##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period ended September 30, 2007
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number 000-31311
 PDF SOLUTIONS, INC.
  Delaware
    
    25-1701361(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)333 West San Carlos Street, Suite 700San Jose, California
    
    95110(Address of Principal Executive Offices)
    
    (Zip Code)
 (408) 280-7900
 þ o
  o þ o
 o þ




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##### 



TABLE OF CONTENTS
 PagePART I FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Condensed Consolidated Balance Sheets (Unaudited)
    
    
    3Condensed Consolidated Statements of Operations (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows (Unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    26PART II OTHER INFORMATION
    
    
    26Item 1. Legal Proceedings
    
    
    26Item 1A. Risk Factors
    
    
    26Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34Item 3. Defaults Upon Senior Securities
    
    
    34Item 4. Submission of Matters to a Vote of Security Holders
    
    
    34Item 5. Other Information
    
    
    34Item 6. Exhibits
    
    
    35SIGNATURES
    
    
    36INDEX TO EXHIBITS
    
    
    37EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01EXHIBIT 32.02
  2




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##### Table of Contents



Item 1. Financial Statements.
 
 PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except par values)
 September 30,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    38,461
    
    
    $
    36,451Short-term investments
    
    
    11,500
    
    
    
    16,402Accounts receivable, net of allowance of $254 in 2007 and 2006
    
    
    32,609
    
    
    
    27,575Prepaid expenses and other current assets
    
    
    2,825
    
    
    
    2,796Deferred tax assets
    
    
    2,644
    
    
    
    2,581Total current assets
    
    
    88,039
    
    
    
    85,805Property and equipment, net
    
    
    3,761
    
    
    
    3,916Goodwill
    
    
    64,593
    
    
    
    60,034Intangible assets, net
    
    
    13,855
    
    
    
    13,605Deferred tax assets
    
    
    6,265
    
    
    
    4,994Other assets
    
    
    472
    
    
    
    503Total assets
    
    $
    176,985
    
    
    $
    168,857LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of long-term debt
    
    $
    403
    
    
    $
    302Accounts payable
    
    
    2,424
    
    
    
    3,182Accrued compensation and related benefits
    
    
    5,430
    
    
    
    3,325Other accrued liabilities
    
    
    2,541
    
    
    
    3,843Taxes payable
    
    
    2,919
    
    
    
    4,767Deferred revenue
    
    
    4,221
    
    
    
    3,705Billings in excess of recognized revenue
    
    
    301
    
    
    
    95Total current liabilities
    
    
    18,239
    
    
    
    19,219Long-term debt
    
    
    946
    
    
    
    1,198Long-term taxes payable
    
    
    5,355
    
    
    
    Other liabilities
    
    
    78
    
    
    
    221Total liabilities
    
    
    24,618
    
    
    
    20,638Stockholders 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 and outstanding
28,022 in 2007 and 27,948 in 2006
    
    
    4
    
    
    
    4Additional paid-in-capital
    
    
    177,992
    
    
    
    167,323Treasury stock at cost, 988 shares in 2007 and 551 shares in 2006
    
    
    (10,001
    )
    
    
    (5,549
    )Accumulated deficit
    
    
    (18,423
    )
    
    
    (13,890
    )Accumulated other comprehensive income
    
    
    2,795
    
    
    
    331Total stockholders equity
    
    
    152,367
    
    
    
    148,219Total liabilities and stockholders equity
    
    $
    176,985
    
    
    $
    168,857
 See notes to condensed consolidated financial statements.
 3




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##### Table of Contents



PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,
    
    
    September 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue:Design-to-silicon- yield solutions:Integrated solutions
    
    $
    16,294
    
    
    $
    11,153
    
    
    $
    46,090
    
    
    $
    33,859Software licenses
    
    
    967
    
    
    
    3,811
    
    
    
    6,228
    
    
    
    8,217Gain share
    
    
    6,807
    
    
    
    4,400
    
    
    
    17,590
    
    
    
    15,155Total revenue
    
    
    24,068
    
    
    
    19,364
    
    
    
    69,908
    
    
    
    57,231Cost of design-to-silicon yield solutions:Direct costs of design-to-silicon-yield solutions:Integrated solutions
    
    
    8,052
    
    
    
    6,734
    
    
    
    22,842
    
    
    
    19,808Software licenses
    
    
    48
    
    
    
    58
    
    
    
    134
    
    
    
    98Amortization of acquired technology
    
    
    1,331
    
    
    
    1,266
    
    
    
    4,516
    
    
    
    3,798Total cost of designto silicon-yield solutions
    
    
    9,431
    
    
    
    8,058
    
    
    
    27,492
    
    
    
    23,704Gross margin
    
    
    14,637
    
    
    
    11,306
    
    
    
    42,416
    
    
    
    33,527Operating expenses:Research and development
    
    
    9,008
    
    
    
    6,416
    
    
    
    26,175
    
    
    
    19,543Selling, general and administrative
    
    
    5,789
    
    
    
    5,028
    
    
    
    18,278
    
    
    
    14,850Amortization of other acquired intangible assets
    
    
    985
    
    
    
    235
    
    
    
    3,029
    
    
    
    705Total operating expenses
    
    
    15,782
    
    
    
    11,679
    
    
    
    47,482
    
    
    
    35,098Loss from operations
    
    
    (1,145
    )
    
    
    (373
    )
    
    
    (5,066
    )
    
    
    (1,571
    )Interest and other income, net
    
    
    322
    
    
    
    892
    
    
    
    1,347
    
    
    
    2,338Income (loss) before taxes
    
    
    (823
    )
    
    
    519
    
    
    
    (3,719
    )
    
    
    767Income tax provision (benefit)
    
    
    116
    
    
    
    (51
    )
    
    
    276
    
    
    
    776Net income (loss)
    
    $
    (939
    )
    
    $
    570
    
    
    $
    (3,995
    )
    
    $
    (9
    )Net income (loss) per share:Basic
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    (0.14
    )
    
    $
    (0.00
    )Diluted
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    (0.14
    )
    
    $
    (0.00
    )Weighted average common shares:Basic
    
    
    28,223
    
    
    
    26,860
    
    
    
    28,127
    
    
    
    26,694Diluted
    
    
    28,223
    
    
    
    27,621
    
    
    
    28,127
    
    
    
    26,694
 See notes to condensed consolidated financial statements.
 4




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PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 Nine Months EndedSeptember 30,2007
    
    
    2006Operating activities:Net loss
    
    $
    (3,995
    )
    
    $
    (9
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    1,513
    
    
    
    1,532Stock-based compensation expense
    
    
    5,453
    
    
    
    5,462Amortization of acquired intangible assets
    
    
    7,594
    
    
    
    4,503Tax benefit related to stock-based compensation expense
    
    
    223
    
    
    
    579Excess tax benefit from stock-based compensation expense
    
    
    (43
    )
    
    
    (286
    )Deferred taxes
    
    
    (3,706
    )
    
    
    (1,020
    )Changes in operating assets and liabilities, net of effect of acquisitions:Accounts receivable, net of allowances
    
    
    (5,034
    )
    
    
    (1,338
    )Prepaid expenses and other assets
    
    
    11
    
    
    
    (986
    )Accounts payable
    
    
    (1,081
    )
    
    
    1,045Accrued compensation and related benefits
    
    
    662
    
    
    
    (2,179
    )Other accrued liabilities
    
    
    (489
    )
    
    
    290Taxes payable
    
    
    3,815
    
    
    
    (89
    )Deferred revenue
    
    
    516
    
    
    
    421Billings in excess of recognized revenue
    
    
    206
    
    
    
    (1,465
    )Net cash provided by operating activities
    
    
    5,645
    
    
    
    6,460Investing activities:Purchases of available-for-sale securities
    
    
    (20,840
    )
    
    
    (42,198
    )Maturities and sales of available-for-sale securities
    
    
    26,221
    
    
    
    25,242Purchases of property and equipment
    
    
    (1,654
    )
    
    
    (1,915
    )Payments on businesses acquired, net of cash acquired
    
    
    (4,584
    )
    
    
    Net cash used in investing activities
    
    
    (857
    )
    
    
    (18,871
    )Financing activities:Proceeds from exercise of stock options
    
    
    1,337
    
    
    
    3,425Proceeds from employee stock purchase plan
    
    
    782
    
    
    
    978Stock repurchases
    
    
    (4,452
    )
    
    
    Principal payments on long-term obligations
    
    
    (267
    )
    
    
    (36
    )Principal payments on notes to stockholders
    
    
    (416
    )
    
    
    Excess tax benefit from stock-based compensation expense
    
    
    43
    
    
    
    286Net cash
provided by (used in) financing activities
    
    
    (2,973
    )
    
    
    4,653Effect of exchange rate changes on cash
    
    
    195
    
    
    
    33Net increase (decrease) in cash and cash equivalents
    
    
    2,010
    
    
    
    (7,725
    )Cash and cash equivalents, beginning of period
    
    
    36,451
    
    
    
    60,506Cash and cash equivalents, end of period
    
    $
    38,461
    
    
    $
    52,781Non-cash investing and financing activities:Purchase price adjustments
    
    $
    9
    
    
    $
    923Reversal of deferred stock compensation
    
    $
    
    
    
    $
    27Purchase of property and equipment on account
    
    $
    133
    
    
    $
    28Stock issued
for business acquired
    
    $
    2,874
    
    
    $
    Supplemental disclosure of cash flow information:Cash paid during the year for:Taxes
    
    $
    518
    
    
    $
    1,381Interest
    
    $
    36
    
    
    $
    1
 See notes to condensed consolidated financial statements
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PDF SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1. BASIS OF PRESENTATION
    Revenue Recognition
 Accounting for Performance of
Construction-Type and Certain Production-Type Contracts Software Revenue
Recognition,
 Design-to-Silicon-Yield Solutions
 Integrated Solutions
   6




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Software Licenses
 Gain Share
 Stock-Based Compensation
 Share-Based Payment
 2. BUSINESS COMBINATIONS
    7




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AmortizationPeriodPreliminary Allocation of Purchase Price
    
    (Years)
    
    
    AmountFair value of tangible assets
    
    
    
    
    
    $
    406Fair value of intangible assets:Developed technology
    
    
    5
    
    
    
    6,430Patent and applications
    
    
    7
    
    
    
    1,400Goodwill
    
    
    N/A
    
    
    
    2,217Total assets acquired
    
    
    
    
    
    
    10,453Deferred tax liability
    
    
    
    
    
    
    (3,210
    )Notes to stockholders
    
    
    
    
    
    
    (416
    )Accrued liabilities
    
    
    
    
    
    
    (364
    )Accounts payable
    
    
    
    
    
    
    (219
    )Total liabilities assumed
    
    
    
    
    
    
    (4,209
    )Total consideration, net
    
    
    
    
    
    $
    6,244
   Nine Months Ended September 30,2007
    
    2006Revenue
    
    $
    69,908
    
    
    $
    57,231Net income (loss)
    
    $
    (5,145
    )
    
    $
    (1,050
    )Pro forma net income (loss) per share  basic
    
    $
    (0.18
    )
    
    $
    (0.04
    )Pro forma net income (loss) per share  diluted
    
    $
    (0.18
    )
    
    $
    (0.04
    )
   3. RECENT ACCOUNTING PRONOUNCEMENTS
 Fair Value Measurement
 Accounting for Sabbatical Leave and Other Similar Benefits
 Pursuant to FASB Statement No. 43
 The Fair Value Option for
Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115.
 8




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4. INVESTMENTS
  September 30, 2007Unrealized
    
    
    UnrealizedAmortized
    
    
    Holding
    
    
    Holding
    
    
    MarketCost
    
    
    Gains
    
    
    Losses
    
    
    ValueCommercial paper
    
    $
    14,013
    
    
    $
    1
    
    
    $
    
    
    
    $
    14,014Auction rate securities
    
    
    4,650
    
    
    
    
    
    
    
    
    
    
    
    4,650Money market funds
    
    
    1,068
    
    
    
    
    
    
    
    
    
    
    
    1,068$
    19,731
    
    
    $
    1
    
    
    $
    
    
    
    $
    19,732Included in cash and cash
equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    8,232Included in short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,500Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    19,732
  December 31, 2006Unrealized
    
    
    UnrealizedAmortized
    
    
    Holding
    
    
    Holding
    
    
    MarketCost
    
    
    Gains
    
    
    Losses
    
    
    ValueCommercial paper
    
    $
    13,307
    
    
    $
    1
    
    
    $
    
    
    
    $
    13,308Auction rate securities
    
    
    5,050
    
    
    
    
    
    
    
    
    
    
    
    5,050Corporate bonds and notes
    
    
    1,984
    
    
    
    
    
    
    
    (1
    )
    
    
    1,983Money market funds
    
    
    23,744
    
    
    
    
    
    
    
    
    
    
    
    23,744$
    44,085
    
    
    $
    1
    
    
    $
    (1
    )
    
    $
    44,085Included in cash and cash
equivalents
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    27,683Included in short-term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,402Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    44,085
 5. ACCOUNTS RECEIVABLE
  6. NET INCOME (LOSS) PER SHARE
  Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    (939
    )
    
    $
    570
    
    
    $
    (3,995
    )
    
    $
    (9
    )Denominator:Weighted average common shares outstanding
    
    
    28,223
    
    
    
    26,860
    
    
    
    28,127
    
    
    
    26,694Dilutive items:Weighted average stock options outstanding
    
    
    
    
    
    
    761
    
    
    
    
    
    
    
    Denominator for diluted computation
    
    
    28,223
    
    
    
    27,621
    
    
    
    28,127
    
    
    
    26,694Net income (loss) per share  basic
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    (0.14
    )
    
    $
    (0.00
    )Net income (loss) per share  diluted
    
    $
    (0.03
    )
    
    $
    0.02
    
    
    $
    (0.14
    )
    
    $
    (0.00
    )
 9




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Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2007
    
    2006
    
    2007
    
    2006Common stock options
    
    
    6,757
    
    
    
    2,883
    
    
    
    6,735
    
    
    
    5,501
 7. COMPREHENSIVE INCOME (LOSS)
  Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    (939
    )
    
    $
    570
    
    
    $
    (3,995
    )
    
    $
    (9
    )Unrealized gain (loss) on short term investments
    
    
    
    
    
    
    38
    
    
    
    1
    
    
    
    (3
    )Foreign currency translation adjustments
    
    
    1,066
    
    
    
    (16
    )
    
    
    2,463
    
    
    
    33Comprehensive income (loss)
    
    $
    127
    
    
    $
    592
    
    
    $
    (1,531
    )
    
    $
    21
 8. GOODWILL AND PURCHASED INTANGIBLE ASSETS
 , Goodwill and Other Intangible Assets,
  December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    September 30,Amortization
    
    
    2006
    
    
    
    
    
    
    Purchase
    
    
    
    
    
    
    Foreign
    
    
    2007Period
    
    
    Net Carrying
    
    
    
    
    
    
    Price
    
    
    
    
    
    
    Currency
    
    
    Net Carrying(Years)
    
    
    Amount
    
    
    Acquisition
    
    
    Adjustments
    
    
    Amortization
    
    
    Translation
    
    
    AmountGoodwill
    
    
    N/A
    
    
    $
    60,034
    
    
    $
    2,155
    
    
    $
    21
    
    
    $
    
    
    
    $
    2,383
    
    
    $
    64,593Acquired identifiable
intangibles:Acquired technology
    
    
    4 - 5
    
    
    $
    7,901
    
    
    $
    6,430
    
    
    $
    
    
    
    $
    (4,516
    )
    
    $
    
    
    
    $
    9,815Brand name
    
    
    4
    
    
    
    822
    
    
    
    
    
    
    
    
    
    
    
    (429
    )
    
    
    
    
    
    
    393Customer relationships
and backlog
    
    
    1 - 6
    
    
    
    4,362
    
    
    
    
    
    
    
    
    
    
    
    (2,238
    )
    
    
    
    
    
    
    2,124Patent and applications
    
    
    7
    
    
    
    
    
    
    
    1,400
    
    
    
    
    
    
    
    (67
    )
    
    
    
    
    
    
    1,333Other acquired intangibles
    
    
    4
    
    
    
    520
    
    
    
    
    
    
    
    
    
    
    
    (344
    )
    
    
    14
    
    
    
    190Total
    
    
    
    
    
    $
    13,605
    
    
    $
    7,830
    
    
    $
    
    
    
    $
    (7,594
    )
    
    $
    14
    
    
    $
    13,855
 December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    December 31,Amortization
    
    
    2005
    
    
    
    
    
    
    Purchase
    
    
    
    
    
    
    Foreign
    
    
    2006Period
    
    
    Net Carrying
    
    
    
    
    
    
    Price
    
    
    
    
    
    
    Currency
    
    
    Net Carrying(Years)
    
    
    Amount
    
    
    Acquisitions
    
    
    Adjustments
    
    
    Amortization
    
    
    Translation
    
    
    AmountGoodwill
    
    
    N/A
    
    
    $
    39,886
    
    
    $
    21,071
    
    
    $
    (923
    )
    
    $
    
    
    
    $
    
    
    
    $
    60,034Acquired identifiable
intangibles:Acquired technology
    
    
    4
    
    
    $
    8,221
    
    
    $
    4,950
    
    
    $
    
    
    
    $
    (5,270
    )
    
    $
    
    
    
    $
    7,901Brand name
    
    
    4
    
    
    
    833
    
    
    
    510
    
    
    
    
    
    
    
    (521
    )
    
    
    
    
    
    
    822Customer relationships
and backlog
    
    
    1 - 6
    
    
    
    
    
    
    
    4,860
    
    
    
    
    
    
    
    (498
    )
    
    
    
    
    
    
    4,362Other acquired intangibles
    
    
    4
    
    
    
    733
    
    
    
    255
    
    
    
    
    
    
    
    (477
    )
    
    
    9
    
    
    
    520Total
    
    
    
    
    
    $
    9,787
    
    
    $
    10,575
    
    
    $
    
    
    
    $
    (6,766
    )
    
    $
    9
    
    
    $
    13,605
  10




---



##### Table of Contents



Year Ending December 31,
    
    Amount2007 (three-month period)
    
    $
    1,0412008
    
    
    3,2962009
    
    
    3,2962010
    
    
    3,0292011
    
    
    1,8612012 and thereafter
    
    
    1,332Total
    
    $
    13,855
 9. INCOME TAXES
 Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109
      10. STOCKHOLDERS EQUITY
  11




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##### Table of Contents



Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Cost of design-to-silicon yield solutions
    
    $
    435
    
    
    $
    443
    
    
    $
    1,405
    
    
    $
    1,519Research and development
    
    
    553
    
    
    
    443
    
    
    
    1,731
    
    
    
    1,629Selling, general and administrative
    
    
    682
    
    
    
    621
    
    
    
    2,317
    
    
    
    2,314Stock-based compensation before income taxes
    
    $
    1,670
    
    
    $
    1,507
    
    
    $
    5,453
    
    
    $
    5,462
  Stock Plans:
 Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2007
    
    2006
    
    2007
    
    2006Expected life (in years)
    
    
    6.07
    
    
    
    4.26
    
    
    
    6.05
    
    
    
    4.26Volatility
    
    
    59.4
    %
    
    
    56.9
    %
    
    
    59.9
    %
    
    
    58.1
    %Risk-free interest rate
    
    
    4.88
    %
    
    
    4.97
    %
    
    
    4.92
    %
    
    
    4.82
    %Expected dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weighted average fair value of options granted during the period
    
    $
    7.14
    
    
    $
    6.26
    
    
    $
    6.53
    
    
    $
    7.63
 Employee Stock Purchase Plan:
 Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2007
    
    2006
    
    2007
    
    2006Expected life (in years)
    
    
    0.25
    
    
    
    0.25
    
    
    
    0.76
    
    
    
    0.97Volatility
    
    
    57.4
    %
    
    
    60.3
    %
    
    
    52.2
    %
    
    
    52.8
    %Risk-free interest rate
    
    
    5.02
    %
    
    
    5.08
    %
    
    
    5.15
    %
    
    
    3.79
    %Expected dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weighted average fair value of employee stock
    
    $
    3.14
    
    
    $
    3.45
    
    
    $
    4.00
    
    
    $
    4.14
  Stock Plans 
  Weighted AverageWeighted Average
    
    
    Remaining
    
    
    AggregateNumber of
    
    
    Exercise Price
    
    
    Contractual
    
    
    Intrinsic ValueOptions
    
    
    per Share
    
    
    Term (years)
    
    
    (in 000s)Outstanding, January 1, 2007
    
    
    6,664,094
    
    
    $
    12.11Granted
    
    
    595,103
    
    
    
    10.81Exercised
    
    
    (161,836
    )
    
    
    8.26Forfeited or expired
    
    
    (340,690
    )
    
    
    13.87Outstanding, September 30, 2007
    
    
    6,756,671
    
    
    
    12.00
    
    
    
    7.10
    
    
    $
    3,619Vested and expected to vest
    
    
    6,385,309
    
    
    
    11.93
    
    
    
    6.99
    
    
    $
    3,615Exercisable, September 30, 2007
    
    
    3,769,689
    
    
    
    10.94
    
    
    
    5.77
    
    
    $
    3,544
 12




---



##### Table of Contents



Weighted AverageMeasurementShares
    
    Date Fair ValueNonvested, January 1, 2007
    
    
    
    
    
    $
    Granted
    
    
    133,000
    
    
    
    9.88Vested
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Nonvested, September 30, 2007
    
    
    133,000
    
    
    $
    9.88
  Employee Stock Purchase Plan
 Stock Repurchase Program
  Weighted-AverageNine Months Ended September 30, 2007
    
    Shares Repurchased
    
    
    Price per Share
    
    
    Amount RepurchasedCumulative balance, January 1, 2007
    
    
    550,521
    
    
    $
    10.08
    
    
    $
    5,549Repurchase of common stock
    
    
    437,287
    
    
    $
    10.18
    
    
    
    4,452Cumulative balance, September 30, 2007
    
    
    987,808
    
    
    $
    10.12
    
    
    $
    10,001
 11. CUSTOMER AND GEOGRAPHIC INFORMATION
 Disclosures about Segments of an Enterprise and Related Information
 13




---



##### Table of Contents



Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,Customer
    
    2007
    
    2006
    
    2007
    
    2006A
    
    
    20
    %
    
    
    9
    %
    
    
    18
    %
    
    
    12
    %B
    
    
    16
    %
    
    
    18
    %
    
    
    16
    %
    
    
    27
    %C
    
    
    10
    %
    
    
    7
    %
    
    
    9
    %
    
    
    3
    %D
    
    
    6
    %
    
    
    9
    %
    
    
    6
    %
    
    
    10
    %E
    
    
    2
    %
    
    
    14
    %
    
    
    2
    %
    
    
    8
    %
  Customer
    
    September 30, 2007
    
    December 31, 2006A
    
    
    21
    %
    
    
    12
    %B
    
    
    17
    %
    
    
    18
    %C
    
    
    11
    %
    
    
    10
    %F
    
    
    11
    %
    
    
    12
    %
  Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Asia
    
    $
    13,792
    
    
    $
    10,396
    
    
    $
    37,820
    
    
    $
    28,626United States
    
    
    6,668
    
    
    
    7,096
    
    
    
    22,377
    
    
    
    23,585Europe
    
    
    3,608
    
    
    
    1,872
    
    
    
    9,711
    
    
    
    5,020Total
    
    $
    24,068
    
    
    $
    19,364
    
    
    $
    69,908
    
    
    $
    57,231
  12. RELATED PARTY TRANSACTIONS
  14




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 Forward-Looking Statements
  Overview
    15




---



##### Table of Contents



Industry Trend
  Financial Highlights
  
    
    Total revenue for the three months ended September 30, 2007 was $24.1 million, an
increase of 24% compared to the three months ended September 30, 2006. Revenue from
Design-to-Silicon-Yield solutions for the three months ended September 30, 2007 increased to
$17.3 million compared to $15.0 million for the three months ended September 30, 2006. The
change was primarily a result of increases in revenue related to integrated solutions of
$5.1 million and partially offset by a decrease in revenue related to software licenses of
$2.8 million over the three months ended September 30, 2006. Gain share revenue for the
three months ended September 30, 2007 increased to $6.8 million from $4.4 million for the
three months ended September 30, 2006. Our gain share revenue may continue to fluctuate from
quarter to quarter as a result of each customers contractual performance measures for
achieving gain share as well as each customers production volumes in any given period.
    
    Net loss for the three months ended September 30, 2007 was $939,000, compared to net
income of $570,000 for the three months ended September 30, 2006. The decrease in net income
was primarily attributable to increases in operating expenses and amortization of acquired
intangible assets, both as a result of the acquisitions of Si Automation S.A. in October
2006 and Fabbrix, Inc. in May 2007.
    
    Net loss per basic and diluted share was $0.03 for the three months ended September 30,
2007 compared to net income per basic and diluted share of $0.02 for the three months ended
September 30, 2006.
  
    
    Total revenue for the nine months ended September 30, 2007 was $69.9 million, an increase
of 22% compared to the nine months ended September 30, 2006. Revenue from
Design-to-Silicon-Yield solutions for the nine months ended September 30, 2007 increased to
$52.3 million compared to $42.1 million for the nine months ended September 30, 2006. The
change was primarily a result of increase in revenues related to integrated solutions of
$12.2 million and partially offset by decrease in revenue related to software licenses of
$2.0 million over the nine months ended September 30, 2006. Gain share revenue was $17.6
million, an increase of 16% compared to the nine months ended September 30, 2006.
    
    Net loss for the nine months ended September 30, 2007 was $4.0 million, compared to net
loss of $9,000 for the nine months ended September 30, 2006. The net loss was primarily
attributable to increases in operating expenses and amortization of acquired intangible
assets, both primarily the result of the acquisition of Si Automation S.A. in October 2006
and Fabbrix, Inc. in May 2007.
 16




---



##### Table of Contents




    
    Net loss per basic and diluted share was $0.14 for the nine months ended September 30,
2007 compared to net loss per basic and diluted share of $0.00 for the nine months ended
September 30, 2006.
    
    Cash, cash equivalents and short-term investments decreased by $2.9 million from $52.9
million as of December 31, 2006 to $50.0 million as of September 30, 2007. Net cash provided by
operating activities for the nine months ended September 30, 2007 totaled $5.6 million. Net
cash used in investing activities for the nine months ended September 30, 2007 included $1.9
million as final payments for our acquisition of Si Automation S.A., $2.7 million payment
for our acquisition of Fabbrix, Inc., and $1.7 million to purchase property and equipment.
Net cash used in financing activities for the nine months ended September 30, 2007 totaled
$3.0 million and was primarily related to $4.5 million in stock repurchases and $683,000 in
debt payments, partially offset by the exercise of stock options and purchases under the
employee stock purchase plan of $2.1 million. The fluctuations in foreign exchange rates
favorably impacted our cash flow by $195,000.
 Critical Accounting Policies
  General
  Revenue Recognition
 Accounting for Performance of Construction-Type and Certain
Production-Type Contracts Software Revenue Recognition,
 Design-to-Silicon-Yield Solutions
 Integrated Solutions
  17




---



##### Table of Contents



Software Licenses
 Gain Share
 Software Development Costs
 Computer
Software to be Sold, Leased or Otherwise Marketed.
 Goodwill and Acquired Intangible Assets
 Goodwill and Other Intangible Assets.
  18




---



##### Table of Contents



Realization of Deferred Tax Assets
  Stock-Based Compensation
  Results of Operations
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Revenue:Design-to-silicon-yield solutionsIntegrated solutions
    
    
    68
    %
    
    
    57
    %
    
    
    66
    %
    
    
    59
    %Software licenses
    
    
    4
    
    
    
    20
    
    
    
    9
    
    
    
    14Gain share
    
    
    28
    
    
    
    23
    
    
    
    25
    
    
    
    27Total revenue
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Cost of design-to-silicon-yield solutions:Direct costs of design-to-silicon-yield
solutionsIntegrated solutions
    
    
    33
    
    
    
    35
    
    
    
    33
    
    
    
    35Software licenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of acquired technology
    
    
    6
    
    
    
    7
    
    
    
    6
    
    
    
    7Total cost of design-to silicon-yield solutions
    
    
    39
    
    
    
    42
    
    
    
    39
    
    
    
    42Gross margin
    
    
    61
    
    
    
    58
    
    
    
    61
    
    
    
    58Operating expenses:Research and development
    
    
    38
    
    
    
    33
    
    
    
    38
    
    
    
    34Selling, general and administrative
    
    
    24
    
    
    
    26
    
    
    
    26
    
    
    
    26Amortization of other acquired intangible
assets
    
    
    4
    
    
    
    1
    
    
    
    4
    
    
    
    1Total operating expenses
    
    
    66
    
    
    
    60
    
    
    
    68
    
    
    
    61Loss from operations
    
    
    (5
    )
    
    
    (2
    )
    
    
    (7
    )
    
    
    (3
    )Interest and other income, net
    
    
    1
    
    
    
    5
    
    
    
    2
    
    
    
    4Income (loss) before taxes
    
    
    (4
    )
    
    
    3
    
    
    
    (5
    )
    
    
    1Income tax provision (benefit)
    
    
    
    
    
    
    (
    )
    
    
    
    
    
    
    1Net income (loss)
    
    
    (4
    )%
    
    
    3
    %
    
    
    (5
    )%
    
    
    (
    )%
 19




---



##### Table of Contents



Comparison of the Three Months Ended September 30, 2007 and 2006
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofRevenue
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Design-to-silicon-yield solutionsIntegrated solutions
    
    $
    16,294
    
    
    $
    11,153
    
    
    $
    5,141
    
    
    
    46
    %
    
    
    68
    %
    
    
    57
    %Software licenses
    
    
    967
    
    
    
    3,811
    
    
    
    (2,844
    )
    
    
    (75
    )%
    
    
    4
    %
    
    
    20
    %Gain share
    
    
    6,807
    
    
    
    4,400
    
    
    
    2,407
    
    
    
    55
    %
    
    
    28
    %
    
    
    23
    %Total
    
    $
    24,068
    
    
    $
    19,364
    
    
    $
    4,704
    
    
    
    24
    %
    
    
    100
    %
    
    
    100
    %
 Design-to-Silicon-Yield Solutions
 Integrated Solutions
 Software Licenses
 Gain Share
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofCost of Design-to-Silicon Yield Solutions
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Direct costs of design-to-silicon- yield
solutions:Integrated solutions
    
    $
    8,052
    
    
    $
    6,734
    
    
    $
    1,318
    
    
    
    20
    %
    
    
    33
    %
    
    
    35
    %Software licenses
    
    
    48
    
    
    
    58
    
    
    
    (10
    )
    
    
    (17
    )%
    
    
    
    
    
    
    Amortization of acquired technology
    
    
    1,331
    
    
    
    1,266
    
    
    
    65
    
    
    
    5
    %
    
    
    6
    %
    
    
    7
    %Total
    
    $
    9,431
    
    
    $
    8,058
    
    
    $
    1,373
    
    
    
    17
    %
    
    
    39
    %
    
    
    42
    %
 Direct Costs of Design-to-Silicon-Yield Solutions
 Integrated Solutions.
 20




---



##### Table of Contents



Software Licenses.
 Amortization of Acquired Technology
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofResearch and Development
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Research and development
    
    $
    9,008
    
    
    $
    6,416
    
    
    $
    2,592
    
    
    
    40
    %
    
    
    38
    %
    
    
    33
    %
 Research and Development.
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofSelling, General and Administrative
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Selling, general and administrative
    
    $
    5,789
    
    
    $
    5,028
    
    
    $
    761
    
    
    
    15
    %
    
    
    24
    %
    
    
    26
    %
 Selling, General and Administrative
 Three Months Ended September 30,2007
    
    
    2006Amortization of Other Acquired
    
    Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofIntangible Assets
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Amortization of other
acquired intangible assets
    
    $
    985
    
    
    $
    235
    
    
    $
    750
    
    
    
    319
    %
    
    
    4
    %
    
    
    1
    %
 21




---



##### Table of Contents



Amortization of Other Acquired Intangible Assets
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofInterest and Other Income, net
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Interest and other income, net
    
    $
    322
    
    
    $
    892
    
    
    $
    (570
    )
    
    
    (64
    )%
    
    
    1
    %
    
    
    5
    %
 Interest and Other Income, net
 Three Months Ended September 30,2007
    
    
    2006Three Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofIncome Tax Provision (Benefit)
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Income tax provision (benefit)
    
    $
    116
    
    
    $
    (51
    )
    
    $
    167
    
    
    
    (327
    )%
    
    
    
    %
    
    
    (
    )%
 Income Tax Provision (Benefit).
 Comparison of the Nine Months Ended September 30, 2007 and 2006
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofRevenue
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Design-to-silicon-yield solutions:Integrated solutions
    
    $
    46,090
    
    
    $
    33,859
    
    
    $
    12,231
    
    
    
    36
    %
    
    
    66
    %
    
    
    59
    %Software licenses
    
    
    6,228
    
    
    
    8,217
    
    
    
    (1,989
    )
    
    
    (24
    )%
    
    
    9
    %
    
    
    14
    %Gain share
    
    
    17,590
    
    
    
    15,155
    
    
    
    2,435
    
    
    
    16
    %
    
    
    25
    %
    
    
    27
    %Total
    
    $
    69,908
    
    
    $
    57,231
    
    
    $
    12,677
    
    
    
    22
    %
    
    
    100
    %
    
    
    100
    %
 Design-to-Silicon-Yield Solutions
 Integrated Solutions
 Software Licenses
 Gain Share
 22




---



##### Table of Contents



Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofCost of Design-to-Silicon Yield Solutions
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Direct costs of design-to-silicon- yield
solutions:Integrated solutions
    
    $
    22,842
    
    
    $
    19,808
    
    
    $
    3,034
    
    
    
    15
    %
    
    
    33
    %
    
    
    35
    %Software licenses
    
    
    134
    
    
    
    98
    
    
    
    36
    
    
    
    37
    %
    
    
    
    
    
    
    Amortization of acquired technology
    
    
    4,516
    
    
    
    3,798
    
    
    
    718
    
    
    
    19
    %
    
    
    6
    %
    
    
    7
    %Total
    
    $
    27,492
    
    
    $
    23,704
    
    
    $
    3,788
    
    
    
    16
    %
    
    
    39
    %
    
    
    42
    %
 Direct Costs of Design-to-Silicon-Yield Solutions
 Integrated Solutions.
 Software Licenses.
 Amortization of Acquired Technology
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofResearch and Development
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Research and development
    
    $
    26,175
    
    
    $
    19,543
    
    
    $
    6,632
    
    
    
    34
    %
    
    
    38
    %
    
    
    34
    %
 Research and Development.
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofSelling, General and Administrative
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Selling, general and administrative
    
    $
    18,278
    
    
    $
    14,850
    
    
    $
    3,428
    
    
    
    23
    %
    
    
    26
    %
    
    
    26
    %
 Selling, General and Administrative
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofAmortization of Other Acquired Intangible Assets
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Amortization of other
acquired intangible assets
    
    $
    3,029
    
    
    $
    705
    
    
    $
    2,324
    
    
    
    330
    %
    
    
    4
    %
    
    
    1
    %
 23




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##### Table of Contents



Amortization of Other Acquired Intangible Assets
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofInterest and Other Income, net
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Interest and other income, net
    
    $
    1,347
    
    
    $
    2,338
    
    
    $
    (991
    )
    
    
    (42
    )%
    
    
    2
    %
    
    
    4
    %
 Interest and Other Income, Net
 Nine Months Ended September 30,2007
    
    
    2006Nine Months Ended September 30,
    
    
    $
    
    
    %
    
    
    % of
    
    
    % ofIncome Tax Provision
    
    2007
    
    
    2006
    
    
    Change
    
    
    Change
    
    
    Revenue
    
    
    Revenue(In thousands, except for %s)Income tax provision
    
    $
    276
    
    
    $
    776
    
    
    $
    (500
    )
    
    
    (64
    )%
    
    
    0
    %
    
    
    1
    %
 Income Tax Provision.
 Liquidity and Capital Resources
    24




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##### Table of Contents



Payments due by period2007(Three monthsContractual obligations
    
    remaining)
    
    
    2008-2009
    
    
    2010-2011
    
    
    Thereafter
    
    
    Other
    
    
    TotalDebt principal (1)
    
    $
    28
    
    
    $
    640
    
    
    $
    512
    
    
    $
    
    
    
    $
    
    
    
    $
    1,180Debt interest
    
    
    8
    
    
    
    44
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    68Capital lease obligations (including interest)
    
    
    31
    
    
    
    143
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    186Operating lease obligations
    
    
    817
    
    
    
    1,607
    
    
    
    525
    
    
    
    48
    
    
    
    
    
    
    
    2,997Unrecognized tax benefits (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,355
    
    
    
    5,355Total
    
    $
    884
    
    
    $
    2,434
    
    
    $
    1,065
    
    
    $
    48
    
    
    $
    5,355
    
    
    $
    9,786
 
 (1)
    
    Amount represents the repayment of an interest free loan of 550,000 and a 400,000 loan which
carries 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 the table.  Recent Accounting Pronouncements
 Fair Value Measurement
 Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No.
43
 The Fair Value Option for
Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115
 25




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk.
  Interest Rate Risk
 Foreign Currency and Exchange Risk.
 
 Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
 Changes in Internal Controls Over Financial Reporting
 
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
  
 Item 1A. Risk Factors
 If semiconductor designers and manufacturers do not continue to adopt our Design-to-Silicon-Yield
solutions, we may be unable to increase or maintain our revenue.
  26




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##### Table of Contents




    
    our customers failure to achieve satisfactory yield improvements using our
Design-to-Silicon-Yield solutions;
    
    a decrease in demand for semiconductors generally or the demand for deep submicron
semiconductors failing to grow as rapidly as expected;
    
    our inability to develop, market, or sell effective solutions that are outside of our
traditional MPS logic focus;
    
    the industry may develop alternative methods to enhance the integration between the
semiconductor design and manufacturing processes due to a rapidly evolving market and the
likely emergence of new technologies;
    
    our existing and potential customers reluctance to understand and accept our innovative
gain share fee component; and
    
    our customers concern about our ability to keep highly competitive information
confidential.
 We generate a large percentage of our total revenue from a limited number of customers, so the
loss of any one of these customers could significantly reduce our revenue and results of
operations below expectations.
  If integrated device manufacturers of logic integrated circuits reduce investment in new process
technology as a result of a shift to a fabless manufacturing business model, the pool of potential
logic customers for our yield ramp solutions will shrink and our results of operations may suffer.
  We must effectively manage and support our operations and recent and planned growth in order for
our business strategy to succeed.
  27




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##### Table of Contents



If we fail to protect our intellectual property rights, customers or potential competitors may be
able to use our technologies to develop their own solutions which could weaken our competitive
position, reduce our revenue, or increase our costs.
  Competition in the market for solutions that address yield improvement and integration between IC
design and manufacturing may intensify in the future, which could slow our ability to grow or
execute our strategy.
  We face operational and financial risks associated with international operations.
  
    
    some of our key engineers and other personnel who are foreign nationals may have
difficulty gaining access to the United States and other countries in which our customers or
our offices may be located and it may be difficult for us to recruit and retain qualified
technical and managerial employees in foreign offices;
    
    greater difficulty in collecting account receivables resulting in longer collection
periods;
 28




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##### Table of Contents




    
    language and other cultural differences may inhibit our sales and marketing efforts and
create internal communication problems among our U.S. and foreign research and development
teams, increasing the difficulty of managing multiple, remote locations performing various
development, quality assurance, and yield ramp analysis projects;
    
    compliance with, and unexpected changes in, a wide variety of foreign laws and regulatory
environments with which we are not familiar, including, among other issues, with respect to
protection of our intellectual property, and a wide variety of trade and export controls
under domestic, foreign, and international law;
    
    currency risk due to the fact that expenses for our international offices are denominated
in the local currency, including the Euro, while virtually all of our revenue is denominated
in U.S. dollars;
    
    quarantine, private travel limitation, or business disruption in regions affecting our
operations, stemming from actual, imminent or perceived outbreak of human pandemic or
contagious disease;
    
    in the event a larger portion of our revenue becomes denominated in foreign currencies,
we would be subject to a potentially significant exchange rate risk; and
    
    economic or political instability, including but not limited to armed conflict,
terrorism, and the resulting disruption to economic activity and business operations.
  
    
    any recurrence of an overall downturn in Asian economies could limit our ability to
retain existing customers and attract new ones in Asia; and
    
    if the U.S. dollar increases in value relative to the Japanese Yen, the cost of our
solutions will be more expensive to existing and potential Japanese customers and therefore
less competitive.
 Our earnings per share and other key operating results may be unusually high in a given quarter,
thereby raising investors expectations, and then unusually low in the next quarter, thereby
disappointing investors, which could cause our stock price to drop.
  
    
    the size and timing of sales volumes achieved by our customers products;
    
    the loss of any of our large customers or an adverse change in any of our large
customers businesses;
    
    the size of improvements in our customers yield and the timing of agreement as to those
improvements;
    
    our long and variable sales cycle;
    
    changes in the mix of our revenue;
    
    changes in the level of our operating expenses needed to support our projected growth;
and
    
    delays in completing solution implementations for our customers.
 Our gain share revenue is dependent on factors outside of our control, including the volume of
integrated circuits, or ICs, our customers are able to sell to their customers.
  29




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##### Table of Contents



Gain share measurement requires data collection and is subject to customer agreement, which can
result in uncertainty and cause quarterly results to fluctuate.
  Changes in the structure of our customer contracts, including the mix between fixed and variable
revenue and the mix of elements, can adversely affect the size and timing of our total revenue.
  It typically takes us a long time to sell our unique solutions to new customers, which can result
in uncertainty and delays in generating additional revenue.
  We have a history of losses, we may incur losses in the future and we may be unable to maintain
profitability.
  
    
    funding for research and development;
    
    expansion of our solution implementation teams;
 30




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##### Table of Contents




    
    expansion of our sales and marketing efforts; and
    
    additional non-cash charges relating to amortization of intangibles and stock-based
compensation.
  We may experience significant fluctuations in operating results due to the cyclical nature of the
semiconductor industry.
  We must continually attract and retain highly talented executives, engineers, and research and
development personnel or we will be unable to expand our business as planned.
  If our products, technologies, services, and integrated solutions fail to keep pace with the rapid
technological changes in the semiconductor industry, we could lose customers and revenue.
  We intend to pursue additional strategic relationships, which are necessary to maximize our
growth, but could substantially divert management attention and resources.
  
    
    potential industry partners become concerned about our ability to protect their
intellectual property;
    
    potential industry partners develop their own solutions to address the need for yield
improvement;
    
    our potential competitors establish relationships with industry partners with which we
seek to establish a relationship; or
    
    potential industry partners attempt to restrict our ability to enter into relationships
with their competitors.
 31




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##### Table of Contents



Our solution implementations may take longer than we anticipate, which could cause us to lose
customers and may result in adjustments to our operating results.
  Key executives, including our chief executive officer and our chief strategy officer, are critical
to our business and we cannot guarantee that they will remain with us indefinitely.
  Inadvertent disclosure of our customers confidential information could result in costly
litigation and cause us to lose existing and potential customers.
  Our technologies could infringe the intellectual property rights of others causing costly
litigation and the loss of significant rights.
  Defects in our proprietary technologies, hardware and software tools, and the cost of support to
remedy any such defects could decrease our revenue and our competitive market share.
  32




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##### Table of Contents



Failing to maintain the effectiveness of our internal control over financial reporting could cause
the cost related to remediation to increase and could cause our stock price to decline.
  We may not be able to expand our business and proprietary technologies if we do not consummate
potential acquisitions or investments or successfully integrate them with our business.
  We may not be able to raise necessary funds to support our growth or execute our strategy.
  Recent acquisitions may adversely affect our business by diverting managements attention,
increasing our expenses or by being more difficult to integrate than expected.
  
    
    consolidating research and development operations;
    
    retaining key employees;
    
    incorporating acquired products and business technology into 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 attention from ongoing business concerns.
 
 33




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 Use of Proceeds
 Stock Repurchases
 ISSUER PURCHASES OF EQUITY SECURITIES
 Total Number of
    
    
    Maximum Number (orTotal
    
    
    
    
    
    
    Shares (or Units)
    
    
    Approximate DollarNumber of
    
    
    Average
    
    
    Purchased as
    
    
    Value) of Shares (orShares (or
    
    
    Price Paid
    
    
    Part of Publicly
    
    
    Units) that May Yet BeUnits)
    
    
    Per Share
    
    
    Announced Plans
    
    
    Purchased Under thePeriod
    
    Purchased
    
    
    (or Unit)
    
    
    or Programs (1)
    
    
    Plans or Programs(1)Month #1 (July 1, 2007 through July 31, 2007)
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    4,451,236Month #2 (August 1, 2007 through August 31, 2007)
    
    
    437,287
    
    
    $
    10.18
    
    
    
    437,287
    
    
    $
    Month #3 (September 1, 2007 through September 30, 2007)
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    Total
    
    
    437,287
    
    
    $
    10.18
    
    
    
    437,287
 
 (1)
    
    On March 26, 2003, we announced that our Board of Directors had approved a share repurchase
program, pursuant to which up to $10.0 million of our outstanding common stock may be
repurchased; the repurchase program has no set expiration or termination date. As of September
30, 2007, 987,808 shares had been repurchased under this program at a weighted average per
share price of $10.12, and the repurchase program has been completed. 
 Item 3. Defaults Upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders.
  
 Item 5. Other Information.
  34




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##### Table of Contents



Item 6. Exhibits.
 ExhibitNumber
    
    Description3.01
    
    
    Third Amended and Restated Certificate of Incorporation of PDF Solutions, Inc. *3.02
    
    
    Amended and Restated Bylaws of PDF Solutions, Inc. 4.01
    
    
    Specimen Stock Certificate **4.02
    
    
    Second Amended and Restated Rights Agreement dated July 6, 2001*10.01
    
    
    2001 Stock Plan and related agreements ***31.01
    
    
    Certification of the President and Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200231.02
    
    
    Certification of the Chief Financial Officer and Vice President of Finance and
Administration pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.01
    
    
    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 and
Administration pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 ****
 
 
    
    Incorporated by reference to PDFs Report on Form 10-Q filed August 9, 2005 (File No.
000-31311).*
    
    Incorporated by reference to PDFs Registration Statement on Form S-1, Amendment No. 7 filed
July 9, 2001 (File No. 333-43192).**
    
    Incorporated by reference to PDFs Report on Form 10-Q filed September 6, 2001 (File No.
000-31311).***
    
    Incorporated by reference to PDFs Report on Form 10-Q filed May 10, 2007 (File No.
000-31311).****
    
    As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly
Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and
are not incorporated by reference in any filing of PDF Solutions, Inc. under the Securities
Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date
hereof and irrespective of any general incorporation language in any filings. 
 35




---



##### Table of Contents



SIGNATURES
  Date: November 9, 2007
    By:
    /s/ JOHN K. KIBARIANJohn K. KibarianPresident and Chief Executive OfficerBy:
    /s/ KEITH A. JONESKeith A. JonesChief Financial Officer and Vice President of Finance 36




---



##### Table of Contents



EXHIBIT INDEX
 ExhibitNumber
    
    Description3.01
    
    
    Third Amended and Restated Certificate of Incorporation of PDF Solutions, Inc.*3.02
    
    
    Amended and Restated Bylaws of PDF Solutions, Inc. 4.01
    
    
    Specimen Stock Certificate **4.02
    
    
    Second Amended and Restated Rights Agreement dated July 6, 2001*10.01
    
    
    2001 Stock Plan and related agreements ***31.01
    
    
    Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.02
    
    
    Certification of the Chief Financial Officer and Vice President of Finance and Administration pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.01
    
    
    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 and Administration pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ****
 
 
    
    Incorporated by reference to PDFs Report on Form 10-Q filed August 9, 2005 (File No.
000-31311).*
    
    Incorporated by reference to PDFs Registration Statement on Form S-1, Amendment No. 7 filed
July 9, 2001 (File No. 333-43192).**
    
    Incorporated by reference to PDFs Report on Form 10-Q filed September 6, 2001 (File No.
000-31311).***
    
    Incorporated by reference to PDFs Report on Form 10-Q filed May 10, 2007 (File No.
000-31311).****
    
    As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly
Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and
are not incorporated by reference in any filing of PDF Solutions, Inc. under the Securities
Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date
hereof and irrespective of any general incorporation language in any filings. 37