Table ofContents

 

 

 

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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##### **FORM 10-Q**

 

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| x | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|--------------------------------------------------------------------------------------------------------|

 

**For the Quarterly Period endedSeptember 30, 2009**

 

or

 
| o | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|------------|---------------------------------------------------------------------------------------------------------|

 

**For the transition period from                       to                       **

 

**CommissionFile Number 000-31311**

 

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**PDF SOLUTIONS, INC.**

(Exact name ofRegistrant as Specified in its Charter)

 

| **Delaware**                                    | ** ** | **25-1701361**       |
|-------------------------------------------------|------------|----------------------|
| (State or Other  Jurisdiction of                |       | (I.R.S. Employer     |
| Incorporation or  Organization)                 |       | Identification  No.) |
|                                            |       |                 |
| **333  West San Carlos Street, Suite 700** |       |                 |
| **San  Jose, California**                       | ** ** | **95110**            |
| (Address of  Principal Executive Offices)       |       | (Zip Code)           |

 

**(408)280-7900**

(Registrant’sTelephone Number, Including Area Code)

 

Indicateby check mark whether the Registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Act of 1934during the preceding 12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| o Large accelerated filer                 |   | x Accelerated filer    |
|------------------------------------------------|--------|-----------------------------|
|                                           |   |                        |
| o Non-accelerated filer                   |   | o Smaller reporting company |
| (Do not check if  a smaller reporting company) |   |                        |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Thenumber of shares outstanding of the Registrant’s Common Stock as of October 30,2009 was 26,528,407.

 

 

 

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**TABLEOF CONTENTS**

 
| ** **                                                                                          | **Page**   |
|-----------------------------------------------------------------------------------------------------|------------|
| **PART I  FINANCIAL INFORMATION**                                                              | ** ** |
| Item 1.  Financial Statements                                                                       | 3          |
| Condensed Consolidated Balance Sheets (Unaudited)                                                   | 3          |
| Condensed Consolidated Statements of Operations  (Unaudited)                                        | 4          |
| Condensed Consolidated Statements of Cash Flows  (Unaudited)                                        | 5          |
| Notes to Condensed Consolidated Financial Statements  (Unaudited)                                   | 6          |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 15         |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 | 26         |
| Item 4. Controls and Procedures                                                                     | 27         |
| **PART II  OTHER INFORMATION**                                                                 |       |
| Item  1. Legal Proceedings                                                                          | 27         |
| Item  1A. Risk Factors                                                                              | 27         |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                | 35         |
| Item 3. Defaults Upon Senior Securities                                                             | 35         |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        | 35         |
| Item  5. Other Information                                                                          | 35         |
| Item 6.  Exhibits                                                                                   | 36         |
| **SIGNATURES**                                                                                      | 37         |
| **INDEX TO  EXHIBITS**                                                                              | 38         |

 

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**PART I — FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**PDFSOLUTIONS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                                                                          | ** ** | **September 30,********2009** | ** ** | **December 31,********2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **(In  thousands,**                | ** ** |
| ** **                                                                                                                                                          | ** ** | **except  par values)**            | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **                         | ** ** | ** **                        | ** ** |
| Current assets:                                                                                                                                                     |       |                               |       |                              |       |
| Cash and cash equivalents                                                                                                                                           |       | $                                  | 33,176     |                              | $          | 31,686 |   |
| Short-term investments                                                                                                                                              |       | —                             |       | 9,051                             |       |
| Accounts receivable, net of allowance of $254 in  2009 and 2008                                                                                                     |       | 18,254                             |       | 24,989                            |       |
| Prepaid expenses, deferred tax assets, and other  current assets                                                                                                    |       | 2,771                              |       | 5,147                             |       |
| Total current assets                                                                                                                                                |       | 54,201                             |       | 70,873                            |       |
| Property and equipment, net                                                                                                                                         |       | 1,724                              |       | 2,675                             |       |
| Non-current investments                                                                                                                                             |       | 718                                |       | 718                               |       |
| Intangible assets, net                                                                                                                                              |       | 3,395                              |       | 4,730                             |       |
| Deferred tax assets and other non-current assets                                                                                                                    |       | 1,150                              |       | 631                               |       |
| Total assets                                                                                                                                                        |       | $                                  | 61,188     |                              | $          | 79,627 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                               |       |                              |       |
| Current liabilities:                                                                                                                                                |       |                               |       |                              |       |
| Current portion of long-term debt                                                                                                                                   |       | $                                  | 117        |                              | $          | 370 |   |
| Accounts payable                                                                                                                                                    |       | 1,438                              |       | 1,384                             |       |
| Accrued compensation and related benefits                                                                                                                           |       | 4,443                              |       | 6,525                             |       |
| Taxes payable and other accrued liabilities                                                                                                                         |       | 2,335                              |       | 3,723                             |       |
| Deferred revenue                                                                                                                                                    |       | 1,540                              |       | 1,792                             |       |
| Billings in excess of recognized revenue                                                                                                                            |       | 88                                 |       | 748                               |       |
| Total current liabilities                                                                                                                                           |       | 9,961                              |       | 14,542                            |       |
| Long-term debt                                                                                                                                                      |       | 148                                |       | 512                               |       |
| Long-term taxes payable                                                                                                                                             |       | 3,506                              |       | 3,356                             |       |
| Long-term other liabilities                                                                                                                                         |       | 1,494                              |       | 1,447                             |       |
| Total liabilities                                                                                                                                                   |       | 15,109                             |       | 19,857                            |       |
| Stockholders’ equity:                                                                                                                                          |       |                               |       |                              |       |
| Preferred stock, $0.00015 par value, 5,000 shares  authorized: no shares issued and outstanding                                                                     |       | —                             |       | —                            |       |
| Common stock, $0.00015 par value, 70,000 shares  authorized: shares issued 30,014 in 2009 and 29,339 in 2008; shares  outstanding 26,525 in 2009 and 25,923 in 2008 |       | 4                                  |       | 4                                 |       |
| Additional paid-in-capital                                                                                                                                          |       | 193,247                            |       | 189,132                           |       |
| Treasury stock at cost, 3,489 shares in 2009 and  3,416 shares in 2008                                                                                              |       | (18,535                            | )          | (18,402                           | )          |
| Accumulated deficit                                                                                                                                                 |       | (129,410                           | )          | (112,620                          | )          |
| Accumulated other comprehensive income                                                                                                                              |       | 773                                |       | 1,656                             |       |
| Total stockholders’ equity                                                                                                                                     |       | 46,079                             |       | 59,770                            |       |
| Total liabilities and stockholders’ equity                                                                                                                     |       | $                                  | 61,188     |                              | $          | 79,627 |   |

 

***See notes to unaudited condensed consolidated financialstatements***

 

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**PDF SOLUTIONS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

 
| ** **                                              | ** ** | **Three  Months Ended September 30,**    | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **2009**                                      | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                              | ** ** | **(In  thousands, except per share amounts)** | ** ** |
| ** **                                              | ** ** | ** **                                    | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                               |       |                                          |       |                                      |       |   |   |   |   |
| Design-to-silicon-yield solutions                       |       | $                                             | 8,439      |                                      | $          | 13,348 |   | $ | 23,525 |   | $ | 43,824 |   |
| Gainshare performance incentives                        |       | 5,439                                         |       | 5,417                                     |       | 10,126 |   | 16,402 |   |
| Total revenues                                          |       | 13,878                                        |       | 18,765                                    |       | 33,651 |   | 60,226 |   |
|                                                    |       |                                          |       |                                      |       |   |   |   |   |
| Cost of design-to-silicon-yield solutions:              |       |                                          |       |                                      |       |   |   |   |   |
| Direct costs of design-to-silicon-yield solutions       |       | 5,270                                         |       | 7,152                                     |       | 16,423 |   | 22,185 |   |
| Amortization of acquired technology                     |       | 360                                           |       | 631                                       |       | 1,079 |   | 1,893 |   |
| Total cost of design-to-silicon-yield solutions         |       | 5,630                                         |       | 7,783                                     |       | 17,502 |   | 24,078 |   |
| Gross margin                                            |       | 8,248                                         |       | 10,982                                    |       | 16,149 |   | 36,148 |   |
|                                                    |       |                                          |       |                                      |       |   |   |   |   |
| Operating expenses:                                     |       |                                          |       |                                      |       |   |   |   |   |
| Research and development                                |       | 4,689                                         |       | 7,835                                     |       | 15,547 |   | 26,045 |   |
| Selling, general and administrative                     |       | 4,321                                         |       | 5,401                                     |       | 12,842 |   | 17,346 |   |
| Amortization of other acquired intangible assets        |       | 86                                            |       | 194                                       |       | 260 |   | 583 |   |
| Restructuring charges                                   |       | 1,743                                         |       | —                                    |       | 3,578 |   | 1,471 |   |
| Total operating expenses                                |       | 10,839                                        |       | 13,430                                    |       | 32,227 |   | 45,445 |   |
|                                                    |       |                                          |       |                                      |       |   |   |   |   |
| Loss from operations                                    |       | (2,591                                        | )          | (2,448                                    | )          | (16,078 | ) | (9,297 | ) |
| Interest and other income (expense), net                |       | 7                                             |       | (343                                      | )          | 121 |   | 397 |   |
| Loss before income taxes                                |       | (2,584                                        | )          | (2,791                                    | )          | (15,957 | ) | (8,900 | ) |
| Income tax provision                                    |       | 247                                           |       | 9,433                                     |       | 833 |   | 7,777 |   |
| Net loss                                                |       | $                                             | (2,831     | )                                         | $          | (12,224 | ) | $ | (16,790 | ) | $ | (16,677 | ) |
|                                                    |       |                                          |       |                                      |       |   |   |   |   |
| Net loss per share — basic and diluted             |       | $                                             | (0.11      | )                                         | $          | (0.44 | ) | $ | (0.64 | ) | $ | (0.60 | ) |
| Weighted average common shares — basic and diluted |       | 26,499                                        |       | 27,540                                    |       | 26,306 |   | 27,663 |   |

 

***See notes to unaudited condensed consolidated financialstatements***

 

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**PDF SOLUTIONS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

 
| ** **                                                                                 | ** ** | **Nine  Months Ended********September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **(In  thousands)**                              | ** ** |
| Operating activities:                                                                      |       |                                             |       |   |   |
| Net loss                                                                                   |       | $                                                | (16,790    | ) | $ | (16,677 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                              |       | 1,097                                            |       | 1,447 |   |
| Stock-based compensation expense                                                           |       | 3,545                                            |       | 5,450 |   |
| Losses on sale of investment security and disposal  of fixed assets                        |       | 70                                               |       | 450 |   |
| Amortization of acquired intangible assets                                                 |       | 1,339                                            |       | 2,476 |   |
| Deferred taxes                                                                             |       | (165                                             | )          | 8,446 |   |
| Gain on debt extinguishment                                                                |       | (393                                             | )          | — |   |
| Changes in operating assets and liabilities:                                               |       |                                             |       |   |   |
| Accounts receivable, net of allowances                                                     |       | 6,733                                            |       | 5,213 |   |
| Prepaid expenses and other assets                                                          |       | 2,034                                            |       | 189 |   |
| Accounts payable                                                                           |       | 47                                               |       | (1,638 | ) |
| Accrued compensation and related benefits                                                  |       | (2,113                                           | )          | (28 | ) |
| Taxes payable and other accrued liabilities                                                |       | (1,205                                           | )          | (1,513 | ) |
| Deferred revenues                                                                          |       | (251                                             | )          | (232 | ) |
| Billings in excess of recognized revenue                                                   |       | (660                                             | )          | (438 | ) |
| Net cash provided by (used in) operating activities                                        |       | (6,712                                           | )          | 3,145 |   |
| Investing activities:                                                                      |       |                                             |       |   |   |
| Purchases of available-for-sale securities                                                 |       | —                                           |       | (27,094 | ) |
| Maturities and sales of available-for-sale  securities                                     |       | 9,054                                            |       | 20,665 |   |
| Purchases of property and equipment                                                        |       | (294                                             | )          | (1,007 | ) |
| Net cash provided by (used in) investing activities                                        |       | 8,760                                            |       | (7,436 | ) |
| Financing activities:                                                                      |       |                                             |       |   |   |
| Proceeds from exercise of stock options                                                    |       | —                                           |       | 63 |   |
| Proceeds from Employee Stock Purchase Plan                                                 |       | 570                                              |       | 590 |   |
| Purchases of treasury stock                                                                |       | (133                                             | )          | (3,108 | ) |
| Principal payments on long-term debt                                                       |       | (234                                             | )          | (361 | ) |
| Net cash provided by (used in) financing activities                                        |       | 203                                              |       | (2,816 | ) |
| Effect of exchange rate changes on cash                                                    |       | (761                                             | )          | (1,182 | ) |
| Net increase (decrease) in cash and cash equivalents                                       |       | 1,490                                            |       | (8,289 | ) |
| Cash and cash equivalents, beginning of period                                             |       | 31,686                                           |       | 35,315 |   |
| Cash and cash equivalents, end of period                                                   |       | $                                                | 33,176     |   | $ | 27,026 |   |
| Supplemental disclosure of cash flow information:                                          |       |                                             |       |   |   |
| Cash paid during the year for:                                                             |       |                                             |       |   |   |
| Taxes                                                                                      |       | $                                                | 1,000      |   | $ | 1,837 |   |
| Interest                                                                                   |       | $                                                | 15         |   | $ | 31 |   |

 

***See notes to unaudited condensed consolidated financialstatements***

 

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**PDFSOLUTIONS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

**1.BASIS OF PRESENTATION**

 

*Basisof Presentation*

 

Theinterim unaudited condensed consolidated financial statements included hereinhave been prepared by PDF Solutions, Inc. (“the Company”), without audit,pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”), including the instructions to the Quarterly Report on Form 10-Qand Article 10 of Regulation S-X. Certain information and footnotedisclosures normally included in annual financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. The interim unaudited condensedconsolidated financial statements reflect, in the opinion of management, alladjustments necessary (consisting only of normal recurring adjustments), topresent a fair statement of results for the interim periods presented. Theoperating results for any interim period are not necessarily indicative of theresults that may be expected for other interim periods or the full fiscal year.The accompanying interim unaudited condensed consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and notes thereto in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

Wehave evaluated subsequent events through November 9, 2009, the date thesefinancial statements were available for issuance and the filing date of thisQuarterly Report on Form 10-Q. Subsequent events are events that occur after the balance sheet date butbefore financial statements are issued or are available to be issued.

 

Thepreparation of the condensed consolidated financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses. A significant portion ofthe Company’s revenues require estimates with respect to total costs which maybe incurred and revenues earned. Actual results could differ from theseestimates.

 

Thecondensed consolidated financial statements include the accounts of the Companyand its wholly-owned subsidiaries after the elimination of all significantintercompany balances and transactions.

 

*RevenueRecognition*

 

TheCompany derives revenue from two sources: Design-to-Silicon-Yield Solutions,which include Services and Software Licenses, and Gainshare PerformanceIncentives.

 

*Design-to-Silicon-Yield Solutions*— Revenue that is derived fromDesign-to-Silicon-Yield solutions comes from services and software licenses.The Company recognizes revenue for each element of Design-to-Silicon-Yieldsolutions as follows:

 

*Services*— The Company generates a significantportion of its Design-to-Silicon-Yield solutions revenue from fixed-pricesolution implementation service contracts delivered over a specific period oftime. These contracts require accurate estimation of costs to performobligations and the overall scope of each engagement. Revenue under contractsfor solution implementation services is recognized as services are performedusing the cost-to-cost percentage of completion method of contract accounting.Losses on solution implementation contracts are recognized in the period whenthey become evident. Revisions in profit estimates are reflected in the periodin which the conditions that require the revisions become known and can beestimated.

 

On occasion, the Company has licensed its softwareproducts as a component of its fixed-price service contract. In such instances,the software products are licensed to customers over a specified term of theagreement with support and maintenance to be provided over the license term.Under these arrangements, where vendor-specific objective evidence of fairvalue (“VSOE”) exists for the support and maintenance element, the support andmaintenance revenue is recognized separately over the term of the supportingperiod. The remaining fee is recognized as services are performed using thecost-to-cost percentage of completion method of contract accounting. VSOE formaintenance, in these instances, is generally established based upon anegotiated renewal rate. Under arrangements where software products arelicensed as a component of its fixed-price service contract and where VSOE doesnot exist to allocate a portion of the total fixed-price to the undeliveredelements, revenue is recognized for the total fixed-price as the lesser ofeither the percentage of completion method of contract accounting or ratablyover the longer of either the term of the agreement or the support period. Costsincurred under these arrangements are deferred and recognized in proportion torevenue recognized under these arrangements.

 

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Revenue from related support and maintenance servicesis recognized ratably over the term of the support and maintenance contract,generally one year, while revenue from consulting, installation, and trainingservices is recognized as services are performed. When bundled with softwarelicenses in multiple element arrangements, support and maintenance, consulting(other than for its fixed-price solution implementations), installation, andtraining revenue is allocated to each element of a transaction based upon itsfair value as determined by the Company’s VSOE. VSOE for maintenance isgenerally established based upon negotiated renewal rates while VSOE forconsulting, installation, and training services is established based upon theCompany’s customary pricing for such services when sold separately. When VSOEdoes not exist to allocate a portion of the total fee to the undeliveredelements, revenue is recognized ratably over the longest period of theundelivered elements.

 

*Software Licenses* — The Company also licenses itssoftware products separately from its integrated solution implementations. Forsoftware license arrangements that do not require significant modification orcustomization of the underlying software, software license revenue isrecognized under the residual method when (1) persuasive evidence of anarrangement exists, (2) delivery has occurred, (3) the fee is fixedor determinable, (4) collectability is probable, and (5) thearrangement does not require services that are essential to the functionalityof the software. When arrangements include multiple elements such as supportand maintenance, consulting (other than for its fixed price solutionimplementations), installation, and training, revenue is allocated to eachelement of a transaction based upon its fair value as determined by the Company’sVSOE and such services are recorded as services revenue. VSOE for maintenanceis generally established based upon negotiated renewal rates while VSOE forconsulting, installation, and training services is established based upon theCompany’s customary pricing for such services when sold separately. When VSOEdoes not exist to allocate a portion of the total fee to the undeliveredelements, revenue is recognized ratably over the longest period of theundelivered elements, and such revenue is recorded as services revenue. Revenuefor software licenses with extended payment terms is not recognized in excessof amounts due. For software license arrangements that require significantmodification or customization of the underlying software, the software licenserevenue is recognized as services are performed using the cost-to-costpercentage of completion method of contract accounting, and such revenue isrecorded as services revenue.

 

*GainsharePerformance Incentives* — When the Company enters into a contract to provide yieldimprovement services, the contract usually includes two components: (1) afixed fee for performance by the Company of services delivered over a specificperiod of time; and (2) a gainshare performance incentives component wherethe customer may pay a variable fee, usually after the fixed fee period hasended. Revenue derived from gainshare performance incentives represents profitsharing and performance incentives earned based upon the Company’s customersreaching certain defined operational levels established in related solutionimplementation service contracts. Gainshare performance incentives periods areusually subsequent to the delivery of all contractual services and thereforehave no cost to the Company. Due to the uncertainties surrounding attainment ofsuch operational levels, the Company recognizes gainshare performanceincentives revenue (to the extent of completion of the related solutionimplementation contract) upon receipt of performance reports or other relatedinformation from the customer supporting the determination of amounts andprobability of collection.

 

*SoftwareDevelopment Costs* —Costs for the development of new software products and substantial enhancementsto existing software products are expensed as incurred until technologicalfeasibility has been established, at which time any additional costs would becapitalized*.*Because the Companybelieves its current process for developing software is essentially completedconcurrently with the establishment of technological feasibility, no costs havebeen capitalized to date.

 

**2.RECENT ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING CHANGES**

 

In October 2009, the Financial AccountingStandards Boards (“FASB”) issued an Accounting Standard Update on revenuerecognition in relation to****multiple-deliverable revenue arrangements. This update provides guidanceon accounting for multiple deliverable arrangements to enable vendors toaccount for products or services (deliverables) separately rather than as acombined unit.  The amendments in thisupdate will replace the term fair value in the revenue allocation guidance withselling price to clarify that the allocation of revenue is based onentity-specific assumptions rather than assumptions of a marketplaceparticipant.  This update is effectiveprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010.  The Company is currently evaluating theimpact, if any, that the adoption of this updated standard will have on itsfinancial results and position.

 

In October 2009, the FASB issued an AccountingStandard Update on software revenue recognition in relation to revenuearrangements that include software elements. This standard scopes out from software revenue recognition accounting,revenue arrangements for tangible products that contain both software and non-software components thatfunction together to deliver the tangible products’ essential functionality. Italso amends the determination of how arrangement consideration should beallocated to deliverables in a multiple-deliverable revenue arrangement.  Thisupdate is effective prospectively for revenue arrangements entered into ormaterially modified in fiscal years beginning on or after June 15,2010.  The Company is currentlyevaluating the impact, if any, that the adoption of this update will have onits financial results and position.

 

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EffectiveApril 1, 2009, the Company adopted FASB’s Accounting Standard Update onthe disclosure of subsequent events that occur after the balance sheet date butbefore financial statements are issued or are available to be issued. Thisstandard requires the disclosure of the date through which an entity hasevaluated subsequent events and the basis for that date, that is, whether thatdate represents the date the financial statements were issued or were availableto be issued. The adoption of this accounting standard did not have a materialimpact on the Company’s financial results and position.

 

Effective April 1, 2009, the Company adopted FASB’s Accounting StandardUpdate on how to determine fair value when the volume and level of activity forassets or liabilities have significantly decreased and for identifyingtransactions that are not orderly*.*  The adoption of this accounting standard didnot have a material impact on the Company’s financial results and position.

 

Effective April 1, 2009, the Company adopted FASB’sAccounting Standard Update on how to account for recognition and presentation of other-than-temporary impairments ofdebt securities.  This update amends the other-than-temporaryimpairment guidance for debt securities to make the guidance more operationaland to improve the presentation and disclosure of other-than-temporaryimpairments in the financial statements. The adoption of  this standarddid not have a material impact on the Company’s financial results and position.

 

EffectiveApril 1, 2009, the Company adopted FASB’s Accounting Standard Update fordisclosures about fair value of financial instruments. This update**requires disclosures about the fair value of financialinstruments for interim reporting periods of publicly traded companies as wellas in annual financial statements.  Thesestandards also require those disclosures in summarized financial information ininterim reporting periods.  The adoptionof these standards had no impact on the Company’s financial results andposition.

 

Effective January 1,2009, the Company adopted FASB’s Accounting Standard Update for business combinations.  These standards establish principlesand requirements for how an acquirer of a business recognizes and measures inits financial statements the identifiable assets acquired, the liabilitiesassumed, any noncontrolling interest in the acquiree, and the goodwillacquired. These standards also establish disclosure requirements to enable theevaluation of the nature and financial effects of the business combination. Theadoption of this standard did not have an effect on the Company’s financialresults and position.

 

**3. INVESTMENTS**

 

The following tables summarize the Company’s investments(in thousands):

 
| ** **                          | ** ** | ** **                 | ** ** | **September 30,  2009**               | ** ** | ** **                                  | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **Amortized********Costs** | ** ** | **Unrealized********Holding********Gains** | ** ** | **Unrealized********Holding********Losses** | ** ** | **Fair********Value** | ** ** |
| Auction-rate securities             |       | $                          | 1,000      |                                       | $          | —                                      |       | $ | (282 | ) | $ | 718 |   |
| Included in non-current investments |       |                       |       |                                       |       |                                        |       | $ | 718 |   |
|                                     |            |                            |            |                                            |            |                                             |            |  |  |  |  |  |  |

 
| ** **                           | ** ** | ** **                 | ** ** | **December 31, 2008**                 | ** ** | ** **                                  | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **Amortized********Costs** | ** ** | **Unrealized********Holding********Gains** | ** ** | **Unrealized********Holding********Losses** | ** ** | **Fair********Value** | ** ** |
| Commercial paper                     |       | $                          | 2,043      |                                       | $          | 4                                           |       | $ | — |   | $ | 2,047 |   |
| Agency obligations                   |       | 6,544                      |       | 68                                         |       |                                        |       | 6,612 |   |
| Auction-rate securities              |       | 1,000                      |       | —                                     |       | (282                                        | )          | 718 |   |
| Corporate Securities                 |       | 400                        |       | —                                     |       | (8                                          | )          | 392 |   |
|                                 |       | $                          | 9,987      |                                       | $          | 72                                          |       | $ | (290 | ) | $ | 9,769 |   |
| Included in short-term  investments  |       |                       |       |                                       |       |                                        |       | $ | 9,051 |   |
| Included in non-current  investments |       |                       |       |                                       |       |                                        |       | 718 |   |
| Total                                |       |                       |       |                                       |       |                                        |       | $ | 9,769 |   |

 

As of September 30,2009, the Company’s investments consisted entirely of auction-rate securities.As of December 31, 2008, all securities, other than auction-ratesecurities held by the Company, had a maturity of one year or less. Pleaserefer to Note 12 “Fair Value” for further discussion of auction-ratesecurities.

 

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**4.ACCOUNTS RECEIVABLE**

 

Accountsreceivable include amounts that are unbilled at the end of the period. Unbilledaccounts receivable are determined on an individual contract basis and wereapproximately $6.8 million and $10.5 million as of September 30, 2009 and December 31,2008, respectively.

 

**5.GOODWILL AND ACQUIRED INTANGIBLE ASSETS**

 

Impairment on goodwill and acquired intangible assetsis evaluated on an annual basis (or more frequently if indicators of impairmentexist). Acquired intangible assets other than goodwill are amortized over theiruseful lives unless these lives are determined to be indefinite. The Company completedits annual impairment test in the fourth quarter of 2008 when the Companyobserved impairment indicators including the trading of common stock below theCompany’s book value and a further deterioration in the semiconductor industry,brought on by the deteriorating global economic environment. The Company alsoevaluated its acquired intangible assets for impairment. As a result of theimpairment analyses, the Company recorded an impairment charge of $64.0 millionrelated to goodwill and $6.3 million relating to its acquired intangible assetsduring the fourth quarter of 2008. During the nine months ended September 30, 2009, there were noindicators of impairment related to the Company’s intangible assets.

 

Thefollowing table provides information relating to the intangible assets andgoodwill as of September 30, 2009 and December 31, 2008 (inthousands):

 
| ** **                             | ** ** | **Amortization********Period********(Years)** | ** ** | **December 31,********2008********Net Carrying********Amount** | ** ** | **Amortization** | ** ** | **Foreign  Currency  Translation** | ** ** | **September 30,********2009********Net Carrying********Amount** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------|------------|------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Acquired Identifiable  Intangibles** |       |                                          |       |                                                                |       |             |       |                               |       |                                                                 |       |
| Acquired technology                    |       | 4 - 5                                         |       | $                                                                   | 3,608      |             | $          | (1,079                             | )          | $                                                                    | —     |   | $ | 2,529 |   |
| Brand name                             |       | 4                                             |       | 129                                                                 |       | (53              | )          | —                             |       | 76                                                                   |       |
| Customer relationships  and backlog    |       | 1 - 6                                         |       | 489                                                                 |       | (96              | )          | —                             |       | 393                                                                  |       |
| Patent and applications                |       | 7                                             |       | 400                                                                 |       | (54              | )          | —                             |       | 346                                                                  |       |
| Other acquired  intangibles            |       | 4                                             |       | 104                                                                 |       | (57              | )          | 4                                  |       | 51                                                                   |       |
| Total                                  |       |                                          |       | $                                                                   | 4,730      |             | $          | (1,339                             | )          | $                                                                    | 4          |   | $ | 3,395 |   |

 
| ** **                          | ** ** | **Amortization********Period********(Years)** | ** ** | **December 31,********2007********Net Carrying********Amount** | ** ** | **Acquisitions** | ** ** | **Purchase********Price********Adjustments** | ** ** | **Amortization** | ** ** | **Foreign********Currency********Translation** | ** ** | **Impairment** | ** ** | **December 31,********2008********Net Carrying********Amount** | ** ** |
|-------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------|------------|----------------------------------------------|------------|------------------|------------|------------------------------------------------|------------|----------------|------------|---------------------------------------------------------------------|------------|
| Goodwill                            |       | N/A                                           |       | $                                                                   | 65,170     |             | $          | 147                                          |       | $                | (216       | )                                              | $          | —         |       | $                                                                   | (1,102     | ) | $ | (63,999 | ) | $ | — |   |
| Acquired identifiable  intangibles: |       |                                          |       |                                                                |       |             |       |                                         |       |             |       |                                           |       |           |       |                                                                |       |
| Acquired technology                 |       | 4-5                                           |       | $                                                                   | 9,184      |             | $          | 420                                          |       | $                | —     |                                           | $          | (2,576         | )          | $                                                                   | —     |   | $ | (3,420 | ) | $ | 3,608 |   |
| Brand name                          |       | 4                                             |       | 361                                                                 |       | —           |       | —                                       |       | (128             | )          | —                                         |       | (104           | )          | 129                                                                 |       |
| Customer relationships and  backlog |       | 1-6                                           |       | 1,812                                                               |       | 1,230            |       | —                                       |       | (509             | )          | —                                         |       | (2,044         | )          | 489                                                                 |       |
| Patents and applications            |       | 7                                             |       | 1,283                                                               |       | —           |       | —                                       |       | (200             | )          | —                                         |       | (683           | )          | 400                                                                 |       |
| Other acquired intangibles          |       | 4                                             |       | 178                                                                 |       | —           |       | —                                       |       | (72              | )          | (2                                             | )          | —         |       | 104                                                                 |       |
| Total                               |       |                                          |       | $                                                                   | 12,818     |             | $          | 1,650                                        |       | $                | —     |                                           | $          | (3,485         | )          | $                                                                   | (2         | ) | $ | (6,251 | ) | $ | 4,730 |   |

 

The Company expects the annual amortization ofacquired intangible assets to be as follows (in thousands):

 
| **Year  Ending December 31,**   | ** ** | **Amount** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2009 (remaining  three-month period) |       | $          | 446        |   |
| 2010                                 |       | 1,579      |       |
| 2011                                 |       | 830        |       |
| 2012                                 |       | 435        |       |
| 2013                                 |       | 74         |       |
| 2014 and thereafter                  |       | 31         |       |
| Total                                |       | $          | 3,395      |   |

 

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**6. STOCKHOLDERS’ EQUITY**

 

Stock-basedcompensation is estimated at the grant date based on the award’s fairvalue  and is recognized on astraight-line basis over the vesting periods of the applicable stock purchaserights and stock options, generally four years*.*Stock-based compensation expenses before taxes related to the Company’semployee stock purchase plan and stock-option plans were allocated as follows(in thousands):

 
| ** **                                 | ** ** | **Three  Months********Ended September 30,** | ** ** | **Nine  Months********Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost of  design-to-silicon-yield solutions |       | $                                                 | 278        |                                             | $          | 453 |   | $ | 1,111 |   | $ | 1,383 |   |
| Research and  development                  |       | 341                                               |       | 537                                              |       | 1,093 |   | 1,843 |   |
| Selling, general and  administrative       |       | 465                                               |       | 723                                              |       | 1,341 |   | 2,224 |   |
| Stock-based  compensation expenses         |       | $                                                 | 1,084      |                                             | $          | 1,713 |   | $ | 3,545 |   | $ | 5,450 |   |

 

TheCompany estimated the fair value of share-based awards granted during theperiod using the Black-Scholes-Merton option-pricing model with the followingweighted average assumptions, resulting in the following weighted average fairvalues:

 

*Stock Plans:*

 
| ** **                                                                  | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected life (in  years)                                                   |       | 5.16                                             |       | 5.77                                            |       | 5.16 |   | 5.77 |   |
| Volatility                                                                  |       | 63.5                                             | %          | 58.6                                            | %          | 63.1 | % | 58.6 | % |
| Risk-free interest rate                                                     |       | 2.54                                             | %          | 3.48                                            | %          | 2.44 | % | 3.27 | % |
| Expected dividend                                                           |       | —                                           |       | —                                          |       | — |   | — |   |
| Weighted average fair  value per share of options granted during the period |       | $                                                | 1.24       |                                            | $          | 2.75 |   | $ | 1.11 |   | $ | 3.13 |   |
|                                                                             |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |  |

 

*EmployeeStock Purchase Plan:*

 
| ** **                                                                        | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected life (in  years)                                                         |       | 1.25                                             |       | 1.26                                            |       | 1.25 |   | 1.31 |   |
| Volatility                                                                        |       | 79.1                                             | %          | 69.8                                            | %          | 79.6 | % | 60.8 | % |
| Risk-free interest rate                                                           |       | 1.19                                             | %          | 2.33                                            | %          | 1.23 | % | 2.80 | % |
| Expected dividend                                                                 |       | —                                           |       | —                                          |       | — |   | — |   |
| Weighted average fair value per share of employee  stock issued during the period |       | $                                                | 1.12       |                                            | $          | 2.43 |   | $ | 0.90 |   | $ | 3.13 |   |
|                                                                                   |            |                                                  |            |                                                 |            |  |  |  |  |  |  |  |  |

 

On September 30,2009, the Company has in effect the following stock-based compensation plans:

 

*Stock Plans —*During 2001, the Company terminated the 1996 and 1997Stock Plans as to future option grants, and adopted the 2001 Stock Plan. Underthe Company’s 2001 Stock Plan, on January 1 of each year, starting withyear 2002, the number of shares in the reserve will increase by the lesser of (1) 3,000,000shares, (2) 5% of the outstanding common stock on the last day of theimmediately preceding year, or (3) the number of shares determined by theboard of directors. Under the 2001 Stock Plan, the Company may grant stockpurchase rights and stock options to purchase shares of common stock toemployees, directors and consultants. The exercise price for stock options mustgenerally be at prices not less than the fair market value at the date of grantfor incentive stock options and not less than 85% of fair market value fornon-statutory stock options. Stock options generally expire ten years from thedate of grant and become vested and exercisable ratably over a four-yearperiod.

 

Stockoption activity under the Company’s plan during the nine months ended September 30,2009 was as follows:

 

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| ** **                                            | ** ** | **Number of********Options********(in thousands)** | ** ** | **Weighted Average********Exercise Price********per Share** | ** ** | **Weighted Average********Remaining********Contractual********Term (years)** | ** ** | **Aggregate********Intrinsic Value********(in thousands)** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Outstanding,  January 1, 2009                    |       | 4,412                                              |       | $                                                           | 8.93       |                                                                         |       |                                                       |       |   |
| Granted                                               |       | 152                                                |       | 2.08                                                        |       |                                                                         |       |                                                       |       |
| Exercised                                             |       | —                                             |       | —                                                      |       |                                                                         |       |                                                       |       |
| Canceled                                              |       | (235                                               | )          | 9.09                                                        |       |                                                                         |       |                                                       |       |
| Expired                                               |       | (186                                               | )          | 9.12                                                        |       |                                                                         |       |                                                       |       |
| Outstanding,  September 30, 2009                 |       | 4,143                                              |       | 8.64                                                        |       | 6.62                                                                         |       | $                                                          | 301        |   |
| Vested and expected to  vest, September 30, 2009 |       | 4,001                                              |       | 8.84                                                        |       | 6.40                                                                         |       | $                                                          | 249        |   |
| Exercisable, September 30, 2009                  |       | 2,911                                              |       | 9.45                                                        |       | 5.65                                                                         |       | $                                                          | 78         |   |
|                                                       |            |                                                    |            |                                                             |            |                                                                              |            |                                                            |            |  |  |

 

Theaggregate intrinsic value in the table above represents the total intrinsicvalue based on the Company’s closing stock price of $3.49 per share as of September 30,2009, which would have been received by the option holders had all “in-the-money”option holders exercised their options as of that date. No stock options wereexercised during the nine months ended September 30, 2009.

 

As of September 30,2009, there was $4.4 million of total unrecognized compensation cost related tononvested stock options. That cost is expected to be recognized over a weightedaverage period of 2.1 years. The total fair value of shares vested during thenine months ended September 30, 2009 was $2.6 million.

 

Nonvested shares (restricted stock units) activityduring the nine months ended September 30, 2009 were as follows:

 
| ** **                         | ** ** | **Shares********(in thousands)** | ** ** | **Weighted Average********Grant Date********Fair Value Per Share** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------------------------------------------|------------|
| Nonvested,  January 1, 2009   |       | 852                              |       | $                                                                  | 8.64       |   |
| Granted                            |       | —                           |       | —                                                             |       |
| Vested                             |       | (217                             | )          | 5.52                                                               |       |
| Forfeited                          |       | (102                             | )          | 8.41                                                               |       |
| Nonvested, September 30, 2009 |       | 533                              |       | 9.95                                                               |       |
|                                    |            |                                  |            |                                                                    |            |  |

 

As of September 30,2009, there was $3.2 million of total unrecognized compensation cost related tononvested restricted stock units. That cost is expected to be recognized over aweighted average period of 3.0 years. The total compensation expense related toshares vested during the nine months ended September 30, 2009 was $1.3million.

 

*Employee Stock Purchase Plan*— In July 2001, the Company adopted an EmployeeStock Purchase Plan (“Purchase Plan”), under which eligible employees cancontribute up to 10% of their compensation, as defined in the Purchase Plan,towards the purchase of shares of PDF common stock at a price of 85% of thelower of the fair market value at the beginning of the offering period or theend of each six-month offering period. Under the Purchase Plan, on January 1of each year, starting with 2002, the number of shares reserved for issuancewill automatically increase by the lesser of (1) 675,000 shares, (2) 2%of the Company’s outstanding common stock on the last day of the immediatelypreceding year, or (3) the number of shares determined by the board ofdirectors. For the nine months ended September 30, 2009, the Purchase Plancompensation expense was $174,000.

 

*Stock Repurchase Program*— On March 26, 2003, the Company’s Board ofDirectors approved a share repurchase program to purchase up to $10.0 millionof its outstanding common stock. This program was completed in August 2007with 988,000 shares repurchased at the average price of $10.12 per share. On October 29,2007, the Board of Directors approved a new program to repurchase up to anadditional $10.0 million of the Company’s common stock on the open market. Theright to repurchase stock under this program will expire on October 29,2010. As of September 30, 2009, 2.5 million shares have been repurchasedat the average price of $3.41 per share under this program and $1.5 millionremained available for future repurchases.

 

**7. RESTRUCTURING**

 

In2008, the Company announced two restructuring plans to better allocate itsresources to improve its operational results in light of current marketconditions, one on April 29, 2008 and the other on October 28, 2008.

 

For the plan announced on April 29, 2008, theCompany recorded restructuring charges of $1.5 million during the three monthsended June 30, 2008, which primarily consisted of employee severance costsof $1.4 million. All severance costs and related fees were paid out and theactivities were completed as of March 31, 2009.

 

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Forthe plan announced on October 28, 2008, the Company recorded restructuringcharges of $5.5 million, primarily consisting of employee severance costs of$4.4 million and facility exit costs of $1.0 million. Of the $5.5 million, $3.6million was recorded during the nine months ended September 30, 2009,which primarily consisted of employee severance costs. The following tablesummarizes the activities of these restructuring liabilities (in thousands):

 
| **Restructuring  Announced on October 28, 2008** | ** ** | **Severance** | ** ** | **Facility Exit** | ** ** | **Professional********and Other Fees** | ** ** | **Total** | ** ** |
|-------------------------------------------------------|------------|---------------|------------|-------------------|------------|----------------------------------------|------------|-----------|------------|
| Balance,  January 1, 2009                        |       | $             | 860        |              | $          | 1,108                                  |       | $         | 31         |   | $ | 1,999 |   |
| Restructuring charges                                 |       | 3,446         |       | —            |       | 132                                    |       | 3,578     |       |
| Payments                                              |       | (3,730        | )          | (336              | )          | (145                                   | )          | (4,211    | )          |
| Balance, September 30, 2009                      |       | $             | 576        |              | $          | 772                                    |       | $         | 18         |   | $ | 1,366 |   |

 

As of September 30,2009, of the remaining accrual of $1.4 million, $908,000 was included inaccrued liabilities and $458,000 was included in long-term other liabilities.Accrued severance of $582,000 and accrued professional and other fees of$18,000 are expected to be paid out in the three months ending December 31,2009. Accrued facility exit costs will be paid in accordance with the leasepayment schedule through 2013.

 

**8.INCOME TAXES**

 

The Company accounts for temporary differences between the book and taxbasis of assets and liabilities by recording deferred tax assets andliabilities.**The Company must assess the likelihoodthat its deferred tax assets will be recovered from future taxable income and,to the extent the Company believes that recovery is not likely, the Companymust establish a valuation allowance. Changes in the Company’s net deferred taxassets and valuation allowance in a period are recorded through the income taxprovision in the condensed consolidated statements of operations.

 

TheCompany classifies its liabilities related to unrecognized tax benefits aslong-term. The Company includes interest and penalties related to unrecognizedtax benefits within the Company’s income tax provision. As of September 30,2009 and December 31, 2008, the Company had $674,000 and $562,000,respectively, accrued for payment of interest and penalties related tounrecognized tax benefits.

 

TheCompany’s total amount of unrecognized tax benefits as of September 30,2009 was $8.4 million, of which $2.8 million, if recognized, would affect theCompany’s effective tax rate. The Company’s total amount of unrecognized taxbenefits as of December 31, 2008 was $8.2 million, of which $2.8 million,if recognized, would affect the Company’s effective tax rate. As of September 30,2009, the Company has recognized a net amount of $3.5 million as long-termtaxes payable for unrecognized tax benefits in its condensed consolidatedbalance sheets. The Company does not expect the change in unrecognized taxbenefits over the next twelve months to materially impact its results ofoperations and financial position.

 

TheCompany conducts business globally and, as a result, files numerousconsolidated and separate income tax returns in the U.S. federal, various stateand foreign jurisdictions. Because the Company used some of the tax attributescarried forward from previous years to tax years that are still open, statutesof limitation remain open for all tax years to the extent of the attributescarried forward into tax year 2001 for federal tax purposes and tax year 2002for California tax purposes. With few exceptions, the Company is no longersubject to income tax examinations in its major foreign subsidiaries’jurisdictions for years before 2004.

 

**9.NET LOSS PER SHARE**

 

Basicnet loss per share is computed by dividing net loss by the weighted averagecommon shares outstanding for the period (excluding outstanding stock optionsand shares subject to repurchase). Diluted net loss per share reflects theweighted average common shares outstanding plus the potential effect ofdilutive securities which are convertible into common shares (using thetreasury stock method), except in cases where the effect would beanti-dilutive. The following is a reconciliation of the numerators anddenominators used in computing basic and diluted net loss per share (inthousands, except per share amounts):

 

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| ** **                                              | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                              | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net loss                                                |       | $                                                | (2,831     | )                                               | $          | (12,224 | ) | $ | (16,790 | ) | $ | (16,677 | ) |
| Denominator for basic  calculation:                     |       |                                             |       |                                            |       |   |   |   |   |
| Weighted average common  shares outstanding— basic |       | 26,499                                           |       | 27,540                                          |       | 26,306 |   | 27,663 |   |
| Dilutive items                                          |       |                                             |       |                                            |       |   |   |   |   |
| Stock options  outstanding                              |       | —                                           |       | —                                          |       | — |   | — |   |
| Denominator for diluted  computation                    |       | 26,499                                           |       | 27,540                                          |       | 26,306 |   | 27,663 |   |
| Net loss per share —  basic and diluted            |       | $                                                | (0.11      | )                                               | $          | (0.44 | ) | $ | (0.64 | ) | $ | (0.60 | ) |

 

**10.COMPREHENSIVE LOSS**

 

Thecomponents of comprehensive loss are as follows (in thousands):

 
| ** **                                                           | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                           | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net loss                                                             |       | $                                                | (2,831     | )                                               | $          | (12,224 | ) | $ | (16,790 | ) | $ | (16,677 | ) |
| Unrealized loss  on investments, net of income tax effects           |       | (4                                               | )          | (97                                             | )          | (65 | ) | (182 | ) |
| Foreign currency  translation adjustments, net of income tax effects |       | 223                                              |       | (3,002                                          | )          | (818 | ) | (938 | ) |
| Comprehensive  loss                                                  |       | $                                                | (2,612     | )                                               | $          | (15,323 | ) | $ | (17,673 | ) | $ | (17,797 | ) |

 

**11.CUSTOMER AND GEOGRAPHIC INFORMATION**

 

Operatingsegments are defined as components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker, or group, in deciding how to allocate resources andin assessing performance.

 

The Company’schief operating decision maker, the Chief Executive Officer, reviews discretefinancial information presented on a consolidated basis for purposes of makingoperating decisions and assessing financial performance. Accordingly theCompany considers itself to be in one operating segment, specifically thelicensing and implementation of yield improvement solutions for integratedcircuit manufacturers.

 

The Company had revenues from individual customers inexcess of 10% of total revenues as follows:

 
| ** **   | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|--------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **Customer** | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| A            |       | 25                                               | %          | 21                                              | %          | 15 | % | 19 | % |
| B            |       | 17                                               | %          | 19                                              | %          | 22 | % | 16 | % |
| C            |       | 11                                               | %          | *                                               | %          | 10 | % | * | % |

 

----

*  represents less than 10%

 

TheCompany had gross accounts receivable from the following individual customersin excess of 10% of gross accounts receivable as follows:

 
| **Customer** | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------|------------|------------------------------|------------|-----------------------------|------------|
| B            |       | 21                           | %          | 17                          | %          |
| A            |       | 15                           | %          | 12                          | %          |
| D            |       | 13                           | %          | 12                          | %          |
| E            |       | 11                           | %          | 11                          | %          |
| F            |       | 10                           | %          | *                           | %          |

 

----

*  represents less than 10%

 

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Revenues from customers by geographic area are asfollows (in thousands):

 
| ** **    | ** ** | **Three Months********Ended September 30,** | ** ** | **Nine Months********Ended September 30,** | ** ** |
|---------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **2009**                                         | ** ** | **2008**                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Asia          |       | $                                                | 9,680      |                                            | $          | 10,499 |   | $ | 20,724 |   | $ | 33,032 |   |
| United States |       | 3,084                                            |       | 5,307                                           |       | 10,128 |   | 16,072 |   |
| Europe        |       | 1,114                                            |       | 2,959                                           |       | 2,799 |   | 11,122 |   |
| Total         |       | $                                                | 13,878     |                                            | $          | 18,765 |   | $ | 33,651 |   | $ | 60,226 |   |

 

As of September 30,2009 and December 31, 2008, long-lived assets related to PDF SolutionsS.A.S. (formerly Si Automation S.A.), located in France, totaled $150,000 and$336,000, respectively. The majority of the Company’s remaining long-livedassets are in the United States.

 

**12. FAIR VALUE**

 

Fairvalue is the exit price, or the amount that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants as of the measurement date. The multiple assumptions used to valuefinancial instruments are referred to as inputs, and a hierarchy for inputsused in measuring fair value is established, that maximizes the use ofobservable inputs and minimizes the use of unobservable inputs by requiringthat the most observable inputs be used when available. Observable inputsreflect assumptions market participants would use in pricing an asset orliability based on market data obtained from independent sources whileunobservable inputs reflect a reporting entity’s pricing based upon its ownmarket assumptions. These inputs are ranked according to a fair value hierarchythat prioritizes the inputs to valuation techniques used to measure fair valueinto three broad levels.

 
| Level 1 — |   | Inputs are  quoted prices in active markets for identical assets or liabilities.                                                                                                                                                                                                                                                                   |
|----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |   |                                                                                                                                                                                                                                                                                                                                               |
| Level 2 — |   | Inputs are  quoted prices for similar assets or liabilities in an active market, quoted  prices for identical or similar assets or liabilities in markets that are not  active, inputs other than quoted prices that are observable and  market-corroborated inputs which are derived principally from or corroborated  by observable market data. |
|           |   |                                                                                                                                                                                                                                                                                                                                               |
| Level 3 — |   | Inputs are  derived from valuation techniques in which one or more significant inputs or  value drivers are unobservable.                                                                                                                                                                                                                          |

 

The followingtable represents the Company’s assets measured at fair value on a recurringbasis as of September 30, 2009 and the basis for that measurement (inthousands):

 
| **Assets**                | ** ** | **Total** | ** ** | **Quoted  Prices in********Active Markets for********Identical Assets********(Level 1)** | ** ** | **Significant  Other********Observable Inputs********(Level 2)** | ** ** | **Significant********Unobservable Inputs********(Level 3)** | ** ** |
|---------------------------|------------|-----------|------------|------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Money market mutual funds |       | $         | 30,231     |                                                                                     | $          | 30,231                                                           |       | $                                                           | —     |   | $ | — |   |
| Auction-rate securities   |       | 718       |       | —                                                                                   |       | —                                                           |       | 718                                                         |       |
| Total                     |       | $         | 30,949     |                                                                                     | $          | 30,231                                                           |       | $                                                           | —     |   | $ | 718 |   |

 

TheCompany holds investments in auction-rate securities (“ARS”), which arevariable rate debt instruments whose interest rates are reset through a “dutch”auction process at regular intervals, typically every 28 days. All ARS arebacked by pools of student loans guaranteed by governmental agencies andprivate entities, and were rated AAA/Aaa at the date of acquisition. Theliquidity and fair value of these securities has been reduced by theuncertainty in the credit markets and the exposure of these securities to thefinancial condition of bond insurance companies, as evidenced by the ratingdowngrade of MBIA (bond insurer on one of the Company’s ARS) from Aaa to A2, byMoody’s Investor Services on June 19, 2008. All ARS have failed to sell atauction since February 2008, and as a result, their interest rates werereset to the maximum LIBOR + 150 basis points. The only activity associatedwith these instruments since February 2008 was the repurchase of $500,000of ARS at par by issuers. As a result of these auction failures, there waslimited active market with observable prices for these securities as of September 30,2009; therefore, the Company computed the fair value of these securities basedon a discounted cash flow model, using significant level 3 inputs, to take intoaccount the lack of liquidity. The Company does not believe that the studentloans backing these securities, the principal of these assets, is at risk.Furthermore, the Company intends to hold these securities until the creditmarkets recover and these securities resume pricing at or near par and it is notmore likely than not that the Company will be required to sell the securitiesbefore recovery of the principal. As a result, the Company recorded a temporaryimpairment to other comprehensive income and classified these securities asnon-current investments. The valuation may be revised in future periods asmarket conditions evolve.

 

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There was no change in the beginning and endingbalance of assets measured at fair value on a recurring basis using significantunobservable inputs (Level 3) during the nine months ended September 30,2009.

 

**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results****of Operations.**

 

**Forward-Looking Statements**

 

Thefollowing discussion of our financial condition and results of operationscontains forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934. In some cases, you can identify forward-looking statements by terminologysuch as “may,” “could,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,”“predict,” “potential” or “continue,” the negative effect of terms like theseor other similar expressions. Any statement concerning future financialperformance (including future revenues, earnings or growth rates), ongoingbusiness strategies or prospects, and possible actions taken by us or oursubsidiaries, which may be provided by us are also forward-looking statements.These forward-looking statements are only predictions. Forward-lookingstatements are based on current expectations and projections about futureevents and are inherently subject to a variety of risks and uncertainties, manyof which are beyond our control, which could cause actual results to differmaterially from those anticipated or projected. All forward-looking statementsincluded in this document are based on information available to us on the dateof filing and we further caution investors that our business and financialperformance are subject to substantial risks and uncertainties. We assume noobligation to update any such forward-looking statements. In evaluating thesestatements, you should specifically consider various factors, including therisk factors set forth in Part II, Item 1A in this Quarterly Report andset forth at the end of Item 1A in our Annual Report on Form 10-K for theyear ended December 31, 2008 filed with the Securities and ExchangeCommission on March 16, 2009.

 

**Overview**

 

Weanalyze our customers’ integrated circuit (“IC”) design and manufacturingprocesses to identify, quantify, and correct the issues that cause yield lossto improve our customers’ profitability by improving time-to-market, increasingyield and reducing total design and manufacturing costs. We package oursolutions in various ways to meet our customers’ specific business andbudgetary needs, each of which provides us various revenue streams. We receivea mix of fixed fees and variable, performance-based fees for the vast majorityof our Yield Improvement Solutions offerings. The fixed fees are typicallyreflective of the length of time and the resources needed to characterize acustomer’s manufacturing process and receive preliminary results of proposedyield improvement suggestions. The variable fee, or what we call gainshareperformance incentives, usually depends on our achieving certain yield targetsby a deadline.  Variable fees arecurrently typically tied to wafer volume on the node size of the process on whichwe performed the yield improvement. We also receive license fees and servicefees for related installation, integration, training, and maintenance andsupport services for our software that we license on a stand-alone basis.

 

***History***

 

From ourincorporation in 1992 through late 1995, we were primarily focused on researchand development of our proprietary manufacturing process simulation and yieldand performance modeling software. From late 1995 through late 1998, wecontinued to refine and sell our software, while expanding our offering toinclude yield and performance improvement consulting services. In late 1998, webegan to sell our software and consulting services, together with our newlydeveloped proprietary technologies, under the term Design-to-Silicon-Yieldsolutions, reflecting our current business model. In April 2000, weexpanded our research and development team and gained additional technology byacquiring AISS. AISS now operates as PDF Solutions GmbH, a German company,which continues to develop software and provide development services to thesemiconductor industry. In July 2001, we completed the initial publicoffering of our common stock. In 2003, we enhanced our product and serviceofferings, including increased software applications, through the acquisitionsof IDS and WaferYield. In 2006, we further complemented our technology offeringby acquiring Si Automation S.A. and adding its Fault Detection andClassification (“FDC”) software capabilities to our integrated solution. In2007, we increased our intellectual property solutions portfolio, particularlyin logic design technology, through the acquisition of Fabbrix, Inc. In2008, we solidified our market leading position in the FDC software market,particularly in Korea, and now provide complementary technology to our mæstriaproduct through the acquisition of certain assets of Triant Holdings, Inc.

 

***Industry Trend***

 

Subject to thecurrent general economic downturn, demand for consumer electronics andcommunications devices continues to drive technological innovation in the semiconductorindustry as the need for products with greater performance, lower powerconsumption, reduced costs and smaller size continues to grow with each newproduct generation. In addition, advances in computing systems and mobiledevices have fueled demand for higher capacity memory chips. To meet thesedemands, IC manufacturers and designers are constantly challenged to improvethe overall performance of their ICs by designing and manufacturing ICs withmore 

 

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embedded applications tocreate greater functionality while lowering cost per transistor. As a result,both logic and memory manufacturers have migrated to more and more advancedmanufacturing nodes, capable of integrating more devices with higherperformance, higher density, and lower power. As this trend continues,companies will continually be challenged to improve process capabilities tooptimally produce ICs with minimal random and systematic yield loss, which isdriven by the lack of compatibility between the design and its respectivemanufacturing process. We believe that as volume production of deep submicronICs continues to grow, the difficulties of integrating IC designs with theirrespective processes and ramping new manufacturing processes will create agreater need for products and services that address the yield loss andescalating cost issues the semiconductor industry is facing today and will facein the future.

 

***FinancialHighlights***

 

The semiconductor industry is currently experiencing significantchallenges, primarily due to the poor macroeconomic environment, and it isunclear when a sustained rebound may occur. As a result of this downturn, someof our customers faced financial challenges in fiscal 2008 and have continuedto face such challenges in fiscal 2009. The current economic downturn hascontributed to the substantial reduction in our revenue and could continue toharm our business, operating results and financial condition.

 

We plan operating expense levels primarily based onforecasted revenue levels. To partially offset the impact of our expecteddecrease in revenue, we have implemented several cost saving initiatives,including reducing headcount and other discretionary spending. During the yearended December 31, 2008, we initiated two restructuring plans to improveour operating results and to align our cost structure with expected revenue.

 

Financialhighlights for the three months ended September 30, 2009 were as follows:

 

·**            **Total revenue for the three months ended September 30,2009 was $13.9 million, a decrease of $4.9 million, or 26%, compared to thethree months ended September 30, 2008. Design-to-Silicon-Yield solutions revenuefor the three months ended September 30, 2009 was $8.4 million, a decreaseof $4.9 million, or 37%, compared to $13.3 million for the three months ended September 30,2008. The decrease in Design-to-Silicon-Yield solutions revenue was primarilythe result of lower bookings. The dramatic downturn in the semiconductorindustry combined with weakness in worldwide economy have been the primarycontributors to this reduction. Gainshare performance incentives revenue forthe three months ended September 30, 2009 was $5.4 million, the same asthe three months ended September 30, 2008.

 

·**            **Net loss for the three months ended September 30,2009 was $2.8 million, compared to $12.2 million for the three months ended September 30,2008. The decrease in net loss was primarily attributable to the establishmentof a valuation allowance against deferred tax assets during the three monthsended September 30, 2008, and decreases in operating expenses as theresult of our cost control efforts, partially offset by a significant decreasein revenue.

 

·**            **Net loss per basic and diluted share was $0.11 for thethree months ended September 30, 2009 compared to $0.44 for the threemonths ended September 30, 2008, a decrease in net loss of $0.33 per basicand diluted share.

 

Financialhighlights for the nine months ended September 30, 2009 were as follows:

 

·**            **Total revenue for the nine months ended September 30,2009 was $33.7 million, a decrease of $26.6 million, or 44%, compared to thenine months ended September 30, 2008. Revenue from Design-to-Silicon-Yieldsolutions for the nine months ended September 30, 2009 decreased $20.3million to $23.5 million, or 46%, compared to $43.8 million for the nine monthsended September 30, 2008.  Thedecrease in Design-to-Silicon-Yield solutions revenue was primarily the resultof lower bookings, as customers have delayed purchases for capacity expansionand investment in leading-edge technology. The dramatic downturn in thesemiconductor industry combined with weakness in worldwide economy have beenthe primary contributors to this reduction. Revenue from gainshare performanceincentives for the nine months ended September 30, 2009 decreased $6.3million to $10.1 million from the nine months ended September 30,2008.  The decrease in revenue fromgainshare performance incentives was primarily the result of reduced volumes atour customers’ manufacturing facilities.

 

·**            **Net loss for the nine months ended September 30,2009 was $16.8 million, an increase of $113,000 compared to $16.7 million forthe nine months ended September 30, 2008. The increase in net loss wasprimarily attributable to a significant decrease in revenue, partially offsetby decreases in operating expenses as the result of our cost control effortsand the establishment of a valuation allowance against deferred tax assetsduring the three months ended September 30, 2008.

 

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·**           **Net loss per basic and diluted share was $0.64 for thenine months ended September 30, 2009 compared to $0.60 for the nine monthsended September 30, 2008, an increase in net loss of $0.04 per basic anddiluted share.

 

·**            **Cash, cash equivalents and investments decreased $7.6million to $33.9 million during the nine months ended September 30, 2009,primarily due to payments of $4.2 million for restructuring charges.

 

**Critical Accounting Policies**

 

Item 7of the Annual Report on Form 10-K for the year ended December 31,2008, includes a summary of the significant accounting policies and methodsused in the preparation of our condensed consolidated financial statements. Thefollowing is a brief discussion of the more significant accounting policies andmethods that we use.

 

***General***

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on our consolidated financial statements, which have been prepared inconformity with accounting principles generally accepted in the United Statesof America. Our preparation of these consolidated financial statements requiresus to make estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities at thedates of the financial statements and the reported amounts of revenues andexpenses during the reporting periods. We based our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances. The most significant estimates and assumptions relateto revenue recognition, software development costs, recoverability of goodwilland acquired intangible assets, estimated useful lives of acquired intangibles,the realization of deferred tax assets, and stock based compensation. Actualamounts may differ from such estimates under different assumptions orconditions.

 

***Revenue Recognition***

 

Wederive revenue from two sources: Design-to-Silicon-Yield Solutions, whichinclude Services and Software Licenses, and Gainshare Performance Incentives.

 

*Design-to-Silicon-Yield Solutions*— Revenue that is derived fromDesign-to-Silicon-Yield solutions comes from services and software licenses. Werecognize revenue for each element of Design-to-Silicon-Yield solutions asfollows:

 

*Services* — We generate a significant portion of ourDesign-to-Silicon-Yield solutions revenue from fixed-price solutionimplementation service contracts delivered over a specific period of time.These contracts require accurate estimation of cost to perform obligations andthe overall scope of each engagement. Revenue under contracts for solutionimplementation services is recognized as services are performed using thecost-to-cost percentage of completion method of contract accounting. Losses onsolution implementation contracts are recognized in the period when they becomeevident. Revisions in profit estimates are reflected in the period in which theconditions that require the revisions become known and can be estimated. If wedo not accurately estimate the resources required or the scope of work to beperformed, or do not manage the projects properly within the planned period oftime or satisfy our obligations under contracts, resulting contract marginscould be materially different than those anticipated when the contracts wereexecuted. Any such reductions in contract margin could have a material negativeimpact on our operating results.

 

Onoccasion, we have licensed our software products as a component of our fixedprice service contracts. In such instances, the software products are licensedto customers over a specified term of the agreement with support andmaintenance to be provided over the license term. Under these arrangements,where vendor-specific objective evidence of fair value (“VSOE”) exists for thesupport and maintenance element, the support and maintenance revenue isrecognized separately over the term of the supporting period. The remaining feeis recognized as services are performed using the cost-to-cost percentage ofcompletion method of contract accounting. VSOE for maintenance, in theseinstances, is generally established based upon a negotiated renewal rate. Underarrangements where software products are licensed as a component of itsfixed-price service contract and where VSOE does not exist to allocate aportion of the total fixed-price to the undelivered elements, revenue isrecognized for the total fixed-price as the lesser of either the percentage ofcompletion method of contract accounting or ratably over the longer of eitherthe term of the agreement or the supporting period. Costs incurred under thesearrangements are deferred and recognized in proportion to revenue recognizedunder these arrangements.

 

Revenuefrom related support and maintenance services is recognized ratably over theterm of the support and maintenance contract, generally one year, while revenuefrom consulting, installation, and training services is recognized as servicesare performed. When bundled with software licenses in multiple elementarrangements, support and maintenance, consulting (other than for our fixedprice solution implementations), installation, and training revenue isallocated to each element of a transaction 

 

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based upon itsfair value as determined by our VSOE. VSOE for maintenance is generallyestablished based upon negotiated renewal rates while VSOE for consulting,installation, and training is established based upon our customary pricing forsuch services when sold separately. When VSOE does not exist to allocate aportion of the total fee to the undelivered elements, revenue is recognizedratably over the longest service period of the undelivered elements.

 

*Software Licenses* — We also license our software productsseparately from our integrated solution implementations. For software licensearrangements that do not require significant modification or customization ofthe underlying software, software license revenue is recognized under theresidual method when (1) persuasive evidence of an arrangement exists, (2) deliveryhas occurred, (3) the fee is fixed or determinable, (4) collectabilityis probable, and (5) the arrangement does not require services that areessential to the functionality of the software. When arrangements includemultiple elements such as support and maintenance, consulting (other than forour fixed price solution implementations), installation, and training, revenueis allocated to each element of a transaction based upon its fair value asdetermined by our VSOE and such services are recorded as services revenue. VSOEfor maintenance is generally established based upon negotiated renewal rateswhile VSOE for consulting, installation, and training services is establishedbased upon our customary pricing for such services when sold separately. WhenVSOE does not exist to allocate a portion of the total fee to the undeliveredelements, revenue is recognized ratably over the longest period of theundelivered elements. Revenue for software licenses with extended payment termsis not recognized in excess of amounts due. For software license arrangementsthat require significant modification or customization of the underlyingsoftware, the software license revenue is recognized as services are performedusing the cost-to-cost percentage of completion method of contract accounting,and such revenue is recorded as services revenue.

 

*GainsharePerformance Incentives* — When we enter into a contract to provide yield improvementservices, the contract usually includes two components: (1) a fixed feefor performance by us of services delivered over a specific period of time; and(2) a gainshare performance incentives component where the customer maypay a variable fee, usually after the fixed fee period has ended. Revenuederived from gainshare performance incentives represents profit sharing andperformance incentives earned based upon our customers reaching certain definedoperational levels established in related solution implementation servicecontracts. Gainshare performance incentives periods are usually subsequent tothe delivery of all contractual services and therefore have no cost to us. Dueto the uncertainties surrounding attainment of such operational levels, werecognize gainshare performance incentives revenue (to the extent of completionof the related solution implementation contract) upon receipt of performancereports or other related information from our customers supporting thedetermination of amounts and probability of collection. Gainshare performanceincentives revenue is dependent on many factors which are outside our control,including among others, continued production of the related ICs by ourcustomers, sustained yield improvements by our customers, and our ability toenter into new Design-to-Silicon-Yield solutions contracts containingprovisions for gainshare performance incentives.

 

***Software Development Costs***

 

Costs for thedevelopment of new software products and substantial enhancements to existingsoftware products are expensed as incurred until technological feasibility hasbeen established, at which time any additional costs would be capitalized.Because we believe our current process for developing software is essentiallycompleted concurrently with the establishment of technological feasibility, nocosts have been capitalized to date.

 

***Goodwill and Acquired Intangible Assets***

 

As of September 30,2009 and December 31, 2008, the recorded value of our intangible assetswas $3.4 million and $4.7 million, respectively, and the recorded value ofgoodwill was zero. In assessing the valuation and recoverability of ourgoodwill and intangible assets, we must make assumptions regarding estimatedfuture cash flows to be derived from the acquired assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets, which would have a material adverse effecton our operating results. We evaluate goodwill for impairment annually and wehave selected December 31 as the date upon which to perform our annualtesting for goodwill impairment. During the fourth quarter of fiscal 2008, weobserved impairment indicators, relating to our long-lived assets, includingthe trading of our common stock below our book value and a furtherdeterioration in the semiconductor industry brought on by the deterioratingglobal economic environment which triggered the necessity of an impairment testfor our intangible and long lived assets as of December 31, 2008.  Weassessed the recoverability of our intangible and long-lived assets bycomparing the carrying value of those intangible and long lived assets to theundiscounted cash flows of each asset group. The analysis indicated that thecarrying value of certain assets exceeded the undiscounted cash flows. As such,we determined that certain acquired intangible assets were impaired. We measuredthe amount of impairment by calculating the amount by which the carrying valueof the intangible assets exceeded their estimated fair values, which were basedon projected discounted future net cash flows. As a result of this impairmentanalysis, we recorded an impairment charge of $6.3 million during the fourthquarter of 2008.  During the nine monthsended September 30, 2009, there were no indicators of impairment relatedto the Company’s intangible assets.

 

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We completed our annual impairment analysis ofgoodwill as of December 31, 2008. We determined the fair value of ourgoodwill by allocating the estimated fair value of our reporting unit to ourassets and liabilities, including the estimated fair value of our unrecordedintangible assets, on a fair value basis. After allocating its assets andliabilities on a fair value basis, we recorded an impairment of all of ourgoodwill of $64.0 million.

 

We are currentlyamortizing our acquired intangible assets over estimated useful lives of one toseven years, which are based on the estimated period of benefit to be derivedfrom such assets. However, a decrease in the estimated useful lives of suchassets would cause additional amortization expense or an impairment of suchassets in future periods.

 

***Income Taxes***

 

Realization ofdeferred tax assets is dependent on our ability to generate future taxableincome and utilize tax planning strategies. We have recorded a deferred taxasset in the amount that is more likely than not to be realized based oncurrent estimations and assumptions. We evaluate the valuation allowance on aquarterly basis. Any resulting changes to the valuation allowance will resultin an adjustment to income in the period the determination is made.

 

***Stock-Based Compensation***

 

Stock-basedcompensation cost is estimated at the grant date based on the award’sfair-value as calculated by the Black-Scholes-Merton (“BSM”) option-pricingmodel and is recognized as expense ratably over the requisite service period.The BSM model requires various highly judgmental assumptions includingvolatility, forfeiture rates, and expected option life. If any of theassumptions used in the BSM model change significantly, stock-basedcompensation expense may differ materially in the future from that recorded inthe current period.

 

**RecentAccounting Pronouncements and Accounting Changes**

 

See Note 2 of “Notesto Condensed Consolidated Financial Statements (Unaudited)” of this QuarterlyReport on Form 10-Q for a description of recent accounting pronouncementsand accounting changes, including the expected dates of adoption and estimatedeffects, if any, on our consolidated financial statements.

 

***Results of Operations***

 

The followingtable sets forth, for the periods indicated, the percentage of total revenuerepresented by the line items reflected in our condensed consolidatedstatements of operations:

 

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| ** **                                       | ** ** | **Three  Months********Ended September 30,** | ** ** | **Nine  Months********Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                        |       |                                              |       |                                             |       |   |   |   |   |
| Design-to-silicon-yield solutions                |       | 61                                                | %          | 71                                               | %          | 70 | % | 73 | % |
| Gainshare performance incentives                 |       | 39                                                |       | 29                                               |       | 30 |   | 27 |   |
| Total revenues                                   |       | 100                                               | %          | 100                                              | %          | 100 | % | 100 | % |
| Cost of design-to-silicon-yield solutions:       |       |                                              |       |                                             |       |   |   |   |   |
| Direct cost of design-to-silicon-yield solutions |       | 38                                                |       | 38                                               |       | 49 |   | 37 |   |
| Amortization of acquired technology              |       | 3                                                 |       | 3                                                |       | 3 |   | 3 |   |
| Total cost of design-to-silicon-yield solutions  |       | 41                                                |       | 41                                               |       | 52 |   | 40 |   |
| Gross margin                                     |       | 59                                                |       | 59                                               |       | 48 |   | 60 |   |
| Operating expenses:                              |       |                                              |       |                                             |       |   |   |   |   |
| Research and development                         |       | 34                                                |       | 42                                               |       | 46 |   | 43 |   |
| Selling, general and administrative              |       | 31                                                |       | 29                                               |       | 38 |   | 29 |   |
| Amortization of other acquired intangible assets |       | —                                            |       | 1                                                |       | 1 |   | 1 |   |
| Restructuring charges                            |       | 13                                                |       | —                                           |       | 11 |   | 2 |   |
| Total operating expenses                         |       | 78                                                |       | 72                                               |       | 96 |   | 75 |   |
| Loss from operations                             |       | (19                                               | )          | (13                                              | )          | (48 | ) | (15 | ) |
| Interest and other income (expense), net         |       | —                                            |       | (2                                               | )          | 1 |   | — |   |
| Loss before income taxes                         |       | (19                                               | )          | (15                                              | )          | (47 | ) | (15 | ) |
| Income tax provision                             |       | 1                                                 |       | 50                                               |       | 3 |   | 13 |   |
| Net loss                                         |       | (20                                               | )%         | (65                                              | )%         | (50 | )% | (28 | )% |

 

***Comparison of the Three Months Ended September 30, 2009and 2008***

 
| ** **                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **Revenue**                             | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Design-to-silicon-yield solutions       |       | $                                          | 8,439      |       | $          | 13,348     |       | $                    | (4,909     | )                                          | (37        | )% | 61 | % | 71 | % |
| Gainshare performance incentives        |       | 5,439                                      |       | 5,417      |       | 22         |       | —               | %          | 39                                         | %          | 29 | % |
| Total                                   |       | $                                          | 13,878     |       | $          | 18,765     |       | $                    | (4,887     | )                                          | (26        | )% | 100 | % | 100 | % |

 

*Design-to-Silicon-YieldSolutions*.Design-to-Silicon-Yield solutions revenue is derived from services (includingsolution implementations, software support and maintenance, consulting, andtraining) and software licenses, provided during our customer yield improvementengagements as well as during solution product sales.  Design-to-Silicon-Yieldsolutions revenue decreased $4.9 million for the three months ended September 30,2009 compared to the three months ended September 30, 2008, primarily dueto a decrease of $3.3 million in fixed fee integrated solutions and a decreaseof $1.7 million in software and software related services.  The decreases were primarily the result oflower bookings, as some of our customers have delayed purchases for capacityexpansion and investment in leading edge technology. The dramatic downturn inthe semiconductor industry combined with weakness in worldwide economies havebeen the primary contributors to this shortfall. Our Design-to-Silicon-YieldSolutions revenue may fluctuate in the future and is dependent on a number offactors including our ability to obtain new customers at emerging technologynodes.

 

*GainsharePerformance Incentives*. Gainshare performance incentives revenue represents profit sharingand performance incentives earned based upon our customers reaching certaindefined operational levels. Revenue derived from gainshare performanceincentives increased $22,000 for the three months ended September 30, 2009compared to the three months ended September 30, 2008. The revenue fromgainshare performance incentives was generated from six customers and sevenengagements for the three months ended September 30, 2009 and sixcustomers and eight engagements for the three months ended September 30,2008. Our gainshare performance incentives revenue may continue to fluctuatefrom period to period. Gainshare performance incentives revenue is dependent onmany factors that are outside our control, including among others, continuedproduction of ICs by our customers, sustained yield improvements by ourcustomers, and our ability to enter into new Design-to-Silicon-Yield solutionscontracts containing provisions for gainshare performance incentives.

 

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| ** **                                        | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Three  Months Ended September 30,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|--------------------------------------------|------------|
| **Cost of Design-to-Silicon-Yield**               | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                             | ** ** |
| **Solutions**                                     | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**     | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**           | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Direct costs of design-to-silicon-yield solutions |       | $                                          | 5,270      |       | $          | 7,152      |       | $              | (1,882     | )                                          | (26        | )% | 38 | % | 38 | % |
| Amortization of acquired technology               |       | 360                                        |       | 631        |       | (271       | )          | (43            | )%         | 3                                          | %          | 3 | % |
| Total                                             |       | $                                          | 5,630      |       | $          | 7,783      |       | $              | (2,153     | )                                          | (28        | )% | 41 | % | 41 | % |

 

*Costsof Design-to-Silicon-Yield Solutions*. Costs of Design-to-Silicon-Yield solutions consistof costs incurred to provide and support our services, costs recognized inconnection with licensing our software, and amortization of acquiredtechnology.

 

*DirectCosts of Design-to-Silicon-Yield Solutions. *Directcosts of Design-to-Silicon-Yield solutions consist of services costs andsoftware licenses costs. Services costs consist of material, labor, overheadcosts, and stock-based compensation charges associated with solutionimplementations. Costs include purchased materials, employee compensation andrelated benefits, travel and facilities-related costs. Software license costsconsist of costs associated with licensing third-party software sold inconjunction with our software products and expenses incurred to produce anddistribute our product documentation.**Directcosts of Design-to-Silicon-Yield solutions decreased $1.9 million for the threemonths ended September 30, 2009 compared to the three months ended September 30,2008, primarily due to a decrease of $892,000 in domestic personnel expenses, adecrease of $688,000 in the use of outside consultants, and a decrease of$290,000 in travel expenses, all as a result of our cost control efforts.  If we do not accurately estimate theresources required or the scope of work to be performed, or we do not managethe projects properly within the planned period of time or satisfy ourobligations under contracts, resulting contract margins could be materiallydifferent than those anticipated when the contracts were executed. Any suchreductions in contract margin could have a material negative impact on ouroperating results.

 

*Amortizationof Acquired Technology*. Amortization of acquired technology consists of amortization ofintangible assets acquired as a result of certain business combinations.Amortization of acquired technology expense decreased $271,000 for the threemonths ended September 30, 2009 compared to the three months ended September 30,2008, primarily due to decreased amortization as a result of the impairment ofacquired technology recorded in the fourth quarter of 2008. We anticipateamortization of acquired technology to be $360,000 for the remaining threemonths in 2009, $1.3 million in 2010, $626,000 in 2011, and $261,000 in 2012.

 
| ** **                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months********Ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|----------------------------------------------------|------------|
| ** **                              | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                               | ** ** |
| **Research and Development**            | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                        | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Research and development                |       | $                                          | 4,689      |       | $          | 7,835      |       | $                    | (3,146     | )                                                  | (40        | )% | 34 | % | 42 | % |
|                                         |            |                                            |            |            |            |            |            |                      |            |                                                    |            |  |  |  |  |  |

 

*Researchand Development.*Researchand development expenses consist primarily of personnel-related costs tosupport product development activities, including compensation and benefits,outside development services, travel and facilities cost allocations, andstock-based compensation charges. Research and development expenses decreased$3.1 million for the three months ended September 30, 2009 compared to thethree months ended September 30, 2008, primarily due to a decrease of $1.1million in domestic personnel expenses and a decrease of $1.1 million in expensesat European subsidiaries, both the results of our cost control efforts, and adecrease of $251,000 in support costs associated with third-party softwareapplications. We anticipate our expenses in research and development willfluctuate in absolute dollars from period to period as a result of cost controlinitiatives and the timing of when we hire personnel as a result of the sizeand the timing of product development projects.

 
| ** **                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| **Selling, General and**                | ** ** | **Three Months  Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **Administrative**                      | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Selling, general and administrative     |       | $                                          | 4,321      |       | $          | 5,401      |       | $                    | (1,080     | )                                          | (20        | )% | 31 | % | 29 | % |
|                                         |            |                                            |            |            |            |            |            |                      |            |                                            |            |  |  |  |  |  |

 

*Selling,General and Administrative*. Selling, general and administrative expenses consistprimarily of compensation and benefits for sales, marketing and general andadministrative personnel in addition to outside sales commissions, legal andaccounting services, marketing communications, travel and facilities costallocations, and stock-based compensation charges. Selling, general andadministrative expenses decreased $1.1 million for the three months ended September 30,2009 compared to the three months ended September 30, 2008, primarily dueto a decrease of $451,000 in legal fees and a decrease of $258,000 instock-based compensation expense.  Weanticipate our selling, general and administrative expenses will fluctuate inabsolute dollars from period to period as a result of cost control initiativesand to support increased selling efforts in the future.

 

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| ** **                                       | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| **Amortization of Other Acquired**               | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **Intangible Assets**                            | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Amortization of other acquired intangible assets |       | $                                          | 86         |       | $          | 194        |       | $                    | (108       | )                                          | (56        | )% | — | % | 1 | % |
|                                                  |            |                                            |            |            |            |            |            |                      |            |                                            |            |  |  |  |  |  |

 

*Amortizationof Other Acquired Intangible Assets*. Amortization of other acquired intangible assetsconsists of amortization of intangibles acquired as a result of certainbusiness combinations. Amortization of other acquired intangible assets for thethree months ended September 30, 2009 decreased $108,000 compared to thethree months ended September 30, 2008, primarily due to decreasedamortization as a result of the impairment of other acquired intangible assetsrecorded in the fourth quarter of fiscal 2008. We anticipate amortization ofother acquired intangible assets to be $86,000 in the remaining three months in2009, $293,000 in 2010, $204,000 in 2011, $174,000 in 2012, and $105,000 in2013 and thereafter.

 
| ** **                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **Restructuring Charges**               | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Restructuring charges                   |       | $                                          | 1,743      |       | $          | —     |       | $                    | 1,743      |                                       | N/A        |   | 13 | % | — | % |
|                                         |            |                                            |            |            |            |            |            |                      |            |                                            |            |  |  |  |  |  |

 

*RestructuringCharges.*  Restructuringcharges for the three months ended September 30, 2009 increased $1.7million compared to the three months ended September 30, 2008.  Restructuring charges for the three monthsended September 30, 2009 consisted primarily of employee severance costsresulting from our cost control efforts in light of current market conditions.

 
| ** **                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| **Interest and Other Income**            | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **(Expense), net**                       | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Interest and other income (expense), net |       | $                                          | 7          |       | $          | (343       | )          | $                    | 350        |                                       | (102       | )% | — | % | (2 | )% |
|                                          |            |                                            |            |            |            |            |            |                      |            |                                            |            |  |  |  |  |  |

 

*Interestand Other Income (Expense), net*. Interest and other income increased $350,000 for thethree months ended September 30, 2009 compared to interest and otherexpense of $343,000 for the three months ended September 30, 2008,primarily due to a gain of $393,000 on debt extinguishment associatedwith the forgiveness of a loan we assumed at the time of acquisition of SiAutomation S.A., anda loss of $445,000 on the sale of commercial paper from a bankrupt financialinstitution during the three months ended September 30, 2008, partiallyoffset by an increase of $214,000 in foreign currency exchange lossesassociated with intercompany payments to fund our foreign operations and adecrease of $117,000 in interest income from lower average cash, cashequivalent, and investments balances and lower interest rates.  We anticipate interest and other income willfluctuate in future periods as a result of our projected use of cash.

 
| ** **                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **Three  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                       | ** ** |
| **Income Tax Provision**                | ** ** | **2009**                                   | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                                | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Income tax provision                    |       | $                                          | 247        |       | $          | 9,433      |       | $                    | (9,186     | )                                          | (97        | )% | 1 | % | 50 | % |
|                                         |            |                                            |            |            |            |            |            |                      |            |                                            |            |  |  |  |  |  |

 

*IncomeTax Provision.*Incometax provision decreased $9.2 million for the three months ended September 30,2009 compared to the three months ended September 30, 2008, primarily dueto the establishment of a valuation allowance against deferred tax assetsduring the three months ended September 30, 2008.

 

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***Comparison of the Nine Months Ended September 30, 2009and 2008***

 
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **Nine  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                      | ** ** |
| **Revenue**                             | ** ** | **2009**                                  | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Design-to-silicon-yield solutions       |       | $                                         | 23,525     |       | $          | 43,824     |       | $                    | (20,299    | )                                         | (46        | )% | 70 | % | 73 | % |
| Gainshare performance incentives        |       | 10,126                                    |       | 16,402     |       | (6,276     | )          | (38                  | )%         | 30                                        | %          | 27 | % |
| Total                                   |       | $                                         | 33,651     |       | $          | 60,226     |       | $                    | (26,575    | )                                         | (44        | )% | 100 | % | 100 | % |

 

*Design-to-Silicon-YieldSolutions*.Design-to-Silicon-Yield solutions revenue decreased $20.3 million for the ninemonths ended September 30, 2009 compared to the nine months ended September 30,2008, primarily due to a decrease of $13.5 million in fixed fee integratedsolutions and a decrease of $6.6 million in software and software relatedservices. The decreases were primarily the result of lower bookings, as some ofour customers have delayed purchases for capacity expansion and investment inleading edge technology. The dramatic downturn in the semiconductor industrycombined with weakness in worldwide economies have been the primary contributorsto this shortfall.

 

*GainsharePerformance Incentives*. Revenue derived from gainshare performance incentives decreased $6.3million for the nine months ended September 30, 2009 compared to the ninemonths ended September 30, 2008, primarily due to decreases in wafervolumes at our customer sites. Revenue derived from gainshare performanceincentives was generated from six customers and eight engagements for the ninemonths ended September 30, 2009, and seven customers and elevenengagements for the nine months ended September 30, 2008.

 
| ** **                                        | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **Cost of Design-to-Silicon-Yield**               | ** ** | **Nine  Months********Ended  September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                  | ** ** |
| **Solutions**                                     | ** ** | **2009**                                          | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**           |       |                                              |       |       |       |       |       |       |       |                                      |       |   |   |
| Direct costs of design-to-silicon-yield solutions |       | $                                                 | 16,423     |       | $          | 22,185     |       | $          | (5,762     | )                                         | (26        | )% | 49 | % | 37 | % |
| Amortization of acquired technology               |       | 1,079                                             |       | 1,893      |       | (814       | )          | (43        | )%         | 3                                         | %          | 3 | % |
| Total                                             |       | $                                                 | 17,502     |       | $          | 24,078     |       | $          | (6,576     | )                                         | (27        | )% | 52 | % | 40 | % |

 

*Costsof Design-to-Silicon-Yield Solutions*.

 

*DirectCosts of Design-to-Silicon-Yield Solutions.*Direct costs of Design-to-Silicon-Yield solutionsdecreased $5.8 million for the nine months ended September 30, 2009compared to the nine months ended September 30, 2008, primarily due to adecrease of $2.1 million in domestic personnel expenses, a decrease of $1.2million in the use of outside consultants, and a decrease of $920,000 in travelexpenses, the results of our cost control efforts.

 

*Amortizationof Acquired Technology*. Amortization of acquired technology decreased $814,000 for the ninemonths ended September 30, 2009 compared to the nine months ended September 30,2008. The decrease in amortization of acquired technology was primarily due todecreased amortization as a result of the impairment of acquired technologyrecorded in the fourth quarter of 2008.

 
| ** **                              | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months********Ended  September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                          | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **Nine  Months********Ended  September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                          | ** ** |
| **Research and Development**            | ** ** | **2009**                                          | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                                       | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** |       |                                              |       |       |       |       |       |       |       |                                              |       |   |   |
| Research and development                |       | $                                                 | 15,547     |       | $          | 26,045     |       | $          | (10,498    | )                                                 | (40        | )% | 46 | % | 43 | % |
|                                         |            |                                                   |            |            |            |            |            |            |            |                                                   |            |  |  |  |  |  |

 

*Researchand Development.*Researchand development expenses decreased $10.5 million for the nine months ended September 30,2009 compared to the nine months ended September 30, 2008, primarily dueto a decrease of $4.3 million in domestic personnel expenses, decreases of $3.8million in expenses at our European subsidiaries, a decrease of $658,000 inmaintenance expense on third-party software applications, and a decrease of$388,000 in travel expenses, all as a result of our cost control efforts.

 

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| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **Selling, General and**                | ** ** | **Nine  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                  | ** ** |
| **Administrative**                      | ** ** | **2009**                                  | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** |       |                                      |       |       |       |       |       |       |       |                                      |       |   |   |
| Selling, general and administrative     |       | $                                         | 12,842     |       | $          | 17,346     |       | $          | (4,504     | )                                         | (26        | )% | 38 | % | 29 | % |
|                                         |            |                                           |            |            |            |            |            |            |            |                                           |            |  |  |  |  |  |

 

*Selling,General and Administrative*. Selling, general and administrative expensesdecreased $4.5 million for the nine months ended September 30, 2009compared to the nine months ended September 30, 2008, primarily due to adecrease of $1.3 million in domestic personnel expenses, a decrease of $933,000in legal fees, a decrease of $311,000 in the use of outside services, and adecrease of $245,000 in travel expenses, all as a result of our cost controlefforts.

 
| ** **                                       | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| **Amortization of Other Acquired**               | ** ** | **Nine  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                  | ** ** |
| **Intangible Assets**                            | ** ** | **2009**                                  | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**          | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Amortization of other acquired intangible assets |       | $                                         | 260        |       | $          | 583        |       | $          | (323       | )                                         | (55        | )% | 1 | % | 1 | % |
|                                                  |            |                                           |            |            |            |            |            |            |            |                                           |            |  |  |  |  |  |

 

*Amortizationof Other Acquired Intangible Assets*. Amortization of other acquired intangible assetsdecreased $323,000 for the nine months ended September 30, 2009 comparedto the nine months ended September 30, 2008, primarily due to decreasedamortization as a result of the impairment of other acquired intangible assetsrecorded in the fourth quarter of fiscal 2008.

 
| ** **                              | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months********Ended  September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                          | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **Nine  Months********Ended  September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                          | ** ** |
| **Restructuring Charges**               | ** ** | **2009**                                          | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                                       | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Restructuring charges                   |       | $                                                 | 3,578      |       | $          | 1,471      |       | $          | 2,107      |                                              | 143        | % | 11 | % | 2 | % |
|                                         |            |                                                   |            |            |            |            |            |            |            |                                                   |            |  |  |  |  |  |

 

*RestructuringCharges*.Restructuring charges increased $2.1 million for the nine months ended September 30,2009 compared to the nine months ended September 30, 2008.  Restructuring charges for the nine monthsended September 30, 2009 and 2008 consisted primarily of employeeseverance costs and were the result of our cost control efforts implemented inlight of current market conditions.

 
| ** **                              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **Nine  Months Ended September 30** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                  | ** ** |
| **Interest and Other Income, net**      | ** ** | **2009**                                 | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Interest and other income, net          |       | $                                        | 121        |       | $          | 397        |       | $          | (276       | )                                         | (70        | )% | 1 | % | — | % |
|                                         |            |                                          |            |            |            |            |            |            |            |                                           |            |  |  |  |  |  |

 

*Interestand Other Income, net*. Interest and other income decreased $276,000 for the nine monthsended September 30, 2009 compared to the nine months ended September 30,2008, primarily due to a decrease of $581,000 in interest income from loweraverage cash, cash equivalent, and investments balances and lower interestrates and an increase of $432,000 in foreign currency exchange lossesassociated with inter-company payments to fund our foreign operations,partially offset by a gain of $393,000 on debt extinguishment associatedwith the forgiveness of a loan we assumed at the time of acquisition of SiAutomation S.A., anda loss of $445,000 on the sale of commercial paper from a bankrupt financialinstitution during the three months ended September 30, 2008.

 
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **Nine  Months Ended September 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                                  | ** ** |
| **Income Tax Provision**                | ** ** | **2009**                                  | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                               | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Income tax provision                    |       | $                                         | 833        |       | $          | 7,777      |       | $          | (6,944     | )                                         | (89        | )% | 3 | % | 13 | % |
|                                         |            |                                           |            |            |            |            |            |            |            |                                           |            |  |  |  |  |  |

 

*IncomeTax Provision.*Incometax provision decreased $6.9 million for the nine months ended September 30,2009 as compared to the nine months ended September 30, 2008, primarilydue to the establishment of a valuation allowance against deferred tax assetsduring the nine months ended September 30, 2008.

 

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**Liquidityand Capital Resources**

** **

***Operating Activities***

 

Cash flows fromoperating activities consist of net loss adjusted for certain non-cash itemsand changes in assets and liabilities. Net cash used in operating activitieswas $6.7 million for the nine months ended September 30, 2009, an increaseof $9.9 million compared to net cash provided by operating activities of $3.1million for the nine months ended September 30, 2008, primarily due to ahigher net loss after adjusting non-cash items, decreases in accruedcompensation and related benefits, partially offset by decreases in accountsreceivable and prepaid expenses and other assets, and an increase in accountspayable. Deferred taxes and other assets decreased $8.6 million for the ninemonths ended September 30, 2009 compared to the nine months ended September 30,2008 primarily due to the establishment of a valuation allowance for ourdeferred tax assets during the three months ended September 30, 2008.Stock-based compensation decreased $1.9 million primarily due to a reduction inheadcount.

 

Accruedcompensation decreased $2.1 million during the nine months ended September 30,2009 compared to a decrease of $28,000 during the nine months ended September 30,2008. The decrease in accrued compensation during the nine months ended September 30,2009 was primarily due to the increased usage of accrued vacation as a resultof Company work furloughs.  Accountsreceivable decreased $6.7 million during the nine months ended September 30,2009 compared to a decrease of $5.2 million during the nine months ended September 30,2008. The decrease in accounts receivable during the nine months ended September 30,2009 and 2008 was primarily due to decreased revenue and the timing of billingmilestones and payments received. Prepaid expenses and other assets decreased $2.0 million during the ninemonths ended September 30, 2009 compared to a decrease of $189,000 duringthe nine months ended September 30, 2008. The decrease in prepaid expensesand other assets during the nine months ended September 30, 2009 wasprimarily due to the collection of income tax refunds. Accounts payableincreased $47,000 during the nine months ended September 30, 2009 comparedto a decrease of $1.6 million during the nine months ended September 30,2008. The decrease in accounts payable during the nine months ended September 30,2008 was primarily due to the timing of vendor payments and lower purchasingactivity.

 

***Investing Activities***

 

Cash flows frominvesting activities consist of proceeds from investment maturities and sales,offset by payments for investments acquired and payments for capitalexpenditures. Net cash provided by investing activities was $8.8 million forthe nine months ended September 30, 2009, an increase of $16.2 millioncompared to net cash used in investing activities of $7.4 million for the ninemonths ended September 30, 2008. The increase was primarily due to theabsence of purchases of investments during the nine months ended September 30,2009 while we purchased $27.1 million of investments during the nine monthsended September 30, 2008. The increase was partially offset by a decreaseof $11.6 million in proceeds from investment maturities and sales. As of September 30,2009, we had no investments in derivative securities.

 

***Financing Activities***

 

Cash flows fromfinancing activities consist primarily of proceeds from sales of shares throughemployee equity incentive plans, offset by payments for the purchase oftreasury stock, and principal payments on long-term obligations. Net cashprovided by financing activities was $203,000 for the nine months ended September 30,2009, an increase of $3.0 million compared to net cash used in financing activities of$2.8 million for the nine months ended September 30, 2008. During the ninemonths ended September 30, 2009, we repurchased 73,000 shares of commonstock for $133,000 whereas we repurchased 562,000 shares of common stock for$3.1 million during the nine months ended September 30, 2008.

 

***Liquidity***

 

As of September 30,2009, our working capital was $44.2 million, compared with $56.3 million as of December 31,2008. Cash and cash equivalents were $33.2 million as of September 30,2009 compared to $40.7 million as of December 31, 2008, a decrease of $7.6million. The decrease in cash, cash equivalents, and short-term investments wasprimarily attributable to the payments of $4.2 million in accrued restructuringduring the nine months ended September 30, 2009. We anticipate that ouroverall expenses, as well as planned capital expenditures, may constitute amaterial use of our cash resources. In addition, we may use cash resources torepurchase common stock, fund potential investments in, or acquisitions ofcomplementary products, technologies or businesses. We believe that ourexisting cash resources and anticipated funds from operations will satisfy ourcash requirements to fund our operating activities, capital expenditures andother obligations for at least the next twelve months. However, in the eventthat during such period, or thereafter, we are not successful in generatingsufficient cash flows from operations we may need to raise additional capitalthrough private or public financings, strategic relationships or otherarrangements, which may not be available to us on acceptable terms or at all.

 

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As of September 30,2009, our non-current investments included auction-rate securities with a fairvalue of $718,000. See Note 12 to “Notes to Condensed Consolidated FinancialStatements (Unaudited)” in Part I, and Item 3. “Quantitative and QualitativeDisclosures About Market Risk” in this Quarterly Report on Form 10-Q forfurther discussion.

 

We do not have anyoff-balance sheet arrangements, investments in special purpose entities orundisclosed borrowings or debt, other than operating leases on our facilities.As of September 30, 2009, other than Euro and Japanese Yen denominatedreceivables, we had no foreign currency contracts outstanding.

 

The followingtable summarizes our known contractual obligations (in thousands):

 
| ** **                    | ** ** | **Payments  due by period**                     | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|
| **Contractual obligations**   | ** ** | **2009********(three months********remaining)** | ** ** | **2010-2011** | ** ** | **2012-2013** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Debt principal (1)            |       | $                                               | 29         |   | $ | 236 |   | $ | — |   | $ | — |   | $ | 265 |   |
| Debt interest                 |       | 3                                               |       | 11 |   | — |   | — |   | 14 |   |
| Operating lease obligations   |       | 763                                             |       | 5,697 |   | 3,993 |   | — |   | 10,453 |   |
| Unrecognized tax benefits (2) |       | —                                          |       | — |   | — |   | 3,506 |   | 3,506 |   |
| Total                         |       | $                                               | 795        |   | $ | 5,944 |   | $ | 3,993 |   | $ | 3,506 |   | $ | 14,238 |   |

 

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(1)       Amount represents the repayment of a €400,000 Eurosloan with a variable interest rate based on the EURIBOR plus 160 basis points.

 

(2)       Due to the inherent uncertainty of the tax positions,it is not practicable to assign this liability to any particular years in thetable.

 

Operating leaseamounts include minimum rental payments under our operating leases for ouroffice facilities, as well as computers, office equipment, and vehicles that weutilize under lease agreements. These minimum rental payments include paymentson those facilities abandoned as part of the restructuring activities. Theseagreements expire at various dates through 2013.

 

**Item3. Quantitative and Qualitative Disclosures About Market Risk.**

 

The followingdiscusses our exposure to market risk related to changes in interest rates andforeign currency exchange rates. We do not currently own any equityinvestments, nor do we expect to own any in the foreseeable future. Thisdiscussion contains forward-looking statements that are subject to risks anduncertainties. Actual results could vary materially as a result of a number offactors.

 

*InterestRate Risk*. As of September 30,2009, we had cash and cash equivalents of $33.2 million. Cash and cashequivalents consisted of cash and highly liquid money market instruments. Wehad no exposure to interest rate risk as of September 30, 2009 as ourshort-term investment portfolio consisted entirely of money market instruments.Declines in interest rates over time will result in decreased interest income.

 

As of September 30,2009, we held auction-rate securities (“ARS”) with a par value of $1.0 million.ARS are variable rate debt instruments whose interest rates are reset through a“dutch” auction process at regular intervals, typically every 28 days. Aportion of these securities are insured by third party bond insurers and arecollateralized by student loans guaranteed by governmental agencies and privateentities. The liquidity of the securities has been negatively impacted by theuncertainty in the credit markets and the exposure of these securities to thefinancial condition of bond insurance companies. All of our ARS have failed tosell at auction since February 2008 due to an insufficient number ofbidders. The only activity associated with these instruments since February 2008was the repurchase of $500,000 of ARS at par by issuers. We do not believe thatthe student loans backing these securities, the principal of these assets, isat risk. Furthermore, we intend to hold these securities until the creditmarkets recover and these securities resume pricing at or near par and it is notmore likely than not that we will be required to sell the securities beforerecovery of the principal. We reviewed the value of these securities for impairment as of September 30,2009, and concluded that these securities continued to be temporarily impaired.During the year ended December 31, 2008, there was an unrealized loss of$282,000 recorded as a component of accumulated other comprehensive incomerelated to these auction-rate securities. There was no additional impairmentrecorded during the nine months ended September 30, 2009. In futureperiods, the estimated fair value of our ARS could decline further based onmarket conditions, which could result in additional impairment.

 

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*ForeignCurrency and Exchange Risk.*Certain of our sales contracts are denominated in acurrency other than the functional currency of the selling entity. Therefore, aportion of our revenue is subject to foreign currency risks. The effect of animmediate 10% adverse change in exchange rates on foreign currency denominatedreceivables as of September 30, 2009 would result in a loss of animmaterial amount. As of September 30, 2009, we did not have outstandinghedging contracts, although we may enter into such contracts in the future. Weintend to monitor our foreign currency exposure. Future exchange ratefluctuations may have a material negative impact on our business.

 

**Item4. Controls and Procedures.**

 

*Evaluationof Disclosure Controls and Procedures*. Our management, with the participation of ourprincipal executive officer and our principal financial officer, has evaluatedthe effectiveness of our “disclosure controls and procedures” (as such itemsare defined in Rules 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934, as amended (“the Exchange Act”)), as of the end of theperiod covered by this Quarterly Report on Form 10-Q.  Based on that evaluation, our principalexecutive officer and our principal financial officer have concluded that, asof the end of the period covered by this Quarterly Report on Form 10-Q,our disclosure controls and procedures are effective and designed to ensurethat information required to be disclosed by us in the reports we file orsubmit under the Exchange Act is (1) recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms, and (2) is accumulated and communicatedto our management, including our principal executive officer and principalfinancial officer, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

 

*Changesin Internal Controls Over Financial Reporting*. There was no change in our internal control overfinancial reporting identified in connection with the evaluation required byparagraph (d) of Rule 13a-15 or Rule 15d-15 under the ExchangeAct that occurred during the period covered by this Quarterly Report on Form 10-Qthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II— OTHER INFORMATION**

 

**Item1. Legal Proceedings.**

 

From time to time, we are subject to various legalproceedings and claims that arise in the ordinary course of business. If aclaim arises, the Company records a contingent liability when the probableoutcome of a claim against the Company can be reasonably assessed. Inmanagement’s opinion, the probable outcome of any current claim against theCompany cannot be reasonably estimated. Also, in management’s opinion, theultimate resolution of these claims will not materially impact our financialstatements.

 

**Item1A. Risk Factors.**

 

***The semiconductor market is volatile and unpredictable,which limits our ability to forecast our business and could negatively impactour results of operations.***

 

The semiconductorindustry experienced significant challenges in 2008 and 2009 as a result of thedecline in the macroeconomic environment. As a provider to global semiconductorcompanies, we are subject to business cycles, the timing, length and volatilityof which can be difficult to predict. The semiconductor industry historicallyhas been cyclical due to sudden changes in customers’ manufacturing capacityrequirements and spending, which depend in part on capacity utilization, demandfor customers’ integrated circuit (“IC”) products, inventory levels relative todemand, and access to affordable capital. These changes have affected thetiming and amounts of customers’ purchases and investments in ourDesign-to-Silicon-Yield solutions, and continue to affect our sales, operatingexpenses and net income. If we are not able to make adjustments to our businessquickly to appropriately align our cost structure with prevailing marketconditions in periods of low demand, or if we do not have sufficient resourcesto meet customers’ demands in periods of high demand, results could benegatively impacted and could differ greatly from our expectations.

 

***Our business is subject to risksassociated with the ongoing financial crisis and weakening global economy.***

 

The severetightening of the credit markets, turmoil in the financial markets, andweakening global economy starting in 2008 and continuing in 2009 to date,contributed to slowdowns in the semiconductor industry, which impacts ourability to make sales.  The markets forsemiconductors depend largely on consumer spending. Economic uncertaintyexacerbates negative trends in consumer spending and may cause some of ourcustomers to delay or refrain altogether from entering into new engagements,licensing new or 

 

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additional software products, or renewingmaintenance and support for existing licensed software at historicallevels.  This will negatively affect ourrevenues. Difficulties in obtaining capital and deteriorating market conditionsmay also lead to the inability of some customers to obtain affordable financingfor other purchases, which could tie up funds otherwise budgeted for purchasesof our solutions and technologies. Customers with liquidity issues may alsolead to additional bad debt expense. Further, these conditions and uncertaintyabout future economic conditions make it challenging for us to forecast ouroperating results, make business decisions, and identify the risks that mayaffect our business, financial condition and results of operations. If we arenot able to timely and appropriately adapt to changes resulting from thedifficult macroeconomic environment, our business, financial condition, andresults of operations may be significantly negatively affected.

 

***If semiconductor designers and manufacturers do not continueto adopt, or they significantly delay adoption of, our******Design-to-Silicon-Yield solutions, our******revenue will suffer.***

 

If semiconductordesigners and manufacturers do not continue to adopt ourDesign-to-Silicon-Yield solutions, both as currently comprised and as we mayoffer them in the future, our revenue will decline. We may not be successful ifwe do not continue to enter into agreements with existing customers and newcustomers that cover a larger number of IC products and processes. If we do notdevelop new customer relationships with companies that are integrated devicemanufacturers (“IDMs”), fabless semiconductor companies, and foundries, as wellas system manufacturers, the market acceptance of our solutions will suffer.Factors that may limit adoption of our Design-to-Silicon-Yield solutions bysemiconductor companies include:

 

·             our existing and potential customers’ delay in theiradoption of the next process technology;

 

·             IDMs of logic ICs discontinuing or significantlycutting back their investment in the development of new process technology as aresult of a shift to a model of outsourcing a larger proportion, or all, of themass production of their ICs;

 

·             our inability to keep pace with the rapidly evolvingtechnologies and equipment used in the semiconductor design and manufacturingprocesses;

 

·             our customers’ failure to achieve satisfactory yieldimprovements using our Design-to-Silicon-Yield solutions; and

 

·             our inability to develop, market, or sell effectivesolutions that are outside of our traditional logic focus of manufacturingprocess solutions.

 

***Revenue from our gainshare performance incentives isdependent on factors outside of******ourcontrol, including the volume of ICs that our customers are able******to sell to theircustomers.***

 

Our gainshareperformance incentives fee component ties the profits of our customers to ourown. Through this component, revenue for a particular product is largelydetermined by the volume of that product that our customer is able to sell toits customers, which is outside of our control. Decreased demand forsemiconductor products decreases the volume of products our customers are ableto sell, which directly decreases our gainshare performance incentives revenue.Important factors that could cause demand for semiconductor products to negativelyfluctuate include:

 

·             changes in business and economic conditions, includingthe current downturn in the semiconductor industry and the overall economy; and

 

·             decreases in consumer confidence caused by changes inmarket conditions, including changes in the credit market.

 

Also, our customers mayunilaterally decide to implement changes to their manufacturing processesduring the period that is covered by gainshare performance incentives, whichcould negatively affect yield results. Since we currently work on a smallnumber of large projects, any product that does not achieve commercialviability or a significant increase in yield, or sustain significant volumemanufacturing during the time we receive gainshare performance incentives,revenue from such customers could significantly reduce our revenue and resultsof operations below expectations. In addition, if we work with two directlycompetitive products, volume in one may offset volume, and thus any of ourrelated gainshare performance incentives, in the other product.

 

***We may not be able to effectively implement ourrestructuring plans, and our restructuring plans may not result in the expectedbenefits on our planned schedule, or at all, which could negatively impact ourfuture results of operations.***

 

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During the yearend December 31, 2008 and through the filing of this Quarterly Report, wehave implemented restructuring plans in an effort to align our cost structurewith expected revenue. We may not be able to successfully complete and realizethe expected benefits of our restructuring plans, such as improvements inoperating margins and cash flows, in the restructuring periods contemplated orat all. The restructuring plans may involve higher costs or a longer timetablethan we currently anticipate, mainly due to the timing and execution of someplans and programs subject to local labor law requirements, and consultationwith appropriate work councils. Our inability to realize these benefits mayresult in an inefficient business structure that could negatively impact ourresults of operations. We also expect our restructuring plans to cause us toincur substantial costs related to severance and other employee-related costs.Our restructuring plans may also subject us to litigation risks and expenses.In addition, our restructuring plans may have other consequences, such asattrition beyond our planned reduction in workforce or a negative impact onemployee morale, and our competitors may seek to gain a competitive advantageover us. The restructuring plans could also cause our remaining employees to beless productive, which in turn may negatively affect our revenue and otheroperating results in the future.

 

***We generate a large percentage of our total revenue from alimited number of******customers, sodecreased volumes at any one of these customers, or the loss of any one ofthese customers could significantly reduce our******revenue and results of operationsbelow expectations.***

 

Historically, wehave had a small number of large customers for our core Design-to-Silicon-Yieldsolutions and we expect this to continue in the near term. In the nine monthsended September 30, 2009, three customers accounted for 47% of our totalnet revenue, with IBM representing 22%, Toshiba Corporation representing 15%,and Chartered Semiconductor Manufacturing representing 10%. In the nine monthsended September 30, 2008, two customers accounted for 35% of our total netrevenue, with Toshiba Corporation representing 19% and IBM representing 16%. Wecould lose a customer due to its decision not to engage us on future processnodes, its decision not to develop its own future process node, or as a resultof industry consolidation. The loss of any of these customers or a decrease inthe sales volumes of their products could significantly reduce our totalrevenue below expectations. In particular, such a loss could cause significantfluctuations in results of operations because our expenses are fixed in theshort term and it takes us a long time to replace customers.

 

***If we do not effectively manage and support our operationsand integrate recent and******plannedgrowth, our business strategy may fail.***

 

We haveexperienced in the past, and may experience in the future, interruptions in ourinformation systems on which our global operations depend. Further, physicaldamage to, failure of, or digital damage (such as significant viruses or worms)to, our information systems could disrupt and delay time-sensitive services orcomputing operations that we perform for our customers, which could negativelyimpact our business results and reputation. In addition, we must frequentlyexpand our internal information system to meet increasing demand in storage,computing and communication. Our internal information system is expensive toexpand and must be highly secure due to the sensitive nature of our customers’information that we transmit. Building and managing the support necessary forour growth places significant demands on our management and resources. Thesedemands may divert these resources from the continued growth of our businessand implementation of our business strategy. Further, we must adequately trainour new personnel, especially our client service and technical supportpersonnel, to effectively and accurately, respond to and support our customers.If we fail to do this, it could lead to dissatisfaction among our customers,which could slow our growth.

 

***Our stock price may be volatile, and our common stock coulddecline in value, increasing potential dilution to our stockholders, or we maybe delisted from the NASDAQ Global Market.***

 

Our stock pricehas fluctuated widely during the last few years, from a low closing price of$0.97 per share during March 2009 to a high closing price of $19.36 pershare during April 2006. This significant reduction in our stock pricenegatively impacts our ability to raise equity capital in the public marketsand increases the cost to us, as measured by dilution to our existingshareholders, of equity financing. In addition, the reduced stock price alsoincreases the cost to us, in terms of dilution, of using our equity foremployee compensation or for acquisitions of other businesses. Additionally, inorder for our common stock to continue to be quoted on the NASDAQ Global Market(“NASDAQ”), we must satisfy various listing maintenance standards establishedby NASDAQ, including, among other things, the general requirement that ourstock price consistently trades at or above $1.00 per share and that the totalmarket value of our common stock exceed $50,000,000. We have had in the past,and may have again in the future, periods when our stock does not trade at, orthe market value of our common stock has been below, the levels required byNASDAQ rules. If we were to be delisted from the NASDAQ and move to analternative market, which may be less efficient and less broad-based, we mayhave difficulty accessing capital markets for additional funding, and theability of our stockholders to sell any of our common stock at all would beseverely, if not completely, limited, which could cause our stock price todecline further. Delisting could also have other negative results, includingthe potential loss of confidence by employees, the loss of institutionalinvestor interest, and fewer business development opportunities.  Also, significant volatility in the stockprice could be followed by a securities class action lawsuit, which couldresult in substantial costs and a diversion of our management’s attention andresources.

 

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***If we fail to protect our intellectual property (“IP”)rights, customers or potential******competitorsmay be able to use our technologies to develop their own solutions which******could weaken ourcompetitive position, reduce our revenue, or increase our costs.***

 

Our successdepends largely on the proprietary nature of our technologies. We currentlyrely primarily on contractual, patent, copyright, trademark, and trade secretprotection. Our pending patent applications may not result in issued patents,and even if issued, they may not be sufficiently broad to protect ourproprietary technologies. Litigation may be necessary from time to time toenforce our IP rights or to determine the validity and scope of the proprietaryrights of others. As a result of any such litigation, we could lose ourproprietary rights and incur substantial unexpected operating costs. Litigationcould also divert our resources, including our managerial and engineeringresources.

 

***Competition in the market for yield improvement solutionsand increased integration******betweenIC design and manufacturing may intensify in the future, which could impede******our ability to grow orexecute our strategy.***

 

Competition in ourmarket may intensify in the future, which could slow our ability to grow orexecute our strategy and could lead to increased pricing pressure. Our currentand potential customers may choose to develop their own solutions internally,particularly if we are slow in deploying our solutions or improving them tomeet market needs. Many of these companies have the financial and technicalcapability to develop their own solutions. Also, competitors may be able tooperate with a lower cost structure than our engineering organization, whichwould give any such competitor’s products a competitive advantage over oursolutions. There may be other providers of commercial solutions for systematicIC yield and performance enhancement of which we are not aware. We currentlyface indirect competition from the internal groups at IC companies and somedirect competition from providers of yield management or prediction softwaresuch as KLA-Tencor, MKS Instruments, Inc. (“MKS”) (through its acquisitionof Yield Dynamics, Inc.), Mentor Graphics (through its acquisition ofPonte Solutions), TIBCO Software Inc. (through its acquisition of SpotfireInc.), and Synopsys, Inc., and process control software, such as AppliedMaterials, Inc., BISTel Inc., and Trancom Technology, Inc., and MKS.Further, ARM Ltd. and Virage Logic Corporation provide standard cells in thephysical IP space and Tela provides software for standard cell synthesis, eachof which could compete with our pdBRIX solution. Some providers of yieldmanagement software or inspection equipment may seek to broaden their productofferings and compete with us. For example, KLA-Tencor has announced adding theuse of test structures to one of their inspection product lines. In addition,we believe that the demand for solutions that address the need for betterintegration between the silicon design and manufacturing processes mayencourage direct competitors to enter into our market. For example, largeintegrated organizations, such as IDMs, electronic design automation softwareproviders, IC design service companies or semiconductor equipment vendors, maydecide to spin-off a business unit that competes with us. Other potentialcompetitors include fabrication facilities that may decide to offer solutionscompetitive with ours as part of their value proposition to their customers. Inaddition, Synopsys, Inc. now appears to offer directly competingdesign-for-manufacturability (“DFM”), while other electronic design automationsuppliers provide alternative DFM solutions that may compete for the samebudgetary funds. If these potential competitors change the pricing environmentor are able to attract industry partners or customers faster than we can, wemay not be able to grow and execute our strategy as quickly or at all. Inaddition, customer preferences may shift away from our solutions as a result ofthe increase in competition.

 

***We face operational and financial risks associated withinternational operations that******couldnegatively impact our revenue.***

 

We have in thepast expanded our non-U.S. operations and may in the future continue suchexpansion by establishing overseas subsidiaries, offices, or contractor relationshipsin locations, if and when, deemed appropriate by our management. Thus, thesuccess of our business is subject to risks inherent in doing businessinternationally, including in particular:

 

·             some of our key engineers and other personnel areforeign nationals and they may have difficulty gaining access to the UnitedStates and other countries in which our customers or our offices may be locatedand it may be difficult for us to recruit and retain qualified technical andmanagerial employees in foreign offices;

 

·             greater difficulty in collecting account receivablesresulting in longer collection periods;

 

·             language and other cultural differences may inhibitour sales and marketing efforts and create internal communication problemsamong our U.S. and foreign research and development teams, increasing thedifficulty of managing multiple, remote locations performing variousdevelopment, quality assurance, and yield ramp analysis projects;

 

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·             compliance with, inconsistencies among, and unexpectedchanges in, a wide variety of foreign laws and regulatory environments withwhich we are not familiar, including, among other issues, with respect toemployees, protection of our IP, and a wide variety of operational regulationsand trade and export controls under domestic, foreign, and international law;

 

·             currency risk due to the fact that expenses for ourinternational offices are denominated in the local currency, including theEuro, while virtually all of our revenue is denominated in U.S. dollars;

 

·             quarantine, private travel limitation, or businessdisruption in regions affecting our operations, stemming from actual, imminentor perceived outbreak of human pandemic or contagious disease;

 

·             in the event a larger portion of our revenue becomesdenominated in foreign currencies, we would be subject to a potentiallysignificant exchange rate risk; and

 

·             economic or political instability, including but notlimited to armed conflict, terrorism, interference with information orcommunication of networks or systems, and the resulting disruption to economic activity and businessoperations.

 

Revenues generatedfrom customers in Asia accounted for 62% of total revenue in the nine monthsended September 30, 2009 and 55% for the nine months ended September 30,2008. Thus, in Asia, in particular, we face the following additional risks:

 

·             a downturn in Asian economies which could limit ourability to retain existing customers and attract new ones in Asia; and

 

·             if the U.S. dollar increases in value relative tolocal currencies, including for example, the Japanese Yen, the cost of our solutionswill be more expensive to existing and potential local customers and thereforeless competitive.

 

In the MiddleEast, we use a third-party service provider, whose headquarters are not locatedin a U.S. embargoed country, to provide software quality assurance andother services for certain of our software products. The political uncertaintysurrounding the region could disrupt our third-party service provider’soperations and thus negatively affect the range of services we are able toprovide or our cost for such services.

 

***Our earnings per share and other key operating results maybe unusually high in a******givenquarter, thereby raising investors’ expectations, and then unusually low in the******next quarter, therebydisappointing investors, which could cause our stock price to******drop.***

 

Historically, ourquarterly operating results have fluctuated. Our future quarterly operatingresults will likely fluctuate from time to time and may not meet theexpectations of securities analysts and investors in some future period. Theprice of our common stock has declined significantly in the recent past and maycontinue to decline if we fail to meet expectations about our revenue orexpenses.

 

***Measurement of our gainshare performance incentives requiresdata collection and is******subjectto customer agreement, which can result in uncertainty and cause quarterly******results to fluctuate.***

 

We can onlyrecognize revenue based on gainshare performance incentives once we havereached agreement with our customers on their level of yield performanceimprovements. Because measuring the amount of yield improvement is inherentlycomplicated and dependent on our customers’ internal information systems, theremay be uncertainty as to some components of measurement. This could result inour recognition of less revenue than expected. In addition, any delay inmeasuring revenue attributable to our gainshare performance incentives couldcause all of the associated revenue to be delayed until the next quarter. Sincewe currently have only a few large customers and we are relying on gainshareperformance incentives as a significant component of our total revenue, anydelay could significantly harm our quarterly results.

 

***Changes in the structure of our customer contracts,including the mix between fixed******andvariable revenue and the mix of elements, including perpetual and term-basedlicenses, can adversely affect the amount and******timing of our total revenue.***

 

Our long-termsuccess is largely dependent upon our ability to structure our future customercontracts to include a larger gainshare performance incentives componentrelative to the fixed fee component. We typically recognize the fixed feecomponent earlier than the gainshare performance incentives component so if weare successful in increasing the gainshare performance incentives component ofour customer contracts, we will experience an adverse impact on our operatingresults in the short term as we reduce the fixed fee component. Due toacquisitions and expanded business strategies, the mix of elements in some ofour contracts has changed recently and the relative importance of the softwarecomponent in some of our contracts has increased. We have experienced, and mayin the future experience, delays in the expected recognition of revenueassociated with generally accepted accounting principles

 

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regarding the timing ofrevenue recognition in multi-element software arrangements, including theeffect of acceptance criteria as a result of the change in our contracts. If wefail to meet contractual acceptance criteria on time or at all, the totalrevenue we receive under a contract could be delayed or decline. Further, if wemix term-based licenses with perpetual licenses, it will impact the timing ofthe recognition of revenue from that customer. In addition, by increasing thegainshare performance incentives or the software component, we may increase thevariability or timing of recognition of our revenue, and therefore increase therisk that our total future revenue will be lower than expected and fluctuatesignificantly from period to period.

 

***It typically takes us a long time to sell our uniquesolutions to new customers and******into new market******s, andthat can result in uncertainty and delays in generating revenue.***

 

Our gainshareperformance incentives business model is unique and our Design-to-Silicon-Yieldsolutions are often unfamiliar to new customers. This results in a lengthiersales cycle compared to some of our competitors and requires a significantamount of our senior management’s time and effort. Furthermore, we need totarget those individuals within a customer’s organization who have overallresponsibility for the profitability of an IC. These individuals tend to besenior management or executive officers. We may face difficulty identifying andestablishing contact with such individuals. Even after initial acceptance, dueto the complexity of structuring the gainshare performance incentivescomponent, the negotiation and documentation processes can be lengthy. It cantake nine months or more to reach a signed contract with a customer. Unexpecteddelays in our sales cycle could cause our revenue to fall short ofexpectations. By way of example, one of the industries that we have recentlytargeted that we believe would greatly benefit from our yield management systemand FDC technology is the rapidly growing solar panel industry. Our efforts toleverage our products in this industry may not be successful. Further, ongoingnegotiations and evaluation projects with photovoltaic manufacturers may notresult in significant revenue for us if we are unable to close new engagementsin these markets on terms favorable to us, in a timely manner, or at all, or ifwe are unable to successfully deliver our products and services to suchmarkets.

 

***We have a history of losses, we may incur losses in thefuture and we may be unable******toreach, or thereafter maintain, profitability.***

 

We haveexperienced losses in the nine months ended September 30, 2009, the yearended December 31, 2008, and in the past. We may not achieve, andthereafter maintain, profitability if our revenue increases more slowly than weexpect or if it decreases. In addition, virtually all of our operating expensesare fixed in the short term, so any shortfall in anticipated revenue in a givenperiod could significantly reduce our operating results below expectations. Ouraccumulated deficit was $129.4 million as of September 30, 2009. Weexpect to continue to incur significant expenses in connection with:

 

·             funding for research and development;

 

·             expansion of our solution implementation teams;

 

·             expansion of our sales and marketing efforts; and

 

·             additional non-cash charges relating to amortizationand stock-based compensation.

 

As a result, if wedo not significantly increase revenue to reach or maintain profitability on aquarterly or annual basis, our stock price could decline. We may besubject to additional impairment of our long-lived assets.

 

***We intend to pursue additional strategic relationships, whichare necessary to******maximize our growth, butcould substantially divert management attention and******resources.***

 

We have sought inthe past, and may seek in the future, to establish and maintain strategicrelationships with industry leaders at each stage of the IC design andmanufacturing processes. This requires us to expend significant resources andto commit a significant amount of management’s time and attention, although anysuch relationship may not be successful. If we are unable to enter intostrategic relationships with these companies, we will not be as effective atmodeling existing technologies or at keeping ahead of the technology curve asnew technologies are introduced. In the past, the absence of an establishedworking relationship with key companies in the industry has meant that we havehad to exclude the effect of their component parts from our modeling analysis,which reduces the overall effectiveness of our analysis and limits our abilityto improve yield.

 

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***Our solution implementations may take longer than weanticipate, which could cause us******tolose customers and may result in adjustments to our operating results.***

 

Our solutionimplementations require a team of engineers to collaborate with our customersto address complex yield loss issues by using our software and othertechnologies. We must estimate the amount of time needed to complete an existingsolution implementation in order to estimate when the engineers will be able tocommence a new solution implementation. In addition, our accounting forsolution implementation contracts, which generate fixed fees, sometimes requireadjustments to profit and loss based on revised estimates during theperformance of the contract. These adjustments may have a material effect onour results of operations in the period in which they are made. The estimatesgiving rise to these risks, which are inherent in fixed-price contracts,include the forecasting of costs and schedules, and contract revenues relatedto contract performance.

 

***If we are not able to attract, retain,motivate, and strategically locate talented employees, including some keyexecutives, our business may suffer.***

 

Our success andcompetitiveness depend on our ability to attract, retain, motivate, andstrategically locate in our offices around the globe talented employees,including some of our key executives. Achieving this objective may be difficultdue to many factors, including fluctuations in global economic and industryconditions, changes in our management or leadership, the hiring practices atour competitors or customers, cost reduction activities, and the effectivenessof our compensation programs, including equity-based programs. Further, we have had, and expect tocontinue to have, difficulty in obtaining visas permitting entry for some ofour employees that are foreign nationals into the United States, and delays inobtaining visas permitting entry into other key countries, for several of ourkey personnel, which disrupts our ability to strategically locate ourpersonnel. If we lose the services of any of our key executives or asignificant number of our engineers, it could disrupt our ability to implementour business strategy. If we do notsuccessfully attract, retain, and motivate key employees, including keyexecutives, we may be unable to realize our business objectives and ouroperating results may suffer.

 

***Inadvertent disclosure of our customers’ confidentialinformation could result in******costlylitigation and cause us to lose existing and potential customers.***

 

Our customersconsider their product yield information and other confidential information,which we must gather in the course of our engagement with the customer, to beextremely competitively sensitive. If we inadvertently disclosed or wererequired to disclose this information, we would likely lose existing andpotential customers and could be subject to costly litigation. In addition, toavoid potential disclosure of confidential information to competitors, some ofour customers may, in the future, ask us not to work with key competitiveproducts, which could limit our revenue opportunities.

 

***Our technologies could infringe the IP rights of others,causing******costly litigation and the loss ofsignificant rights.***

 

Significantlitigation regarding intellectual property rights exists in the semiconductorindustry. It is possible that a third party may claim that our technologies infringetheir intellectual property rights or misappropriate their trade secrets. Anyclaim, even if without merit, could be time consuming to defend, result incostly litigation, or require us to enter into royalty or licensing agreements,which may not be available to us on acceptable terms, or at all. A successfulclaim of infringement against us in connection with the use of our technologiescould adversely affect our business.

 

***Defects in our proprietary technologies, hardware andsoftware tools, and the cost of******supportto remedy any such defects could decrease our revenue and our competitive******market share.***

 

If the software,hardware, or proprietary technologies we provide to a customer contain defectsthat increase our customer’s cost of goods sold and time-to-market or damageour customer’s property, these defects could significantly decrease the marketacceptance of our solutions. Further, the cost of support resources required toremedy any defects in our technologies, hardware, or software tools couldexceed our expectations. Any actual or perceived defects with our software,hardware, or proprietary technologies may also hinder our ability to attract orretain industry partners or customers, leading to a decrease in our revenue.These defects are frequently found during the period following introduction ofnew software, hardware, or proprietary technologies or enhancements to existingsoftware, hardware, or proprietary technologies. Our software, hardware, andproprietary technologies may contain errors not discovered until after customerimplementation of the silicon design and manufacturing process recommended byus. If our software, hardware, or proprietary technologies contain errors ordefects, it could require us to expend significant resources to remedy theseproblems, which could reduce margins and result in the diversion of technicaland other resources from our other development efforts.

 

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***Failing to maintain the effectiveness of our internalcontrol over financial******reportingcould cause the cost related to remediation to increase and could cause our******stock price to decline.***

 

In the future, ourmanagement may identify deficiencies regarding the design and operatingeffectiveness of our system of internal control over financial reportingpursuant to Section 404 of the Sarbanes-Oxley Act (“Section 404”).Such deficiencies could include those arising from turnover of qualifiedpersonnel or arising as a result of acquisitions, which we may not be able toremediate in time to meet the continuing reporting deadlines imposed by Section 404and the costs of which may harm our results of operations. In addition, if wefail to maintain the adequacy of our internal controls, as such standards aremodified, supplemented or amended from time to time, we may not be able toensure that our management can conclude on an ongoing basis that we haveeffective internal controls. We also may not be able to retain an independentregistered public accounting firm with sufficient resources to attest to andreport on our internal controls in a timely manner. Moreover, our independentregistered public accounting firm may deem our controls ineffective if we areunable to remediate deficiencies on a timely basis. If in the future we areunable to assert that we maintain effective internal controls, our investorscould lose confidence in the accuracy and completeness of our financial reportsthat in turn could cause our stock price to decline.

 

***We may not be able to raise necessary funds to support ourgrowth or execute our******strategy.***

 

Unanticipatedefforts to support more rapid expansion, develop or enhanceDesign-to-Silicon-Yield solutions, respond to competitive pressures or acquirecomplementary businesses or technologies could impact our future capitalrequirements and the adequacy of our available funds. In such event, we mayneed to raise additional funds through public or private financings, strategicrelationships or other arrangements. We may not be able to raise necessaryfunds on terms favorable to us, or at all.

 

***Recent or potential acquisitions may adversely affect ourbusiness by diverting management’s******attention,increasing our expenses or by being more difficult to integrate than******expected.***

 

Our success inrealizing the strategic benefits, the timing of this realization, and growthopportunities to be gained from acquiring technology or companies andincorporating into PDF the operations of recently acquired businesses,including Si Automation S.A. (“SiA”), a French company, acquired in October 2006,Fabbrix, Inc. (“Fabbrix”), a U.S. company, acquired in May 2007, andTriant Holdings, Inc. and Triant Technologies (2005) Inc. (“Triant”), bothCanadian companies acquired in October 2008, depend upon our ability tosuccessfully identify the technology or company, negotiate favorable terms,close the related transaction in a timely manner, and integrate thosebusinesses or assets. We may be unable to identify suitable acquisition orinvestment candidates at reasonable prices or on reasonable terms, orconsummate future acquisitions or investments at all or in a timely manner,each of which could slow our growth strategy. Further, the integration ofacquired businesses or assets is a complex, costly and time-consuming process.The difficulties of combining our existing operations associated with acquiredbusinesses or assets include:

 

·             consolidating research and development operations;

 

·             integrating acquired products and business technologyinto our existing product lines;

 

·             coordinating effective sales and marketing functions;

 

·             preserving research and development, marketing,customer and other important relationships; and

 

·             minimizing the diversion of management’s attentionfrom ongoing business concerns.

 

***Changes in effective tax rates could negatively affect ouroperating results.***

 

We conduct ourbusiness globally and, as a result, are subject to taxation in the UnitedStates and foreign countries. Our future tax rates could be affected bynumerous factors, including changes in tax laws or the interpretation of suchtax laws and changes in accounting policies. Our filings are subject to reviewsor audit by the Internal Revenue Service and state, local and foreign taxingauthorities. We cannot be sure that any final determination in an audit wouldnot be materially different than the treatment reflected in our historicalincome tax provisions and accruals. If additional taxes are assessed as aresult of an audit, there could be a significant negative effect on our incometax provision and our operating results in the period or periods for which thatdetermination is made.

 

***The uncertainty in the credit markets might impact the valueof certain auction-rate******securitieswe have and we might have to record impairment******charges in the future.***

 

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Credit concerns inthe capital markets have significantly reduced our ability to liquidateauction-rate securities that we classify as non-current investment securitieson our balance sheet. The liquidity of the securities has been reduced by theuncertainty in the credit markets and the exposure of these securities to thefinancial condition of bond insurance companies. All auction-rate securities wehold have been failing to sell at auction since February 2008 due to aninsufficient number of bidders. We reviewed the value of these securities forimpairment as of September 30, 2009, concluded that these securities weretemporarily impaired, and have recorded an unrealized loss of $282,000 as acomponent of accumulated other comprehensive income. In future periods, theestimated fair value of our auction-rate securities could decline further basedon market conditions, which could result in additional impairment and couldresult in the need to classify such impairment as other than temporary, thisresulting in a charge to operations.

 

**Item2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

(b) *Use of Proceeds*. Our first registrationstatement, filed on Form S-1 (Registration No. 333-43192), related toour initial public offering and was declared effective by the SEC on July 26,2001. There has been no change to the disclosure contained in our QuarterlyReport on Form 10-Q for the quarter ended September 30, 2005 withrespect to the use of proceeds generated by our initial public offering.

 

(c) *Stock Repurchase*. The table below setsforth the information with respect to purchases made by or on behalf of theCompany or any “affiliated purchaser” (as the term is defined in Rule 10b-18(a)(3) underthe Securities Exchange Act of 1934) of our common stock during the threemonths ended September 30, 2009 (in thousands except per share amounts):

 

**ISSUERPURCHASES OF EQUITY SECURITIES**

 
| **Period**                                                         | ** ** | **Total********Number of********Shares (or********Units)********Purchased** | ** ** | **Average********Price Paid********Per Share********(or Unit)** | ** ** | **Total  Number of********Shares (or Units)********Purchased as********Part of Publicly********Announced Plans********or Programs (1)** | ** ** | **Maximum  Number (or********Approximate Dollar********Value) of Shares (or********Units) that May Yet Be********Purchased Under the********Plans or Programs(1)** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Month #1 (July 1, 2009 through July 31,  2009)           |       | —                                                                      |       | $                                                               | —     |                                                                                                                                         | —     |                                                                                                                                                                    | $          | 1,467 |   |
| Month #2 (August 1, 2009 through  August 31, 2009)       |       | —                                                                      |       | —                                                          |       | —                                                                                                                                       |       | $                                                                                                                                                                       | 1,467      |   |
| Month #3 (September 1, 2009 through  September 30, 2009) |       | —                                                                      |       | —                                                          |       | —                                                                                                                                       |       | $                                                                                                                                                                       | 1,467      |   |
| Total                                                              |       | —                                                                      |       | $                                                               | —     |                                                                                                                                         | —     |                                                                                                                                                                    |       |   |

 

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(1)     On March 26, 2003, our Board of Directorsapproved a share repurchase program to purchase up to $10.0 million of ouroutstanding common stock. The program was completed in August 2007 with988,000 shares repurchased at the average price of $10.12 per share. On October 29,2007, the Board of Directors approved a new program to repurchase up to anadditional $10.0 million of the Company’s common stock on the open market. Theright to repurchase stock under this program will expire on October 29,2010.  As of September 30, 2009, 2,5million shares had been repurchased at the average price of $3.41 per shareunder this program and $1.5 million remained available for future repurchases.

 

**Item3. Defaults Upon Senior Securities.**

 

Not Applicable.

 

**Item4. Submission of Matters to a Vote of Security Holders.**

 

No matters weresubmitted to a vote of security holders during the third quarter of 2009.

 

**Item5. Other Information.**

 

None.

 

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**Item6. Exhibits.**

** **
| **Exhibit********Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                      |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.01                      |       | Third Amended and  Restated Certificate of Incorporation of PDF Solutions, Inc.  (incorporated herein by reference to registrant’s Registration Statement on  Form S-1/A filed July 9, 2001.)                                                                                                    |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 3.02                      |       | Amended and Restated  Bylaws of PDF Solutions, Inc. (incorporated herein by reference to  registrant’s Quarterly Report on Form  10-Q filed August 9, 2005.)                                                                                                                                     |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 4.01                      |       | Specimen Stock  Certificate (incorporated herein by reference to registrant’s Quarterly  Report on Form 10-Q filed September 6, 2001.)                                                                                                                                                                |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 4.02                      |       | Second Amended and  Restated Rights Agreement dated July 6, 2001 (incorporated herein by  reference to registrant’s Registration Statement on Form S-1/A filed  July 9, 2001.)                                                                                                                   |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 10.01                     |       | PDF  Solutions, Inc. 2001 Stock Plan (incorporated herein by reference to  registrant’s Quarterly Report on Form 10-Q filed May 10, 2007) and  related agreements (incorporated herein by reference to registrant’s  Registration Statement on Form S-1/A filed on July 9, 2001.) |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 10.02                     |       | PDF  Solutions, Inc. 2001 Employee Stock Purchase Plan (incorporated herein  by reference to registrant’s Registration Statement on Form S-8 filed  January 14, 2003.)                                                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 31.01                     |       | Certification of the  President and Chief Executive Officer pursuant to Exchange Act  Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 31.02                     |       | Certification of the  Chief Financial Officer and Vice President of Finance pursuant to Exchange  Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 32.01                     |       | Certification of the  President and Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. *                                                                                                                                  |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 32.02                     |       | Certification the Chief  Financial Officer and Vice President of Finance pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. *                                                                                                                     |

 

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*          As contemplated by SEC Release No. 33-8212, theseexhibits are furnished with this Quarterly Report on Form 10-Q and are notdeemed filed with the Securities and Exchange Commission and are notincorporated by reference in any filing of PDF Solutions, Inc. under theSecurities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any filings.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| ** **                   | **PDF  SOLUTIONS, INC.** |
|------------------------------|--------------------------|
| ** **                   | ** **               |
| ** **                   | ** **               |
| Date: November 9, 2009  | By:                      | /s/ JOHN K. KIBARIAN |
|                         |                     | John K. Kibarian |
|                         |                     | President and Chief  Executive Officer |
|                         |                     | (Principal Executive  Officer) |
|                         |                     |   |
|                         |                     |   |
| Date: November 9,  2009 | By:                      | /s/ KEITH A. JONES |
|                         |                     | Keith A. Jones |
|                         |                     | Chief Financial Officer  and Vice President of Finance |
|                         |                     | (Principal Financial or  Accounting Officer) |

 

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**INDEX TO EXHIBITS**

** **
| **Exhibit********Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                      |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.01                      |       | Third Amended and  Restated Certificate of Incorporation of PDF Solutions, Inc.  (incorporated herein by reference to registrant’s Registration Statement on  Form S-1/A filed July 9, 2001.)                                                                                                    |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 3.02                      |       | Amended and Restated  Bylaws of PDF Solutions, Inc. (incorporated herein by reference to registrant’s  Quarterly Report on Form  10-Q filed August 9, 2005.)                                                                                                                                     |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 4.01                      |       | Specimen Stock  Certificate (incorporated herein by reference to registrant’s Quarterly  Report on Form 10-Q filed September 6, 2001.)                                                                                                                                                                |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 4.02                      |       | Second Amended and  Restated Rights Agreement dated July 6, 2001 (incorporated herein by  reference to registrant’s Registration Statement on Form S-1/A filed  July 9, 2001.)                                                                                                                   |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 10.01                     |       | PDF  Solutions, Inc. 2001 Stock Plan (incorporated herein by reference to  registrant’s Quarterly Report on Form 10-Q filed May 10, 2007) and  related agreements (incorporated herein by reference to registrant’s  Registration Statement on Form S-1/A filed on July 9, 2001.) |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 10.02                     |       | PDF  Solutions, Inc. 2001 Employee Stock Purchase Plan (incorporated herein  by reference to registrant’s Registration Statement on Form S-8 filed  January 14, 2003.)                                                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 31.01                     |       | Certification of the  President and Chief Executive Officer pursuant to Exchange Act  Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 31.02                     |       | Certification of the  Chief Financial Officer and Vice President of Finance pursuant to Exchange  Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                           |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 32.01                     |       | Certification of the  President and Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. *                                                                                                                                  |
|                      |       |                                                                                                                                                                                                                                                                                                                 |
| 32.02                     |       | Certification the Chief  Financial Officer and Vice President of Finance pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. *                                                                                                                     |

 

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*          As contemplated by SEC Release No. 33-8212, theseexhibits are furnished with this Quarterly Report on Form 10-Q and are notdeemed filed with the Securities and Exchange Commission and are notincorporated by reference in any filing of PDF Solutions, Inc. under theSecurities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any filings.

 

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