Table ofContents

 

 

 

**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

##### **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 June 30, 2009**                                                                                                                                                                               |
|                                                                                                                                                                                                                                 |
| **or**                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                 |
| **o**                                                                                                                                                                                                                                | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                           | ** ** | ** **                                                                                              |
| **For the transition period from                to                ** |

 

**CommissionFile Number 000-31311**

 

**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)

 

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

 

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

 

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

 

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

 

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

 

The number ofshares outstanding of the Registrant’s Common Stock as of July 31, 2009was 26,394,159.

 

 

 

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**Table of Contents**

** **

**TABLE OF CONTENTS**

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

 

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**PART I — FINANCIALINFORMATION**

 

**Item 1. Financial Statements.**

 

**PDFSOLUTIONS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                                                                          | ** ** | **June 30,********2009** | ** ** | **December 31,********2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **(In  thousands,**           | ** ** |
| ** **                                                                                                                                                          | ** ** | **except  par values)**       | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **                    | ** ** | ** **                        | ** ** |
| Current assets:                                                                                                                                                     |       |                          |       |                              |       |
| Cash and cash equivalents                                                                                                                                           |       | $                             | 36,365     |                              | $          | 31,686 |   |
| Short-term investments                                                                                                                                              |       | 2,000                         |       | 9,051                             |       |
| Accounts receivable, net of allowance of $254 in  2009 and 2008                                                                                                     |       | 16,911                        |       | 24,989                            |       |
| Prepaid expenses, deferred tax assets, and other  current assets                                                                                                    |       | 2,586                         |       | 5,147                             |       |
| Total current assets                                                                                                                                                |       | 57,862                        |       | 70,873                            |       |
| Property and equipment, net                                                                                                                                         |       | 2,006                         |       | 2,675                             |       |
| Non-current investments                                                                                                                                             |       | 718                           |       | 718                               |       |
| Intangible assets, net                                                                                                                                              |       | 3,839                         |       | 4,730                             |       |
| Deferred tax assets and other non-current assets                                                                                                                    |       | 974                           |       | 631                               |       |
| Total assets                                                                                                                                                        |       | $                             | 65,399     |                              | $          | 79,627 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                       |       |                          |       |                              |       |
| Current liabilities:                                                                                                                                                |       |                          |       |                              |       |
| Current portion of long-term debt                                                                                                                                   |       | $                             | 337        |                              | $          | 370 |   |
| Accounts payable                                                                                                                                                    |       | 1,515                         |       | 1,384                             |       |
| Accrued compensation and related benefits                                                                                                                           |       | 5,152                         |       | 6,525                             |       |
| Taxes payable and other accrued liabilities                                                                                                                         |       | 2,701                         |       | 3,723                             |       |
| Deferred revenue                                                                                                                                                    |       | 1,968                         |       | 1,792                             |       |
| Billings in excess of recognized revenue                                                                                                                            |       | 796                           |       | 748                               |       |
| Total current liabilities                                                                                                                                           |       | 12,469                        |       | 14,542                            |       |
| Long-term debt                                                                                                                                                      |       | 451                           |       | 512                               |       |
| Long-term taxes payable                                                                                                                                             |       | 3,463                         |       | 3,356                             |       |
| Long-term other liabilities                                                                                                                                         |       | 1,562                         |       | 1,447                             |       |
| Total liabilities                                                                                                                                                   |       | 17,945                        |       | 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 29,883 in 2009 and 29,339 in 2008; shares  outstanding 26,394 in 2009 and 25,923 in 2008 |       | 4                             |       | 4                                 |       |
| Additional paid-in-capital                                                                                                                                          |       | 192,010                       |       | 189,132                           |       |
| Treasury stock at cost, 3,489 shares in 2009 and  3,416 shares in 2008                                                                                              |       | (18,535                       | )          | (18,402                           | )          |
| Accumulated deficit                                                                                                                                                 |       | (126,579                      | )          | (112,620                          | )          |
| Accumulated other comprehensive income                                                                                                                              |       | 554                           |       | 1,656                             |       |
| Total stockholders’ equity                                                                                                                                     |       | 47,454                        |       | 59,770                            |       |
| Total liabilities and stockholders’ equity                                                                                                                     |       | $                             | 65,399     |                              | $          | 79,627 |   |

 

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

 

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**PDF SOLUTIONS, INC.**

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

 
| ** **                                              | ** ** | **Three  Months Ended June 30,**         | ** ** | **Six  Months Ended June 30,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | **2009**                                      | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                              | ** ** | **(In  thousands, except per share amounts)** | ** ** |
| ** **                                              | ** ** | ** **                                    | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                               |       |                                          |       |                                |       |   |   |   |   |
| Design-to-silicon-yield solutions                       |       | $                                             | 7,292      |                                | $          | 15,452 |   | $ | 15,086 |   | $ | 30,476 |   |
| Gainshare performance incentives                        |       | 2,291                                         |       | 5,662                               |       | 4,687 |   | 10,985 |   |
| Total revenues                                          |       | 9,583                                         |       | 21,114                              |       | 19,773 |   | 41,461 |   |
|                                                    |       |                                          |       |                                |       |   |   |   |   |
| Cost of design-to-silicon-yield solutions:              |       |                                          |       |                                |       |   |   |   |   |
| Direct costs of design-to-silicon-yield solutions       |       | 4,863                                         |       | 7,267                               |       | 11,153 |   | 15,033 |   |
| Amortization of acquired technology                     |       | 360                                           |       | 631                                 |       | 719 |   | 1,262 |   |
| Total cost of design-to-silicon-yield solutions         |       | 5,223                                         |       | 7,898                               |       | 11,872 |   | 16,295 |   |
| Gross margin                                            |       | 4,360                                         |       | 13,216                              |       | 7,901 |   | 25,166 |   |
|                                                    |       |                                          |       |                                |       |   |   |   |   |
| Operating expenses:                                     |       |                                          |       |                                |       |   |   |   |   |
| Research and development                                |       | 5,069                                         |       | 9,134                               |       | 10,858 |   | 18,210 |   |
| Selling, general and administrative                     |       | 4,108                                         |       | 5,646                               |       | 8,521 |   | 11,945 |   |
| Amortization of other acquired intangible assets        |       | 87                                            |       | 195                                 |       | 174 |   | 389 |   |
| Restructuring charges                                   |       | 1,202                                         |       | 1,471                               |       | 1,835 |   | 1,471 |   |
| Total operating expenses                                |       | 10,466                                        |       | 16,446                              |       | 21,388 |   | 32,015 |   |
|                                                    |       |                                          |       |                                |       |   |   |   |   |
| Loss from operations                                    |       | (6,106                                        | )          | (3,230                              | )          | (13,487 | ) | (6,849 | ) |
| Interest and other income (expense), net                |       | (210                                          | )          | 251                                 |       | 114 |   | 740 |   |
| Loss before taxes                                       |       | (6,316                                        | )          | (2,979                              | )          | (13,373 | ) | (6,109 | ) |
| Income tax provision (benefit)                          |       | 322                                           |       | (1,039                              | )          | 586 |   | (1,656 | ) |
| Net loss                                                |       | $                                             | (6,638     | )                                   | $          | (1,940 | ) | $ | (13,959 | ) | $ | (4,453 | ) |
|                                                    |       |                                          |       |                                |       |   |   |   |   |
| Net loss per share – basic and diluted             |       | $                                             | (0.25      | )                                   | $          | (0.07 | ) | $ | (0.53 | ) | $ | (0.16 | ) |
| Weighted average common shares – basic and diluted |       | 26,328                                        |       | 27,608                              |       | 26,210 |   | 27,724 |   |

 

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

 

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** **

**PDF SOLUTIONS, INC.**

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

 
| ** **                                                                                 | ** ** | **Six  Months Ended********June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2009**                                   | ** ** | **2008** | ** ** |
| ** **                                                                                 | ** ** | **(In  thousands)**                        | ** ** |
| Operating activities:                                                                      |       |                                       |       |   |   |
| Net loss                                                                                   |       | $                                          | (13,959    | ) | $ | (4,453 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                       |       |   |   |
| Depreciation and amortization                                                              |       | 786                                        |       | 1,017 |   |
| Stock-based compensation expense                                                           |       | 2,461                                      |       | 3,737 |   |
| Amortization of acquired intangible assets                                                 |       | 893                                        |       | 1,651 |   |
| Tax shortfall related to stock-based compensation  expense                                 |       | —                                     |       | (33 | ) |
| Deferred taxes                                                                             |       | 32                                         |       | (2,873 | ) |
| Changes in operating assets and liabilities:                                               |       |                                       |       |   |   |
| Accounts receivable, net of allowances                                                     |       | 8,076                                      |       | 3,103 |   |
| Prepaid expenses and other assets                                                          |       | 2,170                                      |       | (360 | ) |
| Accounts payable                                                                           |       | 213                                        |       | (1,233 | ) |
| Accrued compensation and related benefits                                                  |       | (1,381                                     | )          | 508 |   |
| Taxes payable and other accrued liabilities                                                |       | (799                                       | )          | 282 |   |
| Deferred revenues                                                                          |       | 176                                        |       | 367 |   |
| Billings in excess of recognized revenue                                                   |       | 49                                         |       | (443 | ) |
| Net cash provided by (used in) operating activities                                        |       | (1,283                                     | )          | 1,270 |   |
| Investing activities:                                                                      |       |                                       |       |   |   |
| Purchases of available-for-sale securities                                                 |       | —                                     |       | (16,805 | ) |
| Maturities and sales of available-for-sale  securities                                     |       | 7,053                                      |       | 12,810 |   |
| Purchases of property and equipment                                                        |       | (266                                       | )          | (604 | ) |
| Net cash provided by (used in) investing activities                                        |       | 6,787                                      |       | (4,599 | ) |
| Financing activities:                                                                      |       |                                       |       |   |   |
| Proceeds from exercise of stock options                                                    |       | —                                     |       | 63 |   |
| Proceeds from Employee Stock Purchase Plan                                                 |       | 417                                        |       | — |   |
| Purchases of treasury stock                                                                |       | (133                                       | )          | (2,611 | ) |
| Principal payments on long-term debt                                                       |       | (80                                        | )          | (113 | ) |
| Net cash provided by (used in) financing activities                                        |       | 204                                        |       | (2,661 | ) |
| Effect of exchange rate changes on cash                                                    |       | (1,029                                     | )          | 1,162 |   |
| Net increase (decrease) in cash and cash equivalents                                       |       | 4,679                                      |       | (4,828 | ) |
| Cash and cash equivalents, beginning of period                                             |       | 31,686                                     |       | 35,315 |   |
| Cash and cash equivalents, end of period                                                   |       | $                                          | 36,365     |   | $ | 30,487 |   |
| Supplemental disclosure of cash flow information:                                          |       |                                       |       |   |   |
| Cash paid during the year for:                                                             |       |                                       |       |   |   |
| Taxes                                                                                      |       | $                                          | 679        |   | $ | 1,334 |   |
| Interest                                                                                   |       | $                                          | 11         |   | $ | 21 |   |

 

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

 

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**PDFSOLUTIONS, INC.**

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

 

**1.BASIS OF PRESENTATION**

 

*Basisof Presentation*

 

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

 

Wehave evaluated subsequent events, as defined by Statement of FinancialAccounting Standards (“SFAS”) No. 165, *SubsequentEvents*, through the filing date of this document.

 

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

 

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

 

*RevenueRecognition*

 

TheCompany derives revenue from two sources: Design-to-Silicon-Yield Solutions,which includes Services and Software Licenses, and Gainshare PerformanceIncentives. The Company recognizes revenue in accordance with the provisions ofAmerican Institute of Certified Public Accountants Statement of Position (“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-Yield Solutions*— Revenue that is derived fromDesign-to-Silicon-Yield solutions comes from services and software licenses.The Company recognizes revenue for each element of Design-to-Silicon-Yieldsolutions as follows:

 

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

 

On occasion, the Company has licensed its softwareproducts as a component of its fixed-price services contracts. In suchinstances, the software products are licensed to customers over a specifiedterm of the agreement with support and maintenance to be provided over thelicense term. Under these arrangements, where vendor-specific objectiveevidence of fair value (“VSOE”) exists for the support and maintenance element,the support and maintenance revenue is recognized separately over the term ofthe supporting period. The remaining fee is recognized as services areperformed using the cost-to-cost percentage of completion method of contractaccounting. VSOE for maintenance, in these instances, is generally establishedbased upon a negotiated renewal rate. Under arrangements where softwareproducts are licensed as a component of its fixed-price service contract andwhere VSOE does not exist to allocate a portion of the total fixed-price to theundelivered elements, revenue is recognized for the total fixed-price as thelesser of either the percentage of completion method of contract accounting orratably over the longer of either the term of the agreement or the supportperiod. Costs incurred under these arrangements are deferred and recognized inproportion to revenue recognized under these arrangements.

 

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Revenue from related support and maintenance servicesis recognized ratably over the term of the support and maintenance contract,generally one year, while revenue from consulting, installation and trainingservices is recognized as the services are performed. When bundled withsoftware licenses in multiple element arrangements, support and maintenance,consulting (other than for its fixed-price solution implementations),installation, and training revenue is allocated to each element of atransaction based upon its fair value as determined by the Company’s VSOE. VSOEfor maintenance is generally established based upon negotiated renewal rateswhile VSOE for consulting, installation, and training services is establishedbased upon the Company’s customary pricing for such services when soldseparately. When VSOE does not exist to allocate a portion of the total fee tothe undelivered elements, revenue is recognized ratably over the longest periodof the undelivered elements.

 

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

 

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

 

*SoftwareDevelopment Costs* —Costs for the development of new software products and substantial enhancementsto existing software products are expensed as incurred until technologicalfeasibility has been established, at which time any additional costs would becapitalized in accordance with Statement of Financial Accounting Standards (“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 PRONOUNCEMENTS AND ACCOUNTING CHANGES**

 

EffectiveApril 1, 2009, the Company adopted the provisions of the FinancialAccounting Standard Board’s (“FASB’s”) SFAS No. 165, *Subsequent Events* (“SFAS 165”).  SFAS 165 establishes general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued. SFAS165 requires the disclosure of the date through which an entity has evaluatedsubsequent events and the basis for that date, that is, whether that daterepresents the date the financial statements were issued or were available tobe issued. The adoption of SFAS 165 did not have a material impact on theCompany’s financial results and position.

 

Effective April 1, 2009, the Company adopted the provisions of theFASB’s Staff Position (“FSP”) FAS 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*(“FSP157-4”). FSP 157-4 provides guidance for estimating fair value in accordancewith SFAS No. 157*,*when thevolume and level of activity for the asset or liability have significantlydecreased. This FSP also includes guidance on identifying circumstances thatindicate a transaction is not orderly. The adoption of FSP 157-4 did not have a material impact on the Company’sfinancial results and position.

 

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Effective April 1, 2009, the Company adopted the provisionsof FSP FAS 115-2 and FAS 124-2, *Recognitionand Presentation of Other-Than-Temporary Impairments* (“FSP 115-2 and124-2”).  FSP 115-2 and 124-2 amends the other-than-temporary impairmentguidance for debt securities to make the guidance more operational and toimprove the presentation and disclosure of other-than-temporary impairments inthe financial statements. The adoption of  FSP 115-2 and 124-2 did nothave a material impact on the Company’s financial results and position.

 

EffectiveApril 1, 2009, the Company adopted the provisions of FSP FAS 107, *Disclosures about Fair Value of Financial Instruments* (“FSP107”). FSP 107**requires disclosures about fairvalue of financial instruments for interim reporting periods of publicly tradedcompanies as well as in annual financial statements.  This FSP also amends the AccountingPrincipals Board Opinion No. 28, *Interim FinancialReporting,*to require those disclosures in summarized financialinformation at interim reporting periods. The adoption of FSP 107 had no impact on the Company’s financial resultsand position.

 

Effective January 1,2009, the Company adopted the provisions of the FASB’s SFAS No. 141(revised 2007), *Business Combinations*(“SFAS No. 141R”).  SFAS No. 141R establishes principles andrequirements for how an acquirer of a business recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,any noncontrolling interest in the acquiree, and the goodwill acquired. SFAS No. 141Ralso establishes disclosure requirements to enable the evaluation of the natureand financial effects of the business combination. The adoption of SFAS No. 141Rdid not have an effect on the Company’s financial results and position.

 

**3. INVESTMENTS**

 

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

 
| ** **                          | ** ** | ** **           | ** ** | **June 30,  2009**        | ** ** | ** **                        | ** ** |
|-------------------------------------|------------|----------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **Amortized  Costs** | ** ** | **Unrealized  Holding  Gains** | ** ** | **Unrealized  Holding****Losses** | ** ** | **Fair****Value** | ** ** |
| Agency obligations                  |       | $                    | 1,996      |                           | $          | 4                                 |       | $ | — |   | $ | 2,000 |   |
| Auction-rate securities             |       | 1,000                |       | —                         |       | (282                              | )          | 718 |   |
|                                |       | $                    | 2,996      |                           | $          | 4                                 |       | $ | (282 | ) | $ | 2,718 |   |
| Included in short term investments  |       |                 |       |                           |       |                              |       | $ | 2,000 |   |
| Included in non-current investments |       |                 |       |                           |       |                              |       | 718 |   |
| Total                               |       |                 |       |                           |       |                              |       | $ | 2,718 |   |

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

 

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

 

**4.ACCOUNTS RECEIVABLE**

 

Accountsreceivable include amounts that are unbilled at the end of the period. Unbilledaccounts receivable are determined on an individual contract basis and wereapproximately $8.0 million and $10.5 million as of June 30, 2009 and December 31,2008, respectively.

 

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**5.GOODWILL AND ACQUIRED INTANGIBLE ASSETS**

 

SFAS No. 142*,Goodwill and other Intangible Assets,*requires goodwill to be testedfor impairment on an annual basis (or more frequently if indicators ofimpairment exist) and requires purchased intangible assets other than goodwillto be amortized over their useful lives unless these lives are determined to beindefinite. The Company completed its annual impairment test in the fourthquarter of 2008 and the Company observed impairment indicators during thefourth quarter of 2008 including the trading of common stock below the Company’sbook value and a further deterioration in the semiconductor industry, broughton by the deteriorating global economic environment. The Company also evaluatedits acquired intangible assets for impairment. As a result of the impairmentanalyses, the Company recorded an impairment charge of $64.0 million related togoodwill and $6.3 million relating to its acquired intangible assets during thefourth quarter of 2008.  During the sixmonths ended June 30, 2009, there were no indicators of impairment relatedto the Company’s intangible assets.

 

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

 
| **Acquired Identifiable  Intangibles** | ** ** | ******Amortization  Period  (Years)** | ** ** | **December 31,  2008********Net Carrying********Amount** | ** ** | ******Amortization** | ** ** | ******Foreign********Currency********Translation** | ** ** | **June 30,********2009********Net Carrying********Amount** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|---------------------------------------------------------------|------------|----------------------|------------|----------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| Acquired technology                    |       | 4 - 5                                 |       | $                                                             | 3,608      |                 | $          | (719                                               | )          | $                                                               | —     |   | $ | 2,889 |   |
| Brand name                             |       | 4                                     |       | 129                                                           |       | (36                  | )          | —                                             |       | 93                                                              |       |
| Customer relationships  and backlog    |       | 1 - 6                                 |       | 489                                                           |       | (66                  | )          | —                                             |       | 423                                                             |       |
| Patent and applications                |       | 7                                     |       | 400                                                           |       | (37                  | )          | —                                             |       | 363                                                             |       |
| Other acquired  intangibles            |       | 4                                     |       | 104                                                           |       | (35                  | )          | 2                                                  |       | 71                                                              |       |
| Total                                  |       |                                  |       | $                                                             | 4,730      |                 | $          | (893                                               | )          | $                                                               | 2          |   | $ | 3,839 |   |

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

 

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

 
| **Year  Ending December 31,** | ** ** | **Amount** | ** ** |
|------------------------------------|------------|------------|------------|
| 2009 (remaining  six-month period) |       | $          | 891        |   |
| 2010                               |       | 1,578      |       |
| 2011                               |       | 830        |       |
| 2012                               |       | 435        |       |
| 2013                               |       | 74         |       |
| 2014 and thereafter                |       | 31         |       |
| Total                              |       | $          | 3,839      |   |

 

**6.STOCKHOLDERS’ EQUITY**

 

TheCompany accounts for stock-based compensation in accordance with SFAS No. 123(revised 2004), *Share-Based Payment.* Stock-basedcompensation expenses before taxes related to the Company’s employee stockpurchase plan and stock-option plans were allocated as follows (in thousands):

 
| ****                                      | ** ** | **Three  Months********Ended June 30,** | ** ** | **Six  Months********Ended June 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2009**                                     | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Cost of design-to-silicon yield-solutions |       | $                                            | 444        |                                       | $          | 400 |   | $ | 833 |   | $ | 930 |   |
| Research and development                  |       | 404                                          |       | 711                                        |       | 752 |   | 1,306 |   |
| Selling, general and administrative       |       | 477                                          |       | 643                                        |       | 876 |   | 1,501 |   |
| Stock-based compensation expenses         |       | $                                            | 1,325      |                                       | $          | 1,754 |   | $ | 2,461 |   | $ | 3,737 |   |

 

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TheCompany estimated the fair value of share-based payments using theBlack-Scholes-Merton option-pricing model with the following weighted averageassumptions and weighted average fair values:

 

*Stock Plans:*

 
| ** **                                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected life (in  years)                                                   |       | 5.16                                 |       | 5.77                               |       | 5.16 |   | 5.77 |   |
| Volatility                                                                  |       | 61.7                                 | %          | 59.2                               | %          | 61.3 | % | 58.7 | % |
| Risk-free interest rate                                                     |       | 3.16                                 | %          | 3.23                               | %          | 2.03 | % | 3.07 | % |
| Expected dividend                                                           |       | —                               |       | —                             |       | — |   | — |   |
| Weighted average fair  value per share of options granted during the period |       | —                               |       | $                                  | 3.07       |   | $ | 0.57 |   | $ | 3.45 |   |
|                                                                             |            |                                      |            |                                    |            |  |  |  |  |  |  |  |

 

Therewere no stock option grants during the three months ended June 30, 2009.

 

*EmployeeStock Purchase Plan:*

 
| ** **                                                                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                        | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Expected life (in  years)                                                         |       | 1.25                                 |       | 1.33                               |       | 1.25 |   | 1.33 |   |
| Volatility                                                                        |       | 80.1                                 | %          | 54.9                               | %          | 79.9 | % | 54.9 | % |
| Risk-free interest rate                                                           |       | 1.22                                 | %          | 3.10                               | %          | 1.25 | % | 3.10 | % |
| Expected dividend                                                                 |       | —                               |       | —                             |       | — |   | — |   |
| Weighted average fair value per share of employee  stock issued during the period |       | $                                    | 0. 73      |                               | $          | 3.60 |   | $ | 0. 77 |   | $ | 3.60 |   |
|                                                                                   |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

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

 

*Stock Plans —*During 2001, the Company terminated the 1996 and 1997Stock Plans as to future option grants, and adopted the 2001 Stock Plan. Underthe 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.

 

Stockoption activity under the Company’s plan during the six months ended June 30,2009 was as 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                          |       | (104                                                   | )          | 8.39                                                            |       |                                                                    |       |                                                           |       |
| Expired                           |       | (89                                                    | )          | 9.84                                                            |       |                                                                    |       |                                                           |       |
| Outstanding, June 30, 2009   |       | 4,249                                                  |       | 8.87                                                            |       | 6.70                                                                    |       | $                                                              | 87         |   |
| Vested and expected to vest       |       | 4,014                                                  |       | 8.95                                                            |       | 6.59                                                                    |       | $                                                              | 77         |   |
| Exercisable at June 30, 2009 |       | 2,743                                                  |       | 9.49                                                            |       | 5.71                                                                    |       | $                                                              | 46         |   |
|                                   |            |                                                        |            |                                                                 |            |                                                                         |            |                                                                |            |  |  |

 

Theaggregate intrinsic value in the table above represents the total intrinsicvalue based on the Company’s closing stock price of $2.55 as of June 30,2009, which would have been received by the option holders had all “in-the-money”option holders exercised their options as of that date. No stock options wereexercised during the six months ended June 30, 2009.

 

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As of June 30,2009, there was $5.4 million of total unrecognized compensation cost related tononvested stock options. That cost is expected to be recognized over a weightedaverage period of 2.3 years. The total fair value of shares vested during thethree months ended June 30, 2009 was $1.6 million.

 

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

 
| ** **                       | ** ** | ******Shares********(in thousands)** | ** ** | **Weighted Average********Grant Date********Fair Value** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|----------------------------------------------------------|------------|
| Nonvested,  January 1, 2009 |       | 852                                  |       | $                                                        | 8.64       |   |
| Granted                          |       | —                               |       | —                                                   |       |
| Vested                           |       | (215                                 | )          | 1.17                                                     |       |
| Forfeited                        |       | (49                                  | )          | 8.59                                                     |       |
| Nonvested, June 30, 2009    |       | 588                                  |       | 9.88                                                     |       |
|                                  |            |                                      |            |                                                          |            |  |

 

As of June 30,2009, there was $3.4 million of total unrecognized compensation cost related tononvested restricted stock units. That cost is expected to be recognized over aweighted average period of 3.1 years. The total compensation expense related toshares vested during the six months ended June 30, 2009 was $927,000.

 

*Employee Stock Purchase Plan*— In July 2001, the Company adopted an EmployeeStock Purchase Plan (“Purchase Plan”), under which eligible employees cancontribute up to 10% of their compensation, as defined in the Purchase Plan,towards the purchase of shares of PDF common stock at a price of 85% of thelower of the fair market value at the beginning of the offering period or theend of each six-month offering period. Under the Purchase Plan, on January 1of each year, starting with 2002, the number of shares reserved for issuancewill automatically increase by the lesser of (1) 675,000 shares, (2) 2%of the Company’s outstanding common stock on the last day of the immediatelypreceding year, or (3) the number of shares determined by the board ofdirectors. For the six months ended June 30, 2009, the Purchase Plancompensation expense was $110,000.

 

*Stock Repurchase Program*— On March 26, 2003, the Company’s Board ofDirectors approved a share repurchase program to purchase up to $10.0 millionof its outstanding common stock. 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 June 30, 2009, 2.5 million shares have been repurchased at theaverage price of $3.41 per share under this program and $1.5 million remainedavailable for future repurchases.

 

**7. RESTRUCTURING**

 

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

 

Forthe plan announced on April 29, 2008, the Company recorded restructuringcharges of $1.5 million during the three months ended June 30, 2008, whichprimarily consisted of employee severance costs of $1.4 million. All severancecosts and related fees were paid out and the activities were completed as of March 31,2009.

 

Forthe plan announced on October 28, 2008, the Company recorded restructuringcharges of $3.8 million, primarily consisting of employee severance costs of$2.7 million and facility exit costs of $985,000. Of the $3.8 million, $1.8million was recorded during the six months ended June 30, 2009, whichprimarily consisted of employee severance costs. The following table summarizesthe activities of these restructuring liabilities (in thousands):

 
| **Restructuring  Announced on October 28, 2008** | ** ** | ******Severance** | ** ** | ******Facility Exit** | ** ** | **Professional********and Other Fees** | ** ** | ******Total** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------------------------------|------------|---------------|------------|
| Balance,  January 1, 2009                        |       | $                 | 860        |                  | $          | 1,108                                  |       | $             | 31         |   | $ | 1,999 |   |
| Restructuring charges                                 |       | 1,755             |       | —                |       | 80                                     |       | 1,835         |       |
| Payments                                              |       | (1,650            | )          | (224                  | )          | (85                                    | )          | (1,959        | )          |
| Balance, June 30, 2009                           |       | $                 | 965        |                  | $          | 884                                    |       | $             | 26         |   | $ | 1,875 |   |

 

As of June 30,2009, of the remaining accrual of $1.9 million, $1.4 million was included inaccrued liabilities and $501,000 was included in long-term other liabilities.Accrued severance of $965,000 and accrued professional and other fees of$26,000 are expected to be paid out in the three months ending September 30,2009. Accrued facility exit costs will be paid in accordance with the lease paymentschedule through 2013.

 

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**8.INCOME TAXES**

 

The Company accounts for temporary differences between the book and taxbasis of assets and liabilities by recording deferred tax assets andliabilities in accordance with SFAS No. 109, *Accounting for Income Taxes*, and Financial Interpretation No. 48,*Accounting for Uncertainty in Income Taxes — AnInterpretation of FASB Statement No. 109* (“FIN No. 48”).**The Company must assess the likelihood that its deferredtax assets will be recovered from future taxable income and, to the extent theCompany believes that recovery is not likely, the Company must establish a valuationallowance. Changes in the Company’s net deferred tax assets and valuationallowance, in a period are recorded through the income tax provision in thecondensed consolidated statements of operations.

 

Inaccordance with FIN No. 48, the Company classifies its liabilitiesrelated to unrecognized tax benefits as long-term. The Company includesinterest and penalties related to unrecognized tax benefits within the Company’sincome tax provision (benefit). As of June 30, 2009 and December 31,2008, the Company had $684,000 and $562,000, respectively, accrued for paymentof interest and penalties related to unrecognized tax benefits.

 

TheCompany’s total amount of unrecognized tax benefits as of June 30, 2009was $8.5 million, of which $2.9 million, if recognized, would affect theCompany’s effective tax rate. The Company’s total amount of unrecognized taxbenefits as of December 31, 2008 was $8.2 million, of which $2.8 million,if recognized, would affect the Company’s effective tax rate. As of June 30,2009, the Company has recognized a net amount of $3.5 million as long-termtaxes payable for unrecognized tax benefits in its consolidated balance sheets.The Company does not expect the change in unrecognized tax benefits over thenext twelve months to materially impact its results of operations and financialposition.

 

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

 

**9.NET LOSS PER SHARE**

 

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

 
| ** **                                         | ** ** | **Three Months********Ended June 30,** | ** ** | **Six Months********Ended June 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net loss                                           |       | $                                           | (6,638     | )                                         | $          | (1,940 | ) | $ | (13,959 | ) | $ | (4,453 | ) |
| Denominator for basic  calculation:                |       |                                        |       |                                      |       |   |   |   |   |
| Weighted average common  shares outstanding- basic |       | 26,328                                      |       | 27,608                                    |       | 26,210 |   | 27,724 |   |
| Dilutive items                                     |       |                                        |       |                                      |       |   |   |   |   |
| Stock options  outstanding                         |       | —                                      |       | —                                    |       | — |   | — |   |
| Denominator for diluted  computation               |       | 26,328                                      |       | 27,608                                    |       | 26,210 |   | 27,724 |   |
| Net loss per share —  basic and diluted       |       | $                                           | (0.25      | )                                         | $          | (0.07 | ) | $ | (0.53 | ) | $ | (0.16 | ) |

 

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**10. COMPREHENSIVE LOSS**

 

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

 
| ** **                                                           | ** ** | **Three Months********Ended June 30,** | ** ** | **Six Months********Ended June 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                           | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net loss                                                             |       | $                                           | (6,638     | )                                         | $          | (1,940 | ) | $ | (13,959 | ) | $ | (4,453 | ) |
| Unrealized loss  on investments, net of income tax effects           |       | (24                                         | )          | (43                                       | )          | (61 | ) | (85 | ) |
| Foreign currency  translation adjustments, net of income tax effects |       | 226                                         |       | 106                                       |       | (1,041 | ) | 2,064 |   |
| Comprehensive  loss                                                  |       | $                                           | (6,436     | )                                         | $          | (1,877 | ) | $ | (15,061 | ) | $ | (2,474 | ) |

 

**11.CUSTOMER AND GEOGRAPHIC INFORMATION**

 

SFAS No. 131,*Disclosures about Segments of an Enterpriseand Related**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’schief operating decision maker, the Chief Executive Officer, reviews discretefinancial information presented on a consolidated basis for purposes of makingoperating decisions and assessing financial performance. Accordingly theCompany considers itself to be in one operating segment, specifically thelicensing and implementation of yield improvement solutions for integrated circuitmanufacturers.

 

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

 
| ** **   | ** ** | **Three  Months  Ended June 30,** | ** ** | **Six  Months  Ended June 30,** | ** ** |
|--------------|------------|-----------------------------------|------------|---------------------------------|------------|
| **Customer** | ** ** | **2009**                          | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| A            |       | 22                                | %          | 14                              | %          | 26 | % | 15 | % |
| B            |       | 12                                | %          | *                               | %          | 10 | % | * | % |
| C            |       | *                                 | %          | 17                              | %          | * | % | 17 | % |
| D            |       | *                                 | %          | 11                              | %          | * | % | * | % |

 

----

*  represents less than 10%

 

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

 
| **Customer** | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------|------------|-------------------------|------------|-----------------------------|------------|
| A            |       | 19                      | %          | 17                          | %          |
| C            |       | 12                      | %          | 13                          | %          |
| E            |       | 12                      | %          | 11                          | %          |
| F            |       | 11                      | %          | *                           | %          |
| G            |       | 11                      | %          | *                           | %          |
| D            |       | *                       | %          | 12                          | %          |

 

----

*  represents less than 10%

 

Revenuesfrom customers by geographic area are as follows (in thousands):

 
| ** **    | ** ** | **Three Months********Ended June 30,** | ** ** | **Six Months********Ended June 30,** | ** ** |
|---------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **    | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Asia          |       | $                                           | 5,586      |                                      | $          | 12,135 |   | $ | 11,044 |   | $ | 22,534 |   |
| United States |       | 2,978                                       |       | 5,156                                     |       | 7,044 |   | 10,764 |   |
| Europe        |       | 1,019                                       |       | 3,823                                     |       | 1,685 |   | 8,163 |   |
| Total         |       | $                                           | 9,583      |                                      | $          | 21,114 |   | $ | 19,773 |   | $ | 41,461 |   |

 

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As of June 30,2009 and December 31, 2008, long-lived assets related to PDF SolutionsS.A.S. (formerly Si Automation S.A.), located in France, totaled $218,000 and$336,000, respectively. The majority of the Company’s remaining long-livedassets are in the United States.

 

**12. FAIR VALUE**

 

UnderSFAS No. 157, fair value is defined as the exit price, or the amount thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants as of the measurement date.SFAS No. 157 refers to the multiple assumptions used to value financialinstruments as inputs, and establishes hierarchy for inputs used in measuringfair value that maximizes the use of observable inputs and minimizes the use ofunobservable inputs by requiring that the most observable inputs be used whenavailable. Observable inputs reflect assumptions market participants would usein pricing an asset or liability based on market data obtained from independentsources while unobservable inputs reflect a reporting entity’s pricing basedupon its own market assumptions. These inputs are ranked according to a fairvalue hierarchy that prioritizes the inputs to valuation techniques used tomeasure fair 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.                                                                                                                                                                                                                          |

 

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

 
| **Assets**                | ** ** | ******Total** | ** ** | **Quoted  Prices in********Active Markets for********Identical Assets********(Level 1)** | ** ** | ******Significant Other********Observable Inputs********(Level 2)** | ** ** | ******Significant********Unobservable Inputs********(Level 3)** | ** ** |
|---------------------------|------------|---------------|------------|------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| Money market mutual funds |       | $             | 30,996     |                                                                                     | $          | 30,996                                                              |       | $                                                               | —     |   | $ | — |   |
| Agency obligations        |       | 2,000         |       | —                                                                                   |       | 2,000                                                               |       | —                                                          |       |
| Auction-rate securities   |       | 718           |       | —                                                                                   |       | —                                                              |       | 718                                                             |       |
| Total                     |       | $             | 33,714     |                                                                                     | $          | 30,996                                                              |       | $                                                               | 2,000      |   | $ | 718 |   |

 

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

 

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

 

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

 

**Forward-Looking Statements**

 

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

 

**Overview**

 

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

 

***History***

 

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

 

***Industry Trend***

 

Subject to thecurrent general economic downturn, demand for consumer electronics andcommunications devices continues to drive technological innovation in thesemiconductor industry as the need for products with greater performance, lowerpower consumption, reduced costs and smaller size continues to grow with eachnew product generation. In addition, advances in computing systems and mobiledevices have fueled demand for higher capacity memory chips. To meet thesedemands, IC manufacturers and designers are constantly challenged to improvethe overall performance of their ICs by designing and manufacturing ICs withmore embedded applications to create greater functionality while lowering costper transistor. As a result, both logic and memory 

 

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manufacturers havemigrated to more and more advanced manufacturing nodes, capable of integratingmore devices with higher performance, higher density, and lower power. As thistrend continues, companies will continually be challenged to improve processcapabilities to optimally produce ICs with minimal random and systematic yieldloss, which is driven by the lack of compatibility between the design and itsrespective manufacturing process. We believe that as volume production of deepsubmicron ICs continues to grow, the difficulties of integrating IC designswith their respective processes and ramping new manufacturing processes willcreate a greater need for products and services that address the yield loss andescalating cost issues the semiconductor industry is facing today and will facein the future.

 

***FinancialHighlights***

 

The semiconductor industry is currently experiencing significantchallenges, primarily due to a deteriorating macroeconomic environment, and itis unclear when a turnaround may occur. As a result of this downturn, some ofour customers faced financial challenges in fiscal 2008 and may continue toface such challenges in fiscal 2009. The current economic downturn hascontributed to the substantial reduction in our revenue and could continue toharm our business, operating results and financial condition.

 

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

 

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

 

·**            **Total revenue for the three months ended June 30,2009 was $9.6 million, a decrease of $11.5 million, or 55% compared to thethree months ended June 30, 2008. Design-to-Silicon-Yield solutionsrevenue for the three months ended June 30, 2009 was $7.3 million, adecrease of $8.2 million, or 53%, compared to $15.5 million for the threemonths ended June 30, 2008. The decrease in Design-to-Silicon-Yieldsolutions revenue was primarily the result of lower bookings. The dramaticdownturn in the semiconductor industry combined with weakness in worldwideeconomies have been the primary contributors to this reduction. Gainshareperformance incentives revenue for the three months ended June 30, 2009was $2.3 million, a decrease of $3.4 million, or 60%, compared to $5.7 millionfor the three months ended June 30, 2008. The decrease in revenue fromGainshare performance incentives was primarily the result of reduced volumes incustomer manufacturing facilities.

 

·**            **Net loss for the three months ended June 30, 2009was $6.6 million, compared to $1.9 million for the three months ended June 30,2008. The increase in net loss was primarily attributable to a significantdecrease in revenue, partially offset by decreases in operating expenses as theresult of our cost control efforts.

 

·**            **Net loss per basic and diluted share was $0.25 for thethree months ended June 30, 2009 compared to $0.07 for the three monthsended June 30, 2008, an increase in net loss of $0.18 per basic anddiluted share.

 

Financialhighlights for the six months ended June 30, 2009 were as follows:

 

·**            **Total revenue for the six months ended June 30,2009 was $19.8 million, a decrease of $21.7 million, or 52% compared to the sixmonths ended June 30, 2008. Revenue from Design-to-Silicon-Yield solutionsfor the six months ended June 30, 2009 decreased $15.4 million to $15.1million compared to $30.5 million for the six months ended June 30,2008.  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 been theprimary contributors to this reduction. Revenue from gainshare performanceincentives for the six months ended June 30, 2009 decreased $6.3 millionto $4.7 million from the six months ended June 30, 2008.  The decrease in revenue from Gainshareperformance incentives was primarily the result of reduced volumes in customermanufacturing facilities.

 

·**            **Net loss for the six months ended June 30, 2009was $14.0 million, an increase of $9.5 million compared to a $4.5 million lossfor the six months ended June 30, 2008. The increase in net loss wasprimarily attributable to a significant decrease in revenue, partially offsetby decreases in operating expenses as the result of our cost control efforts.

 

·**           **Net loss per basic and diluted share was $0.53 for thesix months ended June 30, 2009 compared to $0.16 for the six months ended June 30,2008, an increase in net loss of $0.37 per basic and diluted share.

 

·**            **Cash, cash equivalents and investments decreased $2.4million to $39.1 million during the six months ended June 30, 2009,primarily due to payments of $2.0 million for accrued restructuring charges.

 

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**Critical Accounting Policies**

 

FinancialReporting Release No. 60 requires all companies to include a discussion ofcritical accounting policies or methods used in the preparation of financialstatements. Item 7 of the consolidated financial statements on the AnnualReport on Form 10-K for the year ended December 31, 2008, includes asummary of the significant accounting policies and methods used in thepreparation of our condensed consolidated financial statements. The followingis a brief discussion of the more significant accounting policies and methodsthat we use.

 

***General***

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on our consolidated financial statements, which have been prepared inconformity with accounting principles generally accepted in the United Statesof America. Our preparation of these consolidated financial statements requiresus to make estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosure of contingent assets and liabilities at thedates of the financial statements and the reported amounts of revenues 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, therealization of deferred tax assets, and stock based compensation. Actualamounts may differ from such estimates under different assumptions orconditions.

 

***Revenue Recognition***

 

Wederive revenue from two sources: Design-to-Silicon-Yield Solutions, whichincludes Services and Software Licenses, and Gainshare Performance Incentives.We recognize revenue in accordance with the provisions of American Institute ofCertified Public Accountants’ Statement of Position (“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-Yield Solutions*— Revenue that is derived fromDesign-to-Silicon-Yield solutions comes from services and software licenses. Werecognize revenue for each element of Design-to-Silicon-Yield solutions asfollows:

 

*Services* — We generate a significant portion of ourDesign-to-Silicon-Yield solutions revenue from fixed-price solutionimplementation service contracts delivered over a specific period of time.These contracts require accurate estimation of cost to perform obligations 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. If wedo not accurately estimate the resources required or the scope of work to beperformed, or do not manage the projects properly within the planned period oftime or satisfy our obligations under contracts, resulting contract marginscould be materially different than those anticipated when the contract wasexecuted. Any such reductions in contract margin could have a material negativeimpact on our operating results.

 

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

 

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

 

*Software Licenses* — We also license our software products separatefrom our integrated solution implementations. For software license arrangementsthat do not require significant modification or customization of the underlyingsoftware, software license revenue is recognized under the residual method when(1) persuasive evidence of an arrangement exists, (2) delivery hasoccurred, (3) the fee is fixed or determinable, (4) collectibility isprobable, 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 formaintenance is generally established 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.

 

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

 

***Software Development Costs***

 

Costs for thedevelopment of new software products and substantial enhancements to existingsoftware products are expensed as incurred until technological feasibility hasbeen established, at which time any additional costs would be capitalized inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 86,*Computer Software to be Sold, Leased or**Otherwise Marketed*. Because webelieve our current process for developing software is essentially completedconcurrently with the establishment of technological feasibility, no costs havebeen capitalized to date.

 

***Goodwill and Acquired Intangible Assets***

 

As of June 30,2009 and December 31, 2008, the recorded value of our intangible assetswas $3.9 million and $4.7 million, respectively, and the recorded value ofgoodwill was zero. In assessing the valuation and recoverability of ourgoodwill and intangible assets, we must make assumptions regarding estimatedfuture cash flows to be derived from the acquired assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets, which would have a material adverse effecton our operating results. We evaluate goodwill for impairment pursuant to theprovisions of SFAS No. 142, *Goodwilland Other Intangible Assets*. We have selected December 31 asthe date upon which to perform our annual testing for goodwill impairment.During the fourth quarter of fiscal 2008, we observed impairment indicators,relating to our long-lived assets, including the trading of our common stockbelow our book value and a further deterioration in the semiconductor industrybrought on by the deteriorating global economic environment which triggered thenecessity of an 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. 

 

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The analysis indicatedthat the carrying value of certain assets exceeded the undiscounted cash flows.As such, we determined that certain acquired intangible assets were impaired.We measured the amount of impairment by calculating the amount by which thecarrying value of the intangible assets exceeded their estimated fair values,which were based on projected discounted future net cash flows. As a result ofthis impairment analysis, we recorded an impairment charge of $6.3 millionduring the fourth quarter of 2008. During the six months ended June 30, 2009, there were no indicatorsof impairment related to the Company’s intangible assets.

 

We completed our annual impairment analysis ofgoodwill as of December 31, 2008, including the second step prescribed bySFAS No. 142. As part of the second step of our goodwill impairmenttest, we determined the fair value of our goodwill by allocating the estimatedfair value of our reporting unit to our assets and liabilities, including theestimated fair value of our unrecorded intangible assets, on a fair valuebasis. After allocating its assets and liabilities on a fair value basis, werecorded an impairment of all of our goodwill of $64.0 million.

 

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

 

***Income Taxes***

 

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

 

***Stock-BasedCompensation***

 

We account forstock-based compensation in accordance with SFAS No. 123 (revised 2004), *Share-Based Payment*(“SFAS No. 123R”). Under theprovisions of SFAS No. 123R, stock-based compensation cost is estimated atthe grant date based on the award’s fair-value as calculated by theBlack-Scholes-Merton (“BSM”), option-pricing model and is recognized as expenseratably over the requisite service period. The BSM model requires varioushighly judgmental assumptions including volatility, forfeiture rates, andexpected option life. If any of the assumptions used in the BSM model changesignificantly, stock-based compensation expense may differ materially in thefuture from that recorded in the current period.

 

**RecentAccounting Pronouncements and Accounting Changes**

 

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

 

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***Results of Operations***

 

The followingtable sets forth, for the periods indicated, the percentage of total revenuerepresented by the line items reflected in our condensed consolidatedstatements of operations:
| ** **                                        | ** ** | **Three Months Ended********June 30,** | ** ** | **Six Months Ended********June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **2009**                                    | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                         |       |                                        |       |                                      |       |   |   |   |   |
| Design-to-silicon-yield  solutions                |       | 76                                          | %          | 73                                        | %          | 76 | % | 74 | % |
| Gainshare performance  incentives                 |       | 24                                          |       | 27                                        |       | 24 |   | 26 |   |
| Total revenues                                    |       | 100                                         | %          | 100                                       | %          | 100 | % | 100 | % |
| Cost of  design-to-silicon-yield solutions:       |       |                                        |       |                                      |       |   |   |   |   |
| Direct cost of  design-to-silicon-yield solutions |       | 51                                          |       | 34                                        |       | 56 |   | 36 |   |
| Amortization of  acquired technology              |       | 4                                           |       | 3                                         |       | 4 |   | 3 |   |
| Total cost of  design-to-silicon-yield solutions  |       | 55                                          |       | 37                                        |       | 60 |   | 39 |   |
| Gross margin                                      |       | 45                                          |       | 63                                        |       | 40 |   | 61 |   |
| Operating expenses:                               |       |                                        |       |                                      |       |   |   |   |   |
| Research and  development                         |       | 53                                          |       | 43                                        |       | 55 |   | 44 |   |
| Selling, general and  administrative              |       | 43                                          |       | 27                                        |       | 43 |   | 29 |   |
| Amortization of other  acquired intangible assets |       | 1                                           |       | 1                                         |       | 1 |   | 1 |   |
| Restructuring charges                             |       | 12                                          |       | 7                                         |       | 9 |   | 4 |   |
| Total operating  expenses                         |       | 109                                         |       | 78                                        |       | 108 |   | 78 |   |
| Loss from operations                              |       | (64                                         | )          | (15                                       | )          | (68 | ) | (17 | ) |
| Interest and other  income (expense), net         |       | (2                                          | )          | 1                                         |       | — |   | 2 |   |
| Loss before taxes                                 |       | (66                                         | )          | (14                                       | )          | (68 | ) | (15 | ) |
| Income tax provision  (benefit)                   |       | 3                                           |       | (5                                        | )          | 3 |   | (4 | ) |
| Net loss                                          |       | (69                                         | )%         | (9                                        | )%         | (71 | )% | (11 | )% |

 

***Comparison of theThree Months Ended June 30, 2009 and 2008***

 
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------|------------|
| **Revenue**                              | ** ** | **Three Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                 | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                          | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Design-to-silicon-yield  solutions       |       | $                                    | 7,292      |       | $          | 15,452     |       | $                    | (8,160     | )                                    | (53        | )% | 76 | % | 73 | % |
| Gainshare performance  incentives        |       | 2,291                                |       | 5,662      |       | (3,371     | )          | (60                  | )%         | 24                                   | %          | 27 | % |
| Total                                    |       | $                                    | 9,583      |       | $          | 21,114     |       | $                    | (11,531    | )                                    | (55        | )% | 100 | % | 100 | % |

 

*Design-to-Silicon-YieldSolutions*.Design-to-Silicon-Yield solutions revenue is derived from services (includingsolution implementations, software support and maintenance, consulting, andtraining) and software licenses, provided during our customer yield improvementengagements and solution product sales.  Design-to-Silicon-Yield solutionsrevenue decreased $8.2 million for the three months ended June 30, 2009compared to the three months ended June 30, 2008, primarily due to adecrease of $6.1 million in fixed fee integrated solutions and a decrease of$1.9 million in software and software related services.  The decreases were primarily the result oflower bookings, 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 have beenthe primary contributors to this shortfall. Our Design-to-Silicon-YieldSolutions revenue may fluctuate in the future and is dependent on a number offactors including our ability to obtain new customers at emerging technologynodes.

 

*GainsharePerformance Incentives*. Gainshare performance incentives revenue represents profit sharingand performance incentives earned based upon our customers reaching certaindefined operational levels. Revenue derived from gainshare performanceincentives decreased $3.4 million for the three months ended June 30, 2009compared to the three months ended June 30, 2008, primarily due todecreases in wafer volumes at our customer sites. The revenue from gainshareperformance incentives was generated from six customers and seven engagementsfor the three months ended June 30, 2009 and six customers and nineengagements for the three months ended June 30, 2008. Our gainshareperformance incentives revenue may continue to fluctuate from period to period.Gainshare performance incentives revenue is dependent on many factors that areoutside our 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 containingprovisions for gainshare performance incentives.

 

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| ** **                                         | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------|------------|
| **Cost of  Design-to-Silicon Yield Solutions**     | ** ** | **Three Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                 | ** ** |
| **(In  thousands, except for %’s)**           | ** ** | **2009**                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                          | ** ** | **Revenue** | ** ** |
| ** **                                         | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Direct costs of  design-to-silicon-yield solutions |       | $                                    | 4,863      |       | $          | 7,267      |       | $                    | (2,404     | )                                    | (33        | )% | 51 | % | 34 | % |
| Amortization of  acquired technology               |       | 360                                  |       | 631        |       | (271       | )          | (43                  | )%         | 4                                    | %          | 3 | % |
| Total                                              |       | $                                    | 5,223      |       | $          | 7,898      |       | $                    | (2,675     | )                                    | (34        | )% | 55 | % | 37 | % |

 

*Costs of Design-to-Silicon-Yield Solutions*. Costs of Design-to-Silicon-Yieldsolutions consist of costs incurred to provide and support our services, costsrecognized in connection with licensing our software, and amortization ofacquired technology.

 

*Direct costs 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 licensing third-partysoftware sold in conjunction with our software products and expenses incurredto produce and distribute our product documentation.**Direct costs of Design-to-Silicon-Yield solutions decreased$2.4 million for the three months ended June 30, 2009 compared to thethree months ended June 30, 2008, primarily due to a decrease of $750,000in personnel expenses in the U.S.,  adecrease of $337,000 in the use of outside consultants, a decrease of $312,000in the deployment of our pdFasTest products, and a decrease of $291,000 intravel expenses, as a result of our cost control efforts.  If we do not accurately estimate theresources required or the scope of work to be performed, or we do not managethe projects properly within the planned period of time or satisfy ourobligations under contracts, resulting contract margins could be materiallydifferent than those anticipated when the contract was executed. Any suchreductions in contract margin could have a material negative impact on ouroperating results.

 

*Amortization of Acquired Technology*. Amortization of acquired technologyconsists of amortization of intangible assets acquired as a result of certainbusiness combinations. Amortization of acquired technology expense decreased$271,000 for the three months ended June 30, 2009 compared to the threemonths ended June 30, 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 $719,000 forthe remaining six months in 2009, $1.3 million in 2010, $626,000 in 2011, and$261,000 in 2012.

 
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------|------------|
| **Research  and Development**            | ** ** | **Three Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                 | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                          | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Research and development                 |       | $                                    | 5,069      |       | $          | 9,134      |       | $                    | (4,065     | )                                    | (45        | )% | 53 | % | 43 | % |
|                                          |            |                                      |            |            |            |            |            |                      |            |                                      |            |  |  |  |  |  |

 

*Research and Development.*Research and development expenses consist primarily ofpersonnel-related costs to support product development activities, includingcompensation and benefits, outside development services, travel and facilitiescost allocations, and stock-based compensation charges. Research anddevelopment expenses decreased $4.1 million for the three months ended June 30,2009 compared to the three months ended June 30, 2008, primarily due to adecrease of $2.4 million in personnel expenses in the U.S. and France resultingfrom a shift in research and development resources to lower cost areas and ourcost control efforts, and a decrease of $221,000 in the use of outsideconsultants as a result of our cost control efforts. We anticipate our expensesin research and development will fluctuate in absolute dollars from period toperiod as a result of cost control initiatives and the timing of when we hirepersonnel as a result of the size and the timing of product developmentprojects.

 
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------|------------|
| **Selling,  General and Administrative** | ** ** | **Three Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                 | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                          | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Selling, general and administrative      |       | $                                    | 4,108      |       | $          | 5,646      |       | $                    | (1,538     | )                                    | (27        | )% | 43 | % | 27 | % |
|                                          |            |                                      |            |            |            |            |            |                      |            |                                      |            |  |  |  |  |  |

 

*Selling,General and Administrative*. Selling, general and administrative expenses consistprimarily of compensation and benefits for sales, marketing and general andadministrative personnel in addition to outside sales commissions, legal andaccounting services, marketing communications, travel and facilities cost allocations,and stock-based compensation charges. Selling, general and administrativeexpenses decreased $1.5 million for the three months ended June 30, 2009compared to the three months ended June 

 

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30, 2008, primarily dueto a decrease of $1.1 million in personnel expenses and a decrease of $331,000in the use of outside consultants, both the results of our cost controlefforts. We anticipate our selling, general and administrative expenses willfluctuate in absolute dollars from period to period as a result of cost controlinitiatives and to support increased selling efforts in the future.

 
| ** **                                            | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|---------------------------------------|------------|
| **Amortization of Other Acquired  Intangible Assets** | ** ** | **Three  Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                  | ** ** |
| **(In thousands, except for %’s)**               | ** ** | **2009**                              | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                           | ** ** | **Revenue** | ** ** |
| ** **                                            | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Amortization of other acquired intangible assets      |       | $                                     | 87         |       | $          | 195        |       | $                    | (108       | )                                     | (55        | )% | 1 | % | 1 | % |
|                                                       |            |                                       |            |            |            |            |            |                      |            |                                       |            |  |  |  |  |  |

 

*Amortization of Other Acquired Intangible Assets*. Amortization of other acquiredintangible assets consists of amortization of intangibles acquired as a resultof certain business combinations. Amortization of other acquired intangibleassets for the three months ended June 30, 2009 decreased $108,000compared to the three months ended June 30, 2008, primarily due todecreased 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 $172,000 in theremaining six months in 2009, $293,000 in 2010, $204,000 in 2011, $174,000 in2012, and $105,000 in 2013 and thereafter.

 
| ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|---------------------------------------|------------|
| **Restructuring Charges**               | ** ** | **Three  Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                  | ** ** |
| **(In thousands, except for %’s)** | ** ** | **2009**                              | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                           | ** ** | **Revenue** | ** ** |
| ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Restructuring charges                   |       | $                                     | 1,202      |       | $          | 1,471      |       | $                    | (269       | )                                     | (18        | )% | 12 | % | 7 | % |
|                                         |            |                                       |            |            |            |            |            |                      |            |                                       |            |  |  |  |  |  |

 

*RestructuringCharges.*  Restructuringcharges for the three months ended June 30, 2009 decreased $269,000compared to the three months ended June 30, 2008.  Restructuring charges for the three monthsended June 30, 2009 and 2008 consisted primarily of employee severancecosts and were the result of our cost control efforts in light of currentmarket conditions.

 
| ** **                                    | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|--------------------------------------|------------|
| **Interest  and Other Income (Expense), net** | ** ** | **Three Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                 | ** ** |
| **(In  thousands, except for %’s)**      | ** ** | **2009**                             | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                          | ** ** | **Revenue** | ** ** |
| ** **                                    | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Interest and other  income (expense), net     |       | $                                    | (210       | )          | $          | 251        |       | $                    | (461       | )                                    | (184       | )% | (2 | )% | 1 | % |
|                                               |            |                                      |            |            |            |            |            |                      |            |                                      |            |  |  |  |  |  |

 

*Interest and Other Income (Expense), net*. Interest and other income (expense),net decreased $461,000 for the three months ended June 30, 2009 comparedto the three months ended June 30, 2008, primarily due to a decrease of$266,000 in interest income from lower average cash and cash equivalent andinvestments balances coupled with lower interest rates, and an increase of$239,000 in foreign currency losses associated with intercompany payments tofund our foreign operations. We anticipate interest and other income willfluctuate in future periods as a result of our projected use of cash.

 
| ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | **Three  Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|----------------------|------------|---------------------------------------|------------|
| **Income Tax Provision (Benefit)**      | ** ** | **Three  Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**                  | ** ** |
| **(In thousands, except for %’s)** | ** ** | **2009**                              | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                           | ** ** | **Revenue** | ** ** |
| ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Income tax provision (benefit)          |       | $                                     | 322        |       | $          | (1,039     | )          | $                    | 1,361      |                                  | (131       | )% | 3 | % | (5 | )% |
|                                         |            |                                       |            |            |            |            |            |                      |            |                                       |            |  |  |  |  |  |

 

*Income Tax Provision (Benefit).*Income tax provision increased $1.4million for the three months ended June 30, 2009 to $322,000 as comparedto $1.0 million of income tax benefit for the three months ended June 30,2008. The income tax provision for the three months ended June 30, 2009primarily consisted of foreign withholding taxes and statutory taxes associatedwith our foreign subsidiaries.  Theincome tax benefit for the three months ended June 30, 2008 consisted of atax benefit for the net loss during the period and its related tax carryforward effects.

 

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***Comparison of theSix Months Ended June 30, 2009 and 2008***

 
| ** **                               | ** ** | ** **                         | ** ** | ** **  | ** ** | ** ** | ** ** | ** **           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|-------------|------------|------------|------------|----------------------|------------|------------------------------------|------------|
| **Revenue**                              | ** ** | **Six Months Ended June 30,** | ** ** | **$ ** | ** ** | **%**      | ** ** | **2009********% of** | ** ** | **2008********% of**               | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**    | ** ** | **Change** | ** ** | **Change**           | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
|                                     |       |                               |       |        |       |       |       |                 |       |                               |       |   |   |
| Design-to-silicon-yield  solutions       |       | $                                  | 15,086     |        | $          | 30,476     |       | $                    | (15,390    | )                                  | (50        | )% | 76 | % | 74 | % |
| Gainshare performance  incentives        |       | 4,687                              |       | 10,985      |       | (6,298     | )          | (57                  | )%         | 24                                 | %          | 26 | % |
| Total                                    |       | $                                  | 19,773     |        | $          | 41,461     |       | $                    | (21,688    | )                                  | (52        | )% | 100 | % | 100 | % |

 

*Design-to-Silicon-YieldSolutions*.Design-to-Silicon-Yield solutions revenue decreased $15.4 million for the sixmonths ended June 30, 2009 compared to the six months ended June 30,2008, primarily due to a decrease of $10.3 million in fixed fee integratedsolutions and a decrease of $4.9 million in software and software relatedservices. The decreases were primarily the result of lower bookings, ascustomers have delayed purchases for capacity expansion and investment inleading edge technology. The dramatic downturn in the semiconductor industrycombined with weakness in worldwide economies have been the primarycontributors to this shortfall.

 

*Gainshare Performance Incentives*. Revenue derived from gainshareperformance incentives decreased $6.3 million for the six months ended June 30,2009 compared to the six months ended June 30, 2008, primarily due todecreases in wafer volumes at our customer sites. Revenue derived fromgainshare performance incentives was generated from six customers and tenengagements for the six months ended June 30, 2009, and seven customersand eleven engagements for the six months ended June 30, 2008.

 
| ** **                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Cost of  Design-to-Silicon-Yield Solutions**     | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)**           | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Direct costs of  design-to-silicon-yield solutions |       | $                                  | 11,153     |       | $          | 15,033     |       | $          | (3,880     | )                                  | (26        | )% | 56 | % | 36 | % |
| Amortization of  acquired technology               |       | 719                                |       | 1,262      |       | (543       | )          | (43        | )%         | 4                                  | %          | 3 | % |
| Total                                              |       | $                                  | 11,872     |       | $          | 16,295     |       | $          | (4,423     | )                                  | (27        | )% | 60 | % | 39 | % |

 

*Costs of Design-to-Silicon-YieldSolutions*.

 

*DirectCosts of Design-to-Silicon-Yield Solutions.*Direct costs of Design-to-Silicon-Yield solutionsdecreased $3.9 million for the six months ended June 30, 2009 compared tothe six months ended June 30, 2008, primarily due to a decrease of $1.1million in personnel expenses, a decrease of $955,000 in travel expenses, and adecrease of $529,000 in the use of outside consultants, as a result of our costcontrol efforts.

 

*Amortizationof Acquired Technology*. Amortization of acquired technology decreased $543,000 for the sixmonths ended June 30, 2009 compared to the six months ended June 30,2008. The decrease in amortization of acquired technology was primarily due todecreased amortization as a result of the impairment of acquired technologyrecorded in the fourth quarter of 2008.

 
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Research  and Development**            | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Research and development                 |       | $                                  | 10,858     |       | $          | 18,210     |       | $          | (7,352     | )                                  | (40        | )% | 55 | % | 44 | % |
|                                          |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*Researchand Development.*Researchand development expenses decreased $7.4 million for the six months ended June 30,2009 compared to the six months ended June 30, 2008, primarily due to adecrease of $4.5 million in personnel expenses resulting from a shift inresearch and development resources to lower cost areas and out cost controlefforts, a decrease of $456,000 in travel expenses, and a decrease of $371,000in the use of outside services, both the results of our cost control efforts.

 

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| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Selling,  General and Administrative** | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Selling, general and administrative      |       | $                                  | 8,521      |       | $          | 11,945     |       | $          | (3,424     | )                                  | (29        | )% | 43 | % | 29 | % |
|                                          |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*Selling, General and Administrative*. Selling, general and administrativeexpenses decreased $3.4 million for the six months ended June 30, 2009compared to the six months ended June 30, 2008, primarily due to adecrease of $1.2 million in personnel expenses, a decrease of $403,000 in legalfees, and a decrease of $212,000 in the use of outside services, as a result ofour cost control efforts.

 
| ** **                                            | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Amortization  of Other Acquired Intangible Assets** | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)**              | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                                            | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Amortization of other acquired intangible assets      |       | $                                  | 174        |       | $          | 389        |       | $          | (215       | )                                  | (55        | )% | 1 | % | 1 | % |
|                                                       |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*Amortizationof Other Acquired Intangible Assets*. Amortization of other acquired intangible assets forthe six months ended June 30, 2009 decreased $215,000 compared to the sixmonths ended June 30, 2008, primarily due to decreased amortization as aresult of the impairment of other acquired intangible assets recorded in thefourth quarter of fiscal 2008.

 
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Restructuring  Charges**               | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Restructuring charges                    |       | $                                  | 1,835      |       | $          | 1,471      |       | $          | 364        |                               | 25         | % | 9 | % | 4 | % |
|                                          |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*RestructuringCharges*.Restructuring charges for the six months ended June 30, 2009 increased$364,000 compared to the six months ended June 30, 2008.  Restructuring charges for the six months endedJune 30, 2009 and 2008 consisted primarily of employee severance costs andwere the result of our cost control efforts in light of current marketconditions.

 
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Interest  and Other Income, net**      | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Interest and other income, net           |       | $                                  | 114        |       | $          | 740        |       | $          | (626       | )                                  | (85        | )% | — | % | 2 | % |
|                                          |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*Interest and Other Income, net*. The decrease in interest and otherincome, net of $626,000 for the six months ended June 30, 2009 compared tothe six months ended June 30, 2008 was primarily due to a decrease of$464,000 in interest income from lower average cash and cash equivalent andinvestments balances coupled with lower interest rates, and an increase of$218,000 in foreign currency losses associated with intercompany payments tofund our foreign operations..

 
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------------------------------|------------|
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| **Income  Tax Provision (Benefit)**      | ** ** | **Six Months Ended June 30,** | ** ** | **$**      | ** ** | **%**      | ** ** | **% of**   | ** ** | **% of**                           | ** ** |
| **(In  thousands, except for %’s)** | ** ** | **2009**                           | ** ** | **2008**   | ** ** | **Change** | ** ** | **Change** | ** ** | **Revenue**                        | ** ** | **Revenue** | ** ** |
| ** **                               | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Income tax provision (benefit)           |       | $                                  | 586        |       | $          | (1,656     | )          | $          | 2,242      |                               | (135       | )% | 3 | % | (4 | )% |
|                                          |            |                                    |            |            |            |            |            |            |            |                                    |            |  |  |  |  |  |

 

*IncomeTax Provision (Benefit).*Income tax provision increased $2.2 million for the six months ended June 30,2009  to $586,000 as compared to theincome tax benefit of $1.7 million for the six months ended June 30, 2008.The income tax provision for the six months ended June 30, 2009 primarilyconsisted of foreign withholding taxes and statutory taxes associated with ourforeign subsidiaries.  The income taxbenefit for the six months ended June 30, 2008 consisted of a tax benefitfor the net loss during the period.

 

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**Liquidity and Capital Resources**

** **

***Operating Activities***

 

Cashflows from operating activities consist of net loss adjusted for certainnon-cash items and changes in assets and liabilities. Net cash used inoperating activities was $1.3 million for the six months ended June 30,2009, a decrease of $2.6 million compared to net cash of $1.3 million providedby operating activities for the six months ended June 30, 2008, primarilydue to a higher net loss and decreases in accrued compensation and relatedbenefits, partially offset by decreases in accounts receivable and prepaidexpenses and other assets.

 

Accruedcompensation decreased $1.4 million during the six months ended June 30,2009 compared to an increase of $508,000 during the six months ended June 30,2008. The decrease in accrued compensation during the six months ended June 30,2009 was primarily due to paid vacation used in company-wide shutdowns as oneof our cost control efforts. The increase in accrued compensation during thesix months ended June 30, 2008 was primarily due to withheld contributionsto the employee stock purchase plan. Accounts receivable decreased $8.1 millionduring the six months ended June 30, 2009 compared to an decrease of $3.1million during the six months ended June 30, 2008. The decrease inaccounts receivable during the six months ended June 30, 2009 and 2008were primarily due to decreased revenue and the timing of billing milestonesand payments received. Prepaid expenses and other assets decreased $2.2 millionduring the six months ended June 30, 2009 compared to an increase of$360,000 during the six months ended June 30, 2008. The decrease in prepaidexpenses and other assets during the six months ended June 30, 2009 wasprimarily due to the collection of income tax refunds. The increase in prepaidexpenses and other assets during the six months ended June 30, 2008 wasprimarily due to the timing of prepayments.

 

***Investing Activities***

 

Cashflows from investing activities consist of proceeds from investment maturitiesand sales, offset by payments for investments acquired and payments for capitalexpenditures. Net cash provided by investing activities was $6.8 million forthe six months ended June 30, 2009, an increase of $11.4 million comparedto net cash used in investing activities of $4.6 million for the six monthsended June 30, 2008. The increase was primarily due to the absence ofpurchases of investments during the six months ended June 30, 2009 whilewe purchased $16.8 million of investments during the six months ended June 30,2008. The increase was partially offset by a decrease of $5.8 million inproceeds from investment maturities and sales. As of June 30, 2009, we hadno investments in derivative securities.

 

***Financing Activities***

 

Cashflows from financing activities consist primarily of proceeds from sales ofshares through employee equity incentive plans, offset by payments for the purchaseof treasury stock, and principal payments on long-term obligations. Net cashprovided by financing activities was $204,000 for the six months ended June 30,2009, an increase of $2.9 million compared to net cash used in financing activities of$2.7 million for the six months ended June 30, 2008. During the six monthsended June 30, 2009, we repurchased 73,000 shares of common stock for$133,000 whereas we repurchased 481,000 shares of common stock for $2.6 millionduring the six months ended June 30, 2008. We received proceeds of$417,000 from our employee stock purchase plan during the six months ended June 30,2009 whereas we had no proceeds from our employee stock purchase plan duringthe six months ended June 30, 2008 as the result of changes of thepurchase dates to January 31 and July 31 from December 31 and June 30,respectively.

 

***Liquidity***

 

As of June 30,2009, our working capital was $45.4 million, compared with $56.3 million as of December 31,2008. Cash and cash equivalents, and short-term investments were $38.4 millionas of June 30, 2009 compared to $40.7 million as of December 31,2008, a decrease of $2.4 million. The decrease in cash, cash equivalents, andshort-term investments was primarily attributable to the payments of $2.0million in accrued restructuring during the six months ended June 30,2009. We anticipate that our overall expenses, as well as planned capitalexpenditures, may constitute a material use of our cash resources. In addition,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 operating activities,capital expenditures and other obligations for at least the next twelve months.However, in the event that during such period, or thereafter, we are notsuccessful in generating sufficient cash flows from operations we may need toraise additional capital through private or public financings, strategicrelationships or other arrangements, which may not be available to us onacceptable terms or at all.

 

As of June 30,2009, 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)” in Part I, and Item 3. “Quantitative andQualitative Disclosures About Market Risk” in Part II in this QuarterlyReport on Form 10-Q for further discussion.

 

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We donot have any off-balance sheet arrangements, investments in special purposeentities or undisclosed borrowings or debt, other than operating leases on ourfacilities. As of June 30, 2009, other than Euro denominated receivables,we had no foreign currency contracts outstanding.

 

Thefollowing table summarizes our known contractual obligations (in thousands):

 
| ** **                                     | ** ** | **Payments  due by period**                   | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|
| **Contractual obligations**                    | ** ** | **2009********(six months********remaining)** | ** ** | **2010-2011** | ** ** | **2012-2013** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Debt principal (1)                             |       | $                                             | 280        |   | $ | 505 |   | $ | — |   | $ | — |   | $ | 785 |   |
| Debt interest                                  |       | 6                                             |       | 12 |   | — |   | — |   | 18 |   |
| Capital lease obligations (including interest) |       | 2                                             |       | 1 |   | — |   | — |   | 3 |   |
| Operating lease obligations                    |       | 1,566                                         |       | 5,682 |   | 3,987 |   | — |   | 11,235 |   |
| Unrecognized tax benefits (2)                  |       | —                                        |       | — |   | — |   | 3,463 |   | 3,463 |   |
| Total                                          |       | $                                             | 1,854      |   | $ | 6,200 |   | $ | 3,987 |   | $ | 3,463 |   | $ | 15,504 |   |

 

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(1)       Amount represents the repayment of aninterest free loan of €550,000 and a €400,000 Euros loan with a variableinterest rate based on the EURIBOR plus 160 basis points.

 

(2)       Due to the inherent uncertainty of thetax positions, it is not practicable to assign this liability to any particularyears in the table.

 

Operatinglease amounts include minimum rental payments under our operating leases forour office facilities, as well as computers, office equipment, and vehiclesthat we utilize under lease agreements. These agreements expire at variousdates through 2013. Capital leases were contracted to purchase computer,software, office equipment, and vehicles in our French subsidiary.

 

**Item 3. Quantitative and Qualitative Disclosures About MarketRisk.**

 

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

 

*Interest Rate Risk*. As of June 30, 2009, we had cash and cashequivalents and short term investments of $38.4 million. Cash and cashequivalents consisted of cash, highly liquid money market instruments.Short-term investments consisted of debt securities with maturities of morethan three months but less than twelve months. Because of the short maturitiesof those instruments, a sudden change in market interest rates would not have amaterial impact on the fair value of the portfolio. We would not expect ouroperating results or cash flows to be affected to any significant degree by theeffect of a sudden change in market interest on our portfolio. A hypotheticalincrease in market interest rates of 100 basis points from the market rates ineffect at June 30, 2009 would cause the fair value of these investments todecrease by an immaterial amount which would not have significantly impactedour financial position or results of operations. Declines in interest ratesover time will result in decreased interest income.

 

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

 

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*Foreign Currency and Exchange Risk.*Certain of our sales contracts aredenominated 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 June 30, 2009 would resultin a loss of an immaterial amount. As of June 30, 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.

 

**Item 4. Controls and Procedures.**

 

*Evaluation of Disclosure Controls and Procedures*. Our management, with the participationof our principal executive officer and our principal financial officer, hasevaluated the effectiveness of our “disclosure controls and procedures” (assuch items are defined in Rules 13a-15(e) and 15d-15(e) of theSecurities Exchange Act of 1934, as amended (“the Exchange Act”)), as of theend 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.

 

*Changes in Internal Controls Over Financial Reporting*. There was no change in our internalcontrol over financial reporting identified in connection with the evaluationrequired by paragraph (d) of Rule 13a-15 or Rule 15d-15 underthe Exchange Act that occurred during the period covered by this QuarterlyReport on Form 10-Q that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

**PART II — OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

From time to time, we are subject to various legal proceedings andclaims that arise in the ordinary course of business. In accordance with SFAS No. 5,*Accounting for Contingencies*, theCompany records a contingent liability when the probable outcome of a claimagainst the Company can be reasonably assessed. In management’s opinion, theprobable outcome of any current claim against the Company cannot be reasonablyestimated. Also, in management’s opinion, the ultimate resolution of theseclaims will not materially impact our financial statements.

 

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

 

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

 

The semiconductor industry experienced significant challenges in 2008 andcontinues to face challenges in 2009 as a result of the decline in the macroeconomicenvironment. As a provider to global semiconductor companies, we are subject tobusiness cycles, the timing, length and volatility of which can be difficult topredict. The semiconductor industry historically has been cyclical due tosudden changes in customers’ manufacturing capacity requirements and spending,which depend in part on capacity utilization, demand for customers’ integratedcircuit (“IC”) products, inventory levels relative to demand, and access toaffordable capital. These changes have affected the timing and amounts ofcustomers’ purchases and investments in our Design-to-Silicon-Yield solutions,and continue to affect our sales, operating expenses and net income. If we arenot able to make adjustments to our business quickly to appropriately align ourcost structure with prevailing market conditions in periods of low demand, orif we do not have sufficient resources to meet customers’ demands in periods ofhigh demand, results could be negatively impacted and could differ greatly fromour expectations.

 

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

 

The recent severe tightening of the credit markets, turmoil in thefinancial markets, and weakening global economy are contributing to slowdownsin the semiconductor industry, which impacts our ability to make sales. Theseslowdowns are expected to worsen if these economic conditions are prolonged ordeteriorate further. The markets for semiconductors depend largely on consumerspending. Economic uncertainty exacerbates negative trends in consumer spendingand may cause some of our customers to delay or 

 

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refrain altogetherfrom entering into new engagements, licensing new or additional softwareproducts, or renewing maintenance and support for existing licensed software athistorical levels.  This will negativelyaffect our revenues. Difficulties in obtaining capital and deteriorating marketconditions may also lead to the inability of some customers to obtainaffordable financing for other purchases, which could tie up funds otherwisebudgeted for purchases of our solutions and technologies. Customers withliquidity issues may also lead to additional bad debt expense. Further, theseconditions and uncertainty about future economic conditions make it challengingfor us to forecast our operating results, make business decisions, and identifythe risks that may affect our business, financial condition and results ofoperations. If we are not able to timely and appropriately adapt to changesresulting from the difficult macroeconomic environment, our business, financialcondition, and results of operations may be significantly negatively affected.

 

***If semiconductor designers andmanufacturers do not continue to adopt, or they significantly delay adoptionof, our******Design-to-Silicon-Yield solutions,our******revenuewill suffer.***

 

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

 

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

 

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

 

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

 

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

 

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

 

***Revenue from our gainshareperformance incentives is dependent on factors outside of******our control, including the volume of ICs that our customersare able******tosell to their customers.***

 

Ourgainshare performance incentives fee component ties the profits of ourcustomers to our own. Through this component, revenue for a particular productis largely determined by the volume of that product that our customer is ableto sell to its customers, which is outside of our control. Decreased demand forsemiconductor products decreases the volume of products our customers are ableto sell, which directly decreases our gainshare performance incentives revenue.Important factors that could cause demand for semiconductor products tonegatively fluctuate include:

 

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

 

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

 

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

 

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*** ***

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

 

Duringthe year end December 31, 2008 and through June 30, 2009, weinitiated restructuring plans in an effort to align our cost structure withexpected revenue. We may not be able to successfully complete and realize theexpected benefits of our restructuring plans, such as improvements in operatingmargins and cash flows, in the restructuring periods contemplated or at all.The restructuring plans may involve higher costs or a longer timetable than wecurrently anticipate, mainly due to the timing and execution of some plans andprograms subject to local labor law requirements, and consultation withappropriate work councils. Our inability to realize these benefits may resultin an inefficient business structure that could negatively impact our resultsof operations. We also expect our restructuring plans to cause us to incursubstantial costs related to severance and other employee-related costs. Ourrestructuring plans may also subject us to litigation risks and expenses. Inaddition, our restructuring plans may have other consequences, such asattrition beyond our planned reduction in workforce or a negative impact onemployee morale, and our competitors may seek to gain a competitive advantageover us. The restructuring plans could also cause our remaining employees to beless productive, which in turn may negatively affect our revenue and otheroperating results in the future.

 

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

 

Historically,we have had a small number of large customers for our coreDesign-to-Silicon-Yield solutions and we expect this to continue in the nearterm. In the six months ended June 30, 2009, two customers accounted for36% of our total net revenue, with IBM representing 26% and CharteredSemiconductor Manufacturing representing 10%. In the year ended December 31,2008, two customers accounted for 34% of our total net revenue, with ToshibaCorporation representing 18% and IBM representing 16%. We could lose a customerdue to its decision not to engage us on future process nodes, its decision notto develop its own future process node, or as a result of industryconsolidation. The loss of any of these customers or a decrease in the salesvolumes of their products could significantly reduce our total revenue belowexpectations. In particular, such a loss could cause significant fluctuationsin results of operations because our expenses are fixed in the short term andit takes us a long time to replace customers.

 

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

 

Wehave experienced in the past, and may experience in the future, interruptionsin our information systems on which our global operations depend. Further,physical damage to, failure of, or digital damage (such as significant virusesor worms) to, our information systems could disrupt and delay time-sensitiveservices or computing operations that we perform for our customers, which couldnegatively impact our business results and reputation. In addition, we mustfrequently expand our internal information system to meet increasing demand instorage, computing and communication. Our internal information system isexpensive to expand and must be highly secure due to the sensitive nature ofour customers’ information that we transmit. Building and managing the supportnecessary for our growth places significant demands on our management andresources. These demands may divert these resources from the continued growthof our business and implementation of our business strategy. Further, we mustadequately train our new personnel, especially our client service and technicalsupport personnel, to effectively and accurately, respond to and support ourcustomers. If we fail to do this, it could lead to dissatisfaction among ourcustomers, which could slow our growth.

 

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

 

Ourstock price has fluctuated widely during the last few years from a low closingprice of $0.97 per share during March 2009 to a high of $19.36 per shareduring April 2006. This significant reduction in our stock pricenegatively impacts our ability to raise equity capital in the public marketsand increases the cost to us, as measured by dilution to our existingshareholders, of equity financing. In addition, the reduced stock price alsoincreases the cost to us, in terms of dilution, of using our equity foremployee compensation or for acquisitions of other businesses. Additionally, inorder for our common stock to continue to be quoted on the NASDAQ Global Market(“Nasdaq”), we must satisfy various listing maintenance standards establishedby Nasdaq, including, among other things, the general requirement, shouldNasdaq choose to enforce such requirements again after the April 2009 enddate of the current extension of suspension of any such enforcement, that ourstock price consistently trades at or above $1.00 per share and that the totalmarket value of our common stock exceed $50,000,000. We may have periods whenour stock does not trade at, or the market value of our common stock has beenbelow, the levels required by Nasdaq rules. If we were to be delisted from theNasdaq and move to an alternative market, which may be less efficient and lessbroad-based, we may have difficulty accessing capital markets for additionalfunding, and the ability of our stockholders to sell any of our common stock atall would be severely, if not completely, limited, which could cause our stockprice to decline further. Delisting could also have other negative results,including the potential loss of confidence by employees, the loss ofinstitutional investor interest, and fewer business developmentopportunities.  Also, significantvolatility in the stock price could be followed by a securities class actionlawsuit, which could result in substantial costs and a diversion of our management’sattention and resources.

 

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***If we fail toprotect our intellectual property (“IP”) rights, customers or potential******competitors may be able to use our technologies to developtheir own solutions which******could weaken our competitive position, reduce our revenue,or increase our costs.***

 

Oursuccess depends largely on the proprietary nature of our technologies. Wecurrently rely primarily on contractual, patent, copyright, trademark, andtrade secret protection. Our pending patent applications may not result inissued patents, and even if issued, they may not be sufficiently broad toprotect our proprietary technologies. Litigation may be necessary from time totime to enforce our IP rights or to determine the validity and scope of theproprietary rights of others. As a result of any such litigation, we could loseour proprietary rights and incur substantial unexpected operating costs.Litigation could also divert our resources, including our managerial andengineering resources. Further litigation may not be available or effective insome foreign countries where we have operations, some of which locations have areputation for higher incident of intellectual property theft.

 

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

 

Competitionin our market may intensify in the future, which could slow our ability to growor execute our strategy and could lead to increased pricing pressure. Ourcurrent and potential customers may choose to develop their own solutionsinternally, particularly if we are slow in deploying our solutions or improvingthem to meet market needs. Many of these companies have the financial andtechnical capability to develop their own solutions. Also, competitors may beable to operate with a lower cost structure than our engineering organization,which would give any such competitor’s products a competitive advantage overour solutions. There may be other providers of commercial solutions forsystematic IC yield and performance enhancement of which we are not aware. Wecurrently face indirect competition from the internal groups at IC companiesand some direct competition from providers of yield management or predictionsoftware such as KLA-Tencor, MKS Instruments, Inc. (“MKS”) (through itsacquisition of Yield Dynamics, Inc.), Mentor Graphics (through itsacquisition of Ponte Solutions), TIBCO Software Inc. (through its acquisitionof Spotfire Inc.), and Synopsys, Inc., and process control software, suchas Applied Materials, Inc., BISTel Inc., and Trancom Technology, Inc.,and MKS. Further, ARM Ltd. and Virage Logic Corporation provide standard cellsin the physical IP space and Tela provides software for standard cellsynthesis, each of which could compete with our pdBRIX solution. Some providersof yield management software or inspection equipment may seek to broaden theirproduct offerings and compete with us. For example, KLA-Tencor has announcedadding the use of test structures to one of their inspection product lines. Inaddition, we believe that the demand for solutions that address the need forbetter integration between the silicon design and manufacturing processes mayencourage direct competitors to enter into our market. For example, largeintegrated organizations, such as IDMs, electronic design automation softwareproviders, IC design service companies or semiconductor equipment vendors, maydecide to spin-off a business unit that competes with us. Other potentialcompetitors include fabrication facilities that may decide to offer solutionscompetitive with ours as part of their value proposition to their customers. Inaddition, Synopsys, Inc. now appears to offer directly competingdesign-for-manufacturability (“DFM”), while other electronic design automationsuppliers provide alternative DFM solutions that may compete for the samebudgetary funds. If these potential competitors change the pricing environmentor are able to attract industry partners or customers faster than we can, wemay not be able to grow and execute our strategy as quickly or at all. Inaddition, customer preferences may shift away from our solutions as a result ofthe increase in competition.

 

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

 

Wehave in the past expanded our non-U.S. operations and may in the futurecontinue such expansion by establishing overseas subsidiaries, offices, orcontractor relationships in locations, if and when, deemed appropriate by ourmanagement. Thus, the success of our business is subject to risks inherent indoing business internationally, including in particular:

 

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

 

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

 

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

 

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

 

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

 

·             quarantine, private travel limitation, or business disruptionin regions affecting our operations, stemming from actual, imminent orperceived outbreak of human pandemic or contagious disease;

 

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

 

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

 

Revenuesgenerated from customers in Asia accounted for 56% of total revenue in the sixmonths ended June 30, 2009 and 54% for the six months ended June 30,2008. Thus, in Asia, in particular, we face the following additional risks:

 

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

 

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

 

In theMiddle East, we use a third-party service provider, whose headquarters are notlocated in a U.S. embargoed country, to provide software quality assuranceand other services for certain of our software products. The politicaluncertainty surrounding the region could disrupt our third-party serviceprovider’s operations and thus negatively affect the range of services we areable to provide or our cost for such services.

 

***Our earnings pershare and other key operating results may be unusually high in a******given quarter, thereby raising investors’ expectations, andthen unusually low in the******next quarter, thereby disappointing investors, which couldcause our stock price to******drop.***

 

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

 

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

 

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

 

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

 

Ourlong-term success is largely dependent upon our ability to structure our futurecustomer contracts to include a larger gainshare performance incentivescomponent relative to the fixed fee component. We typically recognize the fixedfee component earlier than the gainshare performance incentives component so ifwe are successful in increasing the gainshare performance incentives componentof our customer contracts, we will experience an adverse impact on ouroperating results in the short term as we reduce the fixed fee component. Dueto acquisitions and expanded business strategies, the mix of elements in someof our contracts has changed recently and the relative importance of thesoftware component in some of our contracts has increased. We have experienced,and may in the future experience, delays in the expected recognition of revenueassociated with generally accepted accounting principles 

 

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

 

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

 

Ourgainshare performance incentives business model is unique and ourDesign-to-Silicon-Yield solutions are often unfamiliar to new customers. Thisresults in a lengthier sales cycle compared to some of our competitors andrequires a significant amount of our senior management’s time and effort.Furthermore, we need to target those individuals within a customer’sorganization who have overall responsibility for the profitability of an IC.These individuals tend to be senior management or executive officers. We mayface difficulty identifying and establishing contact with such individuals.Even after initial acceptance, due to the complexity of structuring thegainshare performance incentives component, the negotiation and documentationprocesses can be lengthy. It can take nine months or more to reach a signedcontract with a customer. Unexpected delays in our sales cycle could cause ourrevenue to fall short of expectations. By way of example, one of the industriesthat we have recently targeted that we believe would greatly benefit from ouryield management system and FDC technology is the rapidly growing solar panelindustry. Our efforts to leverage our products in this industry may not besuccessful. Further, ongoing negotiations and evaluation projects withphotovoltaic manufacturers may not result in significant revenue for us if weare unable to close new engagements in these markets on terms favorable to us,in a timely manner, or at all, or if we are unable to successfully deliver ourproducts and services to such markets.

 

***We have a historyof losses, we may incur losses in the future and we may be unable******to reach, or thereafter maintain, profitability.***

 

Wehave experienced losses in the six months ended June 30, 2009, the yearended December 31, 2008, and in the past. We may not achieve, andthereafter maintain, profitability if our revenue increases more slowly than weexpect or if it decreases. In addition, virtually all of our operating expensesare fixed in the short term, so any shortfall in anticipated revenue in a givenperiod could significantly reduce our operating results below expectations. Ouraccumulated deficit was $126.6 million as of June 30, 2009. We expectto continue to incur significant expenses in connection with:

 

·             funding for research and development;

 

·             expansion of our solution implementation teams;

 

·             expansion of our sales and marketing efforts; and

 

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

 

As aresult, if we do not significantly increase revenue to reach or maintainprofitability on a quarterly or annual basis, our stock price could decline. We may besubject to additional impairment of our long-lived assets.

 

***We intend to pursue additional strategic relationships,which are necessary to******maximizeour growth, but could substantially divert management attention and******resources.***

 

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

 

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***Our solutionimplementations may take longer than we anticipate, which could cause us******to lose customers and may result in adjustments to ouroperating results.***

 

Oursolution implementations require a team of engineers to collaborate with ourcustomers to 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.

 

***If weare not able to attract, retain, motivate, and strategically locate talentedemployees, including some key executives, our business may suffer.***

 

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

 

***Inadvertentdisclosure of our customers’ confidential information could result in******costly litigation and cause us to lose existing andpotential customers.***

 

Ourcustomers consider their product yield information and other confidentialinformation, which we must gather in the course of our engagement with thecustomer, to be extremely competitively sensitive. If we inadvertentlydisclosed or were required to disclose this information, we would likely loseexisting and potential customers and could be subject to costly litigation. Inaddition, to avoid potential disclosure of confidential information tocompetitors, some of our customers may, in the future, ask us not to work withkey competitive products, which could limit our revenue opportunities.

 

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

 

Significantlitigation regarding intellectual property rights exists in the semiconductorindustry. It is possible that a third party may claim that our technologiesinfringe their intellectual property rights or misappropriate their tradesecrets. Any claim, even if without merit, could be time consuming to defend,result in costly litigation, or require us to enter into royalty or licensingagreements, which may not be available to us on acceptable terms, or at all. Asuccessful claim of infringement against us in connection with the use of ourtechnologies could adversely affect our business.

 

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

 

If thesoftware, hardware, or proprietary technologies we provide to a customercontain defects that increase our customer’s cost of goods sold andtime-to-market or damage our customer’s property, these defects couldsignificantly decrease the market acceptance of our solutions. Further, thecost of support resources required to remedy any defects in our technologies,hardware, or software tools could exceed our expectations. Any actual orperceived defects with our software, hardware, or proprietary technologies mayalso hinder our ability to attract or retain industry partners or customers,leading to a decrease in our revenue. These defects are frequently found duringthe period following introduction of new software, hardware, or proprietarytechnologies or enhancements to existing software, hardware, or proprietarytechnologies. Our software, hardware, and proprietary technologies may containerrors not discovered until after customer implementation of the silicon designand manufacturing process recommended by us. If our software, hardware, orproprietary technologies contain errors or defects, it could require us toexpend significant resources to remedy these problems, which could reducemargins and result in the diversion of technical and other resources from ourother development efforts.

 

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

 

In thefuture, our management may identify deficiencies regarding the design andeffectiveness of our system of internal control over financial reporting thatwe engage in pursuant to Section 404 of the Sarbanes-Oxley Act (“Section 404”)as part of our Form 10-K. Such deficiencies could include those arisingfrom turnover of qualified personnel or arising as a result of acquisitions,which we 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.

 

***We may not be ableto raise necessary funds to support our growth or execute our******strategy.***

 

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

 

***Recent or potentialacquisitions may adversely affect our business by diverting management’s******attention, increasing our expenses or by being moredifficult to integrate than******expected.***

 

Oursuccess in realizing the strategic benefits, the timing of this realization,and growth opportunities to be gained from acquiring technology or companiesand incorporating 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:

 

·             consolidating research and development operations;

 

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

 

·             coordinating effective sales and marketing functions;

 

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

 

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

 

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

 

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

 

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***The uncertainty inthe credit markets might impact the value of certain auction-rate******securities we have and we might have to record impairment******charges in the future.***

 

Creditconcerns in the capital markets have significantly reduced our ability toliquidate auction-rate securities that we classify as non-current investmentsecurities on our balance sheet. The liquidity of the securities has beenreduced by the uncertainty in the credit markets and the exposure of thesesecurities to the financial condition of bond insurance companies. Allauction-rate securities we hold have been failing to sell at auction since February 2008due to an insufficient number of bidders. We reviewed the value of thesesecurities for impairment as of June 30, 2009, concluded that thesesecurities were temporarily impaired, and have recorded an unrealized loss of$282,000 as a component of accumulated other comprehensive income. In futureperiods, the estimated fair value of our auction-rate securities could declinefurther based on market conditions, which could result in additional impairmentand could result in the need to classify such impairment as other thantemporary, this resulting in a change to operations.

 

**Item 2. Unregistered Sales of Equity Securities and Use ofProceeds.**

 

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

 

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

 

**ISSUERPURCHASES OF EQUITY SECURITIES**

 
| **Period**                                                 | ** ** | **Total********Number of********Shares (or********Units)********Purchased** | ** ** | **Average********Price Paid********Per Share********(or Unit)** | ** ** | **Total  Number of********Shares (or Units)********Purchased as********Part of Publicly********Announced Plans********or Programs (1)** | ** ** | **Maximum  Number (or********Approximate Dollar********Value) of Shares (or********Units) that May Yet Be********Purchased Under the********Plans or Programs(1)** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Month #1 (April 1, 2009 through April 30,  2009) |       | —                                                                      |       | —                                                          |       | —                                                                                                                                       |       | $                                                                                                                                                                       | 1,559      |   |
| Month #2 (May 1, 2009 through May 31,  2009)     |       | 72,918                                                                      |       | $                                                               | 1.82       |                                                                                                                                         | 72,918     |                                                                                                                                                                    | $          | 1,467 |   |
| Month #3 (June 1, 2009 through June 30,  2009)   |       | —                                                                      |       | —                                                          |       | —                                                                                                                                       |       | $                                                                                                                                                                       | 1,467      |   |
| Total                                                      |       | 72,918                                                                      |       | $                                                               | 1.82       |                                                                                                                                         | 72,918     |                                                                                                                                                                    |       |   |

 

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(1)          On March 26, 2003, our Board of Directorsapproved a share repurchase program to purchase up to $10.0 million of ouroutstanding common stock. The program was completed in August 2007 with988,000 shares repurchased at the average price of $10.12. 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 June 30, 2009,2,501,000 shares had been repurchased at the average price of $3.41 per shareunder this program and $1.5 million remained available for future repurchases.

 

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

 

NotApplicable.

 

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

 

Nomatters were submitted to a vote of security holders during the second quarterof 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 by SEC Release No. 33-8212,these exhibits are furnished with this Quarterly Report on Form 10-Q andare not deemed filed with the Securities and Exchange Commission and are notincorporated by reference in any filing of PDF Solutions, Inc. under theSecurities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any filings.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                        | **PDF  SOLUTIONS, INC.** |
|-----------------------------|--------------------------|
|                        | ** **               |
|                        |                     |   |
| Date: August 10, 2009  | By:                      | /s/ JOHN K.  KIBARIAN |
|                        |                     | John K. Kibarian |
|                        |                     | President and  Chief Executive Officer |
|                        |                     | (Principal  Executive Officer) |
|                        |                     |
|                        |                     |
| Date:  August 10, 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 by SEC Release No. 33-8212,these exhibits are furnished with this Quarterly Report on Form 10-Q andare not deemed filed with the Securities and Exchange Commission and are notincorporated by reference in any filing of PDF Solutions, Inc. under theSecurities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any filings.

 

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