Table of Contents

 

 

 

**UNITEDSTATESSECURITIES 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 ended  March 31, 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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**PDFSOLUTIONS, 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)

 

Indicate by check markwhether the Registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes  x     No  £

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes  o     No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

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

 

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

 

The number of shares outstanding of the Registrant’sCommon Stock as of May 1, 2009 was 26,261,010.

 

 

 

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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 | 14         |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                 | 23         |
| Item 4. Controls and Procedures                                                                     | 24         |
| **PART II  OTHER INFORMATION**                                                                 |       |
| Item  1. Legal Proceedings                                                                          | 24         |
| Item 1A. Risk Factors                                                                               | 24         |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                | 32         |
| Item 3. Defaults Upon Senior Securities                                                             | 32         |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        | 32         |
| Item  5. Other Information                                                                          | 32         |
| Item 6. Exhibits                                                                                    | 33         |
| **SIGNATURES**                                                                                      | 34         |
| **INDEX TO  EXHIBITS**                                                                              | 35         |

 

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**Item 1.Financial Statements.**

 

**PDFSOLUTIONS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                                                                          | ** ** | **March 31,  2009**         | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **(In thousands,**          | ** ** |
| ** **                                                                                                                                                          | ** ** | **except par values)** | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **                       | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                     |       |                             |       |                        |       |
| Cash and cash  equivalents                                                                                                                                          |       | $                                | 32,780     |                        | $          | 31,686 |   |
| Short-term  investments                                                                                                                                             |       | 6,354                            |       | 9,051                       |       |
| Accounts  receivable, net of allowance of $254 in 2009 and 2008                                                                                                     |       | 20,387                           |       | 24,989                      |       |
| Prepaid  expenses, deferred tax assets, and other current assets                                                                                                    |       | 3,639                            |       | 5,147                       |       |
| Total current  assets                                                                                                                                               |       | 63,160                           |       | 70,873                      |       |
| Property and  equipment, net                                                                                                                                        |       | 2,427                            |       | 2,675                       |       |
| Non-current  investments                                                                                                                                            |       | 718                              |       | 718                         |       |
| Intangible  assets, net                                                                                                                                             |       | 4,280                            |       | 4,730                       |       |
| Deferred tax  assets and other non-current assets                                                                                                                   |       | 626                              |       | 631                         |       |
| Total assets                                                                                                                                                        |       | $                                | 71,211     |                        | $          | 79,627 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                             |       |                        |       |
| Current liabilities:                                                                                                                                                |       |                             |       |                        |       |
| Current portion  of long-term debt                                                                                                                                  |       | $                                | 336        |                        | $          | 370 |   |
| Accounts payable                                                                                                                                                    |       | 1,715                            |       | 1,384                       |       |
| Accrued  compensation and related benefits                                                                                                                          |       | 5,850                            |       | 6,525                       |       |
| Taxes payable  and other accrued liabilities                                                                                                                        |       | 3,093                            |       | 3,723                       |       |
| Deferred revenue                                                                                                                                                    |       | 2,057                            |       | 1,792                       |       |
| Billings in  excess of recognized revenue                                                                                                                           |       | 247                              |       | 748                         |       |
| Total current  liabilities                                                                                                                                          |       | 13,298                           |       | 14,542                      |       |
| Long-term debt                                                                                                                                                      |       | 461                              |       | 512                         |       |
| Long-term taxes  payable                                                                                                                                            |       | 3,354                            |       | 3,356                       |       |
| Long-term other  liabilities                                                                                                                                        |       | 1,400                            |       | 1,447                       |       |
| Total  liabilities                                                                                                                                                  |       | 18,513                           |       | 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 29,680 in 2009  and 29,339 in 2008; shares outstanding 26,264 in 2009 and 25,923 in 2008 |       | 4                                |       | 4                           |       |
| Additional  paid-in-capital                                                                                                                                         |       | 190,685                          |       | 189,132                     |       |
| Treasury stock  at cost, 3,416 shares in 2009 and 2008                                                                                                              |       | (18,402                          | )          | (18,402                     | )          |
| Accumulated  deficit                                                                                                                                                |       | (119,941                         | )          | (112,620                    | )          |
| Accumulated  other comprehensive income                                                                                                                             |       | 352                              |       | 1,656                       |       |
| Total  stockholders’ equity                                                                                                                                    |       | 52,698                           |       | 59,770                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                    |       | $                                | 71,211     |                        | $          | 79,627 |   |

 

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

 

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**PDF SOLUTIONS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

 
| ** **                                               | ** ** | **Three Months Ended March 31,**    | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                               | ** ** | **2009**                                                | ** ** | **2008** | ** ** |
| ** **                                               | ** ** | **(In thousands, except per share** | ** ** |
| ** **                                               | ** ** | **amounts)**                                            | ** ** |
| Revenues:                                                |       |                                                    |       |   |   |
| Design-to-silicon-yield  solutions                       |       | $                                                       | 7,794      |   | $ | 15,024 |   |
| Gainshare  performance incentives                        |       | 2,396                                                   |       | 5,323 |   |
| Total revenues                                           |       | 10,190                                                  |       | 20,347 |   |
|                                                     |       |                                                    |       |   |   |
| Cost of  design-to-silicon-yield solutions:              |       |                                                    |       |   |   |
| Direct costs of  design-to-silicon-yield solutions       |       | 6,290                                                   |       | 7,766 |   |
| Amortization of  acquired technology                     |       | 359                                                     |       | 631 |   |
| Total cost of  design-to silicon-yield solutions         |       | 6,649                                                   |       | 8,397 |   |
| Gross margin                                             |       | 3,541                                                   |       | 11,950 |   |
|                                                     |       |                                                    |       |   |   |
| Operating  expenses:                                     |       |                                                    |       |   |   |
| Research and  development                                |       | 5,789                                                   |       | 9,076 |   |
| Selling, general  and administrative                     |       | 4,413                                                   |       | 6,299 |   |
| Amortization of  other acquired intangible assets        |       | 87                                                      |       | 194 |   |
| Restructuring  charges                                   |       | 633                                                     |       | — |   |
| Total operating  expenses                                |       | 10,922                                                  |       | 15,569 |   |
| Loss from  operations                                    |       | (7,381                                                  | )          | (3,619 | ) |
|                                                     |       |                                                    |       |   |   |
| Interest and  other income, net                          |       | 324                                                     |       | 489 |   |
| Loss before  taxes                                       |       | (7,057                                                  | )          | (3,130 | ) |
| Income tax  provision (benefit)                          |       | 264                                                     |       | (617 | ) |
| Net loss                                                 |       | $                                                       | (7,321     | ) | $ | (2,513 | ) |
|                                                     |       |                                                    |       |   |   |
| Net loss per  share — basic and diluted             |       | $                                                       | (0.28      | ) | $ | (0.09 | ) |
| Weighted average  common shares — basic and diluted |       | 26,092                                                  |       | 27,840 |   |

 

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

 

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**PDF SOLUTIONS, INC.**

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

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)**                          | ** ** |
| Operating  activities:                                                       |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (7,321     | ) | $ | (2,513 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                               |       | 414                                              |       | 524 |   |
| Stock-based  compensation expense                                            |       | 1,136                                            |       | 1,983 |   |
| Losses on  disposal of property, plant and equipment                         |       | 1                                                |       | 2 |   |
| Amortization of  acquired intangible assets                                  |       | 446                                              |       | 825 |   |
| Tax shortfall  related to stock-based compensation expense                   |       | —                                           |       | (11 | ) |
| Deferred taxes  and other assets                                             |       | (5                                               | )          | (1,284 | ) |
| Changes in  operating assets and liabilities:                                |       |                                             |       |   |   |
| Accounts  receivable, net of allowances                                      |       | 4,595                                            |       | 62 |   |
| Prepaid expenses  and other assets                                           |       | 1,459                                            |       | (418 | ) |
| Accounts payable                                                             |       | 415                                              |       | (1,332 | ) |
| Accrued  compensation and related benefits                                   |       | (609                                             | )          | (525 | ) |
| Taxes payable  and other accrued liabilities                                 |       | (624                                             | )          | 849 |   |
| Deferred  revenues                                                           |       | 265                                              |       | 1,280 |   |
| Billings in  excess of recognized revenue                                    |       | (502                                             | )          | (199 | ) |
| Net cash used in  operating activities                                       |       | (330                                             | )          | (757 | ) |
| Investing  activities:                                                       |       |                                             |       |   |   |
| Purchases of  available-for-sale securities                                  |       | —                                           |       | (8,848 | ) |
| Maturities and  sales of available-for-sale securities                       |       | 2,700                                            |       | 7,585 |   |
| Purchases of  property and equipment                                         |       | (299                                             | )          | (240 | ) |
| Net cash  provided by (used in) investing activities                         |       | 2,401                                            |       | (1,503 | ) |
| Financing  activities:                                                       |       |                                             |       |   |   |
| Proceeds from  exercise of stock options                                     |       | —                                           |       | 40 |   |
| Proceeds from  Employee Stock Purchase Plan                                  |       | 417                                              |       | — |   |
| Purchases of  treasury stock                                                 |       | —                                           |       | (1,124 | ) |
| Principal  payments on long-term debt                                        |       | (51                                              | )          | (56 | ) |
| Net cash  provided by (used in) financing activities                         |       | 366                                              |       | (1,140 | ) |
| Effect of  exchange rate changes on cash                                     |       | (1,343                                           | )          | 1,110 |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | 1,094                                            |       | (2,290 | ) |
| Cash and cash  equivalents, beginning of period                              |       | 31,686                                           |       | 35,315 |   |
| Cash and cash  equivalents, end of period                                    |       | $                                                | 32,780     |   | $ | 33,025 |   |
| Supplemental  disclosure of cash flow information:                           |       |                                             |       |   |   |
| Cash paid during  the year for:                                              |       |                                             |       |   |   |
| Taxes                                                                        |       | $                                                | 232        |   | $ | 244 |   |
| Interest                                                                     |       | $                                                | 7          |   | $ | 11 |   |

 

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

 

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**PDFSOLUTIONS, INC.**

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

 

**1. BASIS OF PRESENTATION**

 

*Basis of Presentation*

 

The interim unauditedcondensed consolidated financial statements included herein have been preparedby PDF Solutions, Inc., or the Company, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission, or the SEC, includingthe instructions to the Quarterly Report on Form 10-Q and Article 10of Regulation S-X. Certain information and footnote disclosures normallyincluded in annual financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted. The interim unaudited condensed consolidated financialstatements reflect, in the opinion of management, all adjustments necessary,(consisting only of normal recurring adjustments) to present a fair statementof results for the interim periods presented. The operating results for anyinterim period are not necessarily indicative of the results that may beexpected for other interim periods or the full fiscal year. The accompanyinginterim unaudited condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements and notesthereto in the Company’s Annual Report on Form 10-K for the year ended December 31,2008.

 

The preparation of thecondensed consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses. A significant portion of theCompany’s revenues require estimates with respect to total costs which may beincurred and revenues earned. Actual results could differ from these estimates.

 

The condensedconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries after the elimination of all significant intercompanybalances and transactions.

 

*Revenue Recognition*

 

The Company derivesrevenue from two sources: Design-to-Silicon-Yield Solutions, which includesServices and Software Licenses, and Gainshare Performance Incentives. TheCompany recognizes revenue in accordance with the provisions of AmericanInstitute of Certified Public Accountants Statement of Position, or SOP, No. 81-1,*Accounting for Performance ofConstruction-Type and**CertainProduction-Type Contracts*and SOP No. 97-2, *Software Revenue**Recognition,*as amended.

 

*Design-to-Silicon-YieldSolutions*— 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 significant portion of itsDesign-to-Silicon-Yield solutions revenue from fixed-price solutionimplementation service contracts delivered over a specific period of time.These contracts require accurate estimation of costs to perform obligations andoverall 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.

 

On occasion, theCompany has licensed its software products as a component of its fixed-priceservices contracts. In such instances, the software products are licensed tocustomers over a specified term of the agreement with support and maintenanceto be provided over the license term. Under these arrangements, wherevendor-specific objective evidence of fair value, or VSOE, exists for thesupport and maintenance element, the support and maintenance revenue isrecognized separately over the term of the support period. The remaining fee isrecognized as services are performed using the cost-to-cost percentage ofcompletion method of contract accounting. VSOE for maintenance, in theseinstances, is generally based upon the Company’s customary pricing formaintenance when sold separately and is measured by the renewal rate offered tothe customer. Under arrangements where software products are licensed as acomponent of its fixed-price service contract and where VSOE does not exist toallocate a portion of the total fixed-price to the undelivered elements,revenue is recognized for the total fixed-price as the lesser of either thepercentage of completion method of contract accounting or ratably over thelonger 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 relatedsupport and maintenance services is recognized ratably over the term of thesupport and maintenance contract, generally one year, while revenue fromconsulting, installation and training services is recognized as the servicesare performed. When bundled with software licenses in multiple elementarrangements, support and maintenance, consulting (other than for itsfixed-price solution implementations), installation, and training revenue isallocated to each element of a transaction based upon its fair value asdetermined by the Company’s VSOE. VSOE for all elements is generally based uponthe Company’s customary pricing for such services when sold separately andsupport and maintenance services is also measured by the renewal rate offeredto the customer. When VSOE does not exist to allocate a portion of the totalfee to the undelivered elements, revenue is recognized ratably over the longestperiod of the undelivered elements.

 

*SoftwareLicenses* — The Company also licenses its softwareproducts separately from its integrated solution implementations. For softwarelicense 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) collectibility 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. VSOE for all elements isgenerally based upon the Company’s customary pricing for such services whensold separately and support and maintenance services is also measured by therenewal rate offered to the customer. When VSOE does not exist to allocate aportion of the total fee to the undelivered elements, revenue is recognizedratably over the longest period of the undelivered elements, and such revenueis recorded as services. Revenue for software licenses with extended paymentterms is not recognized in excess of amounts due. For software licensearrangements that require significant modification or customization of theunderlying software, the software license revenue is recognized as services areperformed using the cost-to-cost percentage of completion method of contractaccounting, and such revenue is recorded as services.

 

*Gainshare Performance Incentives* —When the Company enters into a contract to provide yield improvement services,the contract usually includes two components: (1) a fixed fee forperformance by the Company of services delivered over a specific period oftime; and (2) a gainshare performance incentives component where thecustomer may pay a variable fee, usually after the fixed fee period has ended.Revenue derived from gainshare performance incentives represents profit sharingand performance incentives earned based upon the Company’s customers reachingcertain defined operational levels established in related solution implementationservices contracts. Gainshare performance incentives periods are usuallysubsequent to the delivery of all contractual services and therefore have nocost to the Company. Due to the uncertainties surrounding attainment of suchoperational levels, the Company recognizes gainshare performance incentivesrevenue (to the extent of completion of the related solution implementationcontract) upon receipt of performance reports or other related information fromthe customer supporting the determination of amounts and probability ofcollection.

 

*Software Development 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 in accordance with SFAS No. 86, *Computer Software**to be Sold, Leased or Otherwise Marketed.*Becausethe Company believes its current process for developing software is essentiallycompleted concurrently with the establishment of technological feasibility, nocosts have been capitalized to date.

 

**2. RECENT ACCOUNTING PRONOUNCEMENTSAND ACCOUNTING CHANGES**

 

In April 2009, theFASB issued FSP No. 157-4, *Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly,*or FSP No. 157-4.  FSP No. 157-4provides guidance for estimating fair value in accordance with SFAS No. 157*,*when the volume and level of activity for the asset orliability have significantly decreased. This FSP also includes guidance onidentifying circumstances that indicate a transaction is not orderly. FSP No. 157-4is effective for interim and annual reporting periods ending after June 15,2009 and will be adopted by the Company in the second quarter of fiscal2009.  The adoption of FAS No. 157-4is not expected to have a material impact on the Company’s operating resultsand financial position.

 

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In April 2009, the FASBissued FSP No. FAS 115-2 and FAS 124-2, *Recognitionand Presentation of Other-Than-Temporary Impairments*, or FSP FAS115-2 and 124-2.  FSP FAS 115-2 and 124-2 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. FSP FAS 115-2 and 124-2 are effectivefor interim and annual reporting periods ending after June 15, 2009 and will beadopted by the Company in the second quarter of fiscal 2009. The Company iscurrently evaluating the potential impact, if any, that the adoption of FSP FAS 115-2 and 124-2 will have on its consolidated financial statements.

 

In April 2009, theFASB issued FSP No. 107, *Disclosures about FairValue of Financial Instruments,*or FSP No. 107,**to require disclosures about fair value of financialinstruments for interim reporting periods of publicly traded companies as wellas in annual financial statements.  ThisFSP also amends the Accounting Principals Board, or the APB, Opinion No. 28,*Interim Financial Reporting,*to requirethose disclosures in summarized financial information at interim reportingperiods.  FSP No. 107 is effectivefor interim and annual reporting periods ending after June 15, 2009, andwill be adopted by the Company in the second quarter of fiscal 2009. Theadoption of FSP No 107 is not expected to have a material effect on the Company’soperating results and financial position.

 

Effective January 1, 2009, the Company adoptedthe provisions of the FASB’s SFAS No. 141 (revised 2007), *Business Combinations,*or SFAS No. 141R.SFAS No. 141R establishes principles and requirements for how an acquirerof a business recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any noncontrollinginterest in the acquiree, and the goodwill acquired. SFAS No. 141R alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. The adoption of SFAS No. 141R  did not have an effect on the Company’sfinancial results and position.

 

**3.INVESTMENTS**

 

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

 
| ** **                           | ** ** | ** **           | ** ** | **March 31, 2009**   | ** ** | ** **                      | ** ** |
|--------------------------------------|------------|----------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Amortized  Costs** | ** ** | **Unrealized  Holding  Gains** | ** ** | **Unrealized  Holding  Losses** | ** ** | **Fair  Value** | ** ** |
| Agency  obligations                  |       | $                    | 5,927      |                           | $          | 28                              |       | $ | — |   | $ | 5,955 |   |
| Auction-rate securities              |       | 1,000                |       | —                         |       | (282                            | )          | 718 |   |
| Corporate  securities                |       | 400                  |       | —                         |       | (1                              | )          | 399 |   |
|                                 |       | $                    | 7,327      |                           | $          | 28                              |       | $ | (283 | ) | $ | 7,072 |   |
| Included in  short term investments  |       |                 |       |                           |       |                            |       | 6,354 |   |
| Included in  non-current investments |       |                 |       |                           |       |                            |       | 718 |   |
| Total                                |       |                 |       |                           |       |                            |       | $ | 7,072 |   |

 
| ** **                           | ** ** | ** **           | ** ** | **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 March 31, 2009and December 31, 2008, all securities, other than auction-rate securitiesheld by the Company, had a maturity of one year or less. Please refer to Note12 “Fair Value” for further discussion of auction-rate securities.

 

**4. ACCOUNTS RECEIVABLE**

 

Accounts receivableinclude amounts that are unbilled at the end of the period. Unbilled accountsreceivable are determined on an individual contract basis and wereapproximately $9.5 million and $10.5 million as of March 31, 2009 and December 31,2008, respectively.

 

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**5. GOODWILL AND ACQUIRED INTANGIBLEASSETS**

 

SFAS No. 142*, Goodwill and other Intangible Assets,*requiresgoodwill to be tested for impairment on an annual basis (or more frequently ifindicators of impairment exist) and requires purchased intangible assets otherthan goodwill to be amortized over their useful lives unless these lives aredetermined to be indefinite. The Company completed its annual impairment testin the fourth quarter of 2008 and the Company observed impairment indicatorsduring the fourth quarter of 2008 including the trading of common stock belowthe Company’s book value and a further deterioration in the semiconductorindustry, brought on by the deteriorating global economic environment. TheCompany also evaluated its acquired intangible assets for impairment.  As a result of the impairment analyses, theCompany recorded an impairment charge of $64 million related to goodwill and$6.3 million relating to its acquired intangible assets during the fourthquarter of 2008.

 

The following tableprovides information relating to the intangible assets and goodwill as of March 31,2009 and December 31, 2008 (in thousands):

 
| **Acquired Identifiable Intangibles** | ** ** | **Amortization  Period  (Years)** | ** ** | **December 31,  2008  Net Carrying  Amount** | ** ** | **Amortization** | ** ** | **Foreign  Currency  Translation** | ** ** | **March 31,  2009  Net Carrying  Amount** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------------|------------|------------------|------------|------------------------------------|------------|-----------------------------------------------------|------------|
| Acquired  technology                            |       | 4 - 5                             |       | $                                                      | 3,608      |             | $          | (359                               | )          | $                                                   | —     |   | $ | 3,249 |   |
| Brand name                                      |       | 4                                 |       | 129                                                    |       | (18              | )          | —                             |       | 111                                                 |       |
| Customer  relationships and backlog             |       | 1 - 6                             |       | 489                                                    |       | (32              | )          | —                             |       | 457                                                 |       |
| Patent and  applications                        |       | 7                                 |       | 400                                                    |       | (18              | )          | —                             |       | 382                                                 |       |
| Other acquired  intangibles                     |       | 4                                 |       | 104                                                    |       | (19              | )          | (4                                 | )          | 81                                                  |       |
| Total                                           |       |                              |       | $                                                      | 4,730      |             | $          | (446                               | )          | $                                                   | (4         | ) | $ | 4,280 |   |

 
| ** **                          | ** ** | **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 Companyexpects the annual amortization of acquired intangible assets to be as follows(in thousands):

 
| **Year Ending December 31,** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2009 (remaining  nine-month period)         |       | $          | 1,334      |   |
| 2010                                        |       | 1,577      |       |
| 2011                                        |       | 829        |       |
| 2012                                        |       | 435        |       |
| 2013                                        |       | 74         |       |
| 2014 and  thereafter                        |       | 31         |       |
| Total                                       |       | $          | 4,280      |   |

 

**6. STOCKHOLDERS’ EQUITY**

 

The Company accounts forstock-based compensation in accordance with SFAS No. 123 (revised 2004), *Share-Based Payment.* Stock-based compensation expensesbefore taxes related to the Company’s employee stock purchase plan andstock-option plans were allocated as follows (in thousands):

 
| ** **                                 | ** ** | **Three Months  Ended March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Cost of  design-to-silicon-yield solutions |       | $                                                | 389        |   | $ | 530 |   |
| Research and  development                  |       | 348                                              |       | 595 |   |
| Selling, general  and administrative       |       | 399                                              |       | 858 |   |
| Stock-based  compensation expenses         |       | $                                                | 1,136      |   | $ | 1,983 |   |

 

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The Company estimated thefair value of share-based payments using the Black-Scholes-Mertonoption-pricing model with the following weighted average assumptions andweighted average fair values:

 
| ** **                                                                        | ** ** | **Stock Plans  Three Months Ended March 31,** | ** ** | **Employee Stock Purchase Plan  Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2009**                                                               | ** ** | **2008**                                                                                          | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected life  (in years)                                                         |       | 5.16                                                                   |       | 5.77                                                                                              |       | 1.25 |   | 1.33 |   |
| Volatility                                                                        |       | 61.3                                                                   | %          | 58.2                                                                                              | %          | 79.7 | % | 54.9 | % |
| Risk-free  interest rate                                                          |       | 2.03                                                                   | %          | 2.91                                                                                              | %          | 1.28 | % | 3.10 | % |
| Expected  dividend                                                                |       | —                                                                 |       | —                                                                                            |       | — |   | — |   |
| Weighted average  fair value per share of options granted during the period       |       | $                                                                      | 0.57       |                                                                                              | $          | 3.84 |   | — |   | — |   |
| Weighted average  fair value per share of employee stock issued during the period |       | —                                                                 |       | —                                                                                            |       | $ | 0.81 |   | $ | 3.60 |   |
|                                                                                   |            |                                                                        |            |                                                                                                   |            |  |  |  |  |  |  |  |  |

 

On March 31, 2009,the Company has in effect the following stock-based compensation plans:

 

*StockPlans —*During 2001, the Company terminated the 1996 and 1997Stock Plans as to future option grants, and adopted the 2001 Stock Plan. Underthe 2001 Stock Plan, on January 1 of each year, starting with year 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.

 

Stock option activityunder the Company’s plan during the three months ended March 31, 2009 wasas follows:

 
| ** **                          | ** ** | **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                             |       | 30                                               |       | 1.16                                                           |       |                                                                 |       |                                                     |       |
| Exercised                           |       | —                                           |       | —                                                         |       |                                                                 |       |                                                     |       |
| Canceled                            |       | (19                                              | )          | 8.73                                                           |       |                                                                 |       |                                                     |       |
| Expired                             |       | (53                                              | )          | 9.58                                                           |       |                                                                 |       |                                                     |       |
| Outstanding,  March 31, 2009   |       | 4,370                                            |       | 8.87                                                           |       | 6.97                                                                 |       | $                                                        | 23         |   |
| Vested and  expected to vest        |       | 4,071                                            |       | 8.96                                                           |       | 6.84                                                                 |       | $                                                        | 20         |   |
| Exercisable at  March 31, 2009 |       | 2,618                                            |       | 9.54                                                           |       | 5.80                                                                 |       | $                                                        | 11         |   |
|                                     |            |                                                  |            |                                                                |            |                                                                      |            |                                                          |            |  |  |

 

The aggregate intrinsicvalue in the table above represents the total intrinsic value based on theCompany’s closing stock price of $1.57 as of March 31, 2009, which wouldhave been received by the option holders had all “in-the-money” option holdersexercised their options as of that date. There were no stock options exercisedduring the three months ended March 31, 2009.

 

As of March 31,2009, there was $6.2 million of total unrecognized compensation cost related tononvested stock options. That cost is expected to be recognized over a weightedaverage period of 2.5 years. The total fair value of shares vested during thethree months ended March 31, 2009 was $838,000.

 

Nonvested shares(restricted stock units) activity during the three months ended March 31,2009 were as follows:

 
| ** **                       | ** ** | **Shares  (in thousands)** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|----------------------------------|------------|---------------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested,  January 1, 2009 |       | 852                             |       | $                                                           | 8.64       |   |
| Granted                          |       | —                          |       | —                                                      |       |
| Vested                           |       | (8                              | )          | 10.73                                                       |       |
| Forfeited                        |       | (9                              | )          | 12.36                                                       |       |
| Nonvested,  March 31, 2009  |       | 835                             |       | 8.63                                                        |       |
|                                  |            |                                 |            |                                                             |            |  |

 

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As of March 31,2009, there was $4.0 million of total unrecognized compensation cost related tononvested restricted stock units. That cost is expected to be recognized over aweighted average period of 3.3 years. The total compensation expense related toshares expected to vest during the three months ended March 31, 2009 was$367,000.

 

*EmployeeStock Purchase Plan*— In July 2001, the Company adoptedan Employee Stock Purchase Plan, or Purchase Plan, under which eligibleemployees can contribute up to 10% of their compensation, as defined in thePurchase Plan, towards the purchase of shares of PDF common stock at a price of85% of the lower of the fair market value at the beginning of the offeringperiod or the end of each six-month offering period. Under the Purchase Plan,on January 1 of each year, starting with 2002, the number of sharesreserved for issuance will automatically increase by the lesser of (1) 675,000 shares,(2) 2% of the Company’s outstanding common stock on the last day of theimmediately preceding year, or (3) the number of shares determined by theboard of directors. For the three months ended March 31, 2009, thePurchase Plan compensation expense was $59,000.

 

*StockRepurchase Program*— On March 26, 2003, the Company’sBoard of Directors approved a share repurchase program to purchase up to $10.0million of its outstanding common stock. The 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 March 31, 2009, 2.4 million shares have been repurchased atthe average price of $3.46 per share under this program and $1.6 millionremained available for future repurchases.

 

**7.RESTRUCTURING**

 

In 2008, the Companyannounced two restructuring plans to better allocate its resources to improveits operational results in light of current market conditions, one on April 29,2008 and the other on October 28, 2008.

 

For the plan announced onApril 29, 2008, the Company recorded restructuring charges of $1.5 millionduring the three months ended June 30, 2008, which primarily consisted ofemployee severance costs of $1.4 million. All severance costs and related feeswere paid out and the activities were completed as of March 31, 2009.

 

For the plan announced onOctober 28, 2008, the Company recorded restructuring charges of $1.5million during the three months ended December 31, 2008 and an additional$633,000 during the three months ended March 31, 2009 and expect to incuradditional charges as part of the continuing cost control efforts during thethree months ending June 30, 2009. The restructuring charges primarilyconsisted of employee severance costs of $1.5 million and facility exit costsof $985,000. The following table summarizes the activities of theserestructuring 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                                                   |       | 582           |       | —                 |       | 51                                         |       | 633       |       |
| Payments                                                                 |       | (771          | )          | (110                   | )          | (50                                        | )          | (931      | )          |
| Balance,  March 31, 2009                                            |       | $             | 671        |                   | $          | 998                                        |       | $         | 32         |   | $ | 1,701 |   |

 

As of March 31,2009, of the remaining accrual of $1.7 million, $1.2 million was included inaccrued liabilities and $544,000 was included in long-term other liabilities.Accrued severance of $671,000 and accrued professional and other fees of$28,000 are expected to be paid out in the second quarter of 2009. Accruedfacility exit costs will be paid in accordance with the lease payment schedulethrough 2013.

 

**8. INCOME TAXES**

 

The Company accounts fortemporary differences between the book and tax basis of assets and liabilitiesby recording deferred tax assets and liabilities in accordance with SFAS No. 109,*Accounting for Income Taxes*, andFinancial Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes — An Interpretation of FASB Statement No. 109*,or FIN No. 48.**The Companymust assess the likelihood that its deferred tax assets will be recovered fromfuture taxable income and, to the extent the Company believes that recovery isnot likely, the Company must establish a valuation allowance. Changes in theCompany’s net deferred tax assets, less offsetting valuation allowance, in aperiod are recorded through the income tax provision in the condensedconsolidated statements of operations.

 

In accordance withFIN No. 48, the Company classifies its liabilities related tounrecognized tax benefits as long-term. The Company includes interest andpenalties related to unrecognized tax benefits within the Company’s income taxprovision (benefit). As of March 31, 2009 and December 31, 2008, theCompany had $636,000 and $562,000, respectively, accrued for payment ofinterest and penalties related to unrecognized tax benefits.

 

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The Company’s totalamount of unrecognized tax benefits as of March 31, 2009 was $8.4 million,of which $2.9 million, if recognized, would affect the Company’s effective taxrate. The Company’s total amount of unrecognized tax benefits as of December 31,2008 was $8.2 million of which $2.8 million, if recognized, would affect theCompany’s effective tax rate. As of March 31, 2009, the Company hasrecognized a net amount of $3.4 million as long-term taxes payable forunrecognized tax benefits in its consolidated balance sheets. The Company doesnot expect the change in unrecognized tax benefits over the next twelve monthsto materially impact its results of operations and financial position.

 

The Company conductsbusiness globally and, as a result, files numerous consolidated and separateincome tax returns in the U.S. federal, various state and foreignjurisdictions. Because the Company used some of the tax attributes carriedforward from previous years to tax years that are still open, statutes oflimitation 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**

 

Basic net loss per shareis computed by dividing net loss by the weighted average common sharesoutstanding for the period (excluding outstanding stock options and sharessubject to repurchase). Diluted net loss per share reflects the weightedaverage common shares outstanding plus the potential effect of dilutivesecurities which are convertible into common shares (using the treasury stockmethod), except in cases where the effect would be anti-dilutive. The followingis a reconciliation of the numerators and denominators used in computing basicand diluted net loss per share (in thousands, except per share amount):

 
| ** **                                         | ** ** | **Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Net loss                                           |       | $                                                | (7,321     | ) | $ | (2,513 | ) |
| Denominator for  basic calculation:                |       |                                             |       |   |   |
| Weighted average  common shares outstanding- basic |       | 26,092                                           |       | 27,840 |   |
| Dilutive items                                     |       |                                             |       |   |   |
| Stock options  outstanding                         |       | —                                           |       | — |   |
| Denominator for  diluted computation               |       | 26,092                                           |       | 27,840 |   |
| Net loss per  share — basic and diluted       |       | $                                                | (0.28      | ) | $ | (0.09 | ) |

 

**10.COMPREHENSIVE LOSS**

 

The components ofcomprehensive loss are as follows (in thousands):

 
| ** **                                                           | ** ** | **Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                           | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Net loss                                                             |       | $                                                | (7,321     | ) | $ | (2,513 | ) |
| Unrealized loss  on investments, net of income tax effects           |       | (37                                              | )          | (42 | ) |
| Foreign currency  translation adjustments, net of income tax effects |       | (1,267                                           | )          | 1,958 |   |
| Comprehensive  loss                                                  |       | $                                                | (8,625     | ) | $ | (597 | ) |

 

**11. CUSTOMER AND GEOGRAPHICINFORMATION**

 

SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated**Information*,establishes standards for reporting information about operating segments.Operating segments are defined as components of an enterprise about whichseparate financial information is available that is evaluated regularly by thechief operating decision maker, or group, in deciding how to allocate resourcesand in assessing performance.

 

The Company’s chief operating decision maker, theChief Executive Officer, reviews discrete financial information presented on aconsolidated basis for purposes of making operating decisions and assessingfinancial performance. Accordingly the Company considers itself to be in oneoperating segment, specifically the licensing and implementation of yieldimprovement solutions for integrated circuit manufacturers.

 

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The Company hadrevenues from individual customers in excess of 10% of total revenues asfollows:

 
| ** **   | ** ** | **Three Months  Ended March 31,** | ** ** |
|--------------|------------|--------------------------------------------------|------------|
| **Customer** | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| A            |       | 29                                               | %          | 16 | % |
| B            |       | 10                                               | %          | * | % |
| C            |       | *                                                | %          | 18 | % |

 

----

*  representsless than 10%

 

The Company had grossaccounts receivable from the following individual customers in excess of 10% ofgross accounts receivable as follows:

 
| **Customer** | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|--------------|------------|------------------------------|------------|---------------------------------|------------|
| A            |       | 19                           | %          | 17                              | %          |
| B            |       | 12                           | %          | *                               | %          |
| C            |       | *                            | %          | 12                              | %          |
| D            |       | 15                           | %          | 11                              | %          |
| E            |       | 11                           | %          | *                               | %          |
| F            |       | *                            | %          | 12                              | %          |

 

----

*  representsless than 10%

 

Revenues from customersby geographic area are as follows (in thousands):

 
| ** **    | ** ** | **Three Months  Ended March 31,** | ** ** |
|---------------|------------|--------------------------------------------------|------------|
| ** **    | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Asia          |       | $                                                | 5,458      |   | $ | 10,399 |   |
| United States |       | 4,066                                            |       | 5,608 |   |
| Europe        |       | 666                                              |       | 4,340 |   |
| Total         |       | $                                                | 10,190     |   | $ | 20,347 |   |

 

As of March 31, 2009and December 31, 2008, long-lived assets related to PDF Solutions S.A.S.(formerly Si Automation S.A.), located in France, totaled $273,000 and$336,000, respectively. The majority of the Company’s remaining long-livedassets are in the United States.

 

**12.FAIR VALUE**

 

Under SFAS No. 157,fair value is defined as the exit price, or the amount that would be receivedto sell an asset or paid to transfer a liability in an orderly transactionbetween market participants as of the measurement date. SFAS No. 157refers to the multiple assumptions used to value financial instruments asinputs, and establishes hierarchy for inputs used in measuring fair value thatmaximizes the use of observable inputs and minimizes the use of unobservableinputs by requiring that the most observable inputs be used when available.Observable inputs reflect assumptions market participants would use in pricingan asset or liability based on market data obtained from independent sourceswhile unobservable inputs reflect a reporting entity’s pricing based upon itsown market assumptions. These inputs are ranked according to a fair valuehierarchy that prioritizes the inputs to valuation techniques used to measurefair value into 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.                                                                                                                                                                                                                          |

 

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The following table represents the Company’s assetsmeasured at fair value on a recurring basis as of March 31, 2009 and thebasis for that measurement (in thousands):

 
| **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 |       | $         | 26,569     |                                                                                                | $          | 26,569                                                             |       | $                                                         | —     |   | $ | — |   |
| Agency  Obligations        |       | 5,955     |       | —                                                                                              |       | 5,955                                                              |       | —                                                    |       |
| Corporate  Securities      |       | 399       |       | —                                                                                              |       | 399                                                                |       | —                                                    |       |
| Auction-rate  securities   |       | 718       |       | —                                                                                              |       | —                                                             |       | 718                                                       |       |
| Total                      |       | $         | 33,641     |                                                                                                | $          | 26,569                                                             |       | $                                                         | 6,354      |   | $ | 718 |   |

 

The Company holdsinvestments in auction-rate securities, or ARS, which are variable rate debtinstruments whose interest rates are reset through a “dutch” auction process atregular intervals, typically every 28 days. All ARS are backed by pools ofstudent loans guaranteed by governmental agencies and private entities, andwere rated AAA/Aaa at the date of acquisition. The liquidity and fair value ofthese securities has been reduced by the uncertainty in the credit markets andthe exposure of these securities to the financial condition of bond insurancecompanies, as evidenced by the rating downgrade of MBIA (bond insurer on one ofthe Company’s ARS) from Aaa to A2, by Moody’s Investor Services on June 19,2008. All ARS have failed to sell at auction since February 2008, and as aresult, their interest rates were reset to the maximum LIBOR + 150 basispoints. The only activity since February 2008 was the repurchase of$500,000 of ARS at par by issuers. As a result of these auction failures, therewas limited active market with observable prices for these securities as of March 31,2009; 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. As aresult, the Company recorded a temporary impairment to other comprehensiveincome and classified these securities as non-current investments. Thevaluation may be revised in future periods as market conditions evolve.

 

The followingrepresents the reconciliation of the beginning and ending balance of assetsmeasured at fair value on a recurring basis using significant unobservableinputs (Level 3) during the three months ended March 31, 2009 (inthousands):

 
| ** **                                                                                                                                                                               | ** ** | **Available-For-Sale  Securities** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| Beginning  balance, January 1, 2009                                                                                                                                                 |       | $                                  | 718        |   |
| Total gains and  losses (realized / unrealized):                                                                                                                                         |       |                               |       |
| Included in  earnings                                                                                                                                                                    |       | —                             |       |
| Included in  other comprehensive income, before income tax effects                                                                                                                       |       | —                             |       |
| Purchases,  issuances, and settlements                                                                                                                                                   |       | —                             |       |
| Transfers, in  and/or (out) of Level 3                                                                                                                                                   |       | —                             |       |
| Ending balance,  March 31, 2009                                                                                                                                                     |       | $                                  | 718        |   |
| The amount of  total gains or losses for the period included in earnings attributable to the  change in unrealized gains or losses relating to assets still held at March 31,  2009 |       | $                                  | —     |   |

 

**Item 2. Management’s Discussion and Analysis of FinancialCondition and Results****ofOperations.**

 

**Forward-LookingStatements**

 

The following discussionof our financial condition and results of operations contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934. In some cases, youcan identify forward-looking statements by terminology such as “may,” “could,” “will,”“should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential”or “continue,” the negative effect of terms like these or other similarexpressions. Any statement concerning future financial performance (includingfuture revenues, earnings or growth rates), ongoing business strategies orprospects, and possible actions taken by us or our subsidiaries, which may beprovided by us are also forward-looking statements. These forward-lookingstatements are only predictions. Forward-looking statements are based on currentexpectations and projections about future events and are inherently subject toa variety of risks and uncertainties, many of which are beyond our control,which could cause actual results to differ materially from those anticipated orprojected. All forward-looking statements included in this document are basedon information available to us on the date of filing and we further cautioninvestors that our business and financial performance are subject tosubstantial risks and uncertainties. We assume no obligation to update any suchforward-looking statements. In evaluating these statements, you shouldspecifically consider various factors, including the risk factors set forth in Part II,Item 1A and set forth at the end of Item 1A in our Annual Report on Form 10-Kfor the year ended December 31, 2008 filed with the Securities andExchange Commission on March 16, 2009.

 

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**Overview**

 

We analyze our customers’integrated circuit, or IC design and manufacturing processes to identify,quantify, and correct the issues that cause yield loss to improve our customers’profitability by improving time-to-market, increasing yield and reducing totaldesign and manufacturing costs. We package our solutions in various ways tomeet our customers’ specific business and budgetary needs, each of whichprovides us various revenue streams. We receive a mix of fixed fees andvariable, performance-based fees for the vast majority of our Integrated YieldRamp offerings. The fixed fees are typically reflective of the length of timeand the resources needed to characterize a customer’s manufacturing process andreceive preliminary results of proposed yield improvement suggestions. Thevariable fee, or what we call gainshare performance incentives, usually dependson our achieving certain yield targets by a deadline.  Variable fees are currently typically tied towafer volume on the node size of the manufacturing facility where we performedthe yield improvement. We receive license fees and service fees for relatedinstallation, integration, training, and maintenance and support services forour software that we license on a stand-alone basis.

 

***History***

 

From our incorporation in 1992 through late 1995, wewere primarily focused on research and development of our proprietarymanufacturing process simulation and yield and performance modeling software.From late 1995 through late 1998, we continued to refine and sell our software,while expanding our offering to include yield and performance improvementconsulting services. In late 1998, we began to sell our software and consultingservices, together with our newly developed proprietary technologies, under theterm Design-to-Silicon-Yield solutions, reflecting our current business model.In April 2000, we expanded our research and development team and gainedadditional technology by acquiring AISS. AISS now operates as PDF Solutions,GmbH, a German company, which continues to develop software and providedevelopment services to the semiconductor industry. In July 2001, wecompleted the initial public offering of our common stock. In 2003, we enhancedour product and service offerings, including increased software applications,through the acquisitions of IDS and WaferYield. In 2006, we furthercomplemented our technology offering by acquiring Si Automation S.A. and addingits Fraud Detection and Classification, or FDC software capabilities to ourintegrated solution. In 2007, we increased our IP solutions portfolio,particularly in logic design technology, through the acquisition of Fabbrix,Inc. In 2008, we solidified our market leading position in the FDC softwaremarket, particularly in Korea, and now provide complementary technology to ourmæstria product through the acquisition of certain assets of Triant.

 

***Industry Trend***

 

Subject to the current general economic downturn,demand for consumer electronics and communications devices continues to drivetechnological innovation in the semiconductor industry as the need for productswith greater performance, lower power consumption, reduced costs and smallersize continues to grow with each new product generation. In addition, advancesin computing systems and mobile devices have fueled demand for higher capacitymemory chips. To meet these demands, IC manufacturers and designers areconstantly challenged to improve the overall performance of their ICs bydesigning and manufacturing ICs with more embedded applications to creategreater functionality while lowering cost per transistor. As a result, bothlogic 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 a greaterneed for products and services that address the yield loss and escalating costissues the semiconductor industry is facing today and will face in the future.

 

***Financial Highlights***

 

The semiconductor industryis currently experiencing significant challenges, primarily due to adeteriorating macroeconomic environment, and it is unclear when a turnaroundmay occur. As a result of this downturn, some of our customers faced financialchallenges in fiscal 2008 and may continue to face such challenges in fiscal2009. The current economic downturn has contributed to the substantialreduction in our revenue and could continue to harm our business, operatingresults and financial condition.

 

We plan operatingexpense levels primarily based on forecasted revenue levels. To partiallyoffset the impact of our expected decrease in revenue, we have implementedseveral cost savings initiatives, including reducing headcount and otherdiscretionary spending. During the year ended December 31, 2008, weinitiated two restructuring plans to improve our operating results and to alignour cost structure with expected revenue.

 

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Financial highlights forthe three months ended March 31, 2009 were as follows:

 

**·****           **Total revenue forthe three months ended March 31, 2009 was $10.2 million, a decrease of$10.2 million, or 50% compared to the three months ended March 31, 2008.Design-to-Silicon-Yield solutions revenue for the three months ended March 31,2009 was $7.8 million, a decrease of $7.2 million, or 48%, compared to $15.0million for the three months ended March 31, 2008. The decrease inDesign-to-Silicon Yield solutions revenue was primarily the result of lowerbookings, as customers have delayed purchases for capacity expansion andinvestment in leading-edge technology. The dramatic downturn in thesemiconductor industry combined with weakness in worldwide economies has beenthe primary contributors to this reduction. Gainshare performance incentivesrevenue for the three months ended March 31, 2009 was $2.4 million, adecrease of $2.9 million, or 55%, compared to $5.3 million for the three monthsended March 31, 2008. The decrease in revenue from Gainshare performanceincentives was primarily the result of reduced volumes in customermanufacturing facilities.

 

**·****           **Net loss for thethree months ended March 31, 2009 was $7.3 million, compared to $2.5million for the three months ended March 31, 2008. The increase in netloss was primarily attributable to a significant decrease in revenue, partiallyoffset by decreases in operating expenses as the result of our cost controlefforts.

 

**·****           **Net loss per basicand diluted share was $0.28 for the three months ended March 31, 2009compared to $0.09 for the three months ended March 31, 2008, an increasein net loss of $0.19 per basic and diluted share.

 

**·****           **Cash, cashequivalents and investments decreased $1.6 million to $39.9 million during thethree months ended March 31, 2009, primarily due to the negative effect ofchanges in foreign currency exchange rates.

 

**CriticalAccounting Policies**

 

Financial ReportingRelease No. 60 requires all companies to include a discussion of criticalaccounting policies or methods used in the preparation of financial statements.Item 7 of the consolidated financial statements on the Annual Report on Form10-K for the year ended December 31, 2008, includes a summary of thesignificant accounting policies and methods used in the preparation of ourcondensed consolidated financial statements. The following is a briefdiscussion of the more significant accounting policies and methods that we use.

 

***General***

 

Our discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in conformity withaccounting principles generally accepted in the United States of America. Ourpreparation of these consolidated financial statements requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the datesof the financial statements and the reported amounts of revenues and expensesduring the reporting periods. We based our estimates on historical experienceand on various other assumptions that we believe to be reasonable under thecircumstances. The most significant estimates and assumptions relate to revenuerecognition, software development costs, recoverability of goodwill andacquired intangible assets, estimated useful lives of acquired intangibles,stock based compensation, and the realization of deferred tax assets. Actualamounts may differ from such estimates under different assumptions or conditions.

 

***Revenue Recognition***

 

We derive revenue fromtwo sources: Design-to-Silicon-Yield Solutions, which includes Services andSoftware Licenses, and Gainshare Performance Incentives. We recognize revenuein accordance with the provisions of American Institute of Certified PublicAccountants’ Statement of Position, or SOP, No. 81-1, *Accounting for Performance of Construction-Type andCertain**Production-Type Contracts*and SOP No. 97-2, *SoftwareRevenue Recognition*, as amended.

 

*Design-to-Silicon-YieldSolutions*— 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:

 

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*Services* —We generate a significant portion of our Design-to-Silicon-Yield solutionsrevenue from fixed-price solution implementation service contracts deliveredover a specific period of time. These contracts require accurate estimation ofcost to perform obligations and overall scope of each engagement. Revenue undercontracts for solution implementation services is recognized as services areperformed using the cost-to-cost percentage of completion method of contractaccounting. Losses on solution implementation contracts are recognized in theperiod when they become evident. Revisions in profit estimates are reflected inthe period in which the conditions that require the revisions become known andcan be estimated. If we do not accurately estimate the resources required orthe scope of work to be performed, or do not manage the projects properlywithin the planned period of time or satisfy our obligations under contracts,resulting contract margins could be materially different than those anticipatedwhen the contract was executed. Any such reductions in contract margin couldhave a material negative impact on our operating results.

 

On occasion, we havelicensed our software products as a component of our fixed price servicescontracts. In such instances, the software products are licensed to customersover a specified term of the agreement with support and maintenance to beprovided over the license term. Under these arrangements, where vendor-specificobjective evidence of fair value (“VSOE”) exists for the support andmaintenance element, the support and maintenance revenue is recognizedseparately over the term of the supporting period. The remaining fee is recognizedas services are performed using the cost-to-cost percentage of completionmethod of contract accounting. VSOE for maintenance, in these instances, isgenerally established based upon a negotiated renewal rate. Under arrangementswhere software products are licensed as a component of its fixed-price servicecontract and where VSOE does not exist to allocate a portion of the totalfixed-price to the undelivered elements, revenue is recognized for the totalfixed-price as the lesser of either the percentage of completion method ofcontract accounting or ratably over the longer of either the term of theagreement or the supporting period. Costs incurred under these arrangements aredeferred and recognized in proportion to revenue recognized under these arrangements.

 

Revenue from relatedsupport and maintenance services is recognized ratably over the term of thesupport and maintenance contract, generally one year, while revenue fromconsulting, installation and training services is recognized as services areperformed. 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 based upon its fair value asdetermined by our VSOE. VSOE is generally established for maintenance basedupon negotiated renewal rates while VSOE for consulting, installation, andtraining is established based upon our customary pricing for such services whensold separately. When VSOE does not exist to allocate a portion of the totalfee to the undelivered elements, revenue is recognized ratably over the longestservice period of the undelivered elements

 

*SoftwareLicenses* — We also license our software productsseparate 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) collectibilityis 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. VSOE isgenerally established for maintenance based upon negotiated renewal rates whileVSOE for consulting, installation and training services is established basedupon our 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. 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.

 

*Gainshare Performance Incentives* —When we enter into a contract to provide yield improvement services, thecontract usually includes two components: (1) a fixed fee for performanceby us of services delivered over a specific period of time; and (2) againshare performance incentives component where the customer may pay avariable fee, usually after the fixed fee period has ended. Revenue derivedfrom gainshare performance incentives represents profit sharing and performanceincentives earned based upon our customers reaching certain defined operationallevels established in related solution implementation service contracts.Gainshare performance incentives periods are usually subsequent to the deliveryof all contractual services and therefore have no cost to us. Due to theuncertainties surrounding attainment of such operational levels, we recognizegainshare performance incentives revenue (to the extent of completion of therelated solution implementation contract) upon receipt of performance reportsor other related information from our customers supporting the determination ofamounts and probability of collection. Gainshare performance incentives revenueis dependent on many factors which are outside our control, including amongothers, continued production of the related ICs by our customers, sustainedyield improvements by our customers and our ability to enter into newDesign-to-Silicon-Yield solutions contracts containing provisions for gainshareperformance incentives.

 

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***SoftwareDevelopment Costs***

 

Costs for the development of new software products andsubstantial enhancements to existing software products are expensed as incurreduntil technological feasibility has been established, at which time anyadditional costs would be capitalized in accordance with Statement ofAccounting Standards, or SFAS No. 86, *Computer Software to be Sold, Leased or**Otherwise Marketed*. Because we believe ourcurrent process for developing software is essentially completed concurrentlywith the establishment of technological feasibility, no costs have beencapitalized to date.

 

***Goodwill andAcquired Intangible Assets***

 

As of March 31,2009, the recorded value of our goodwill and intangible assets was zero and$4.3 million, respectively. In assessing the valuation and recoverability ofour goodwill and intangible assets, we must make assumptions regardingestimated future cash flows to be derived from the acquired assets. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for these assets, which would have a materialadverse effect on our operating results. We evaluate goodwill for impairmentpursuant to the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*. We have selected December 31as the date upon which to perform our annual testing for impairment. During thefourth quarter of fiscal 2008, we observed impairment indicators, relating toour long-lived assets, including the trading of our common stock below our bookvalue and a further deterioration in the semiconductor industry brought on bythe deteriorating global economic environment which triggered the necessity ofan impairment test for our intangible and long lived assets as of December 31,2008.  In accordance with SFAS No. 144, we assessed therecoverability of our intangible and long-lived assets by comparing thecarrying value of those intangible and long lived assets to the undiscountedcash flows of each asset group. The analysis indicated that the carrying valueof certain assets exceeded the undiscounted cash flows. As such, we determinedthat certain acquired intangible assets were impaired. We measured the amountof impairment by calculating the amount by which the carrying value of theintangible assets exceeded their estimated fair values, which were based onprojected 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.

 

We completed our annualimpairment analysis of goodwill as of December 31, 2008, including thesecond step prescribed by SFAS No. 142. As part of the second step ofour goodwill impairment test, we determined the fair value of our goodwill byallocating the estimated fair value of our reporting unit to our assets andliabilities, including the estimated fair value of our unrecorded intangibleassets, on a fair value basis. After allocating its assets and liabilities on afair value basis, we recorded an impairment of all of our goodwill of$64.0 million.

 

We are currently amortizing our acquired intangibleassets over estimated useful lives of one to seven years, which are based onthe estimated period of benefit to be derived from such assets. However, adecrease in the estimated useful lives of such assets would cause additionalamortization expense or an impairment of such asset in future periods.

 

***Income Taxes***

 

Realization of deferred tax assets is dependent on ourability to generate future taxable income and utilize tax planning strategies.We have recorded a deferred tax asset in the amount that is more likely thannot to be realized based on current estimations and assumptions. We evaluatethe valuation allowance on a quarterly basis. Any resulting changes to thevaluation allowance will result in an adjustment to income in the period thedetermination is made.

 

***Stock-Based Compensation***

 

We account for stock-based compensation in accordancewith SFAS No. 123 (revised 2004), *Share-BasedPayment*, or SFAS No. 123R. Under the provisions of SFAS No. 123R,stock-based compensation cost is estimated at the grant date based on the award’sfair-value as calculated by the Black-Scholes-Merton, or 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.

 

**Recent Accounting Pronouncements andAccounting Changes**

 

See Note 2 of “Notes to Condensed ConsolidatedFinancial Statements (Unaudited)” of this Quarterly Report on Form 10-Qfor a description of recent accounting pronouncements and accounting changes,including the expected dates of adoption and estimated effects, if any, on ourconsolidated financial statements.

 

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***Results ofOperations***

 

The following table sets forth, for the periodsindicated, the percentage of total revenue represented by the line itemsreflected in our condensed consolidated statements of operations:

 
| ** **                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| Revenues:                                          |       |                                             |       |   |   |
| Design-to-silicon-yield  solutions                 |       | 76                                               | %          | 74 | % |
| Gainshare  performance incentives                  |       | 24                                               |       | 26 |   |
| Total revenues                                     |       | 100                                              | %          | 100 | % |
| Cost of  design-to-silicon-yield solutions:        |       |                                             |       |   |   |
| Direct costs of  design-to-silicon-yield solutions |       | 62                                               |       | 38 |   |
| Amortization of  acquired technology               |       | 3                                                |       | 3 |   |
| Total cost of  design-to silicon-yield solutions   |       | 65                                               |       | 41 |   |
| Gross margin                                       |       | 35                                               |       | 59 |   |
| Operating  expenses:                               |       |                                             |       |   |   |
| Research and  development                          |       | 57                                               |       | 45 |   |
| Selling, general  and administrative               |       | 43                                               |       | 31 |   |
| Amortization of  other acquired intangible assets  |       | 1                                                |       | 1 |   |
| Restructuring  charges                             |       | 6                                                |       | — |   |
| Total operating  expenses                          |       | 107                                              |       | 77 |   |
| Loss from  operations                              |       | (72                                              | )          | (18 | ) |
| Interest and  other income, net                    |       | 3                                                |       | 3 |   |
| Loss before  taxes                                 |       | (69                                              | )          | (15 | ) |
| Income tax  provision (benefit)                    |       | 3                                                |       | (3 | ) |
| Net loss                                           |       | (72                                              | )%         | (12 | )% |

 

***Comparison of theThree Months Ended March 31, 2009 and 2008***

 
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Revenue**                              | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In  thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Design-to-silicon-yield  solutions       |       | $                                                    | 7,794      |       | $          | 15,024     |       | $                   | (7,230     | )                                                    | (48        | )% | 76 | % | 74 | % |
| Gainshare  performance incentives        |       | 2,396                                                |       | 5,323      |       | (2,927     | )          | (55                 | )%         | 24                                                   | %          | 26 | % |
| Total                                    |       | $                                                    | 10,190     |       | $          | 20,347     |       | $                   | (10,157    | )                                                    | (50        | )% | 100 | % | 100 | % |

 

*Design-to-Silicon-Yield Solutions*.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 and solution product sales.  Design-to-Silicon-Yield solutionsrevenue decreased $7.2 million for the three months ended March 31, 2009compared to the three months ended March 31, 2008, primarily due to adecrease of $4.2 million in fixed fee integrated solutions and a decrease of$3.0 million in software and software related services. The decreases wereprimarily the result of lower bookings, as customers have delayed purchases forcapacity expansion and investment in leading edge technology. The dramaticdownturn in the semiconductor industry combined with weakness in worldwideeconomies have been the primary contributors to this shortfall. OurDesign-to-Silicon-Yield revenue may fluctuate in the future and is dependent ona number of factors including our ability to obtain new customers at emergingtechnology nodes.

 

*Gainshare Performance Incentives*.Gainshare performance incentives revenue represents profit sharing andperformance incentives earned based upon our customers reaching certain definedoperational levels. Revenue derived from gainshare performance incentivesdecreased $2.9 million for the three months ended March 31, 2009 comparedto the three months ended March 31, 2008, primarily due to decreases inwafer volumes at our customer sites. The revenue from gainshare performanceincentives was generated from six customers and seven engagements for the threemonths ended March 31, 2009 and seven customers and ten engagements forthe three months ended March 31, 2008. Our gainshare performanceincentives revenue may continue to fluctuate from period to period. Gainshareperformance incentives revenue is dependent on many factors that are outsideour control, including among others, continued production of ICs by ourcustomers, sustained yield improvements by our customers, and our ability toenter into new Design-to-Silicon-Yield solutions contracts containing provisionsfor gainshare performance incentives.

 

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| ** **                                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of**                                  | ** ** | **2008  % of** | ** ** |
| **Cost of Design-to-Silicon  Yield Solution**     | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**                                           | ** ** | **Revenue** | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct costs of  design-to-silicon-yield solutions          |       | $                                                    | 6,290      |       | $          | 7,766      |       | $                                                    | (1,476     | ) | (19 | )% | 62 | % | 38 | % |
| Amortization of  acquired technology                        |       | 359                                                  |       | 631        |       | (272       | )          | (43                                                  | )%         | 3 | % | 3 | % |
| Total                                                       |       | $                                                    | 6,649      |       | $          | 8,397      |       | $                                                    | (1,748     | ) | (21 | )% | 65 | % | 41 | % |

 

*Costsof Design-to-Silicon-Yield Solutions*. Costs ofDesign-to-Silicon-Yield solutions consist of costs incurred to provide andsupport our services, costs recognized in connection with licensing oursoftware, and amortization of acquired technology.

 

*Directcosts of Design-to-Silicon-Yield Solutions. *Direct costs of Design-to-Silicon-Yield solutionsconsist of services costs and software licenses costs. Services costs consistof material, labor, overhead costs, and stock-based compensation chargesassociated with solution implementations. Costs include purchased materials,employee compensation and related benefits, travel and facilities-relatedcosts. Software license costs consist of costs associated with licensingthird-party software sold in conjunction with our software products andexpenses incurred to produce and distribute our product documentation.** Direct costs of Design-to-Silicon-Yieldsolutions decreased $1.5 million for the three months ended March 31, 2009compared to the three months ended March 31, 2008, primarily due to adecrease of $302,000 in travel expenses, a decrease of $229,000 in the use of outsideconsultants, and decreases in other various expenses as a result of our costcontrol efforts. If we do not accurately estimate the resources required or thescope of work to be performed, or we do not manage the projects properly withinthe planned period of time or satisfy our obligations under contracts,resulting contract margins could be materially different than those anticipatedwhen the contract was executed. Any such reductions in contract margin couldhave a material negative impact on our operating results.

 

*Amortizationof Acquired Technology*. Amortization of acquired technologyconsists of amortization of intangible assets acquired as a result of certainbusiness combinations. Amortization of acquired technology expense decreased$272,000 for the three months ended March 31, 2009 compared to the threemonths ended March 31, 2008, primarily due to decreased amortization as aresult of the impairment of acquired technology recorded in the fourth quarterof 2008. We anticipate amortization of acquired technology to be $1.1 millionfor the remaining nine months in 2009, $1.3 million in 2010, $626,000 in 2011,and $261,000 in 2012.

 
| ** **                                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Research and Development**                      | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Research and  development                                   |       | $                                                    | 5,789      |       | $          | 9,076      |       | $                   | (3,287     | )                                                    | (36        | )% | 57 | % | 45 | % |
|                                                             |            |                                                      |            |            |            |            |            |                     |            |                                                      |            |  |  |  |  |  |

 

*Researchand Development.*Research and development expenses consistprimarily of personnel-related costs to support product development activities,including compensation and benefits, outside development services, travel andfacilities cost allocations, and stock-based compensation charges. Research anddevelopment expenses decreased $3.3 million for the three months ended March 31,2009 compared to the three months ended March 31, 2008, primarily due to adecrease of approximately $1.7 million in personnel expenses, a decrease of $320,000in the use of outside consultants, and a decrease of $231,000 in travelexpenses, all of which are the results of our cost control efforts.  We anticipate our expenses in research anddevelopment will fluctuate in absolute dollars from period to period as aresult of cost control initiatives and the timing of when we hire personnel asa result of the size and the timing of product development projects.

 
| ** **                                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Selling, General and Administrative**      | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Selling, general  and administrative                        |       | $                                                    | 4,413      |       | $          | 6,299      |       | $                   | (1,886     | )                                                    | (30        | )% | 43 | % | 31 | % |
|                                                             |            |                                                      |            |            |            |            |            |                     |            |                                                      |            |  |  |  |  |  |

 

*Selling, General and Administrative*.Selling, general and administrative expenses consist primarily of compensationand benefits for sales, marketing and general and administrative personnel inaddition to outside sales commissions, legal and accounting services, marketingcommunications, travel and facilities cost allocations, and stock-basedcompensation charges. Selling, general and administrative expenses decreased$1.9 million for the three months ended March 31, 2009 compared to thethree months ended March 31, 2008, primarily due to a decrease ofapproximately $758,000 in personnel expenses in the U.S. as a result of ourcost control efforts, and a decrease of $439,000 in legal fees due toadditional fees incurred in the three months ended March 31, 2008 indefending our intellectual property rights. We anticipate our selling, generaland administrative expenses will fluctuate in absolute dollars from period toperiod as a result of cost control initiatives and to support increased sellingefforts in the future.

 

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| ** **                                                      | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------|------------|------------|------------|------------|------------|------------------------------------------------------|------------|
| ** **                                                      | ** ** | **Three Months Ended March31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of**                                  | ** ** | **2008  % of** | ** ** |
| **Amortization of Other  Acquired Intangible Assets** | ** ** | **2009**                                       | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**                                           | ** ** | **Revenue** | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)**     | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Amortization of  other acquired intangible assets               |       | $                                              | 87         |       | $          | 194        |       | $                                                    | (107       | ) | (55 | )% | 1 | % | 1 | % |
|                                                                 |            |                                                |            |            |            |            |            |                                                      |            |  |  |  |  |  |  |  |

 

*Amortizationof Other Acquired Intangible Assets*. Amortization of otheracquired intangible assets consists of amortization of intangibles acquired asa result of certain business combinations. Amortization of other acquiredintangible assets for the three months ended March 31, 2009 decreased$107,000 compared to the three months ended March 31, 2008, primarily dueto decreased amortization as a result of the impairment of other acquiredintangible assets recorded in the fourth quarter of fiscal 2008. We anticipateamortization of other acquired intangible assets to be $256,000 in theremaining nine months in 2009, $292,000 in 2010, $204,000 in 2011, $174,000 in2012, and $105,000 in 2013 and thereafter.

 
| ** **                                                  | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Restructuring Charges**                              | ** ** | **2009**                                       | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Restructuring  charges                                      |       | $                                              | 633        |       | $          | —     |       | $                   | 633        |                                                 | N/A        |   | 6 | % | — | % |
|                                                             |            |                                                |            |            |            |            |            |                     |            |                                                      |            |  |  |  |  |  |

 

*Restructuring Charges.*  Restructuringcharges of $633,000 for the three months ended March 31, 2009 consistedprimarily of employee severance costs and were the result of our continued costcontrol efforts in light of current market conditions. There were norestructuring charges during the three months ended March 31, 2008.

 
| ** **                                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Interest and Other Income, net**      | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Interest and  other income, net                             |       | $                                                    | 324        |       | $          | 489        |       | $                   | (165       | )                                                    | (34        | )% | 3 | % | 3 | % |
|                                                             |            |                                                      |            |            |            |            |            |                     |            |                                                      |            |  |  |  |  |  |

 

*Interestand Other Income, net*. Interest and other income, netdecreased $165,000 for the three months ended March 31, 2009 compared tothe three months ended March 31, 2008, primarily due to decreases ininterest income, the result of lower interest rates and lower average cash,cash equivalents and investments balances during the period. We anticipateinterest and other income will fluctuate in future periods as a result of ourprojected use of cash.

 
| ** **                                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------------------------------------|------------|
| ** **                                                  | ** ** | **Three Months Ended March 31,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009  % of** | ** ** | **2008  % of**                                  | ** ** |
| **Income Tax Provision (Benefit)**           | ** ** | **2009**                                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**          | ** ** | **Revenue**                                          | ** ** | **Revenue** | ** ** |
| **(In thousands, except for %’s)** | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Income tax  provision (benefit)                             |       | $                                                    | 264        |       | $          | (617       | )          | $                   | 881        |                                                 | 143        | % | 3 | % | (3 | )% |
|                                                             |            |                                                      |            |            |            |            |            |                     |            |                                                      |            |  |  |  |  |  |

 

*IncomeTax Provision (Benefit).*Income tax provision increased$881,000 for the three months ended March 31, 2009 to $264,000 as comparedto an income tax benefit of $617,000 for the three months ended March 31,2008. The income tax provision for the three months ended March 31, 2009primarily consisted of foreign withholding taxes and statutory taxes associatedwith our foreign subsidiaries.  Theincome tax benefit for the three months ended March 31, 2008 consisted ofa tax benefit for the net loss during the period. We established a valuationallowance for deferred tax assets in the third quarter of 2008, which offsetthe benefit for fiscal year 2008.

 

**Liquidityand Capital Resources**

** **

***OperatingActivities***

 

Cash flows from operatingactivities consist of net loss adjusted for certain non-cash items and changesin assets and liabilities. Net cash used in operating activities was $330,000for the three months ended March 31, 2009, a decrease of $427,000 comparedto $757,000 for the three months ended March 31, 2008, primarily due to ahigher net loss and changes in taxes payable and other accrued liabilities,partially offset by decreases in both accounts receivable and prepaid expensesand other assets.

 

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Taxes payable and otheraccrued liabilities decreased $624,000 during the three months ended March 31,2009 compared to an increase of $849,000 during the three months ended March 31,2008.  The decrease in taxes payable andother accrued liabilities during the three months ended March 31, 2009 wasprimarily due to the payment of accrued restructuring costs.  The increase in taxes payable and otheraccrued liabilities during the three months ended March 31, 2008 wasprimarily due to the increase in taxes payable associated with foreignoperations. Accounts receivable decreased $4.6 million and $62,000 during thethree months ended March 31, 2009 and 2008, respectively.  The decrease during the three months ended March 31,2009 was primarily due to a decrease in revenue during the period coupled withcustomer collections.  Prepaid expensesand other assets decreased $1.5 million during the three months ended March 31,2009, and increased $509,000 during the three months ended March 31,2008.  The decrease in prepaid expensesand other assets during the thee months ended March 31, 2009 was primarilydue to the collection of a tax refund. The increase in prepaid and other assets during the three months ended March 31,2008 was primarily due to an increase in deferred tax assets due to a netincome tax benefit.

 

***InvestingActivities***

 

Cash flows from investingactivities consist of proceeds from investment maturities and sales, offset bypayments for investments acquired and payments for capital expenditures. Netcash provided by investing activities was $2.4 million for the three monthsended March 31, 2009, an increase of $3.9 million compared to net cashused in investing activities of $1.5 million for the three months ended March 31,2008. The Company did not purchase investments during the three months ended March 31,2009.  This is in comparison to purchasesof $8.8 million of investments during the three months ended March 31,2008 which were partially offset by proceeds of $4.9 million from investmentmaturities and sales.  As of March 31,2009, we had no investments in derivative securities.

 

***FinancingActivities***

 

Cash flows from financingactivities consist primarily of proceeds from sales of shares through employeeequity incentive plans, offset by payments for the purchase of treasury stock,and principal payments on long-term obligations. Net cash provided by financingactivities was $366,000 for three months ended March 31, 2009, an increase of $1.5 millioncompared to net cash used in financing activities of $1.1 million for the threemonths ended March 31, 2008. During the three months ended March 31,2009, we received proceeds of $417,000 associated with our employee stockpurchase plan and we did not repurchase any of our common stock on the openmarket.  During the three months ended March 31,2008, we repurchased 197,000 shares of our common stock at a cost of $1.1million.

 

***Liquidity***

 

As of March 31,2009, our working capital was $49.9 million, compared with $56.3 million as of December 31,2008. Cash and cash equivalents, and investments were $39.9 million as of March 31,2009 compared to $40.7 million as of December 31, 2008, a decrease of $1.6million. The decrease in cash, cash equivalents, and short-term investments wasprimarily attributable to the negative effect of changes in foreign currencyexchange rates. We anticipate that our overall expenses, as well as plannedcapital expenditures, may constitute a material use of our cash resources. Inaddition, we may use cash resources to repurchase common stock, fund potentialinvestments in, or acquisitions of complementary products, technologies orbusinesses. We believe that our existing cash resources and anticipated fundsfrom operations will satisfy our cash requirements to fund our operatingactivities, capital expenditures and other obligations for at least the nexttwelve months. However, in the event that during such period, or thereafter, weare not successful in generating sufficient cash flows from operations we mayneed to raise additional capital through private or public financings,strategic relationships or other arrangements, which may not be available to uson acceptable terms or at all.

 

As of March 31,2009, our non-current investments included auction-rate securities with a fairvalue of $718,000, which are variable rate debt instruments whose interestrates are reset through a “dutch” auction process at regular intervals,typically every 28 days. See Note 3 to “Notes to Condensed ConsolidatedFinancial Statements (Unaudited)” and Item 3. “Quantitative and QualitativeDisclosures About Market Risk” in Part I in this Quarterly Report on Form 10-Qfor further 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 March 31, 2009, other than Euro denominated receivables, we had noforeign currency contracts outstanding.

 

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The following tablesummarizes our known contractual obligations (in thousands):

 
| ** **                                      | ** ** | **Payments due by period** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual obligations**                | ** ** | **2009  (Nine months  remaining)**   | ** ** | **2010-2011** | ** ** | **2012-2013** | ** ** | **Thereafter** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Debt principal  (1)                             |       | $                                         | 292        |   | $ | 477 |   | $ | — |   | $ | — |   | $ | — |   | $ | 769 |   |
| Debt interest                                   |       | 15                                        |       | 18 |   | — |   | — |   | — |   | 33 |   |
| Capital lease  obligations (including interest) |       | 17                                        |       | 11 |   | — |   | — |   | — |   | 28 |   |
| Operating lease  obligations                    |       | 2,324                                     |       | 5,587 |   | 3,982 |   | — |   | — |   | 11,893 |   |
| Unrecognized tax  benefits (2)                  |       | —                                    |       | — |   | — |   | — |   | 3,354 |   | 3,354 |   |
| Total                                           |       | $                                         | 2,648      |   | $ | 6,093 |   | $ | 3,982 |   | $ | — |   | $ | 3,354 |   | $ | 16,077 |   |

 

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(1)       Amount represents therepayment of an interest free loan of €550,000 and a €400,000 Euros loan with avariable interest rate based on the EURIBOR plus 160 basis points.

 

(2)       Due to the inherentuncertainty of the tax positions, it is not practicable to assign thisliability to any particular years in the table.

 

Operating lease amountsinclude minimum rental payments under our operating leases for our officefacilities, as well as computers, office equipment, and vehicles that weutilize under lease agreements. These agreements expire at various datesthrough 2013. Capital leases were contracted to purchase computer, software,office equipment, and vehicles in our French subsidiary.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk.**

 

The following discussesour exposure to market risk related to changes in interest rates and foreigncurrency exchange rates. We do not currently own any equity investments, nor dowe expect to own any in the foreseeable future. This discussion containsforward-looking statements that are subject to risks and uncertainties. Actualresults could vary materially as a result of a number of factors.

 

*InterestRate Risk*. As of March 31, 2009, we had cash and cashequivalents and short term investments of $39.1 million. Cash and cashequivalents consisted of cash, highly liquid money market instruments andcommercial paper with maturities of 90 days or less. Short-term investmentsconsisted of debt securities with maturities of more than three months but lessthan twelve months. Because of the short maturities of those instruments, asudden change in market interest rates would not have a material impact on thefair value of the portfolio. We would not expect our operating results or cashflows to be affected to any significant degree by the effect of a sudden changein market interest on our portfolio. A hypothetical increase in market interestrates of 100 basis points from the market rates in effect at March 31,2009 would cause the fair value of these investments to decrease by animmaterial amount which would not have significantly impacted our financialposition or results of operations. Declines in interest rates over time willresult in decreased interest income.

 

As of March 31,2009, we held auction-rate securities with a par value of $1.0 million. Auction-ratesecurities are variable rate debt instruments whose interest rates are resetthrough a “dutch” auction process at regular intervals, typically every 28days. A portion of these securities are insured by third party bond insurersand are collateralized by student loans guaranteed by governmental agencies andprivate entities. The liquidity of the securities has been negatively impactedby the uncertainty in the credit markets and the exposure of these securitiesto the financial condition of bond insurance companies. All of our auction-ratesecurities have failed to sell at auction since February 2008 due to aninsufficient number of bidders. We reviewed the value of these securities forimpairment as of March 31, 2009, and concluded that these securitiescontinued to be temporarily impaired. During the year ended December 31, 2008, there was an unrealizedloss of $282,000 recorded as a component of accumulated other comprehensiveincome related to these auction rate securities.  There was no additional impairment recordedduring the three months ended March 31, 2009. In future periods, theestimated fair value of our auction-rate securities could decline further basedon market conditions, which could result in additional impairment.

 

*ForeignCurrency and Exchange Risk.*Certain of our sales contractsare denominated in a currency other than the functional currency of the sellingentity. Therefore, a portion of our revenue is subject to foreign currencyrisks. The effect of an immediate 10% adverse change in exchange rates onforeign currency denominated receivables as of March 31, 2009 would resultin a loss of an immaterial amount. As of March 31, 2009, we did not haveoutstanding hedging contracts, although we may enter into such contracts in thefuture. We intend to monitor our foreign currency exposure. Future exchangerate fluctuations may have a material negative impact on our business.

 

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**Item 4.Controls and Procedures.**

 

*Evaluationof Disclosure Controls and Procedures*. Our management, withthe participation of our principal executive officer and our principalfinancial officer, has evaluated the effectiveness of our “disclosure controlsand procedures” (as such items are defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended, or theExchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q.  Based on that evaluation, our principalexecutive officer and our principal financial officer have concluded that ourdisclosure controls and procedures are effective and designed to ensure thatinformation required to be disclosed by us in the reports we file or submitunder the Exchange Act is (1) recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’s rules andforms, and (2) is accumulated and communicated to our management,including our principal executive officer and principal financial officer, orpersons performing similar functions, as appropriate to allow timely decisionsregarding required disclosure.

 

*Changesin Internal Controls Over Financial Reporting*. There was nochange in our internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Rule 13a-15or Rule 15d-15 under the Exchange Act that occurred during the periodcovered by this Quarterly Report on Form 10-Q that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II — OTHER INFORMATION**

 

**Item 1.Legal Proceedings.**

 

We are not party to anymaterial pending legal proceedings.

 

**Item 1A.*Risk Factors***

 

***The semiconductormarket is volatile and unpredictable, which limits our ability to forecast ourbusiness and could negatively impact our results of operations.***

 

The semiconductor industry has experiencedsignificant challenges in 2008 and continues to face challenges in 2009 as aresult of the decline in the macroeconomic environment. As a provider to globalsemiconductor companies, we are subject to business cycles, the timing, lengthand volatility of which can be difficult to predict. The semiconductor industryhistorically has been cyclical due to sudden changes in customers’manufacturing capacity requirements and spending, which depend in part oncapacity utilization, demand for customers’ IC products, inventory levelsrelative to demand, and access to affordable capital. These changes haveaffected the timing 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 be negativelyimpacted and could differ greatly from our expectations.

 

***Ourbusiness is subject to risks associated with the ongoing financial crisis andweakening global economy.***

 

The recent severe tightening of the creditmarkets, turmoil in the financial markets, and weakening global economy arecontributing to slowdowns in the semiconductor industry, which impacts ourability to make sales. These slowdowns are expected to worsen if these economicconditions are prolonged or deteriorate further. The markets for semiconductorsdepend largely on consumer spending. Economic uncertainty exacerbates negativetrends in consumer spending and may cause some of our customers to delay orrefrain altogether from entering into new engagements, licensing new oradditional software products, or renewing maintenance and support for existinglicensed software at historical levels. This will negatively affect our revenues. Difficulties in obtainingcapital and deteriorating market conditions may also lead to the inability ofsome customers to obtain affordable financing for other purchases, which couldtie up funds otherwise budgeted for purchases of our solutions andtechnologies. Customers with liquidity issues may also lead to additional baddebt expense. Further, these conditions and uncertainty about future economicconditions make it challenging for us to forecast our operating results, makebusiness decisions, and identify the risks that may affect our business,financial condition and results of operations. If we are not able to timely andappropriately adapt to changes resulting from the difficult macroeconomicenvironment, our business, financial condition, and results of operations maybe significantly negatively affected.

 

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***If semiconductor designers and manufacturers do not continueto adopt, or they significantly delay adoption of, our******Design-to-Silicon-Yield solutions,our******revenuewill 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 IDMs, fablesssemiconductor companies, and foundries, as well as system manufacturers, themarket acceptance of our solutions will suffer. Factors that may limit adoptionof our Design-to-Silicon-Yield solutions by semiconductor companies include:

 

·             our existing andpotential customers’ delay in their adoption of the next process technology;

 

·             IDMs of logic ICsdiscontinuing or significantly cutting back their investment in the developmentof new process technology as a result of a shift to a model of outsourcing alarger proportion, or all, of the mass production of their ICs;

 

·             our inability to keeppace with the rapidly evolving technologies and equipment used in thesemiconductor design and manufacturing processes;

 

·             our customers’failure to achieve satisfactory yield improvements using our Design-to-Silicon-Yieldsolutions; and

 

·             our inability todevelop, market, or sell effective solutions that are outside of ourtraditional MPS logic focus.

 

***Revenue from our gainshare performance incentives isdependent on factors outside of******our control, including the volume ofICs that our customers are able******to sell to their customers.***

 

Our gainshare performanceincentives fee component ties the profits of our customers to our own. Throughthis component, revenue for a particular product is largely determined by thevolume of that product that our customer is able to sell to its customers,which is outside of our control. Decreased demand for semiconductor productsdecreases the volume of products our customers are able to sell, which directlydecreases our gainshare performance incentives revenue. Important factors thatcould cause demand for semiconductor products to negatively fluctuate include:

 

·             changes in businessand economic conditions, including the current downturn in the semiconductorindustry and the overall economy; and

 

·             decreases in consumerconfidence caused by changes in market conditions, including changes in thecredit market.

 

Also, our customers may unilaterally decide toimplement changes to their manufacturing processes during the period that iscovered by gainshare performance incentives, which could negatively affectyield results. Since we currently work on a small number of large projects, anyproduct that does not achieve commercial viability or a significant increase inyield, or sustain significant volume manufacturing during the time we receivegainshare performance incentives, revenue from such customers couldsignificantly reduce our revenue and results of operations below expectations.In addition, if we work with two directly competitive products, volume in onemay offset volume, and thus any of our related gainshare performanceincentives, in the other product.

 

***We may not be ableto effectively implement our restructuring plans, and our restructuring plansmay not result in the expected benefits on our planned schedule, or at all,which could negatively impact our future results of operations.***

 

During the year end December 31,2008 and through March 31, 2009, we initiated restructuring plans in aneffort to align our cost structure with expected revenue. We may not be able tosuccessfully complete and realize the expected benefits of our restructuringplans, such as improvements in operating margins and cash flows, in therestructuring periods contemplated or at all. The restructuring plans mayinvolve higher costs or a longer timetable than we currently anticipate, mainlydue to the timing and execution of some plans and programs subject to locallabor law requirements, and consultation with appropriate work councils. Ourinability to realize these benefits may result in an inefficient businessstructure that could negatively impact our results of operations. We alsoexpect our restructuring plans to cause us to incur substantial costs relatedto severance and other employee-related costs. Our restructuring plans may alsosubject us to litigation risks and expenses. In addition, our restructuringplans may have other consequences, such as attrition beyond our plannedreduction in workforce or a negative impact on employee morale, and ourcompetitors may seek to gain a competitive advantage over us. The restructuringplans could also cause our remaining employees to be less productive, which inturn may negatively affect our revenue and other operating results in thefuture.

 

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***We generate a large percentage of our total revenue from alimited number of******customers, so decreased volumes at any one of thesecustomers, or the loss of any one of these customers could significantly reduceour******revenueand results of operations below expectations.***

 

Historically, we have hada small number of large customers for our core Design-to-Silicon-Yieldsolutions and we expect this to continue in the near term. In the three monthsended March 31, 2009, two customers accounted for 40% of our total netrevenue, with IBM representing 29% and Panasonic representing 11%. In the yearended December 31, 2008, two customers accounted for 34% of our total netrevenue, with Toshiba Corporation representing 18% 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 noteffectively manage and support our operations and integrate recent and******planned growth, ourbusiness strategy may fail.***

 

We have in the past, andmay in the future, experienced interruptions in our information systems onwhich our global operations depend. Further, physical damage to, failure of, ordigital damage (such as significant viruses or worms) to, our informationsystems could disrupt and delay time-sensitive services or computing operationsthat we perform for our customers, which could negatively impact our businessresults and reputation. In addition, we must frequently expand our internalinformation system to meet increasing demand in storage, computing andcommunication. Our internal information system is expensive to expand and mustbe highly secure due to the sensitive nature of our customers’ information thatwe transmit. Building and managing the support necessary for our growth placessignificant demands on our management and resources. These demands may divertthese resources from the continued growth of our business and implementation ofour business strategy. Further, we must adequately train our new personnel,especially our client service and technical support personnel, to effectivelyand accurately, respond to and support our customers. If we fail to do this, itcould lead to dissatisfaction among our customers, which could slow our growth.

 

***Our stock price maybe volatile, and our common stock could decline in value, increasing potentialdilution to our stockholders, or we may be delisted from the NASDAQ GlobalMarket.***

 

Our stock price hasfluctuated widely during the last few years from a low closing price of $0.97per share during March 2009 to a high of $19.36 per share during April 2006.This significant reduction in our stock price negatively impacts our ability toraise equity capital in the public markets and increases the cost to us, as measuredby dilution to our existing shareholders, of equity financing. In addition, thereduced stock price also increases the cost to us, in terms of dilution, ofusing our equity for employee compensation or for acquisitions of otherbusinesses. Additionally, in order for our common stock to continue to bequoted on the NASDAQ Global Market (“Nasdaq”), we must satisfy various listingmaintenance standards established by Nasdaq, including, among other things, thegeneral requirement, should Nasdaq choose to enforce such requirements againafter the April 2009 end date of the current extension of suspension ofany such enforcement, that our stock price consistently trades at or above$1.00 per share and that the total market value of our common stock exceed $50,000,000.We may have periods when our stock does not trade at, or the market value ofour common stock has been below, the levels required by Nasdaq rules. If wewere to be delisted from the Nasdaq and move to an alternative market, whichmay be less efficient and less broad-based, we may have difficulty accessingcapital markets for additional funding, and the ability of our stockholders tosell any of our common stock at all would be severely, if not completely,limited, which could cause our stock price to decline further. Delisting couldalso have other negative results, including the potential loss of confidence byemployees, the loss of institutional investor interest, and fewer businessdevelopment opportunities.  Also,significant volatility in the stock price could be followed by a securitiesclass action lawsuit, which could result in substantial costs and a diversionof our management’s attention and resources.

 

***If we fail to protect our IP rights, customers or potential******competitors may be ableto use our technologies to develop their own solutions which******could weaken our competitiveposition, reduce our revenue, or increase our costs.***

 

Our success dependslargely on the proprietary nature of our technologies. We currently relyprimarily 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.

 

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***Competition in themarket for yield improvement solutions and increased integration******between IC design andmanufacturing may intensify in the future, which could impede******our ability to grow or execute ourstrategy.***

 

Competition in our marketmay intensify in the future, which could slow our ability to grow or executeour strategy and could lead to increased pricing pressure. Our current andpotential 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 competing DFM,while other EDA suppliers provide alternative DFM solutions that may competefor the same budgetary funds. If these potential competitors change the pricingenvironment or are able to attract industry partners or customers faster thanwe can, we may not be able to grow and execute our strategy as quickly or atall. In addition, customer preferences may shift away from our solutions as aresult of the increase in competition.

 

***We face operationaland financial risks associated with international operations that******could negatively impactour revenue.***

 

We have in the past expandedour non-U.S. operations and may in the future continue such expansion byestablishing overseas subsidiaries, offices, or contractor relationships inlocations, if and when, deemed appropriate by our management. Thus, the successof our business is subject to risks inherent in doing business internationally,including in particular:

 

·             some of our keyengineers and other personnel are foreign nationals and they may havedifficulty gaining access to the United States and other countries in which ourcustomers or our offices may be located and it may be difficult for us torecruit and retain qualified technical and managerial employees in foreignoffices;

 

·             greater difficulty incollecting account receivables resulting in longer collection periods;

 

·             language and othercultural differences may inhibit our sales and marketing efforts and createinternal communication problems among our U.S. and foreign research anddevelopment teams, increasing the difficulty of managing multiple, remotelocations performing various development, quality assurance, and yield rampanalysis projects;

 

·             compliance with,inconsistencies among, and unexpected changes in, a wide variety of foreignlaws and regulatory environments with which we are not familiar, including, amongother issues, with respect to employees, protection of our IP, and a widevariety of operational regulations and trade and export controls underdomestic, foreign, and international law;

 

·             currency risk due tothe fact that expenses for our international offices are denominated in thelocal currency, including the Euro, while virtually all of our revenue isdenominated in U.S. dollars;

 

·             quarantine, privatetravel limitation, or business disruption in regions affecting our operations,stemming from actual, imminent or perceived outbreak of human pandemic orcontagious disease;

 

·             in the event a largerportion of our revenue becomes denominated in foreign currencies, we would besubject to a potentially significant exchange rate risk; and

 

·             economic or politicalinstability, including but not limited to armed conflict, terrorism,interference with information or communication of networks or systems,  and the resulting disruption to economicactivity and business operations.

 

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Revenues generated fromcustomers in Asia accounted for 54% of total revenue in the three months ended March 31,2009 and 51% for the three months ended March 31, 2008. Thus, in Asia, inparticular, we face the following additional risks:

 

·             a downturn in Asianeconomies which could limit our ability to retain existing customers andattract new ones in Asia; and

 

·             if theU.S. dollar increases in value relative to local currencies, including forexample, the Japanese Yen, the cost of our solutions will be more expensive toexisting and potential local customers and therefore less competitive.

 

In the Middle East, weuse a third-party service provider, whose headquarters are not located in aU.S. embargoed country, to provide software quality assurance and otherservices 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******given quarter, thereby raising investors’ expectations,and then unusually low in the******next quarter, thereby disappointing investors, whichcould 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 ourgainshare performance incentives requires data collection and is******subject to customeragreement, which can result in uncertainty and cause quarterly******results to fluctuate.***

 

We can only recognizerevenue based on gainshare performance incentives once we have reachedagreement with our customers on their level of yield performance improvements.Because measuring the amount of yield improvement is inherently complicated anddependent on our customers’ internal information systems, there may beuncertainty as to some components of measurement. This could result in ourrecognition of less revenue than expected. In addition, any delay in measuringrevenue attributable to our gainshare performance incentives could cause all ofthe associated revenue to be delayed until the next quarter. Since we currentlyhave only a few large customers and we are relying on gainshare performanceincentives as a significant component of our total revenue, any delay couldsignificantly harm our quarterly results.

 

***Changes in thestructure of our customer contracts, including the mix between fixed******and variable revenue andthe mix of elements, including perpetual and term-based licenses, can adverselyaffect the amount and******timing of our total revenue.***

 

Our long-term success islargely dependent upon our ability to structure our future customer contractsto include a larger gainshare performance incentives component relative to thefixed fee component. We typically recognize the fixed fee component earlierthan the gainshare performance incentives component so if we are successful inincreasing the gainshare performance incentives component of our customercontracts, we will experience an adverse impact on our operating results in theshort term as we reduce the fixed fee component. Due to acquisitions andexpanded business strategies, the mix of elements in some of our contracts haschanged recently and the relative importance of the software component in someof our contracts has increased. We have experienced, and may in the futureexperience, delays in the expected recognition of revenue associated withgenerally accepted accounting principles regarding the timing of revenuerecognition in multi-element software arrangements, including the effect ofacceptance criteria as a result of the change in our contracts. If we fail tomeet contractual acceptance criteria on time or at all, the total revenue wereceive under a contract could be delayed or decline. Further, if we mixterm-based licenses with perpetual licenses, it will impact the timing of therecognition 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.

 

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***It typically takesus a long time to sell our unique solutions to new customers and******into new markets, and that can result in uncertainty anddelays in generating revenue.***

 

Our gainshare performanceincentives business model is unique and our Design-to-Silicon-Yield solutionsare often unfamiliar to new customers. This results in a lengthier sales cyclecompared to some of our competitors and requires a significant amount of oursenior management’s time and effort. Furthermore, we need to target thoseindividuals within a customer’s organization who have overall responsibilityfor the profitability of an IC. These individuals tend to be senior managementor executive officers. We may face difficulty identifying and establishingcontact with such individuals. Even after initial acceptance, due to thecomplexity of structuring the gainshare performance incentives component, thenegotiation and documentation processes can be lengthy. It can take nine monthsor more to reach a signed contract with a customer. Unexpected delays in oursales cycle could cause our revenue to fall short of expectations. By way ofexample, one of the industries that we have recently targeted that we believewould greatly benefit from our yield management system and FDC technology isthe rapidly growing solar panel industry. Our efforts to leverage our productsin this industry may not be successful. Further, ongoing negotiations andevaluation projects with photovoltaic manufacturers may not result in significantrevenue for us if we are unable to close new engagements in these markets onterms favorable to us, in a timely manner, or at all, or if we are unable tosuccessfully deliver our products and services to such markets.

 

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

 

We have experiencedlosses in the past and in the current fiscal year ended December 31, 2008.We may not achieve, and thereafter maintain, profitability if our revenueincreases more slowly than we expect or if it decreases. In addition, virtuallyall of our operating expenses are fixed in the short term, so any shortfall inanticipated revenue in a given period could significantly reduce our operatingresults below expectations. Our accumulated deficit was $119.9 million asof March 31, 2009. We expect to continue to incur significant expenses inconnection with:

 

·             funding for researchand development;

 

·             expansion of oursolution implementation teams;

 

·             expansion of oursales and marketing efforts; and

 

·             additional non-cashcharges relating to amortization and stock-based compensation.

 

As a result, if we do notsignificantly increase revenue to reach or maintain profitability on aquarterly or annual basis, our stock price could decline. We may be subject to additional impairmentof our long-lived assets.

 

***We intend to pursueadditional strategic relationships, which are necessary to******maximize our growth, butcould substantially divert management attention and******resources.***

 

We have in the past, andmay in the future, sought to establish and maintain strategic relationshipswith industry leaders at each stage of the IC design and manufacturingprocesses, This requires us to expend significant resources and to commit asignificant amount of management’s time and attention, although any suchrelationship may not be successful. If we are unable to enter into strategicrelationships with these companies, we will not be as effective at modelingexisting technologies or at keeping ahead of the technology curve as newtechnologies are introduced. In the past, the absence of an established workingrelationship with key companies in the industry has meant that we have had toexclude the effect of their component parts from our modeling analysis, whichreduces the overall effectiveness of our analysis and limits our ability toimprove yield.

 

***Our solution implementations may take longer than weanticipate, which could cause us******to lose customers and may result inadjustments 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 anexisting solution implementation in order to estimate when the engineers willbe able to commence a new solution implementation. In addition, our accountingfor solution implementation contracts, which generate fixed fees, sometimesrequire adjustments 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.

 

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

 

Our success and competitiveness depend onour ability to attract, retain, motivate, and strategically locate in ouroffices around the globe talented employees, including some of our keyexecutives. Achieving this objective may be difficult due to many factors,including fluctuations in global economic and industry conditions, changes inour management or leadership, the hiring practices at our competitors orcustomers, cost reduction activities, and the effectiveness of our compensationprograms, including equity-based programs. Further, we have had, andexpect to continue to have, difficulty in obtaining visas permitting entry forsome of our employees that are foreign nationals into the United States, anddelays in obtaining visas permitting entry into other key countries, forseveral of our key personnel, which disrupts our ability to strategicallylocate our personnel. 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 not successfully attract, retain and motivatekey employees, including key executives, we may be unable to realize ourbusiness objectives and our operating results may suffer.

 

***Inadvertent disclosure of our customers’ confidentialinformation could result in******costly litigation and cause us to lose existing andpotential customers.***

 

Our customers considertheir product yield information and other confidential information, which wemust gather in the course of our engagement with the customer, to be extremelycompetitively sensitive. If we inadvertently disclosed or were required todisclose this information, we would likely lose existing and potentialcustomers and could be subject to costly litigation. In addition, to avoidpotential disclosure of confidential information to competitors, some of ourcustomers may, in the future, ask us not to work with key competitive products,which could limit our revenue opportunities.

 

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

 

Significant litigation regarding intellectual propertyrights exists in the semiconductor industry. It is possible that a third partymay claim that our technologies infringe their intellectual property rights ormisappropriate their trade secrets. Any claim, even if without merit, could betime consuming to defend, result in costly litigation, or require us to enterinto royalty or licensing agreements, which may not be available to us onacceptable terms, or at all. A successful claim of infringement against us inconnection with the use of our technologies could adversely affect ourbusiness.

 

***Defects in ourproprietary technologies, hardware and software tools, and the cost of******support to remedy anysuch 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.

 

***Failing to maintainthe effectiveness of our internal control over financial******reporting could cause the costrelated to remediation to increase and could cause our******stock price to decline.***

 

In the future, ourmanagement may identify deficiencies regarding the design and effectiveness ofour system of internal control over financial reporting that we engage inpursuant to Section 404 of the Sarbanes-Oxley Act (“Section 404”) aspart of our Form 10-K. Such deficiencies could include those arising fromturnover of qualified personnel or arising as a result of acquisitions, whichwe may not be able to remediate in time to meet the continuing reportingdeadlines imposed by Section 404 and the costs of which may harm ourresults of operations. In addition, if we fail to maintain the adequacy of ourinternal controls, as such standards are modified, supplemented or amended fromtime to time, we may not be able to ensure that our management can conclude onan ongoing basis that we have effective internal controls. We also may not beable to retain an independent registered public accounting firm with sufficientresources to attest to and report on our internal controls in a timely manner.Moreover, our registered public accounting firm may not agree with ourmanagement’s future assessments and may deem our controls ineffective if we areunable to remediate on a timely basis. If in the future we are unable to assertthat we maintain effective internal controls, our investors could loseconfidence in the accuracy and completeness of our financial reports that inturn could cause our stock price to decline.

 

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

 

Unanticipated efforts tosupport more rapid expansion, develop or enhance Design-to-Silicon-Yieldsolutions, respond to competitive pressures or acquire complementary businessesor technologies could impact our future capital requirements and the adequacyof our available funds. In such event, we may need to raise additional fundsthrough public or private financings, strategic relationships or otherarrangements. We may not be able to raise necessary funds on terms favorable tous, or at all.

 

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

 

Our success in realizingthe 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,and Fabbrix, Inc. (“Fabbrix”), a U.S. company, acquired in May 2007,and Triant Holdings, Inc. and Triant Technologies (2005) Inc. (“Triant”),both Canadian companies acquired in October 2008, depend upon our abilityto successfully 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:

 

·             consolidatingresearch and development operations;

 

·             integrating acquiredproducts and business technology into our existing product lines;

 

·             coordinatingeffective sales and marketing functions;

 

·             preserving researchand development, marketing, customer and other importantrelationships; and

 

·             minimizing thediversion of management’s attention from ongoing business concerns.

 

***Changes ineffective tax rates could negatively affect our operating results.***

 

We conduct our businessglobally and, as a result, are subject to taxation in the United States andforeign countries. Our future tax rates could be affected by numerous factors,including changes in tax laws or the interpretation of such tax laws andchanges in accounting policies. Our filings are subject to reviews or audit bythe Internal Revenue Service and state, local and foreign taxing authorities.We cannot be sure that any final determination in an audit would not bematerially different than the treatment reflected in our historical income taxprovisions and accruals. If additional taxes are assessed as a result of an audit,there could be a significant negative effect on our income tax provision andour operating results in the period or periods for which that determination ismade.

 

***The uncertainty in the credit markets might impact the valueof certain auction-rate******securities we have and we might have to recordimpairment******chargesin the future.***

 

Credit concerns in thecapital 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 March 31, 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 change to operations.

 

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**Item 2. UnregisteredSales of Equity Securities and Use of Proceeds.**

 

(b) *Use ofProceeds*. Our first registration statement, filed on Form S-1(Registration No. 333-43192), related to our initial public offering andwas declared effective by the SEC on July 26, 2001. There has been nochange to the disclosure contained in our Quarterly Report on Form 10-Qfor the quarter ended September 30, 2005 with respect to the use ofproceeds generated by our initial public offering.

 

(c) *StockRepurchase*. The table below sets forth the information with respectto purchases made by or on behalf of the Company or any “affiliated purchaser”(as the term is defined in Rule 10b-18(a)(3) under the SecuritiesExchange Act of 1934) of our common stock during the three months ended March 31,2009 (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  (January 1, 2009 through January 31, 2009)   |       | —                                                        |       | —                                                       |       | —                                                                                                                                                     |       | $                                                                                                                                                                                                         | 1,559      |   |
| Month #2  (February 1, 2009 through February 28, 2009) |       | —                                                        |       | —                                                       |       | —                                                                                                                                                     |       | $                                                                                                                                                                                                         | 1,559      |   |
| Month #3  (March 1, 2009 through March 31, 2009)       |       | —                                                        |       | —                                                       |       | —                                                                                                                                                     |       | $                                                                                                                                                                                                         | 1,559      |   |
| Total                                                            |       | —                                                        |       | $                                                            | —     |                                                                                                                                                       | —     |                                                                                                                                                                                                      |       |   |
|                                                                  |            |                                                               |            |                                                              |            |                                                                                                                                                            |            |                                                                                                                                                                                                           |            |  |  |

 

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(1)     On March 26, 2003, ourBoard of Directors approved a share repurchase program to purchase up to $10.0 millionof our outstanding common stock. The program was completed in August 2007with 988,000 shares repurchased at the average price of $10.12. 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 March 31, 2009,2,428,000 shares had been repurchased at the average price of $3.46 per shareunder this program and $1.6 million remained available for future repurchases.

 

**Item 3.Defaults Upon Senior Securities.**

 

Not Applicable.

 

**Item 4.Submission of Matters to a Vote of Security Holders.**

 

No matters were submittedto a vote of security holders during the first quarter of 2009.

 

**Item 5.Other Information.**

 

None.

 

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**Item 6. 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 bySEC Release No. 33-8212, these exhibits are furnished with this QuarterlyReport on Form 10-Q and are not deemed filed with the Securities andExchange Commission and are not incorporated by reference in any filing of PDFSolutions, Inc. under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, whether made before or after the date hereof and irrespectiveof any general incorporation language 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:  May 11, 2009 |       | By:                                                    | /s/ JOHN K. KIBARIAN |
|                     |       | John K. Kibarian                                       |
|                     |       | President and Chief Executive Officer                  |
|                     |       | (Principal Executive Officer)                          |
|                     |       |                                                   |
| Date:  May 11, 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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**INDEXTO 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 bySEC Release No. 33-8212, these exhibits are furnished with this QuarterlyReport on Form 10-Q and are not deemed filed with the Securities andExchange Commission and are not incorporated by reference in any filing of PDFSolutions, Inc. under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, whether made before or after the date hereof andirrespective of any general incorporation language in any filings.

 

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