do on a regular basis very much, obviously, and Advantest was a kind of anchor partnership, so it's a little bit special in that regard. In terms of the sizes of them, I'm sure many of them will start out small.
Overall, we see quite a significant opportunity in terms of just the number of equipment, particularly in the newer parts of the semiconductor or electronics industry, where software analytics is really just coming into play. In your advanced packaging, in your advanced system manufacturing, we think there's significant opportunities there.
Got it. Thank you. Just finally, you mentioned DFI taking a little bit longer than everyone had hoped. I was wondering if you had any expectations for when the next couple of machines might ship, and start revenueing.
Yeah. I think that piece of it is, as I said in my prepared remarks, it's taking us longer than we would've liked. We would've liked to have gotten something shipped this year. I think for a number of reasons, it's probably slipping into the first part of 2021. At the same time, we have been working, maybe partly due to the COVID-19 situation, it's easy to fly wafers around, a lot easier to fly wafers around than flying engineers around, or even from our standpoint, even our machines.
We've been having customers send a significant number of wafers to us, and have been generating revenue on DFI in that way, on pilots, many of them paid, demonstrating capabilities. As I said in my prepared remarks, we believe that's increasing the number of applications viable for the customer base, and which is why we remain very confident about the platform and its potential. We are behind on, let's say, the ability to get one shipped and installed.
Got it. Thank you very much.
Your next question comes from the line of Gus Richard your line is now open from Northland . Thank you.
Yes, thanks for taking the question. On the IYR contract, is that for 14 nanometer development?
That's correct, Gus.
Okay. The Analytics revenue was down sequentially, and a big chunk of that is ratable. Is that a decline in a customer rolling off? Is it the fact you took this IYR customer out of that ratable stream and moved it off?
Correct.
Okay. How big of an impact was that in terms of percentage?
Yeah. It would be meaningful, Gus. Probably over 10%.
Okay. Thinking about the bookings, can you help us if you back out Advantest so we can just sort of look at the regular everyday business? Could you give us a sense of what the bookings have been this year relative to last year?
Oh, yeah. Relative to last year, the bookings already As you said, after Q2, it was already greater than all of 2019, when you add the non-Advantest portion of Q3 on pace with the first half of the year. It depends on where Q4 works out to be, but it would suggest that even without Advantest the total bookings for the year would be very close to that 2x number, if not at that 2x number. In that same range anyway.
Okay. Just so I'm clear when you say bookings, is that 12-month basis, or is that the total value of the contract?
Total booking value. Total contract value.
Got it. Okay. Very good. Thanks so much.
Thanks, Gus.
No questions on queue. I would like to turn the call over back to John Kibarian for closing remarks.
Thank you for participating in our Q3 call. We look forward to talking with you again soon. Stay safe and have a great day.
This concludes today's conference call. You may now disconnect.