10-Q 1 f91881e10vq.htm FORM 10-Q PDF Solutions, Inc., Dated 6/30/2003
Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2003
or

[   ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

000-31311
(Commission File Number)


PDF SOLUTIONS, INC.

(Exact name of Registrant as specified in its charter)


     
Delaware
(State or other jurisdiction of
incorporation or organization)
  25-1701361
(I.R.S. Employer
Identification No.)
     
333 West San Carlos Street, Suite 700
San Jose, California

(Address of Registrant’s principal executive offices)
  95110
(Zip Code)

(408) 280-7900
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   [ X ]     No   [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)  Yes  [ X ]   No  [  ]

     The number of shares outstanding of the Registrant’s Common Stock as of August 11, 2003 was 23,242,511.




PART I — FINANCIAL INFORMATION
Item 1 — Financial Statements
UNAUDITED CONSOLIDATED BALANCE SHEETS
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults on Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
INDEX TO EXHIBIT
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


Table of Contents

PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

PDF SOLUTIONS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

                         
            June 30,   December 31,
            2003   2002
           
 
ASSETS          
Current assets:
             
 
Cash and cash equivalents
  $ 67,073     $ 71,490  
 
Accounts receivable, net of allowance of $504 in 2003 and 2002
    6,584       7,924  
 
Prepaid expenses and other current assets
    5,006       4,406  
 
 
   
     
 
   
Total current assets
    78,663       83,820  
Property and equipment, net
    3,453       3,533  
Goodwill
    662       662  
Intangible assets, net
    4,195       220  
Other assets
    1,815       1,564  
 
   
     
 
   
Total assets
  $ 88,788     $ 89,799  
 
   
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
 
Accounts payable
  $ 1,370     $ 499  
 
Accrued compensation and related benefits
    1,910       1,143  
 
Other accrued liabilities
    1,364       1,652  
Other liabilities
    1,500        
 
Taxes payable
    686       1,838  
 
Deferred revenues
    2,163       4,496  
 
Billings in excess of recognized revenue
    274       606  
 
Current portion of long-term debt
    17       17  
 
   
     
 
   
Total current liabilities
    9,284       10,251  
Long-term debt
    6       15  
Deferred tax liabilities
    753       752  
Deferred rent
    49       39  
 
   
     
 
   
Total liabilities
    10,092       11,057  
 
   
     
 
Stockholders’ equity:
               
 
Preferred stock, $0.00015 par value, 5,000 shares authorized; no shares issued and outstanding; in 2003 and 2002
           
 
Common stock, $0.00015 par value, 75,000 shares authorized; shares issued and outstanding: 23,225 in 2003 and 23,130 in 2002
    3       3  
 
Additional paid-in-capital
    100,641       99,884  
 
Deferred stock-based compensation
    (545 )     (1,340 )
 
Notes receivable from stockholders
    (4,614 )     (4,998 )
 
Accumulated deficit
    (16,855 )     (14,845 )
 
Cumulative other comprehensive income
    66       38  
 
   
     
 
   
Total stockholders’ equity
    78,696       78,742  
 
   
     
 
   
Total liabilities and stockholders’ equity
  $ 88,788     $ 89,799  
 
   
     
 

See notes to unaudited consolidated financial statements.

 

1


Table of Contents

PDF SOLUTIONS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

                                     
        Three Months Ended   Six Months Ended
       
 
        June 30,   June 30,   June 30,   June 30,
        2003   2002   2003   2002
       
 
 
 
Revenue:
                               
 
Design-to-silicon yield solutions
  $ 8,034     $ 9,505     $ 16,142     $ 17,885  
 
Gain share
    2,056       2,731       3,015       5,808  
 
 
   
     
     
     
 
   
Total revenue
    10,090       12,236       19,157       23,693  
 
   
     
     
     
 
Cost and expenses:
                               
 
Cost of design-to-silicon yield solutions
    3,514       4,110       6,958       7,974  
 
Research and development
    4,453       3,964       8,785       7,154  
 
Selling, general and administrative
    2,994       2,614       5,697       5,168  
 
Stock-based compensation amortization*
    329       770       978       1,558  
 
 
   
     
     
     
 
   
Total costs and expenses
    11,290       11,458       22,418       21,854  
 
   
     
     
     
 
Income (loss) from operations
    (1,200 )     778       (3,261 )     1,839  
Interest and other income
    345       338       720       697  
 
   
     
     
     
 
Income (loss) before taxes
    (855 )     1,116       (2,541 )     2,536  
Tax (benefit) provision
    (179 )     551       (531 )     1,391  
 
 
   
     
     
     
 
Net income (loss)
  $ (676 )   $ 565     $ (2,010 )   $ 1,145  
 
   
     
     
     
 
Net income (loss) per share:
                               
 
Basic
  $ (0.03 )   $ 0.03     $ (0.09 )   $ 0.05  
 
   
     
     
     
 
 
Diluted
  $ (0.03 )   $ 0.02     $ (0.09 )   $ 0.05  
 
   
     
     
     
 
Weighted average common shares:
                               
 
Basic
    22,614       21,814       22,551       21,726  
 
Diluted
    22,614       22,943       22,551       23,192  
* Stock-based compensation amortization:
                               
 
Cost of design-to-silicon yield solutions
  $ 86     $ 223     $ 216     $ 486  
 
Research and development
    155       366       563       804  
 
Selling, general and administrative
    88       181       199       268  
 
 
   
     
     
     
 
 
  $ 329     $ 770     $ 978     $ 1,558  
 
   
     
     
     
 

See notes to unaudited consolidated financial statements.

2


Table of Contents

PDF SOLUTIONS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

                         
            Six Months Ended
           
            June 30,   June 30,
            2003   2002
           
 
Operating activities:
               
 
Net income (loss)
  $ (2,010 )   $ 1,145  
 
Adjustments to reconcile net income (loss) to net cash used in operating activities:
               
   
Depreciation and amortization
    1,148       787  
   
Stock-based compensation amortization
    978       1,558  
   
Changes in assets and liabilities:
               
     
Accounts receivable
    1,340       (5,557 )
     
Prepaid expenses and other assets
    (784 )     (439 )
     
Accounts payable
    871       (127 )
     
Accrued compensation and related benefits
    767       (1,970 )
     
Other accrued liabilities
    (278 )     (321 )
     
Taxes payable
    (1,152 )     1,088  
     
Deferred revenues
  (2,333 )     (151 )
     
Billings in excess of recognized revenue
    (332 )     (45 )
     
Deferred taxes
    (66 )     (226 )
 
   
     
 
       
Net cash used in operating activities
    (1,851 )     (4,258 )
 
   
     
 
Investing activities:
               
 
Purchases of property and equipment
    (903 )     (1,713 )
 
Business acquired in purchase transaction, net of cash acquired
    (2,640 )      
 
   
     
 
       
Net cash used in investing activities
    (3,543 )     (1,713 )
 
   
     
 
Financing activities:
               
 
Exercise of stock options
    41     179  
 
Proceeds from employee stock purchase plan
    543     889  
 
Collection of notes receivable from stockholders
    373     679  
 
Principal payments on long-term debt and capital lease obligations
    (8 )     (15 )
 
   
     
 
       
Net cash provided by financing activities
    949       1,732  
 
   
     
 
Effect of exchange rate changes on cash
    28       37  
 
   
     
 
Net decrease in cash and cash equivalents
    (4,417 )     (4,202 )
Cash and cash equivalents, beginning of period
    71,490       70,835  
 
   
     
 
Cash and cash equivalents, end of period
  $ 67,073     $ 66,633  
 
   
     
 
Noncash financing activity:
               
 
Repurchase of common stock through cancellation of notes receivable
  $ 11     $ 65  
 
   
     
 
Supplemental disclosure of cash flow information:
               
 
Cash paid during the period for:
               
       
Taxes
  $ 720     $ 110  
 
   
     
 
       
Interest
  $ 1     $ 2  
 
   
     
 

See notes to unaudited consolidated financial statements.

 

3


Table of Contents

PDF SOLUTIONS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

     The interim unaudited consolidated financial statements included herein have been prepared by PDF Solutions, Inc., (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The unaudited interim consolidated financial statements reflect, in the opinion of management, all adjustments necessary, (consisting only of normal recurring adjustments) to present a fair statement of results for the interim periods presented. The operating results for any interim period are not necessarily indicative of the results that may be expected for other interim periods or the full fiscal year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. A significant portion of the Company’s revenues require estimates in regards to total costs which may be incurred and revenues earned. Actual results could differ from these estimates. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies” for additional information regarding the estimates and assumptions the Company makes that affect its financial statements.

     The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after the elimination of all significant intercompany balances and transactions. Certain amounts from prior years have been reclassified to conform to current-year presentation. These reclassifications did not change previously reported total assets, liabilities, stockholders’ equity or net income.

2. ACQUISITIONS

     On May 31, 2003 the Company acquired certain assets and liabilities of WaferYield, Inc., a privately held company, which primarily included WaferYield’s proprietary shot map WAMA™ technology and related business. The WAMA product offering is designed to optimize semiconductor wafer shot maps to help semiconductor companies achieve greater yield and net die per wafer, higher stopper throughput and reduced probe test cost. This acquisition adds to the Company’s product offering and its capabilities in enabling semiconductor companies to improve yield and performance of ICs. The aggregate purchase price was $4.1 million, which included cash payments of $2.6 million and the recognition of $1.5 million in other liabilities associated with future payments that are contingent upon the attainment of certain revenue performance objectives. There were no other assets or liabilities assumed in connection with the acquisition. The agreement also contains additional payments in the event the Company achieves further performance objectives as specified in the agreement, up to an additional payment of $3.5 million. Any additional payments made as a result of achieving such operating levels, which exceed amounts currently accrued, will be accounted for as goodwill in relation to the purchase. The entire purchase price has been allocated to core technology which is being amortized over an estimated useful life of 4 years. The acquisition has been accounted for using the purchase method of accounting and accordingly, the Company’s consolidated financial statements from May 31, 2003 include the impact of the acquisition.

3. RECENT ACCOUNTING PRONOUNCEMENTS

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” and must be applied beginning January 1, 2003. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than when the exit or disposal plan is approved. The Company adopted SFAS No. 146 on January 1, 2003. The adoption of this statement did not have an effect on the financial position and operating results of the Company.

     In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. FIN 45 requires companies to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. Guarantees in existence at December 31, 2002 are grandfathered for the purposes of recognition and would only need to be disclosed. The Company adopted FIN 45 on January 1, 2003. The adoption of this statement did not have an effect on the Company’s financial position and operating results.

     In December 2002, the EITF reached a consensus on EITF 00-21, “Revenue Arrangements with Multiple Deliverables”. This issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. This issue does not change otherwise applicable revenue recognition criteria. The guidance in this issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not expect that the adoption of EITF 00-21 will have a material effect on the Company’s consolidated financial statements.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment to FASB Statement 123”. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting of stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS 148 effective December 31, 2002.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group process and in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003. The Company does not expect the requirements of SFAS No. 149 to have a material impact on its financial position or results of operations.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, which requires that certain financial instruments be presented as liabilities that were previously presented as equity or as temporary equity. Such instruments include mandatory redeemable preferred and common stock, and certain options and warrants. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is generally effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not expect the requirements of SFAS No. 150 to have a material impact on its financial position or results of operations.

4. ACCOUNTS RECEIVABLE

     Accounts receivable include amounts that are unbilled at the end of the period. Unbilled accounts receivable are determined on an individual contract basis and were approximately $1.2 million and $1.0 million at June 30, 2003 and December 31, 2002, respectively.

5. STOCK BASED COMPENSATION

      The Company accounts for stock-based compensation in accordance with the provisions of Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”), and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”) as amended by SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosures”. Deferred compensation recognized under APB No. 25 is amortized to expense using the graded vesting method. The Company accounts for stock options and warrants issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF No. 96-18 under the fair value based method.

     The Company adopted the disclosure-only provisions of SFAS No. 123, and accordingly, no expense has been recognized for options granted to employees under the various stock plans. The Company amortizes deferred stock-based compensation on the graded vesting method over the vesting periods of the applicable stock purchase rights and stock options, generally four years. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in greater vesting in earlier years than the straight-line method. Had compensation expense been determined based on the fair value at the grant date for award, consistent with the provisions of SFAS 123, the Company’s pro forma net income (loss) and pro forma net income (loss) per share would be as follows (in thousands, except per share data):

                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Net income (loss) as reported:
  $ (676 )   $ 565   $ (2,010 )   $ 1,145
Add: stock-based employee compensation expense included in reported net income (loss) under APB 25
    329       770       751       1,558  
Deduct: total employee stock-based compensation determined under fair value based method for all awards, net of related tax effects
    2,968       3,077       4,896       5,013  
     
     
     
     
 
Pro forma net loss
  $ (3,315 )   $ (1,742 )   $ (6,155 )   $ (2,310 )
     
     
     
     
 
Basic and diluted net income (loss) per share:
                               
As reported:
     Basic
  $ (0.03 )   $ 0.03   $ (0.09   $ 0.05  
     Diluted
  $ (0.03 )   $ 0.02   $ (0.09 )   $ 0.05  
     
     
     
     
 
Pro forma:
                               
     Basic
  $ (0.15 )   $ (0.08 )   $ (0.27 )   $ (0.11 )
     Diluted
  $ (0.15 )   $ (0.08 )   $ (0.27 )   $ (0.10 )
     
     
     
     
 

     During the first quarter of 2003, the Company recorded $227,000 in compensation expense for the fair value of options granted to two non-employees. The 45,000 common shares under the 2001 Stock Plan were granted at an exercise price of $7.59 per share, the fair market value per share on the grant date, were fully vested at the date of grant and contained restrictions on when shares could be sold.

 

4


Table of Contents

6. NET INCOME (LOSS) PER SHARE

     Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average common shares outstanding for the period (excluding shares subject to repurchase). Diluted net income (loss) per share reflects the weighted-average common shares outstanding plus the potential effect of dilutive securities which are convertible into common shares (using the treasury stock method), except in cases where the effect would be anti-dilutive. The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income (loss) per share (in thousands):

 

5


Table of Contents

                                   
      Three Months   Six Months
      Ended June 30,   Ended June 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Net income (loss)
  $ (676   $ 565     $ (2,010 )   $ 1,145
 
   
     
     
     
 
Shares:
               
 
Weighted average common shares outstanding
    23,131       22,902     23,130   22,925
 
Weighted average common shares outstanding subject to repurchase
    (517 )     (1,088 )   (579 )   (1,199 )
 
   
     
     
     
 
Shares used in computation — basic
    22,614       21,814     22,551   21,726
 
Dilutive common equivalent shares:
               
 
Weighted average common shares outstanding subject to repurchase
          1,088       1,199
 
Stock options
          41       267
 
   
     
     
     
 
Shares used in computation — diluted
    22,614       22,943     22,551   23,192
 
   
     
     
     
 
Net income (loss) per share — basic
  $ (0.03 )   $ 0.03   $ (0.09 )   $ 0.05
 
   
     
     
     
 
Net income (loss) per share - diluted
  $ (0.03 )   $ 0.02     $ (0.09 )   $ 0.05
 
   
     
     
     
 

     For the three month period ended June 30, 2002, the calculation of diluted net income per share does not include 1.1 million outstanding common stock options as the effect would be anti-dilutive for the period presented. For the three and six month periods ended June 30, 2003, the calculation of diluted net loss per share does not include, respectively 575,000 and 386,000 outstanding common stock options and $1.1 million and $1.2 million shares of common stock subject to repurchase.

7. COMPREHENSIVE INCOME (LOSS)

     The components of comprehensive income (loss) are as follows (in thousands):

                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Net income (loss)
  $ (676   $ 565   $ (2,010 )   $ 1,145
Foreign currency translation adjustments
    14       45   28   37
 
   
     
     
     
 
Comprehensive income (loss)
  $ (662 )   $ 610     $ (1,982 )   1,182
 
   
     
     
     
 

8. GOODWILL AND PURCHASED INTANGIBLE ASSETS

     On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 142 requires goodwill to be tested for impairment under certain circumstances, written down when impaired, and requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. Upon the adoption of SFAS No. 142 the Company ceased amortization of goodwill with a net book value totaling $662,000, which included $192,000 of acquired workforce intangibles, net of related deferred tax liabilities which were reclassified to goodwill pursuant to the requirements of SFAS No. 142.

     Purchased intangible assets are carried at cost less accumulated amortization. Intangible assets at June 30, 2003 consisted entirely of acquired technology with a cost of $4.9 million and accumulated amortization of $607,000. Amortization is computed over the estimated useful life of four years. The amortization expense on acquired technology is expected to be $768,000 for fiscal 2003, $1.1 million in fiscal 2004, $1.0 million in fiscal 2005, $1.0 million in fiscal 2006, and $431,000 in fiscal 2007, at which time it will be fully amortized.

     As required by SFAS No. 142, the Company performed its transitional impairment test of goodwill as of January 1, 2002, at which time the Company determined that the carrying value of goodwill had not been impaired. SFAS No. 142 also requires that goodwill be tested for impairment on an annual basis and more frequently in certain circumstances. Accordingly, the Company has selected the three month period ending December 31 to perform the annual testing requirements. During the three month period ending December 31, 2002, the Company completed its annual testing requirements and determined that the carrying value of goodwill had not been impaired.

      The following table provides information relating to the intangible assets and goodwill contained within the Company’s consolidated balance sheets as of June 30, 2003 and December 31, 2002 (in thousands):

                                                   
June 30, 2003 December 31, 2002


Accumulated Net carrying Accumulated Net carrying
Cost Amortization Amount Cost Amortization Amount






Goodwill
  $ 1,224     $ (562 )   $ 662     $ 1,224     $ (562 )   $ 662  
     
     
     
     
     
     
 
Acquired identifiable intangibles:
                                               
 
Acquired technology
  $ 4,802     $ (607 )   $ 4,195     $ 662     $ (442 )   $ 220  
     
     
     
     
     
     
 

      The Company expects that annual amortization of acquired intangible assets to be as follows (in thousands):

         
Fiscal year ending:
2003 (remaining six months)
  $ 600  
2004
    1,093  
2005
    1,035  
2006
    1,035  
2007
    431  
     
 
Total amortization expense
  $ 4,194  
     
 

6


Table of Contents

9. CUSTOMER AND GEOGRAPHIC INFORMATION

     The Company operates in one segment. The Company had revenues from individual customers in excess of 10% of total revenues as follows:

                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
   
 
Customer   2003   2002   2003   2002

 
 
 
 
A
    28 %     20 %   25 %     24 %
C
    18 %     19 %   17 %     14 %
G
    16 %     21 %   15 %     22 %
H
    15 %     5 %   16 %     5 %
I
    9 %       10 %      

     The Company had accounts receivable from individual customers in excess of 10% of gross accounts receivable as follows:

                 
    June 30,   December 31,
Customer   2003   2002

 
 
A
    35 %     31 %
C
    24 %     11 %
F
    12 %     19 %
K
          11 %
L
    14 %    

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

                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Asia
  $ 7,583     $ 8,262     $ 13,342     $ 16,185  
United States
    2,369       1,666     $ 4,323     $ 3,775  
Europe
    138       2,308     $ 1,492     $ 3,733  

     As of June 30, 2003 and December 31, 2002, long-lived assets related to PDF Solutions GmbH (formerly AISS), located in Germany, totaled $1.0 and $1.1 million in each year, of which $800,000 and $882,000 million, respectively, relates to acquired intangibles (see Note 7). The majority of the Company’s remaining long-lived assets are in the United States.

10. LITIGATION

     In May 2001 the Company was named as a defendant in a lawsuit claiming, among other things, that it misappropriated trade secrets in connection with hiring an employee. This litigation was settled by all parties in the second quarter of 2002. All expenses related to the lawsuit have been reflected in the consolidated financial statements in 2002.

11. SUBSEQUENT EVENTS

     On June 19, 2003, the Company announced that it has signed a definitive agreement to acquire IDS Software Inc., a privately held corporation based in Foster City, California. Under terms of the agreement, the Company will acquire IDS for $20.0 million in cash and 2,500,000 shares of the Company’s common stock. In addition, the Company will assume all of IDS’s stock options outstanding immediately prior to the close of the transaction. The Company currently expects the transaction to close during the fiscal quarter ending September 30, 2003, subject to customary closing conditions.

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

Forward-Looking Statements

     The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative effect of terms like these or other comparable terminology. These statements are only predictions. These statements involve known and unknown risks and uncertainties and other factors that may cause actual events or results to differ materially. All forward-looking statements included in this document are based on information available to us on the date of filing, and we assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors,

 

7


Table of Contents

including the risks outlined under the caption “Factors that May Affect Future Results” set forth at the end of this Item 2 and the Risk Factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2002. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

Overview

     Our technologies and services enable semiconductor companies to improve yield and performance of integrated circuits, or ICs, by integrating the design and manufacturing processes. We believe that our solutions improve a semiconductor company’s time to market, the rate at which yield improves and product profitability. Our solutions combine proprietary manufacturing process simulation software, yield and performance modeling software, test chips, a proprietary electrical wafer test system, yield and performance enhancement methodologies, and professional services. The result of implementing our solutions is the creation of value that can be measured based on improvements to our customers’ actual yield. We align our financial interests with the yield and performance improvement realized by our customers and receive revenue based on this value. To date, we have sold our technologies and services to semiconductor companies including leading integrated device manufacturers, fabless semiconductor companies and foundries.

Critical Accounting Policies

     General

      Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We based our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The most significant estimates and assumptions relate to revenue recognition, impairment of goodwill, the realization of deferred tax assets and the allowance for doubtful accounts. Actual amounts may differ from such estimates under different assumptions or conditions. The following summarizes our critical accounting policies and significant estimates used in preparing our consolidated financial statements:

     Revenue Recognition

      We derive revenue from two sources: Design-to-Silicon-Yield solutions and gain share. We recognize revenue in accordance with the provisions of American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended, and SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts.

      Design-to-Silicon-Yield Solutions — Design-to-Silicon-Yield solutions revenue is derived from solution implementations, software licenses and software support and maintenance. Revenue recognition for each element of Design-to-Silicon Yield solutions is as follows:

        Solution Implementations — Our solution implementations generate a significant portion of revenue from fixed-price contracts delivered over a specific period of time. These contracts require the accurate estimation of the cost to perform obligations and the overall scope of each engagement. Revenue under contracts for solution implementation services is recognized as the services are performed using the cost-to-cost percentage of completion method of accounting. Losses on solution implementation contracts are recognized when determined. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated. If we do not accurately estimate the resources required or the scope of work to be performed, or do not manage the projects properly within the planned period of time or satisfy our obligations under contracts, resulting contract margins could be materially different than those anticipated when the contract was executed. Any such reductions in contract margin could have a material negative impact on our operating results.
 
        Software Licenses — We have entered into a few multi-year time-based licenses, generally three years. Revenue under arrangements which require us to provide support and maintenance over a period of time, where vendor-specific objective evidence of fair value does not exist to allocate a portion of the total fee to the undelivered elements, are recognized ratably over the term of the agreement. No revenue under arrangements with extended payment terms has been recognized in excess of amounts due.
 
       Other license fees are recognized on the residual value method: (i) when an agreement has been signed, the software has been delivered, the license fee is fixed or determinable and collection of the fee is probable or (ii) as a component of a related solution implementation contract.

        Software Support and Maintenance — Amounts allocated to undelivered support and maintenance are based on vendor specific objective evidence and generally negotiated renewal rates. Revenue from allocated support and maintenance and renewals is recognized ratably over the term of the support and maintenance contract, generally one year.

      Gain Share — Gain share revenue represents profit sharing and performance incentives earned based upon our customers reaching certain defined operational levels. Upon achieving such operational levels, we receive either a fixed fee and/or royalties based on the units sold by the customer. Due to the uncertainties surrounding attainment of such operational levels, we recognize gain share revenue (to the extent of completion of the related solution implementation contract) upon receipt of performance reports or other related information from the customer supporting the determination of amounts and probability of collection. Our continued receipt of gain share revenue is dependent on many factors which are outside our control, including among others, continued production of the related ICs by our customers, sustained yield improvements by our customers and our ability to enter into new Design-to-Silicon-Yield solutions contracts containing gain share provisions.

     Software Development Costs

     Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, Computer Software to be Sold, Leased or Otherwise Marketed. Because we believe our current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date.

     Goodwill and Intangible Assets

     As of June 30, 2003, we had $4.9 million of goodwill and intangible assets. In assessing the recoverability of our goodwill and intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. On January 1, 2002 we adopted SFAS No. 142, Goodwill and Other Intangible Assets, and have performed our transition impairment test of goodwill as of January 1, 2002 which did not indicate any impairment. SFAS No. 142 also requires that goodwill be tested for impairment on an annual basis and more frequently in certain circumstances. We have selected the three month period ending December 31 to perform the annual testing requirements. During the three month period ending December 31, 2002, we completed our annual testing requirements and determined that the carrying value of goodwill had not been impaired.

     Realization of Deferred Tax Assets

     As of June 30, 2003, we had net deferred tax assets of $2.8 million. Realization of deferred tax assets is dependent on our ability to generate future taxable income and utilize tax planning strategies. We have recorded a deferred tax asset to the amount that is more likely than not to be realized based on current estimations and assumptions. We evaluate the valuation allowance on a quarterly basis. Any resulting changes to the valuation allowance will result in an adjustment to income in the period the determination is made.

     Stock-based Compensation

          We account for stock-based compensation in accordance with the provisions of Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and comply with the disclosure provisions of SFAS No. 123 as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosures. Deferred compensation recognized under APB No. 25 is amortized to expense using the graded vesting method. We account for stock options and warrants issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force No. 96-18 under the fair value based method.

     We adopted the disclosure-only provisions of SFAS No. 123, and accordingly, no expense has been recognized for options granted to employees under the various stock plans. We amortize deferred stock-based compensation on the graded vesting method over the vesting periods of the applicable stock purchase rights and stock options, generally four years. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in greater vesting in earlier years than the straight-line method. Had compensation expense been determined based on the fair value at the grant date for award, consistent with the provisions of SFAS No. 123, our pro forma net income (loss) and net income (loss) per share would be as follows (in thousands, except per share data):

                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Net income (loss) as reported:
  $ (676 )   $ 565   $ (2,010 )   $ 1,145
Add: stock-based employee compensation expense included in reported net income (loss) under APB 25
    329       770       751       1,558  
Deduct: total employee stock-based compensation determined under fair value based method for all awards, net of related tax effects
    2,968       3,077       4,896       5,013  
     
     
     
     
 
Pro forma net loss
  $ (3,315 )   $ (1,742 )   $ (6,155 )   $ (2,310 )
     
     
     
     
 
Basic and diluted net income (loss) per share:
                               
As reported:
     Basic
  $ (0.03 )   $ 0.03     $ (0.09 )   $ 0.05  
     Diluted
  $ (0.03 )   $ 0.02     $ (0.09 )   $ 0.05  
     
     
     
     
 
Pro forma basic and diluted:
                               
     Basic
  $ (0.15 )   $ (0.08 )   $ (0.27 )   $ (0.11 )
     Diluted
  $ (0.15 )   $ (0.08 )   $ (0.27 )   $ (0.10 )
     
     
     
     
 

     During the first quarter of 2003, we recorded $227,000 in compensation expense for the fair value of options granted to two non-employees. The 45,000 common shares under the 2001 Stock Plan were granted at an exercise price of $7.59 per share, the fair market value per share on the grant date, were fully vested at the date of grant and contained restrictions on when shares could be sold.

Results of Operations

     We have historically experienced fluctuations from period to period. We expect these fluctuations to continue, therefore, historical results are not indicative of future results.

8


Table of Contents

Comparison of Three and Six Months Ended June 30, 2003 and 2002

Revenues

          Total revenue for the three months ended June 30, 2003 was $10.1 million, compared with $12.2 million for the three months ended June 30, 2002, a decrease of 18%. Total revenue for the six months ended June 30, 2003 was $19.2 million, compared with $23.7 million for the six months ended June 30, 2002, a decrease of 19%.

          Design-to-Silicon-Yield Solutions. Design-to-Silicon-Yield solutions revenue for the three months ended June 30, 2003 was $8.0 million, compared with $9.5 million for the three months ended June 30, 2002, a decrease of 15%. Design-to-Silicon-Yield solutions revenue for the six months ended June 30, 2003 was $16.1 million, compared with $17.9 million for the six months ended June 30, 2002, a decrease of 10%. The decreases were attributable to the general weakness in the semiconductor industry, as a whole, that resulted in a decrease in the number of solution implementations.

          Gain Share. Gain share revenue for the three months ended June 30, 2003 was $2.0 million, compared with $2.7 million for the three months ended June 30, 2002, a decrease of 25%. Gain share revenue for the six months ended June 30, 2003 was $3.0 million, compared with $5.8 million for the six months ended June 30, 2002, a decrease of 48%. The decrease for the three and six months ended June 30, 2003 was attributable to lower production volumes at leading edge process nodes. Additionally, a decreased number of existing customer solution implementations contributed to this decrease.

Costs and Expenses

          Cost of Design-to-Silicon-Yield Solutions. Cost of Design-to-Silicon-Yield solutions for the three months ended June 30, 2003 was $3.5 million, compared with $4.1 million for the three months ended June 30, 2002, a decrease of 15%. Cost of Design-to-Silicon-Yield solutions for the six months ended June 30, 2002 was $7.0 million, compared with $8.0 million for the six months ended June 30, 2002, a decrease of 13%. The absolute dollar decreases in both the three-month and six-month periods ended June 30, 2003 were primarily due to a decreased number of solution implementations. As a percentage of Design-to-Silicon-Yield solutions revenue, cost of Design-to-Silicon-Yield solutions for the three months ended June 30, 2003 was 44%, compared with 43% for the three months ended June 30, 2002. As a percentage of Design-to-Silicon-Yield solutions revenue, cost of Design-to-Silicon-Yield solutions for the six months ended June 30, 2003 was 43%, compared with 45% for the six months ended June 30, 2002. The percentage decrease for the six months ending June 30, 2003 was primarily the result of better utilization of client services resources and a favorable mix of Design-to-Silicon-Yield solutions revenue elements.

          Research and Development. Research and development expenses for the three months ended June 30, 2003 were $4.5 million, compared with $4.0 million for the three months ended June 30, 2002, an increase of 12%. Research and development expenses for the six months ended June 30, 2003 were $8.8 million, compared with $7.2 million for the six months ended June 30, 2002, an increase of 23%. The absolute dollar increases in research and development were primarily due to the increase in personnel related costs and expansion of development activities in Europe. As a percentage of total revenue, research and development expenses for the three months ended June 30, 2003 were 44%, compared with 32% for the three months ended June 30, 2002. As a percentage of total revenue, research and development expenses for the six months ended June 30, 2003 were 46%, compared with 30% for the six months ended June 30, 2002. The percentage increase was primarily the result of an increase in personnel related costs and expansion of development activities in Europe coupled with the decrease in revenue. We anticipate that we will continue to commit considerable resources to research and development in the future and that these expenses will continue to increase significantly in absolute dollars.

9


Table of Contents

          Selling, General and Administrative. Selling, general and administrative expenses for the three months ended June 30, 2003 were $3.0 million, compared with $2.6 million for the three months ended June 30, 2002, an increase of 15%. The absolute dollar increase in selling, general and administrative expenses was attributable to an increase in personnel related expenses partially offset by a decrease in sales commissions. Selling, general and administrative expenses for the six months ended June 30, 2003 were $5.7 million compared with $5.2 million for the six months ended June 30, 2002, an increase of 10%. The absolute dollar increase in selling, general and administrative expenses was attributable to an increase in personnel related expenses partially offset by a decrease in sales commissions and legal fees. As a percentage of total revenue, selling, general and administrative expenses for the three months ended June 30, 2003 were 30%, compared with 21% for the three months ended June 30, 2002. As a percentage of total revenue, selling, general and administrative expenses for the six months ended June 30, 2003 were 30%, compared with 22% for the six months ended June 30, 2002. The percentage increase in both the three months and six months ended June 30, 2003 was primarily the result of increased selling, general and administrative expenses and the decrease in overall revenue. We expect that selling, general and administrative expenses will increase in absolute dollars to support increased selling and administrative efforts.

          Stock-Based Compensation Amortization. Stock-based compensation amortization for the three months ended June 30, 2003 was $329,000, compared with $770,000 for the three months ended June 30, 2002, a decrease of 57%. Stock-based compensation amortization for the six months ended June 30, 2003 was $1.0 million, compared with $1.6 million for the six months ended June 30, 2002, a decrease of 37%. The decrease was due to the effects of the graded vesting method of amortization resulting in higher amortization expense during the initial period following the respective option grants, partially offset by a stock compensation charge of $227,000 for stock options granted to non-employees in the quarter ending March 31, 2003.

          Interest and Other Income. Interest and other income for the three months ended June 30, 2003 was $345,000, compared with $338,000 for the three months ended June 30, 2002, an increase of 2%. Interest and other income for the six months ended June 30, 2003 was $720,000, compared with $697,000 for the three months ended June 30, 2002, an increase of 3%. The increases were primarily due to interest earned on higher average cash and cash equivalents balances in 2003.

          Provision (benefit) for Taxes. The tax benefit for the three months ended June 30, 2003 was $179,000 compared with a tax provision of $551,000 for the three months ended June 30, 2002, a decrease of 132%. The tax benefit for the six months ended June 30, 2003 was $531,000 compared with a tax provision of $1.4 million for the six months ended June 30, 2002, a decrease of 138%. The decreases were primarily due to the shift from income before taxes for the three and six months ended June 30, 2002 to a loss before taxes for the three and six months ended June 30, 2003.

Liquidity and Capital Resources

10


Table of Contents

     Net cash used in operating activities was $1.9 million for the six months ended June 30, 2003, compared to net cash used in operating activities of $4.3 million for the six months ended June 30, 2002. Net cash used in operating activities for the six months ended June 30, 2003 resulted from decreases in deferred revenue and deferred taxes of $2.4 million, accounts receivable of $1.3 million, taxes payable of $1.2 million, billings in excess of revenue recognized of $332,000 and other accrued liabilities of $278,000, and increases in accounts payable of $871,000, prepaid expenses and other assets of $784,000, accrued compensation of $767,000, and net income of $116,000 after adjustment for depreciation and amortization of $1.1 million, and deferred stock compensation of $1.0 million. The decrease in deferred revenue was the result of amortizing revenue from four separate business arrangements plus software support and maintenance. The increase in accounts payable was primarily attributable to the expenses associated with a pending business acquisition and the purchases of capital equipment. The increase in accrued compensation was primarily the result of increases in accrued compensation and benefits.

     Net cash used in investing activities during the six months ended June 30, 2003, consisted of $2.6 million paid in connection with our acquisition of certain assets and related business operations of WaferYield, Inc. and purchases of property and equipment of $903,000. Net cash used in investing activities during the six months ended June 30, 2002 consisted of $1.7 million in purchases of property and equipment, principally computer hardware to expand our operations and growing infrastructure.

     Net cash provided by financing activities was $949,000 for the six months ended June 30, 2003, compared to net cash provided by financing activities of $1.7 million for the six months ended June 30, 2002. Net cash provided by financing activities for the six months ended June 30, 2003 were primarily the result of proceeds from the employee stock purchase plan of $543,000 and repayment of employee notes receivable of $373,000.

     As of June 30, 2003, working capital was $69.4 million, compared with $73.6 million as of December 31, 2002. Cash and cash equivalents as of June 30, 2003 were $67.0 million, compared to $71.5 million as of December 31, 2002, a decrease of $4.4 million. We expect to experience growth in our operating expenses, particularly for research and development and additions to our workforce in order to execute our business plan. As a result, we anticipate that our operating expenses, as well as planned capital expenditures, will constitute a material use of our cash resources. In addition, we may use cash resources to fund potential investments in, or acquisitions of, complementary products, technologies or businesses. We believe that our existing cash resources, and anticipated funds from 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 not successful in generating sufficient cash flows from operations we may need to raise additional capital through private or public financings, strategic relationships or other arrangements, which may not be available to us on acceptable terms or at all.

11


Table of Contents

Euro-Currency

     We began doing business in Europe denominated in Euros on January 1, 2002. This adoption did not have a material effect on our business.

Recent Accounting Pronouncements

     In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)”. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than when the exit or disposal plan is approved. We adopted SFAS No. 146 on January 1, 2003. The adoption of this statement did not have an effect on our financial position and operating results.

     In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others”. FIN 45 requires companies to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. We adopted FIN 45 on January 1, 2003. The adoption of this statement did not have an effect on our financial position and operating results.

     In December 2002, the EITF reached a consensus on EITF 00-21, “Revenue Arrangements with Multiple Deliverables”. This issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. In some arrangements, the different revenue-generating activities (deliverables) are sufficiently separable and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables (that is, there are separate units of accounting). In other arrangements, some or all of the deliverables are not independently functional, or there is not sufficient evidence of their fair values to account for them separately. This issue addresses when and, if so, how an arrangement involving multiple deliverables should be divided into separate units of accounting. This issue does not change otherwise applicable revenue recognition criteria. The guidance in this issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not expect that the adoption of EITF 00-21 will have a material effect on our consolidated financial statements.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment to FASB Statement 123”. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting of stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”, to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148 effective December 31, 2002. We adopted the interim disclosure requirements of SFAS No. 148 during the three months ended March 31, 2003.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group process and in connection with implementation issues raised in relation to the application of the definition of a derivative. SFAS 149 is effective for contracts entered into or modified after June 30, 2003. We do not expect the requirements of SFAS No. 149 to have a material impact on our financial position or results of operations.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” which requires that certain financial instruments be presented as liabilities that were previously presented as equity or as temporary equity. Such instruments include mandatory redeemable preferred and common stock, and certain options and warrants. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is generally effective at the beginning of the first interim period after June 15, 2003. We do not expect the requirements of SFAS No. 150 to have a material impact on our financial position or results of operations.

 

12


Table of Contents

Factors Which May Affect Future Results

If semiconductor designers and manufacturers do not adopt our Design-to-Silicon-Yield solutions, we may be unable to increase or maintain our revenue.

      If semiconductor designers and manufacturers do not adopt our Design-to-Silicon-Yield solutions, our revenue could decline. To date, we have worked with a limited number of semiconductor companies on a limited number of IC products and processes. To be successful, we will need to enter into agreements covering a larger number of IC products and processes with existing customers and new customers. Our existing customers are primarily large integrated device manufacturers, or IDMs. We will need to target as new customers additional IDMs, fabless semiconductor companies and foundries, as well as system manufacturers. Factors that may limit adoption of our Design-to-Silicon-Yield solutions by semiconductor companies include:

  •  our customers’ failure to achieve satisfactory yield improvements using our Design-to-Silicon-Yield solutions;
 
  •  a decrease in demand for semiconductors generally or the demand for deep submicron semiconductors failing to grow as rapidly as expected;
 
  •  the industry may develop alternative methods to enhance the integration between the semiconductor design and manufacturing processes due to a rapidly evolving market and the likely emergence of new technologies;
 
  •  our existing and potential customers’ reluctance to understand and accept our innovative gain share fee component; and
 
  •  our customers’ concern about our ability to keep highly competitive information confidential.

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

      Historically, our quarterly operating results have fluctuated. Our future quarterly operating results will likely fluctuate from time to time and may not meet the expectations of securities analysts and investors in some future period. The price of our common stock could decline due to such fluctuations. The following factors may cause significant fluctuations in our future quarterly operating results:

  •  the size and timing of sales volumes achieved by our customers’ products;
 
  •  the loss of any of our large customers or an adverse change in any of our large customers’ businesses;
 
  •  the size of improvements in our customers’ yield and the timing of agreement as to those improvements;
 
  •  our long and variable sales cycle;
 
  •  changes in the mix of our revenue;
 
  •  changes in the level of our operating expenses needed to support our projected growth; and
 
  •  delays in completing solution implementations for our customers.

 
Worldwide events, including the recent outbreak of SARS in Asia and the probability of prolonged involvement in Iraq, may reduce our revenues and harm our business.

      Future political or related events similar or comparable to the September 11, 2001 terrorist attacks, or significant military conflicts such as the continued involvement in Iraq, or long term reactions of governments and society to such events, may cause significant delays or reductions in technology purchases or limit our ability to travel to certain parts of the world. Further, the recent outbreak of Severe Acute Respiratory Syndrome (SARS) in Asia may adversely impact our operations and sales in that region if our business or the businesses of our customers are disrupted by travel restrictions or illness and quarantine of employees.

13


Table of Contents

Our gain share revenue is largely dependent on the volume of integrated circuits, or ICs, our customers are able to sell to their customers, which is outside of our control.

      Our gain share revenue for a particular product is largely determined by the volume of that product our customer is able to sell to its customers, which is outside of our control. We have limited ability to predict the success or failure of our customers’ IC products. We may commit a significant amount of time and resources to a customer who is ultimately unable to sell as many units as we had anticipated when contracting with them. Since we currently work on a small number of large projects, any product that does not achieve commercial viability could significantly reduce our revenue and results of operations below expectations. In addition, if we work with two directly competitive products, volume in one may offset volume, and any of our related gain share, in the other product. Further, decreased demand for semiconductor products decreases the volume of products our customers are able to sell, which may adversely affect our gain share revenue.

 
Gain share measurement requires data collection and is subject to customer agreement, which can result in uncertainty and cause quarterly results to fluctuate.

      We can only recognize gain share revenue once we have reached agreement with our customers on their level of yield performance improvements. Because measuring the amount of yield improvement is inherently complicated and dependent on our customers’ internal information systems, there may be uncertainty as to some components of measurement. This could result in our recognition of less revenue than expected. In addition, any delay in measuring gain share could cause all of the associated revenue to be delayed until the next quarter. Since we currently have only a few large customers and we are relying on gain share as a significant component of our total revenue, any delay could significantly harm our quarterly results.

 
Changes in the structure of our customer contracts, particularly the mix between fixed and variable revenue, can adversely affect the size and timing of our total revenue.

      Our success is largely dependent upon our ability to structure our future customer contracts to include a larger gain share component relative to the fixed fee component. If we are successful in increasing the gain share component of our customer contracts, we will experience an adverse impact on our operating results in the short term as we reduce the fixed fee component, which we typically recognize earlier than gain share fees. In addition, by increasing the gain share component, we increase the variability of our revenue, and therefore increase the risk that our total future revenue will be lower than expected and fluctuate significantly from period to period.

14


Table of Contents

 
We generate virtually all of our total revenue from a limited number of customers, so the loss of any one of these customers could significantly reduce our revenue and results of operations below expectations.

      Historically, we have had a small number of large customers and we expect this to continue in the near term. In the three months ended June 30, 2003, four customers accounted for 77% of our total net revenue, with Toshiba representing 28%, Sony representing 18%, Matsushita representing 16%, and Cadence representing 15%, respectively. For the year ended December 31, 2002, Toshiba, Sony, Matsushita and Cadence represented 25%, 17%, 22%, and 5%, respectively. The loss of any of these customers or a decrease in the sales volumes of their products could significantly reduce our total revenue below expectations. In particular, such a loss could cause significant fluctuations in results of operations because our expenses are fixed in the short term, it takes us a long time to replace customers and any offsetting gain share revenue from new customers would not begin to be recognized until much later.

 
It typically takes us a long time to sell our novel solutions to new customers, which can result in uncertainty and delays in generating additional revenue.

      Because our gain share business model is novel and our Design-to-Silicon-Yield solutions are unfamiliar, our sales cycle is lengthy and requires a significant amount of our senior management’s time and effort. Furthermore, we need to target those individuals within a customer’s organization who have overall responsibility for the profitability of an IC. These individuals tend to be senior management or executive officers. We may face difficulty identifying and establishing contact with such individuals. Even after initial acceptance, due to the complexity of structuring the gain share component, the negotiation and documentation processes can be lengthy. It can take six months or more to reach a signed contract with a customer. Unexpected delays in our sales cycle could cause our revenue to fall short of expectations.

 
We have a history of losses, we expect to incur losses in the future and we may be unable to achieve or subsequently maintain profitability.

      We have experienced losses in the three most recent quarters. We may not achieve or subsequently maintain profitability if our revenue increases more slowly than we expect or not at all. In addition, virtually all of our operating expenses are fixed in the short term, so any shortfall in anticipated revenue in a given period could significantly reduce our operating results below expectations. Our accumulated deficit was $16.9 million as of June 30, 2003. We expect to continue to incur significant expenses in connection with:

  •  increased 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 amortization of intangibles and deferred stock compensation.

      As a result, we will need to significantly increase revenue to maintain profitability on a quarterly or annual basis. Any of these factors could cause our stock price to decline.

 
We must continually attract and retain highly talented executives, engineers and research and development personnel or we will be unable to expand our business as planned.

      We will need to continue to hire highly talented executives, engineers and research and development personnel to support our planned growth. We have experienced, and we expect to continue to experience, delays and limitations in hiring and retaining highly skilled individuals with appropriate qualifications. We intend to continue to hire foreign nationals, particularly as we expand our operations internationally. We have had, and expect to continue to have, difficulty in obtaining visas permitting entry into the United States, for several of our key personnel, which disrupts our ability to strategically locate our personnel. If we lose the services of any of our key executives or a significant number of our engineers, it could disrupt our ability to implement our business strategy. Competition for executives and qualified engineers can be intense, especially in Silicon Valley where we are principally based.

15


Table of Contents

 
If our Design-to-Silicon-Yield solutions fail to keep pace with the rapid technological changes in the semiconductor industry, we could lose customers and revenue.

      We must continually devote significant engineering resources to enable us to keep up with the rapidly evolving technologies and equipment used in the semiconductor design and manufacturing processes. These innovations are inherently complex and require long development cycles. Not only do we need the technical expertise to implement the changes necessary to keep our technologies current, we also rely heavily on the judgment of our advisors and management to anticipate future market trends. Our customers expect us to stay ahead of the technology curve and expect that our Design-to-Silicon-Yield solutions will support any new design or manufacturing processes or materials as soon as they are deployed. If we are not able to timely predict industry changes, or if we are unable to modify our Design-to-Silicon-Yield solutions on a timely basis, our existing solutions will be rendered obsolete and we may lose customers. If we do not keep pace with technology, our existing and potential customers may choose to develop their own solutions internally as an alternative to ours and we could lose market share, which could adversely affect our operating results.

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

      In order to establish strategic relationships with industry leaders at each stage of the IC design and manufacturing processes, we may need to expend significant resources and will need to commit a significant amount of management’s time and attention, with no guarantee of success. If we are unable to enter into strategic relationships with these companies, we will not be as effective at modeling existing technologies or at keeping ahead of the curve as new technologies are introduced. In the past, the absence of an established working relationship with key companies in the industry has meant that we have had to exclude the effect of their component parts from our modeling analysis, which reduces the overall effectiveness of our analysis and limits our ability to improve yield. We may be unable to establish key industry strategic relationships if any of the following occur:

  •  potential industry partners become concerned about our ability to protect their intellectual property;
 
  •  potential industry partners develop their own solutions to address the need for yield improvement;
 
  •  our potential competitors establish relationships with industry partners with which we seek to establish a relationship; or
 
  •  potential industry partners attempt to restrict our ability to enter into relationships with their competitors.

 
The proposed acquisition of IDS Software Systems, Inc. may adversely affect our results of operations whether or not the acquisition is completed, and the acquisition may not be completed on a timely basis or at all.

      Completion of the acquisition is subject to numerous risks and uncertainties. We may be unable to obtain the regulatory approvals required to complete our acquisition of IDS Software, Inc. (“IDS Software”) in a timely manner or at all. If the acquisition is not completed, the price of our common stock may decline to the extent that the current market price of our common stock reflects a market assumption that the acquisition will be completed. Moreover, we would not derive the strategic benefits and growth opportunities expected to result from the integration of IDS Software’s operations with our own. In addition, our business may be harmed to the extent that there is customer and employee uncertainty surrounding our future direction and strategy. We also will be required to pay significant costs incurred in connection with the acquisition, including legal and accounting fees, whether or not the acquisition is completed.

      Our success is realizing these strategic benefits and growth opportunities and the timing of this realization depend upon the successful integration of the operations of IDS Software. The integration of two independent companies is a complex, costly and time-consuming process. The difficulties of combining the operations of the companies include, among others:

  •  consolidating research and development operations;
 
  •  retaining key employees;
 
  •  consolidating corporate and administrative infrastructures;
 
  •  coordinating sales and marketing functions;
 
  •  preserving ours and IDS Software's research and development, marketing, customer and other important relationships;
 
  •  minimizing the diversion of management's attention from ongoing business concerns.

 
We face operational and financial risks associated with international operations.

      We derive a majority of our revenue from international sales, principally from customers based in Asia. Revenue generated from customers in Asia accounted for 75% of total revenue in the quarter ended June 30, 2003. For the year ended December 31, 2002 revenue generated from customers in Asia was 71%. We expect that a significant portion of our total future revenue will continue to be derived from companies based in Asia. We are subject to risks inherent in doing business in international markets. These risks include:

  •  some of our key engineers and other personnel who are foreign nationals may have difficulty gaining access to the United States and other countries in which our customers or our offices may be located;
 
  •  greater difficulty in collecting account receivables resulting in longer collection periods;
 
  •  language and other cultural differences may inhibit our sales and marketing efforts and create internal communication problems among our U.S. and foreign research and development teams;
 
  •  compliance with, and unexpected changes in, a wide variety of foreign laws and regulatory environments with which we are not familiar;

16


Table of Contents

  •  currency risk due to the fact that expenses for our international offices are denominated in the local currency, including the Euro, while virtually all of our revenue is denominated in U.S. dollars;
 
  •  economic or political instability; and
 
  •  the recent outbreak of SARS.

      In Japan, in particular, we face the following additional risks:

  •  any recurrence of the recent overall downturn in Asian economies could limit our ability to retain existing customers and attract new ones in Asia;
 
  •  if the U.S. dollar increases in value relative to the Japanese Yen, the cost of our solutions will be more expensive to existing and potential Japanese customers and therefore less competitive; and
 
  •  if any of these risks materialize, we may be unable to continue to market our design-to-silicon yield solutions successfully in international markets.

 
Competition in the market for solutions that address yield improvement and integration between IC design and manufacturing may intensify in the future, which could slow our ability to grow or execute our strategy.

      Competition in our market may intensify in the future, which could slow our ability to grow or execute our strategy. Our current and potential customers may choose to develop their own solutions internally, particularly if we are slow in deploying our solutions. Many of these companies have the financial and technical capability to develop their own solutions. Currently, we are not aware of any other provider of commercial solutions for systematic IC yield and performance enhancement. We face indirect competition from the internal groups at IC companies that use an incomplete set of components that is not optimized to accelerate their process-design integration. Some providers of yield management software or inspection equipment may seek to broaden their product offerings and compete with us. For example, KLA-Tencor has announced adding the use of test structures to one of their inspection product lines. Other companies, such as HPL Technologies which, through its acquisition of Test Chip Technologies, has indicated its intent to further utilize test chips in its product offering, may in the future seek to enter the silicon infrastructure market. In addition, we believe that the demand for solutions that address the need for better integration between the silicon design and manufacturing processes may encourage direct competitors to enter into our market. For example, large integrated organizations, such as IDMs, electronic design automation software providers, IC design service companies or semiconductor equipment vendors, may decide to spin-off a business unit that competes with us. Other potential competitors include fabrication facilities that may decide to offer solutions competitive with ours as part of their value proposition to their customers. If these potential competitors are able to attract industry partners or customers faster than we can, we may not be able to grow and execute our strategy as quickly or at all. In addition, customer preferences may shift away from our Design-to-Silicon-Yield solutions as a result of the increase in competition.

 
We must effectively manage and support our recent and planned growth in order for our business strategy to succeed.

      We will need to continue to grow in all areas of operation and successfully integrate and support our existing and new employees into our operations, or we may be unable to implement our business strategy in the time frame we anticipate, if at all. We will also need to switch to a new accounting system in the near future, which could disrupt our business operations and distract management. In addition, we will need to expand our intranet to support new data centers to enhance our research and development efforts. Our intranet is expensive to expand and must be highly secure due to the sensitive nature of our customers’ information that we transmit. Building and managing the support necessary for our growth places significant demands on our management and resources. These demands may divert these resources from the continued growth of our business and implementation of our business strategy. Further, we must adequately train our new personnel, especially our client service and technical support personnel, to adequately, and accurately, respond to and support our customers. If we fail to do this, it could lead to dissatisfaction among our customers, which could slow our growth.

17


Table of Contents

 
Our solution implementations may take longer than we anticipate, which could cause us to lose customers and may result in adjustments to our operating results.

      Our solution implementations require a team of engineers to collaborate with our customers to address complex yield loss issues by using our software and other technologies. We must estimate the amount of time needed to complete an existing solution implementation in order to estimate when the engineers will be able to commence a new solution implementation. Given the time pressures involved in bringing IC products to market, targeted customers may proceed without us if we are not able to commence their solution implementation on time. Due to our lengthy sales cycle, we may be unable to replace these targeted implementations in a timely manner, which could cause fluctuations in our operating results.

      In addition, our accounting for solution implementation contracts, which generate fixed fees, sometimes require adjustments to profit and loss based on revised estimates during the performance of the contract. These adjustments may have a material effect on our results of operations in the period in which they are made. The estimates giving rise to these risks, which are inherent in fixed-price contracts, include the forecasting of costs and schedules, and contract revenues related to contract performance.

 
Our chief executive officer and our chief strategy officer are critical to our business and we cannot guarantee that they will remain with us indefinitely.

      Our future success will depend to a significant extent on the continued services of John Kibarian, our President and Chief Executive Officer, and David Joseph, our Chief Strategy Officer. If we lose the services of either of these key executives, it could slow execution of our business plan, hinder our product development processes and impair our sales efforts. Searching for their replacements could divert our other senior management’s time and increase our operating expenses. In addition, our industry partners and customers could become concerned about our future operations, which could injure our reputation. We do not have long-term employment agreements with these executives and we do not maintain any key person life insurance policies on their lives.

 
Inadvertent disclosure of our customers’ confidential information could result in costly litigation and cause us to lose existing and potential customers.

      Our customers consider their product yield information and other confidential information, which we must gather in the course of our engagement with the customer, to be extremely competitively sensitive. If we inadvertently disclosed or were required to disclose this information, we would likely lose existing and potential customers, and could be subject to costly litigation. In addition, to avoid potential disclosure of confidential information to competitors, some of our customers may, in the future, ask us not to work with key competitive products.

 
If we fail to protect our intellectual property rights, customers or potential competitors may be able to use our technologies to develop their own solutions which could weaken our competitive position, reduce our revenue or increase our costs.

      Our success depends largely on the proprietary nature of our technologies. We currently rely primarily on copyright, trademark and trade secret protection. Whether or not patents are granted to us, litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. As a result of any such litigation, we could lose our proprietary rights and incur substantial unexpected operating costs. Litigation could also divert our resources, including our managerial and engineering resources. In the future, we intend to rely primarily on a combination of patents, copyrights, trademarks and trade secrets to protect our proprietary rights and prevent competitors from using our proprietary technologies in their products. These laws and procedures provide only limited protection. Our pending patent applications may not result in issued patents, and even if issued, they may not be sufficiently broad to protect our proprietary technologies. Also, patent protection in foreign countries may be limited or unavailable where we need such protection.

18


Table of Contents

 
Our technologies could infringe the intellectual property rights of others causing costly litigation and the loss of significant rights.

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

 
Defects in our proprietary technologies and software tools could decrease our revenue and our competitive market share.

      If the software or proprietary technologies we provide to a customer contain defects that increase our customer’s cost of goods sold and time to market, these defects could significantly decrease the market acceptance of our Design-to-Silicon-Yield solutions. Any actual or perceived defects with our software or proprietary technologies may also hinder our ability to attract or retain industry partners or customers, leading to a decrease in our revenue. These defects are frequently found during the period following introduction of new software or proprietary technologies or enhancements to existing software or proprietary technologies. Our software or proprietary technologies may contain errors not discovered until after customer implementation of the silicon design and manufacturing process recommended by us. If our software or proprietary technologies contain errors or defects, it could require us to expend significant resources to alleviate these problems, which could result in the diversion of technical and other resources from our other development efforts.

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

      We currently anticipate that our available cash resources will be sufficient to meet our presently anticipated working capital and capital expenditure requirements for at least the next 12 months. However, we may need to raise additional funds in order to:

  •  support more rapid expansion;
 
  •  develop or enhance Design-to-Silicon-Yield solutions;
 
  •  respond to competitive pressures; or
 
  •  acquire complementary businesses or technologies.

      These factors will impact our future capital requirements and the adequacy of our available funds. We may need to raise additional funds through public or private financings, strategic relationships or other arrangements. We cannot guarantee that we will be able to raise any necessary funds on terms favorable to us, or at all.

 
We may not be able to expand our proprietary technologies if we do not consummate potential acquisitions or investments or successfully integrate them with our business.

      To expand our proprietary technologies, we may acquire or make investments in complementary businesses, technologies or products if appropriate opportunities arise. We may be unable to identify suitable acquisition or investment candidates at reasonable prices or on reasonable terms, or consummate future acquisitions or investments, each of which could slow our growth strategy. We may have difficulty integrating the acquired products, personnel or technologies of any acquisitions we might make. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses.

19


Table of Contents

 
The semiconductor industry is cyclical in nature.

      Our revenue is highly dependent upon the overall condition of the semiconductor industry, especially in light of our gain share revenue component. The semiconductor industry is highly cyclical and subject to rapid technological change and has been subject to significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity. One such downturn commenced during the third quarter of calendar 2000 and is continuing currently. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we may experience significant fluctuations in operating results due to general semiconductor industry conditions and overall economic conditions.

 
Semiconductor companies are subject to risk of natural disasters.

      Semiconductor companies have in the past experienced major reductions in foundry capacity due to earthquakes in Taiwan, Japan and California. In light of our gain share revenue component, our results of operations can be significantly decreased if one of our customers must shut down IC production due to a natural disaster such as earthquake, fire, tornado or flood. Moreover, since semiconductor product life cycles have become relatively short, a significant delay in the production of a product could result in lost revenue, not merely delayed revenue.

 
Management has broad discretion as to the use of proceeds from our initial public offering and, as a result, we may not use the proceeds to the satisfaction of our stockholders.

      On August 1, 2001, we closed our initial public offering. Our board of directors and management have broad discretion in allocating the net proceeds therefrom. They may choose to allocate such proceeds in ways that do not produce a favorable return or are not supported by our stockholders. We have designated only limited specific uses for the net proceeds from our initial public offering.

 
The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.

      The concentration of ownership of our outstanding capital stock with our directors and executive officers may limit your ability to influence corporate matters. Our directors, executive officers and their affiliates, beneficially own a significant portion of our outstanding capital stock. As a result, these stockholders, if acting together, will have the ability to control all matters submitted to our stockholders for approval, including the election and removal of directors and the approval of any corporate transactions.

 
We have anti-takeover defenses that could delay or prevent an acquisition of our company.

      Provisions of our certificate of incorporation and bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

 
Our stock price is likely to be extremely volatile as the market for technology companies’ stock has recently experienced extreme price and volume fluctuations.

      Volatility in the market price of our common stock could result in securities class action litigation. Any litigation would likely result in substantial costs and a diversion of management’s attention and resources. Despite the strong pattern of operating losses of technology companies, the market demand, valuation and trading prices of these companies has at times been high. At the same time, the share prices of these companies’ stocks have been highly volatile and have recorded lows well below their historical highs. As a result, investors in these companies often buy the stock at very high prices only to see the price drop substantially a short time later, resulting in an extreme drop in value in the stock holdings of these investors. Our stock may be volatile, may not trade at the same levels as other technology stocks or at or near its historical highs.

 
A large number of shares becoming eligible for sale could cause our stock price to decline.

      Sales of a substantial number of shares of our common stock could cause our stock price to fall. Our current stockholders hold a substantial number of shares, which they are able to sell, from time-to-time, in the public market.

20


Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. We do not currently own any equity investments, nor do we expect to own any in the foreseeable future. This discussion contains forward-looking statements that are subject to risks and uncertainties. Our actual results could vary materially as a result of a number of factors.

     Interest Rate Risk. As of June 30, 2003, we had cash and cash equivalents of $67.1 million, consisting of cash and highly liquid money market instruments with maturities of 90 days or less. Because of the short maturities of those instruments, a sudden change in market interest rates would not have a material impact on the fair value of the portfolio. We would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest on our portfolio. A hypothetical increase in market interest rates of 10% from the market rates in effect at June 30, 2003 would cause the fair value of these investments to decrease by an immaterial amount which would not have significantly impacted our financial position or results of operations. Declines in interest rates over time will result in lower interest income and increased interest expense.

     Foreign Currency and Exchange Risk. Virtually all of our revenue is denominated in U.S. dollars, although such revenue is derived substantially from foreign customers. Foreign sales to date, generated by our German subsidiary PDF Solutions GmbH since the date of its acquisition, have for the most part, been invoiced in local currencies, creating receivables denominated in currencies other than the U.S. dollar. The risk due to foreign currency fluctuations associated with these receivables is partially reduced by local payables denominated in the same currencies, and presently we do not consider it necessary to hedge these exposures. We intend to monitor our foreign currency exposure. There can be no assurance that exchange rate fluctuations will not have a materially negative impact on our business.

Item 4. Controls and Procedures

     We recognize that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance. Our chief executive officer and chief financial officer necessarily were required to apply their judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)), have concluded that as of the end of the period covered by this quarterly report, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities so that we are able to record, process, summarize and disclose such information in the reports we file with the SEC as of the end of the period covered by this report.

21


Table of Contents

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     Not Applicable

Item 2. Changes in Securities and Use of Proceeds

     (d) Use of Proceeds

     Our Registration Statement on Form S-1 (File No. 333-43192) related to our initial public offering was declared effective by the SEC on July 26, 2001. The public offering commenced on July 27, 2001. All 4,500,000 shares of common stock offered in the final prospectus, as well as an additional 675,000 shares of common stock subject to the underwriters’ over-allotment option, were sold at the closing on August 1, 2001 at a price to the public of $12.00 per share (before deducting underwriting discounts and commissions) through a syndicate of underwriters managed by Credit Suisse First Boston Corporation, Robertson Stephens, Inc. and Dain Rauscher Incorporated. The aggregate gross proceeds of the shares offered and sold was $62.1 million, out of which we paid an aggregate of $4.3 million in underwriting discounts and commissions to the underwriters. Our total expenses, including underwriting discounts and commissions were approximately $5.6 million.

     We intend to use the net proceeds of the public offering primarily for general corporate purposes, including working capital and capital expenditures. The amounts and timing of these expenditures will vary depending on a number of factors, including the amount of cash generated or used by our operations, competitive and technological developments and the rate of growth, if any, of our business. We may use some of the net proceeds to acquire up to $10.0 million of outstanding shares of our common stock in open market or negotiated transactions pursuant to the repurchase program approved by our Board of Directors in February 2003. We may also use a portion of the net proceeds to acquire businesses, services, products or technologies or invest in businesses that we believe will complement our current or future business. As a result, we will retain broad discretion in the allocation of the proceeds of the public offering. Pending the uses described above, we will invest the net proceeds of the public offering in cash, cash equivalents, money market funds or short-term interest-bearing, investment-grade securities to the extent consistent with applicable regulations. We cannot predict whether the proceeds will be invested to yield a favorable return.

Item 3. Defaults on Senior Securities

     Not Applicable

22


Table of Contents

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

     During the quarter ended June 30, 2003, we submitted the following matters to our stockholders for approval at our Annual Meeting of Stockholders held on May 16, 2003 and the following proposals were adopted by our stockholders by the margins indicated:

Proposals:

1. To elect two (2) Class I nominees to the Board of Directors.

                 
Election of Director   Votes For   Votes Withheld

 
 
Lucio Lanza — Class II Director
    17,025,837       1,669,199  
Kimon Michaels — Class II Director
    17,197,022       1,496,014  

     As a result, Messrs. Lanza and Michaels were re-elected as Class II directors of the Registrant for a three year term expiring upon the Annual Meeting next following the fiscal year ending December 31, 2005, or until their respective successors have been duly qualified and elected. John K. Kibarian, B.J. Cassin and Donald L. Lucas continued as directors of the Registrant.

2. To amend the Company’s 2001 Stock Plan to increase the annual grant of options to non-employee directors from 7,500 shares per year to 10,000 shares per year.

             
Votes For   Votes Against   Votes Withheld    

 
 
   
15,276,084   3,011,896   407,056    

3. To ratify the appointment of Deloitte & Touche LLP as the independent auditors of the Company for the fiscal year ending December 31, 2003.

             
Votes for   Votes Against   Votes Abstained   Broker Non-votes

 
 
 
16,844,263   1,824,402   26,371   0

Item 5. Other Information

Not Applicable.

Item 6. Exhibits and Reports on Form 8-K

     (a)  Exhibits:

         
Exhibit
Number Description


  3.1     Third Amended and Restated Certificate of Incorporation of PDF Solutions, Inc.**
  3.2     Amended and Restated Bylaws of PDF Solutions, Inc.**
  4.1     Specimen Stock Certificate.**
  4.2     Second Amended and Restated Rights Agreement dated July 6, 2001.*
  31.1     Rule 13(a)-14(a)/15(d)-14(a) Certification of President and Chief Executive Officer
  31.2     Rule 13(a)-14(a)/15(d)-14(a) Certification of Chief Financial Officer and Vice President of Finance and Administration
  32.1     Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
  32.2     Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***


 
* Incorporated by reference to PDF’s Registration Statement on Form S-1, Amendment No. 7 filed July 9, 2001 (File No. 333-43192).
** Incorporated by reference to PDF’s Report on Form 10-Q filed September 6, 2001 (File No. 000-31311).
*** As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are not incorporated by reference in any filing of PDF Solutions, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

     (b)  Reports on Form 8-K:

1. On April 24, 2003, we filed a report on Form 8-K relating to our financial information for the quarter ended March 31, 2003 and forward-looking statements relating to our operational results.

2. On June 19, 2003, we filed a report on Form 8-K announcing that we had entered into a definitive agreement to acquire IDS Software Systems, Inc. The transactions contemplated in this definitive agreement remain subject to customary closing conditions. In addition, we announced that we had entered into a definitive agreement to acquire certain assets and related business operations of WaferYield, Inc. The WaferYield Inc. acquisition was effective as of May 31, 2003.

 

23


Table of Contents

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

     
Date: August 14, 2003 By: /s/ John K. Kibarian
   
    John K. Kibarian
    President and Chief Executive Officer
     
     
  By: /s/ P. Steven Melman
   
    P. Steven Melman
    Chief Financial Officer and Vice President, Finance and Administration

24


Table of Contents

INDEX TO EXHIBITS

         
Exhibit
Number Description


  3.1     Third Amended and Restated Certificate of Incorporation of PDF Solutions, Inc.**
  3.2     Amended and Restated Bylaws of PDF Solutions, Inc.**
  4.1     Specimen Stock Certificate**
  4.2     Second Amended and Restated Rights Agreement dated July 6, 2001.*
  31.1     Rule 13(a)-14(a)/15(d)-14(a) Certification of President and Chief Executive Officer.
  31.2     Rule 13(a)-14(a)/15(d)-14(a) Certification of Chief Financial Officer and Vice President of Finance and Administration.
  32.1     Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
  32.2     Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***


* Incorporated by reference to PDF’s Registration Statement on Form S-1, Amendment No. 7 filed July 9, 2001 (File No. 333-43192).
** Incorporated by reference to PDF’s Report on Form 10-Q filed September 6, 2001 (File No. 000-31311).
*** As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are not incorporated by reference in any filing of PDF Solutions, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.