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TABLE OF CONTENTS
PDF SOLUTIONS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 	 	 	
(Mark One)	 	 	

ý	
 	
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	

For the fiscal year ended December 31, 2008	

or	

o	
 	
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)

Securities registered pursuant to Section 12(b) of the Act:
 	 	 	
Title of Class	 	Name of Each Exchange on Which Registered	
Common Stock, $0.00015 par value	 	The NASDAQ Stock Market LLC	
Securities registered pursuant to Section 12(g) of the Act:

None

         Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         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  ý     No  o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 	 	 	 	 	 	 	
Large accelerated filer  o	 	Accelerated filer  ý	 	Non-accelerated filer o
(Do not check if a smaller
reporting company)	 	Smaller reporting company  o	
         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

         The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $80.6 million as of the last business day of the Registrant's most recently completed second quarter, based upon the closing sale price on the NASDAQ Global Market reported for such date. Shares of Common Stock held by each officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

         There were 26,258,240 shares of the Registrant's Common Stock outstanding as of March 6, 2009.

DOCUMENTS INCORPORATED BY REFERENCE

         Part III incorporates certain information by reference from the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 21, 2009.

Table of Contents
TABLE OF CONTENTS

 
	 	 
	 	Page	
PART I	
Item 1.	 	Business	 	3	
Item 1A.	 	Risk Factors	 	12	
Item 1B.	 	Unresolved Staff Comments	 	22	
Item 2.	 	Properties	 	22	
Item 3.	 	Legal Proceedings	 	22	
Item 4.	 	Submission of Matters to a Vote of Security Holders	 	22	
PART II	
Item 5.	 	Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities	 	23	
Item 6.	 	Selected Financial Data	 	26	
Item 7.	 	Management's Discussion and Analysis of Financial Condition and Results of Operations	 	27	
Item 7A.	 	Quantitative and Qualitative Disclosures About Market Risk	 	44	
Item 8.	 	Financial Statements and Supplementary Data	 	44	
Item 9.	 	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	 	44	
Item 9A.	 	Controls and Procedures	 	44	
Item 9B.	 	Other Information	 	45	
PART III	
Item 10.	 	Directors and Executive Officers of the Registrant	 	47	
Item 11.	 	Executive Compensation	 	47	
Item 12.	 	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	 	47	
Item 13.	 	Certain Relationships and Related Transactions	 	47	
Item 14.	 	Principal Accounting Fees and Services	 	47	
PART IV	
Item 15.	 	Exhibits and Financial Statement Schedules	 	48	
Signatures	 	86	
Index to Exhibits	 	88	
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PART I

        This Annual Report on Form 10-K, particularly in Item 1 "Business" and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations," includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements include, but are not limited to, statements concerning: expectations about the effectiveness of our business and technology strategies; expectations regarding stock market and global economic trends; expectations regarding previous and future acquisitions; current semiconductor industry trends; expectations of the success and market acceptance of our intellectual property and our solutions; expectations concerning recent completed acquisitions; expectations that our cash, cash equivalents and cash generated from operations will satisfy our business requirements for the next twelve months; expectations of our future liquidity requirements; and our ability to obtain additional financing when needed. Our actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties discussed in this Form 10-K, especially those contained in Item 1A of this Form 10-K. The words "may," "will," "anticipate," "continue," "could," "projected," "expects," "believes," "intends," and "assumes," the negative of these terms and similar expressions are used to identify forward-looking statements. All forward-looking statements and information included herein is given as of the filing date of this Form 10-K with the Securities and Exchange Commission ("SEC") and based on information available to us at the time of this report and future events or circumstances could differ significantly from these forward-looking statements. Unless required by law, we undertake no obligation to update publicly any such forward-looking statements.

        The following information should be read in conjunction with the Consolidated Financial Statements and notes thereto included in this Annual Report on Form 10-K. All references to fiscal year apply to our fiscal year that ends on December 31.

Item 1.    Business

Business Overview

        PDF Solutions is a leading provider of infrastructure technologies and services to lower the cost of integrated circuit ("IC") design and manufacturing, enhance time to market, and improve profitability by addressing design and manufacturing interactions from product design to initial process ramps to mature manufacturing operations. Our technologies and services target the entire "process life cycle," which is the term we have coined for the time from the design of an IC through volume manufacturing of that IC. Our solutions combine proprietary software, physical intellectual property ("IP") in the form of cell libraries for IC designs, test chips, an electrical wafer test system, proven methodologies, and professional services. We analyze yield loss mechanisms to identify, quantify, and correct the issues that cause yield loss. Our analysis drives IC design and manufacturing improvements to enable our customers to optimize technology development process, to increase initial yield when an IC design first enters a manufacturing line, to increase the rate at which yield improves, and to minimize excursions and process variability that cause yield loss throughout mass production. The result of successfully implementing our solutions is the creation of value that can be measured based on improvements to our customers' actual yield. Through our gainshare performance incentives component, we have aligned our financial interests with the yield and performance improvements realized by our customers, and we receive revenue based on this value. Our technologies and services have been sold to leading integrated device manufacturers, fabless semiconductor companies, and foundries.

        The key benefits of our solutions to our customers are:

        Faster Time to Market.    Our solutions are designed to accelerate our customers' time-to-market and increase product profitability. Our solutions, which can predict and improve product yield even before IC product design is complete, transform the traditional design-to-silicon sequence into a primarily concurrent process, thereby shortening our customers' time-to-market. Systematically

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incorporating knowledge of the integration of the design and manufacturing processes into our software modules and physical IP enables our customers to introduce products with higher initial yields faster. Our solutions are designed to decrease design and process iterations and reduce our customers' up-front costs, and thus provide our customers with early-mover advantages such as increased market share and higher selling prices.

        Faster Time to Volume.    After achieving higher initial yields and faster time-to-market, our solutions are designed to enable our customers to isolate and eliminate remaining yield issues to achieve cost efficient volume manufacturing. Once a manufacturing process has been modeled using our solutions, our customers are able to diagnose problems and simulate potential corrections more quickly than using traditional methods. In addition, if process changes are required, improvements can be verified more quickly using our technology than using traditional methods. Our solutions thus enable our customers to quickly reach cost efficient volume, so that they are able to increase margins, improve their competitive position, and capture higher market share.

        Increased Manufacturing Efficiencies.    Our solutions for product design, product introduction, yield ramp, and process control are designed to allow our customers to achieve a higher yield at mass production and therefore a lower cost of goods sold. In addition, our solutions, which also include fault detection and classification ("FDC") software, are designed to provide our customers with the ability to proactively monitor process health to avoid potential yield problems.

        Our long-term business objective is to maximize IC yield by providing the industry standard in technologies and services for the Process Life Cycle. To achieve this objective, we intend to:

        Expand Strategic Relationships.    We intend to continue to extend and enhance our relationships with companies at various stages of the design-to-silicon process, such as process licensors, manufacturing and test equipment vendors, electronic design automation vendors, silicon IP providers, semiconductor foundries, and contract test and assembly houses. For example, in February 2009, we announced an agreement with IBM to develop an IC design platform to mitigate the effects of escalating design and manufacturing process complexity at the 32-, 28-, and 22-nanometer (nm) dimensions. This pd BRIX™-based platform will be designed to layer on top of IBM's world class manufacturing process so it can be used by a broad set of manufacturers and fabless firms.

        Extend Our Technology Leadership Position.    We intend to extend our technology leadership position by leveraging our experienced engineering staff and codifying the knowledge that we acquire in our solution implementations. For example, we continue to expand and develop new technology that leverages our Characterization Vehicle® (CV®) methodology to embed test structures on product wafers. This provides valuable insight regarding product yield loss during mass production with minimal or no increase in test time and non-product wafers. In addition, we selectively acquire complementary businesses and technologies to increase the scope of our solutions.

        Leverage Our Gainshare Performance Incentives Business Model.    We intend to continue expanding the gainshare performance incentives component of our customer contracts. We believe this approach allows us to form collaborative and longer-term relationships with our customers by aligning our financial success with that of our customers. Working closely with our customers on their core technologies that implement our solutions, with a common focus on their business results, provides direct and real-time feedback for continual improvement of our solutions. We believe that we will generate expanded relationships with customers that engage us on terms that include a significant gainshare performance incentive component.

        Focus on Key IC Product Segments and High-Growth Adjacent Markets.    We intend to focus our solutions on high-volume, high-growth IC product segments such as system-on-a-chip, memory, CMOS image sensor, and high-performance central processing units. As a result, we will continue to

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expand our solutions for technology drivers such as low-k dielectrics, high-k metal gates, SOI, copper, and 300mm wafer fabs, which are all still somewhat new and are relatively complex manufacturing technologies. We believe that these product segments are particularly attractive because they include complex IC design and manufacturing processes where processed silicon is costly and yield is critical. In addition, we have expanded our efforts to penetrate high growth adjacent markets, such as photovoltaic manufacturing. We are leveraging our yield management system and FDC technology to create products that meet the needs of manufacturing customers in the rapidly growing solar markets.

Industry Background

        Rapid technological innovation, with increasingly shorter product life cycles, now fuels the economic growth of the semiconductor industry. IC companies historically ramped production slowly, produced at high volume once products gained market acceptance, and slowly reduced production volume when price and demand started to decrease near the end of the products' life cycles. Now, companies often need to be the first to market and the first to sell the most volume when a product is first introduced so that they have performance and pricing advantages over their competition, or else they lose market opportunity and revenue. Increased IC complexity and compressed product lifecycles create significant challenges to achieve competitive initial yields and optimized performance. For example, it is not uncommon for an initial manufacturing run to yield only 20%, which means that 80% of the ICs produced are wasted. Yield improvement and performance optimization are critical drivers of IC companies' financial results because they typically lead to cost reduction and revenue generation concurrently, causing a leveraged effect on profitability.

Technology and Intellectual Property Protection

        We have developed proprietary technologies for yield simulation, analysis, loss detection, and improvement. The foundation for many of our solutions is our CV infrastructure ("CV i ") that enables our customers to characterize the manufacturing process, and establish fail-rate information needed to calibrate manufacturing yield models, prioritize yield improvement activities and speed-up process learning-cycles. Our CV i  includes proprietary Characterization Vehicle® test chips, including designs of experiments and layout designs, and a proprietary and patented highly parallel electrical functional-test system, comprised of hardware and software designed to provide an order-of-magnitude reduction in the time required to test our Characterization Vehicle® test chips. In addition our technology embodies many algorithms, which we have developed over the course of many years, and which are implemented in our products including data POWER®, pdCV™, mæstria®, and pdBRIX™, among others. Further, our IP includes methodologies that our implementation teams use as guidelines to drive our customers' use of our CV® test chips and technologies, quantify the yield-loss associated with each process module and design block, simulate the impact of changes to the design and/or to the manufacturing process, and analyze the outcome of executing such changes. We continually enhance our core technologies through the codification of knowledge that we gain in our solution implementations.

        Our future success and competitive position rely to some extent upon our ability to protect these proprietary technologies and IP, and to prevent competitors from using our systems, methods, and technologies in their products. To accomplish this, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, and patent, copyright, and trademark laws. We license our products and technologies pursuant to non-exclusive license agreements that impose restrictions on customers' use. In addition, we seek to avoid disclosure of our trade secrets, including requiring employees, customers, and others with access to our proprietary information to execute confidentiality agreements with us and restricting access to our source code. We also seek to protect our software, documentation, and other written materials under trade secret and copyright laws. As of December 31, 2008, we held 31 U.S. patents. We intend to prepare additional patent applications when we feel it is necessary. Characterization Vehicle®, Circuit Surfer®, CV®, dataPOWER® , mæstria®, ModelWare®, Optissimo®, pdFasTest®, pDfx®,

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PDF Solutions®, Proxecco®, the PDF Solutions logo, Yield Ramp Simulator®, and YRS® are registered trademarks of PDF Solutions, Inc. or its subsidiaries, and Design-to-Silicon-Yield™, dP -bitMAP™, dP -Defect™, dP -Mining™, dP - probeMAP™, dP -shotMAP™, dP -SSA™, dP -Variability Analysis™, dP -VUE™, dP- WorkFlow™, pdBRIX™, pdCV™, and YA-FDC™ are our common law trademarks.

Products and Services

        Our solutions consist of integration engineering services, proprietary software, and other technologies designed to address our customers' specific manufacturing and design issues.

Services and Solutions

        Manufacturing Process Solutions ("MPS").    The IC manufacturing process typically involves four sequential phases: research and development to establish unit manufacturing processes, such as units for the metal CMP or lithography processes; integration of these unit processes into functional modules, such as metal or contact modules; a yield ramp of lead products through the entire manufacturing line; and volume manufacturing of all products through the life of the process. We offer solutions targeted to each of these phases designed to accelerate the efficiency of yield learning by shortening the learning cycle, learning more per cycle, and reducing the number of silicon wafers required. Our targeted offerings include:

•
Process R&D:  Our process R&D solutions are designed to help customers increase the robustness of their manufacturing processes by characterizing and reducing the variability of unit processes and device performance with respect to layout characteristics within anticipated process design rules.

•
Process Integration and Yield Ramp:  Our process integration and yield ramp solutions are designed to enable our customers to more quickly ramp the yield of new products early in the manufacturing process by characterizing the process-design interactions within each key process module, simulating product yield loss by process module, and prioritizing quantitative yield improvement by design blocks in real products.

        Volume Manufacturing Solutions ("VMS").    Our volume manufacturing solutions are designed to enable our customers to extend our yield ramp services through the life of the process by continuing to collect test data and equipment signals during production and improving yield while reducing the overhead of manufacturing separate test wafers. They enable the customer to collect test data and equipment signals during production to improve yield while simultaneously reducing the overhead of manufacturing. Optional software modules allow customers to perform rapid yield signature detection, characterization, and diagnosis. With this software, we enable mapping and analyzing data from memory bits to wafer to final packaged parts with die identification traceability. Our mæstria® and YA-FDC™ process control software offerings enable our customers to monitor and control process signals to detect and diagnose yield loss related to equipment performance.

        Design-for-Manufacturability ("DFM") Solutions.    Our DFM solutions are designed to enable our customers to optimize yields within the design cycle before a design is sent to the mask shop to more quickly and cost-effectively manufacture IC products. We target these solutions to customers' requirements by providing the following:

•
Logic DFM Solutions:  Logic DFM solutions include software, IP, and services designed to make yield improvements by trading off density or performance, for example, in the logic portions of an IC design. Our software helps designers optimize the yield of the logic portion by using process-specific yield models and technology files that include yield enhanced extensions to IP design building block elements.

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•
Circuit Level DFM Solutions:  Circuit level DFM solutions include software and services designed to anticipate the effects of process variability during analog/mixed signal/RF circuit design to optimize the manufacturability of each block given a pre-characterized manufacturing process.

•
Memory DFM Solutions:  Memory DFM solutions include software and services designed to optimize the memory redundancy and bit cell usage given a pre-characterized manufacturing process.

•
pdBRIX Physical IP Solutions:  pdBRIX physical IP solutions include software, IP and services for identifying and developing a set of large, regularly patterned physical IP building blocks that are tailored to a given manufacturing process and target product application. This solution includes mapping software for inserting these physical IP building blocks into a design flow.

Products

        Our Manufacturing Process, Volume Manufacturing, and DFM solutions incorporate the use of various elements of our software products and other technologies, depending on the customers' needs. Our software products and other technologies include the following:

        Characterization Vehicle® Infrastructure.    Our test chip design engineers develop a design of experiments ("DOEs") to determine how IC design building blocks interact with the manufacturing process. Our CV software utilizes the DOE, as well as a library of building blocks that we know has potential yield and performance impact, to generate CV test chip layouts. Our CV infrastructure includes:

•
CV® Test Chips.  Our family of proprietary test chip products are run through the manufacturing process with intentional process modifications to explore the effects of potential process improvements given natural manufacturing variations. Our custom-designed CV test chips are optimized for our test hardware and analysis software and include DOEs tuned to each customer's process. Our full-reticle short-flow CV test chips provide a fast learning cycle for specific process modules and are fully integrated with third-party failure analysis and inspection tools for complete diagnosis to root cause. Our Scribe CV® products are inserted directly on customers' product wafers and collect data from product wafers about critical layers.

•
pdCV™ Analysis Software.  Our proprietary software accumulates data from our CV test chips, enabling models of the performance effects of process variations on these design building blocks to be generated for use with our Yield Ramp Simulator software.

•
pdFasTest®Electrical Wafer Test System. Our proprietary system enables fast defect characterization of manufacturing processes. This automated system provides parallel functional testing, thus minimizing the time required to perform millions of electrical measurements to test our CV test chips.

        Yield Ramp Simulator® (YRS®) Software.    Our YRS software analyzes an IC design to compute its systematic and random yield loss. YRS software allows design attribute extraction and feature-based yield modeling. YRS software takes as input a layout that is typically in industry standard format and proprietary yield models generated by running and testing our CV test chips. YRS software is designed to estimate the yield loss due to optical proximity effects, etch micro-loading, dishing in CMP, and other basic process issues.

        Circuit Surfer® Software.    Our Circuit Surfer software estimates the parametric performance yield and manufacturability of analog/mixed-signal/RF blocks in a design, such as RF transmission, PLLs/DLLs and logic critical paths. Using our Circuit Surfer software, a design engineer is able to estimate how manufacturing process variations will impact circuit performance and yield and then optimizes the circuit to reduce or eliminate the impact of those variations.

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        pDfx® Environment.    Our pDfx environment, which is only offered to customers in a service format, improves the manufacturability of ICs by providing process-aware DFM. The environment incorporates our pDfx yield models with software tools previously incorporated into and subsequently distributed by commercial Electronic Design Automation ("EDA") tool providers to the IC Design community. These tools are either developed by PDF or frequently in partnership with commercial EDA vendors. Incorporating our pDfx modeling capability into the design flow allows designers to optimize yield, performance, power, and area trade-offs within the design flow before the IC is released to manufacturing. In this manner, customers can further optimize designs for yield within their specific guidelines.

        pdBRIX™ Platform.    Our pdBRIX platform includes software for identifying and developing a set of physical IP building blocks that are tailored to a given manufacturing process and target product application. This platform also includes mapper software for inserting these physical IP building blocks into a traditional design flow.

        dataPOWER® YMS Platform.    OurdataPOWER YMS platform collects yield data, loads and stores it in an integrated database and allows product engineers to identify and analyze production yield issues using proprietary yield analysis software tools. data POWER software contains powerful visualization and reporting tools, including web-based access through the dP- Monitor™ module included in the core product in the newest release, which are flexible to address customers' requirements. Our YMS platform is designed to handle very large data sets, to efficiently improve productivity, yield and time-to-market at our customers' sites. Optional modules extend the base platform to enable defect analysis ( dP -Defect™), memory analysis ( dP - bitMAP™), spatial signature analysis ( dP -SSA™), data-mining ( dP -Mining™), optimization of die on the wafer ( dP -shotMAP™), and probe-head optimization ( dP -probeMAP™), and web-based access ( dP -VUE™).

        mæstria® FDC Software.    Our mæstria product provides FDC capabilities to rapidly identify sources of process variations and manufacturing excursions by monitoring equipment parameters through proprietary data collection and analysis features.

        YA-FDC™ Service and Software Platform.    YA-FDC allows online modeling to create real-time virtual measurements of final product attributes during processing. These models enable optimization decisions for process control, process adjustments, PM scheduling, tool corrective actions, and wafer dispatching. The real-time decision-making based on the models is designed to reduce product variability and cost simultaneously.

        With the exception ofdataPOWER, mæstria and pdBRIX, the primary distribution method for our software and technologies is through our manufacturing process solutions although, we have in the past and may in the future separately license these and other technologies. Though data POWER, mæstria and pdBRIX are primarily licensed separately, they may also be distributed within our Design-to-Silicon-Yield solutions.

Customers

        Our current customers are primarily integrated device manufacturers ("IDMs"), but also include fabless semiconductor design companies and foundries. Our customers' targeted product segments vary significantly, including microprocessors, memory, graphics, image sensor solutions, and communications. We believe that the adoption of our solutions by such companies for usage in a wide range of products validates the application of our Design-to-Silicon-Yield solutions to the broader semiconductor market.

        Toshiba Corporation ("Toshiba") and IBM represented 18% and 16%, respectively, of our total revenue for the year ended December 31, 2008. Toshiba and IBM represented 19% and 16% respectively, of our total revenue for the year ended December 31, 2007. IBM and Toshiba represented 25% and 12%, respectively, of our total revenue for the year ended December 31, 2006. No other customer accounted for 10% or more of our revenue in years 2008, 2007, and 2006.

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Sales and Marketing

        Our sales strategy is to pursue targeted accounts through a combination of our direct sales force, sales representatives in some local markets, and strategic alliances. For sales in the United States, we rely on our direct sales team, which primarily operates out of our San Jose, California headquarters. In Japan and Korea, we primarily use our direct sales team. In Taiwan, we use a combination of our direct sales team and a local sales representative, J.I.T. International Co., Ltd. In Singapore, Malaysia, and Indonesia, we use Kromax South Asia PTE LTD, a local sales representative. We expect to continue to establish strategic alliances with process licensors, vendors in the electronic design automation software, capital equipment for IC production, silicon IP and mask-making software segments to create and take advantage of sales channel and co-marketing opportunities.

        After we are engaged by a customer and early in the solution implementation, our engineers seek to establish relationships in the organization and gain an understanding of our customers' business issues. Our direct sales and solution implementation teams combine their efforts to deepen our customer relationships by expanding our penetration across the customer's products, processes and technologies. This close working relationship with the customer has the added benefit of helping us identify new product areas and technologies in which we should next focus our research and development efforts.

        In the year ended December 31, 2008, we derived 55% of total revenue from customers based in Asia compared to 55% and 50%, respectively, in the years ended December 31, 2007 and 2006. In the year ended December 31, 2008, 27% of our total revenue was derived from customers located in the United States as compared to 31% and 39%, respectively, in the years ended December 31, 2007 and 2006. Additional discussion regarding the risks associated with international operations can be found under Item 1A, "Risk Factors".

        See our "Notes to Consolidated Financial Statements", included under Part II, Item 8. "Financial Statements and Supplementary Data" for additional geographic information.

Research and Development

        Our research and development focuses on developing and introducing new proprietary technologies, software products and enhancements to our existing solutions. We use a rapid-prototyping paradigm in the context of the customer engagement to achieve these goals. We have made, and expect to continue to make, substantial investments in research and development. The complexity of our Design-to-Silicon-Yield technologies requires expertise in physical IC design and layout, transistor design and semiconductor physics, semiconductor process integration, numerical algorithms, statistics and software development. We believe that our team of engineers will continue to advance our market and technological leadership. We conduct in-house training for our engineers in the technical areas, as well as focusing on ways to enhance client service skills. At any given time, about one quarter of our research and development engineers are operating in the field, partnered with solution implementation engineers in a deliberate strategy to provide direct feedback between technology development and customer needs. Our research and development expenses were $34.0 million, $36.1 million, and $27.6 million in 2008, 2007, and 2006, respectively.

Competition

        The semiconductor industry is highly competitive and driven by rapidly changing design and process technologies, evolving standards, short product life cycles, and decreasing prices. While the market for process-design integration technologies and services is in its early stages, it is quickly evolving and we expect market competition to continue to develop and increase. We believe the solution to address the needs of IC companies requires a unified system of yield models, design analysis software, CV test chips, physical IP creation, process control software, and yield management software. Currently, we are the only provider of comprehensive commercial solutions for integrating design and manufacturing processes. We face indirect competition from internal groups at IC companies that use an incomplete set of components

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not optimized to accelerate process-design integration. Some providers of yield management software, inspection equipment, electronic design automation, or design IP may seek to broaden their product offerings and compete with us.

        We face competition for some of the point applications of our solutions including some of those used by the internal groups at IC companies. Specifically there are several suppliers of yield management and/or prediction systems, such as KLA-Tencor, MKS Instruments, Inc. ("MKS") (through its acquisition of Yield Dynamics, Inc.), Mentor Graphics (through its acquisition of Ponte Solutions), Syntricity Inc., Synopsys, Inc. ("Synopsys"), and TIBCO Software Inc. (through its acquisition of Spotfire, Inc.), and process control software, such as Applied Materials, Inc. (through its acquisition of the software division of Brooks Automation, Inc.), BISTel Inc., and Trancom Technology, Inc., and MKS. ARM Ltd. and Virage Logic Corporation provide standard cells in the physical IP space and Tela provides software for standard cell synthesis, each of which could compete with our pdBRIX solution. In addition, Synopsys now appears to offer directly competing DFM solutions, while other EDA suppliers provide alternative DFM solutions that may compete for the same budgetary funds.

        We believe the principal factors affecting competition in our market include demonstrated results and reputation, strength of core technology, ability to create innovative technology, and ability to implement solutions for new technology and product generations. We believe that our solutions compete favorably with respect to these factors.

Employees

        As of December 31, 2008, we had 375 employees worldwide, including 174 on client service teams, 124 in research and development, 30 in sales and marketing, and 47 in general and administrative functions. Of these employees, 181 are located in the US, 114 in Asia, and 80 in Europe. Worldwide, we had 382 employees as of December 31, 2007 and 369 as of December 31, 2006.

        None of our employees are represented by a labor union. Our employees in France and Italy are subject to collective bargaining agreements in those countries. We believe our relationship with our employees is good.

Executive Officers

        The following table and notes set forth information about our current executive officers.
 	 	 	 	 	 	
Name	 	Age	 	Position	
John K. Kibarian, Ph.D. 	 	 	44	 	President, Chief Executive Officer, and Director	
Joy E. Leo	 	 	48	 	Chief Administration Officer	
Keith A. Jones	 	 	38	 	Chief Financial Officer and Vice President, Finance	
David A. Joseph	 	 	55	 	Chief Strategy Officer	
Cees Hartgring, Ph.D. 	 	 	55	 	Vice President, Client Services and Sales	
Andre Hawit	 	 	47	 	Vice President, Volume Manufacturing Solutions	
James Jensen	 	 	56	 	Vice President, Volume Manufacturing Solutions	
P. Steven Melman	 	 	54	 	Vice President, Investor Relations and Strategic Initiatives	
Kimon Michaels, Ph.D. 	 	 	42	 	Vice President, Design for Manufacturability, and Director	
        John K. Kibarian, Ph.D., one of our founders, has served as President since November 1991 and has served as our Chief Executive Officer since July 2000. Dr. Kibarian has served as a director since December 1992. Dr. Kibarian received a B.S. in Electrical Engineering, an M.S. E.C.E. and a Ph.D. E.C.E. from Carnegie Mellon University.

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        Joy E. Leo has served as Chief Administration Officer since July 2008. Prior to joining PDF, Ms. Leo served as Senior Vice President, Chief Financial Officer and Secretary for Credence Systems Corporations, now known as LTX-Credence, a provider of focused, cost-optimized ATE solutions. Ms. Leo served as Vice President of Finance and Administration, Chief Financial Officer and Secretary for Artisan Components, Inc., now known as ARM Holdings PLC. Ms. Leo also served as Vice President of Finance and Administration and Chief Financial Officer for IMP, Inc., as Vice President of Finance, Operations and Administration for Innomedia Incorporated, and Vice President and Chief Financial Officer for Philips Components, a multi-billion dollar division of Royal Philips Electronics N.V. Ms. Leo received a B.A. in Business Administration and Finance from the University of Utah.

        Keith A. Jones has served as Chief Financial Officer and Vice President, Finance since January 2006. Mr. Jones served as Director of Finance and SEC Compliance from July 2003 to December 2005. Prior to joining PDF, Mr. Jones served as Assistant Controller for Interwoven, Inc., a provider of enterprise content management solutions, and as Controller for eTime Capital, Inc., a financial software applications company. Prior to that, Mr. Jones served in various positions at Deloitte & Touche LLP, most recently as an Audit Manager. Mr. Jones received a B.S. in Business Administration from California State University, Fresno and is a Certified Public Accountant.

        David A. Joseph has served as Chief Strategy Officer since April 2003. Mr. Joseph served as Executive Vice President Sales, Marketing, and Business Development from August 2001 through March 2003, as Vice President, Products and Methods from July 1999 through August 2001 and as Vice President, Business Development from November 1998 through June 1999. Prior to joining PDF, Mr. Joseph served KLA-Tencor, a semiconductor manufacturing company, in various positions, including Japan Business Manager, Vice President Customer Satisfaction and General Manager of Yield Analysis Software. Mr. Joseph received a B.S. in Mathematical Science from Stanford University.

        Cees Hartgring, Ph.D., has served as Vice President, Client Services and Sales since June 2007. Dr. Hartgring served as Vice President and General Manager, Manufacturing Process Solutions from January 2004 through May 2007, as Vice President, Worldwide Sales and Strategic Business Development from April 2003 through December 2003 and as Vice President of Sales from September 2002 through March 2003. Prior to joining PDF, Dr. Hartgring served as President and Chief Executive Officer of Trimedia Technologies, a Philips Semiconductor spinout. Dr. Hartgring also held various executive positions at Philips Semiconductor, most recently as Vice President and General Manager of the Trimedia business unit. Dr. Hartgring received an undergraduate degree from the Technical University Delft and an M.S.E.E. and a Ph.D. in Electrical Engineering and Computer Science from the University of California at Berkeley.

        Andre Hawit has served as Vice President, Volume Manufacturing Solutions since July 2008. Mr. Hawit served as Vice President, Yield Manufacturing Systems from January 2006 through June 2008, and as Vice President, Software Development from September 2003 through December 2005. Prior to joining PDF, Mr. Hawit was the founder of IDS Software Systems Inc. ("IDS"), a yield management systems software and solutions company. He also held various positions within IDS including President and Chief Executive Officer, and most recently Chief Technology Officer. Mr. Hawit received a B.S. in Electronics and Computer Engineering from San Francisco State University and an M.B.A. from National University School of Business.

        James Jensen has served as Vice President, Volume Manufacturing Solutions since July 2008. Mr. Jensen served as Vice President, Business Development from June 2007 through July 2008, as Vice President, Engineering Services for Manufacturing Process Solutions from January 2006 through May 2007, as Co-Vice President, Client Services from November 2003 through December 2005 and as Director of Business Development, Integrated Yield Ramp Solutions, from March 2002 through October 2003. Prior to joining PDF, Mr. Jensen served as General Manager of a semiconductor fabrication facility of Texas Instruments, a semiconductor products company. Prior to that, Mr. Jensen served as Fabrication

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Operations Director for Silicon Systems Inc., a semiconductor products company. Mr. Jensen received a B.S. in Physics from the University of Utah and an M.S. in Management from Purdue University.

        P. Steven Melman has served as Vice President, Investor Relations and Strategic Initiatives since January 2006. Mr. Melman served as Chief Financial Officer and Vice President, Finance and Administration from July 1998 to December 2005. Prior to joining PDF, Mr. Melman served as Vice President, Finance and Administration with Animation Science Corporation, an animation company. Prior to that, Mr. Melman served as Vice President, Finance and Chief Financial Officer with Business Resource Group, a facilities management and commercial furnishings company. Mr. Melman received a B.S. in Business Administration from Boston University and is a Certified Public Accountant.

        Kimon Michaels, Ph.D., one of our founders, has served as Vice President, Design for Manufacturability since June 2007. Dr. Michaels served as Vice President, Field Operations for Manufacturing Process Solutions from January 2006 through May 2007, and has been a Director since November 1995. From March 1993 through December 2005, he served in various vice presidential capacities. He also served as Chief Financial Officer from November 1995 to July 1998. Dr. Michaels received a B.S. in Electrical Engineering, an M.S. E.C.E. and a Ph.D. E.C.E. from Carnegie Mellon University.

Available Information

        We file or furnish various reports, such as registration statements, periodic and current reports, proxy statements and other materials with the SEC. Our Internet website address is www.PDF.com. You may obtain, free of charge on our Internet website, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information we post is intended for reference purposes only; none of the information posted on our website is part of this report or incorporated by reference herein.

        In addition to the materials that are posted on our website, you may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and other information statements, and other information regarding issuers, including us, that file electronically with the SEC. The Internet address of that site is http://www.sec.gov.

Item 1A.    Risk Factors

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

        The semiconductor industry has experienced significant challenges in 2008 and may continue to face challenges in 2009 as a result of the decline in the macroeconomic environment. As a provider to global semiconductor companies, we are subject to business cycles, the timing, length and volatility of which can be difficult to predict. The semiconductor industry historically has been cyclical due to sudden changes in customers' manufacturing capacity requirements and spending, which depend in part on capacity utilization, demand for customers' IC products, inventory levels relative to demand, and access to affordable capital. These changes have affected the timing and amounts of customers' purchases and investments in our Design-to-Silicon-Yield solutions, and continue to affect our sales, operating expenses and net income. If we are not able to make adjustments to our business quickly to appropriately align our cost structure with prevailing market conditions in periods of low demand, or if we do not have sufficient resources to meet customers' demands in periods of high demand, results could be negatively impacted and could differ greatly from our expectations.

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Our business is subject to risks associated with the ongoing financial crisis and weakening global economy.

        The recent severe tightening of the credit markets, turmoil in the financial markets, and weakening global economy are contributing to slowdowns in the semiconductor industry, which impacts our ability to make sales. These slowdowns are expected to worsen if these economic conditions are prolonged or deteriorate further. The markets for semiconductors depend largely on consumer spending. Economic uncertainty exacerbates negative trends in consumer spending and may cause some of our customers to delay or refrain altogether from entering into new engagements, licensing new or additional software products, or renewing maintenance and support for existing licensed software at historical levels. This will negatively affect our revenues. Difficulties in obtaining capital and deteriorating market conditions may also lead to the inability of some customers to obtain affordable financing for other purchases, which could tie up funds otherwise budgeted for purchases of our solutions and technologies. Customers with liquidity issues may also lead to additional bad debt expense. Further, these conditions and uncertainty about future economic conditions make it challenging for us to forecast our operating results, make business decisions, and identify the risks that may affect our business, financial condition and results of operations. If we are not able to timely and appropriately adapt to changes resulting from the difficult macroeconomic environment, our business, financial condition, and results of operations may be significantly negatively affected.

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

        If semiconductor designers and manufacturers do not continue to adopt our Design-to-Silicon-Yield solutions, both as currently comprised and as we may offer them in the future, our revenue will decline. We may not be successful if we do not continue to enter into agreements with existing customers and new customers that cover a larger number of IC products and processes. If we do not develop new customer relationships with companies that are IDMs, fabless semiconductor companies, and foundries, as well as system manufacturers, the market acceptance of our solutions will suffer. Factors that may limit adoption of our Design-to-Silicon-Yield solutions by semiconductor companies include:

•
our existing and potential customers' delay in their adoption of the next process technology;

•
IDMs of logic ICs discontinuing or significantly cutting back their investment in the development of new process technology as a result of a shift to a model of outsourcing a larger proportion, or all, of the mass production of their ICs;

•
our inability to keep pace with the rapidly evolving technologies and equipment used in the semiconductor design and manufacturing processes;

•
our customers' failure to achieve satisfactory yield improvements using our Design-to-Silicon-Yield solutions; and

•
our inability to develop, market, or sell effective solutions that are outside of our traditional MPS logic focus.

Revenue from our gainshare performance incentives is dependent on factors outside of our control, including the volume of ICs that our customers are able to sell to their customers.

        Our gainshare performance incentives fee component ties the profits of our customers to our own. Through this component, revenue for a particular product is largely determined by the volume of that product that our customer is able to sell to its customers, which is outside of our control. Decreased demand for semiconductor products decreases the volume of products our customers are able to sell,

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which directly decreases our gainshare performance incentives revenue. Important factors that could cause demand for semiconductor products to negatively fluctuate include:

•
changes in business and economic conditions, including the current downturn in the semiconductor industry and the overall economy; and

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

Also, our customers may unilaterally decide to implement changes to their manufacturing processes during the period that is covered by gainshare performance incentives component, which could negatively affect yield results. Since we currently work on a small number of large projects, any product that does not achieve commercial viability or a significant increase in yield, or sustain significant volume manufacturing during the time we receive gainshare performance incentives revenue from such customers, 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 thus any of our related gainshare performance incentives, in the other product.

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

        During the year end December 31, 2008, we initiated restructuring plans in an effort to align our cost structure with expected revenue. We may not be able to successfully complete and realize the expected benefits of our restructuring plans, such as improvements in operating margins and cash flows, in the restructuring periods contemplated or at all. The restructuring plans may involve higher costs or a longer timetable than we currently anticipate, mainly due to the timing and execution of some plans and programs subject to local labor law requirements, and consultation with appropriate work councils. Our inability to realize these benefits may result in an inefficient business structure that could negatively impact our results of operations. We also expect our restructuring plans to cause us to incur substantial costs related to severance and other employee-related costs. Our restructuring plans may also subject us to litigation risks and expenses. In addition, our restructuring plans may have other consequences, such as attrition beyond our planned reduction in workforce or a negative impact on employee morale, and our competitors may seek to gain a competitive advantage over us. The restructuring plans could also cause our remaining employees to be less productive, which in turn may negatively affect our revenue and other operating results in the future.

We generate a large percentage of our total revenue from a limited number of customers, so decreased volumes at any one of these customers, or 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 for our core Design-to-Silicon-Yield solutions and we expect this to continue in the near term. In the year ended December 31, 2008, two customers accounted for 34% of our total net revenue, with Toshiba Corporation representing 18% and IBM representing 16%. In the year ended December 31, 2007, two customers accounted for 35% of our total net revenue, with Toshiba Corporation representing 19% and IBM representing 16%. We could lose a customer due to its decision not to engage us on future process nodes, its decision not to develop its own future process node, or as a result of industry consolidation. 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 and it takes us a long time to replace customers.

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If we do not effectively manage and support our operations and integrate recent and planned growth, our business strategy may fail.

        We have in the past, and may in the future, experienced interruptions in our information systems on which our global operations depend. Further, physical damage to, failure of, or digital damage (such as significant viruses or worms) to, our information systems could disrupt and delay time-sensitive services or computing operations that we perform for our customers, which could negatively impact our business results and reputation. In addition, we must frequently expand our internal information system to meet increasing demand in storage, computing and communication. Our internal information system 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. In addition, we are in the process of switching to a new accounting system, which could disrupt our business operations and distract management. 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 effectively and accurately, respond to and support our customers. If we fail to do this, it could lead to dissatisfaction among our customers, which could slow our growth.

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

        Our stock price has fluctuated widely during the last few years from a low closing price of $1.41 per share in December 2008 to a high of $19.36 per share in April 2006. This significant reduction in our stock price negatively impacts our ability to raise equity capital in the public markets and increases the cost to us, as measured by dilution to our existing shareholders, of equity financing. In addition, the reduced stock price also increases the cost to us, in terms of dilution, of using our equity for employee compensation or for acquisitions of other businesses. Additionally, in order for our common stock to continue to be quoted on the NASDAQ Global Market ("Nasdaq"), we must satisfy various listing maintenance standards established by Nasdaq, including, among other things, the general requirement, should Nasdaq choose to enforce such requirements again after the April 2009 end date of the current extension of suspension of any such enforcement, that our stock price consistently trades at or above $1.00 per share and that the total market value of our common stock exceed $50,000,000. We may have periods when our stock does not trade at, or the market value of our common stock has been below, the levels required by Nasdaq rules. If we were to be delisted from the Nasdaq and move to an alternative market, which may be less efficient and less broad-based, we may have difficulty accessing capital markets for additional funding, and the ability of our stockholders to sell any of our common stock at all would be severely, if not completely, limited, which could cause our stock price to decline further. Delisting could also have other negative results, including the potential loss of confidence by employees, the loss of institutional investor interest, and fewer business development opportunities. Also, significant volatility in the stock price could be followed by a securities class action lawsuit, which could result in substantial costs and a diversion of our management's attention and resources.

If we fail to protect our IP 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 contractual, patent, copyright, trademark, and trade secret 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. Litigation may be necessary from time to time to enforce our IP rights or to determine the validity and scope of the proprietary rights of others. As a result of any such litigation, we

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could lose our proprietary rights and incur substantial unexpected operating costs. Litigation could also divert our resources, including our managerial and engineering resources.

Competition in the market for yield improvement solutions and increased integration between IC design and manufacturing may intensify in the future, which could impede 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 and could lead to increased pricing pressure. Our current and potential customers may choose to develop their own solutions internally, particularly if we are slow in deploying our solutions or improving them to meet market needs. Many of these companies have the financial and technical capability to develop their own solutions. Also, competitors may be able to operate with a lower cost structure than our engineering organization, which would give any such competitor's products a competitive advantage over our solutions. There may be other providers of commercial solutions for systematic IC yield and performance enhancement of which we are not aware. We currently face indirect competition from the internal groups at IC companies and some direct competition from providers of yield management or prediction software such as KLA-Tencor, MKS Instruments, Inc. ("MKS") (through its acquisition of Yield Dynamics, Inc.), Mentor Graphics (through its acquisition of Ponte Solutions), Syntricity Inc., TIBCO Software Inc. (through its acquisition of Spotfire Inc.), and Synopsys, Inc., and process control software, such as Applied Materials, Inc., BISTel Inc., and Trancom Technology, Inc., and MKS. Further, ARM Ltd. and Virage Logic Corporation provide standard cells in the physical IP space and Tela provides software for standard cell synthesis, each of which could compete with our pdBRIX solution. 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. 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. In addition, Synopsys, Inc. now appears to offer directly competing DFM, while other EDA suppliers provide alternative DFM solutions that may compete for the same budgetary funds. If these potential competitors change the pricing environment or 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 solutions as a result of the increase in competition.

We face operational and financial risks associated with international operations that could negatively impact our revenue.

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

•
some of our key engineers and other personnel are foreign nationals and they may have difficulty gaining access to the United States and other countries in which our customers or our offices may be located and it may be difficult for us to recruit and retain qualified technical and managerial employees in foreign offices;

•
greater difficulty in collecting account receivables resulting in longer collection periods;

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•
language and other cultural differences may inhibit our sales and marketing efforts and create internal communication problems among our U.S. and foreign research and development teams, increasing the difficulty of managing multiple, remote locations performing various development, quality assurance, and yield ramp analysis projects;

•
compliance with, inconsistencies among, and unexpected changes in, a wide variety of foreign laws and regulatory environments with which we are not familiar, including, among other issues, with respect to employees, protection of our IP, and a wide variety of operational regulations and trade and export controls under domestic, foreign, and international law;

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

•
currency risk associated with cash denominated in foreign currencies, including the Euro, held by foreign subsidiaries we have acquired;

•
quarantine, private travel limitation, or business disruption in regions affecting our operations, stemming from actual, imminent or perceived outbreak of human pandemic or contagious disease;

•
in the event a larger portion of our revenue becomes denominated in foreign currencies, we would be subject to a potentially significant exchange rate risk; and

•
economic or political instability, including but not limited to armed conflict, terrorism, interference with information or communication of networks or systems, and the resulting disruption to economic activity and business operations.

        Revenues generated from customers in Asia accounted for 55% of total revenue in the years ended December 31, 2008 and 2007. Thus, in Asia, in particular, we face the following additional risks:

•
a downturn in Asian economies which could limit our ability to retain existing customers and attract new ones in Asia; and

•
if the U.S. dollar increases in value relative to local currencies, including for example, the Japanese Yen, the cost of our solutions will be more expensive to existing and potential local customers and therefore less competitive.

        In the Middle East, we use a third-party service provider, whose headquarters are not located in a U.S. embargoed country, to provide software quality assurance and other services for certain of our software products. The political uncertainty surrounding the region could disrupt our third-party service provider's operations and thus negatively affect the range of services we are able to provide or our cost for such services.

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 has declined significantly in the recent past and may continue to decline if we fail to meet expectations about our revenue or expenses.

Measurement of our gainshare performance incentives requires data collection and is subject to customer agreement, which can result in uncertainty and cause quarterly results to fluctuate.

        We can only recognize revenue based on gainshare performance incentives 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

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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 revenue attributable to our gainshare performance incentives 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 gainshare performance incentives as a significant component of our total revenue, any delay could significantly harm our quarterly results.

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

        Our long-term success is largely dependent upon our ability to structure our future customer contracts to include a larger gainshare performance incentives component relative to the fixed fee component. We typically recognize the fixed fee component earlier than the gainshare performance incentives component so if we are successful in increasing the gainshare performance incentives 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. Due to acquisitions and expanded business strategies, the mix of elements in some of our contracts has changed recently and the relative importance of the software component in some of our contracts has increased. We have experienced, and may in the future experience, delays in the expected recognition of revenue associated with generally accepted accounting principles regarding the timing of revenue recognition in multi-element software arrangements, including the effect of acceptance criteria as a result of the change in our contracts. If we fail to meet contractual acceptance criteria on time or at all, the total revenue we receive under a contract could be delayed or decline. Further, if we mix term-based licenses with perpetual licenses, it will impact the timing of the recognition of revenue from that customer. In addition, by increasing the gainshare performance incentives or the software component, we may increase the variability or timing of recognition 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.

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

        Our gainshare performance incentives business model is unique and our Design-to-Silicon-Yield solutions are often unfamiliar to new customers. This results in a lengthier sales cycle compared to some of our competitors 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 gainshare performance incentives component, the negotiation and documentation processes can be lengthy. It can take nine 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. By way of example, one of the industries that we have recently targeted that we believe would greatly benefit from our yield management system and FDC technology is the rapidly growing solar panel industry. Our efforts to leverage our products in this industry may not be successful. Further, ongoing negotiations and evaluation projects with photovoltaic manufacturers may not result in significant revenue for us if we are unable to close new engagements in these markets on terms favorable to us, in a timely manner, or at all, or if we are unable to successfully deliver our products and services to such markets.

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

        We have experienced losses in the past and in the current fiscal year ended December 31, 2008. We may not achieve, and thereafter maintain, profitability if our revenue increases more slowly than we expect or if it decreases. 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 $112.6 million as of December 31, 2008. We expect to continue to incur significant expenses in connection with:

•
funding for research and development;

•
expansion of our solution implementation teams;

•
expansion of our sales and marketing efforts; and

•
additional non-cash charges relating to amortization and stock-based compensation.

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

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

        We have in the past, and may in the future, sought to establish and maintain strategic relationships with industry leaders at each stage of the IC design and manufacturing processes, This requires us to expend significant resources and to commit a significant amount of management's time and attention, although any such relationship may not be successful. 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 technology 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.

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. 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.

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

        Our success and competitiveness depend on our ability to attract, retain, motivate, and strategically locate in our offices around the globe talented employees, including some of our key executives. Achieving this objective may be difficult due to many factors, including fluctuations in global economic and industry conditions, changes in our management or leadership, the hiring practices at our competitors or customers,

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cost reduction activities, and the effectiveness of our compensation programs, including equity-based programs. Further, we have had, and expect to continue to have, difficulty in obtaining visas permitting entry for some of our employees that are foreign nationals into the United States, and delays in obtaining visas permitting entry into other key countries, 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. If we do not successfully attract, retain and motivate key employees, including key executives, we may be unable to realize our business objectives and our operating results may suffer.

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, which could limit our revenue opportunities.

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

        Significant litigation regarding intellectual 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, hardware and software tools, and the cost of support to remedy any such defects could decrease our revenue and our competitive market share.

        If the software, hardware, or proprietary technologies we provide to a customer contain defects that increase our customer's cost of goods sold and time-to-market or damage our customer's property, these defects could significantly decrease the market acceptance of our solutions. Further, the cost of support resources required to remedy any defects in our technologies, hardware, or software tools could exceed our expectations. Any actual or perceived defects with our software, hardware, 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, hardware, or proprietary technologies or enhancements to existing software, hardware, or proprietary technologies. Our software, hardware, and proprietary technologies may contain errors not discovered until after customer implementation of the silicon design and manufacturing process recommended by us. If our software, hardware, or proprietary technologies contain errors or defects, it could require us to expend significant resources to remedy these problems, which could reduce margins and result in the diversion of technical and other resources from our other development efforts.

Failing to maintain the effectiveness of our internal control over financial reporting could cause the cost related to remediation to increase and could cause our stock price to decline.

        In the future, our management may identify deficiencies regarding the design and effectiveness of our system of internal control over financial reporting that we engage in pursuant to Section 404 of the Sarbanes-Oxley Act ("Section 404") as part of our Form 10-K. Such deficiencies could include those arising from turnover of qualified personnel or arising as a result of acquisitions, which we may not be able

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to remediate in time to meet the continuing reporting deadlines imposed by Section 404 and the costs of which may harm our results of operations. In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that our management can conclude on an ongoing basis that we have effective internal controls. We also may not be able to retain an independent registered public accounting firm with sufficient resources to attest to and report on our internal controls in a timely manner. Moreover, our registered public accounting firm may not agree with our management's future assessments and may deem our controls ineffective if we are unable to remediate on a timely basis. If in the future we are unable to assert that we maintain effective internal controls, our investors could lose confidence in the accuracy and completeness of our financial reports that in turn could cause our stock price to decline.

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

        Unanticipated efforts to support more rapid expansion, develop or enhance Design-to-Silicon-Yield solutions, respond to competitive pressures or acquire complementary businesses or technologies could impact our future capital requirements and the adequacy of our available funds. In such event, we may need to raise additional funds through public or private financings, strategic relationships or other arrangements. We may not be able to raise necessary funds on terms favorable to us, or at all.

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

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

•
consolidating research and development operations;

•
integrating acquired products and business technology into our existing product lines;

•
coordinating effective sales and marketing functions;

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

•
minimizing the diversion of management's attention from ongoing business concerns.

Changes in effective tax rates could negatively affect our operating results.

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

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

        Credit concerns in the capital markets have significantly reduced our ability to liquidate auction-rate securities that we classify as available-for-sale securities on our balance sheet. The liquidity of the securities has been reduced by the uncertainty in the credit markets and the exposure of these securities to the financial condition of bond insurance companies. All auction-rate securities we hold have been failing to sell at auction since February 2008 due to an insufficient number of bidders. We reviewed the value of these securities for impairment as of December 31, 2008, concluded that these securities were temporarily impaired, and recorded an unrealized loss of $282,000. In future periods, the estimated fair value of our auction-rate securities could decline further based on market conditions, which could result in additional impairment.

Item 1B.    Unresolved Staff Comments

        None.

Item 2.    Properties

        Our principal executive offices are located in San Jose, California where we lease approximately 39,300 square feet under a lease that expires in August 2013. We lease 11,200 square feet of office and laboratory space in San Diego, California under a lease that expires in July 2013. We lease other sales offices and laboratory spaces in Pennsylvania, Texas, and New Hampshire in the United States. In addition, we have offices in France, Germany, Italy, China, Japan, Korea, Singapore, and Taiwan with an aggregate of square footage of approximately 33,200 square feet each under various leases that expire at different times through 2013. We believe our existing facilities and those in negotiation are adequate to meet our current needs and are being utilized consistently with our past practice.

Item 3.    Legal Proceedings

        We are not currently party to any material legal proceedings.

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

        No matters were submitted to a vote of security holders during the fourth quarter of 2008.

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PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

        Our common stock trades on the NASDAQ Global Market under the symbol "PDFS". As of February 25, 2009 we had approximately 205 stockholders of record and the closing price of our common stock was $1.10 per share as reported by the NASDAQ Global Market. The number of stockholders of record does not include individuals whose stock is in nominee or "street name" accounts through brokers.

        The following table sets forth for the periods indicated the high and low closing sale prices for our common stock as reported by the NASDAQ Global Market:
 	 	 	 	 	 	 	 	
2008	 	High	 	Low	 	
First Quarter	 	$	9.01	 	$	4.70	 	
Second Quarter	 	$	6.24	 	$	4.30	 	
Third Quarter	 	$	6.79	 	$	4.55	 	
Fourth Quarter	 	$	5.41	 	$	1.41	 	

 	 	 	 	 	 	 	 	
2007	 	High	 	Low	 	
First Quarter	 	$	14.82	 	$	10.00	 	
Second Quarter	 	$	12.16	 	$	9.87	 	
Third Quarter	 	$	12.49	 	$	9.36	 	
Fourth Quarter	 	$	10.22	 	$	7.21	 	
        The following graph compares the cumulative total stockholder return data for our stock since December 31, 2003 to the cumulative return over such period of (i) The NASDAQ Composite Index and (ii) the RDG Technology Composite Index. The graph assumes that $100 was invested on December 31, 2003. The graph further assumes that such amount was initially invested in the Common Stock of the Company at a per share price of $14.90 (closing price on December 31, 2003) and that of any dividends were reinvested. This performance graph is not "soliciting material," is not deemed filed with the SEC and is not to be incorporated by reference in any filing by us under the Securities Act or the Exchange Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

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COMPARISON OF 5 YEARS CUMULATIVE TOTAL RETURNS*
Among PDF Solutions, Inc., The NASDAQ Composite Index
And The RDG Technology Composite Index

*
$100 invested on 12/31/03 in stock or index-including reinvestment of dividends.
Fiscal year ending December 31.

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        The information under the heading "Equity Compensation Plan Information" in our definitive Proxy Statement (our "Proxy Statement") to be filed with the SEC in connection with our 2008 Annual Meeting of Stockholders is incorporated into Item 5 of this report by reference.

        The table below sets forth the information with respect to purchases made by or on behalf of the Company or any "affiliated purchaser" (as the term is defined in Rule 10b-18(a)(3) under the Exchange Act) of our common stock during the fourth quarter of the year ended December 31, 2008 (in thousands except per share amounts):
ISSUER PURCHASES OF EQUITY SECURITIES

Period	 	Total
Number of
Shares
Purchased	 	Average
Price Paid
per Share	 	Total Number of
Shares
Purchased as Part
of Publicly
Announced Plans or
Programs(1)	 	Approximate
Dollar
Value of Shares
that
May Yet
Be Purchased
Under the Plans or
Programs(1)	 	
Month #1 (October 1, 2008 through October 31, 2008)	 	 	—	 	$	—	 	 	—	 	$	5,369	 	
Month #2 (November 1, 2008 through November 30, 2008)	 	 	715	 	$	2.36	 	 	715	 	$	3,683	 	
Month #3 (December 1, 2008 through December 31, 2008)	 	 	950	 	$	2.19	 	 	950	 	$	1,599	 	
 	 	 	 	 	 	 	 	 	 	 	 	
 	Total	 	 	1,665	 	$	2.26	 	 	1,665	 	 	 	 	

(1)
On March 26, 2003, our Board of Directors approved a share repurchase program to purchase up to $10.0 million of our outstanding common stock. The program was completed in August 2007 with 988,000 shares repurchased at the average price of $10.12. On October 29, 2007, the Board of Directors approved a new program to repurchase up to an additional $10.0 million of the Company's common stock on the open market. The right to repurchase stock under this program will expire on October 29, 2010. As of December 31, 2008, 2,428,000 shares had been repurchased under this program and $1.6 million remained available for repurchases.

Dividend Policy

        No cash dividends were declared or paid in 2008 or 2007. We currently intend to retain all available funds to finance future internal growth and product development and therefore do not anticipate paying any cash dividends on our common stock for the foreseeable future.

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Item 6.    Selected Financial Data.

        The following selected consolidated financial information has been derived from the audited consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes to those statements included therein and in Part IV of this Form 10-K.

	 	Year Ended December 31,	 	
 
	 	2008(3)(4)	 	2007(2)	 	2006(1)	 	2005	 	2004	 	
 
	 	(In thousands, except per share amounts)
	 	
Consolidated Statements of Operations Data:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Services	 	$	50,273	 	$	63,731	 	$	45,382	 	$	52,719	 	$	49,573	 	
 	 	Software licenses	 	 	4,840	 	 	6,645	 	 	10,774	 	 	9,319	 	 	4,971	 	
 	Gainshare performance incentives	 	 	18,924	 	 	24,087	 	 	20,028	 	 	11,890	 	 	7,802	 	
 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	Total revenue	 	 	74,037	 	 	94,463	 	 	76,184	 	 	73,928	 	 	62,346	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Cost of design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Services	 	 	28,926	 	 	32,279	 	 	27,418	 	 	24,319	 	 	21,811	 	
 	Software licenses	 	 	185	 	 	191	 	 	209	 	 	293	 	 	83	 	
 	Amortization and impairment of acquired technology	 	 	6,012	 	 	5,148	 	 	5,270	 	 	5,064	 	 	5,209	 	
 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	Total costs of design-to silicon-yield solutions	 	 	35,123	 	 	37,618	 	 	32,897	 	 	29,676	 	 	27,103	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Gross margin	 	 	38,914	 	 	56,845	 	 	43,287	 	 	44,252	 	 	35,243	 	
Operating expenses:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Research and development	 	 	33,994	 	 	36,074	 	 	27,613	 	 	22,204	 	 	20,999	 	
 	Selling, general and administrative	 	 	21,778	 	 	24,891	 	 	19,814	 	 	16,146	 	 	15,243	 	
 	Amortization of other acquired intangible assets	 	 	893	 	 	3,422	 	 	1,459	 	 	940	 	 	1,406	 	
 	Restructuring charges	 	 	3,401	 	 	—	 	 	—	 	 	—	 	 	—	 	
 	Impairment on goodwill and other acquired intangible assets	 	 	66,830	 	 	—	 	 	—	 	 	—	 	 	—	 	
 	Write-off of in-process research and development	 	 	—	 	 	—	 	 	800	 	 	—	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	Total operating expenses	 	 	126,896	 	 	64,387	 	 	49,686	 	 	39,290	 	 	37,648	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Income (loss) from operations	 	 	(87,982	)	 	(7,542	)	 	(6,399	)	 	4,962	 	 	(2,405	)	
Interest and other income, net	 	 	353	 	 	1,891	 	 	2,827	 	 	1,658	 	 	675	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Income (loss) before taxes	 	 	(87,629	)	 	(5,651	)	 	(3,572	)	 	6,620	 	 	(1,730	)	
Income tax provision (benefit)	 	 	8,099	 	 	(2,724	)	 	(3,133	)	 	96	 	 	(1,116	)	
 	 	 	 	 	 	 	 	 	 	 	 	
Net income (loss)	 	$	(95,728	)	$	(2,927	)	$	(439	)	$	6,524	 	$	(614	)	
 	 	 	 	 	 	 	 	 	 	 	 	
Net income (loss) per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Basic	 	$	(3.48	)	$	(0.10	)	$	(0.02	)	$	0.25	 	$	(0.02	)	
 	 	 	 	 	 	 	 	 	 	 	 	
 	Diluted	 	$	(3.48	)	$	(0.10	)	$	(0.02	)	$	0.24	 	$	(0.02	)	
 	 	 	 	 	 	 	 	 	 	 	 	
Weighted average common shares:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Basic	 	 	27,514	 	 	28,066	 	 	26,885	 	 	25,983	 	 	25,330	 	
 	 	 	 	 	 	 	 	 	 	 	 	
 	Diluted	 	 	27,514	 	 	28,066	 	 	26,885	 	 	27,473	 	 	25,330	 	
 	 	 	 	 	 	 	 	 	 	 	 	
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        Stock-based compensation expense included in these consolidated statements of operations was recorded under Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees  ("APB No. 25") for the years 2004 through 2005 and under Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), Share-Based Paymen t ("SFAS No. 123(R)") for the years 2006 through 2008.

        For the years ended December 31, 2008, 2007, and 2006, the income tax provision includes income tax benefit from stock-based compensation.

	 	December 31,	 	
 
	 	2008(3)(4)	 	2007(2)	 	2006(1)	 	2005	 	2004	 	
 
	 	(In thousands)
	 	
Consolidated Balance Sheets Data:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	31,686	 	$	35,315	 	$	36,451	 	$	60,506	 	$	45,660	 	
Short-term investments	 	 	9,051	 	 	9,949	 	 	16,402	 	 	—	 	 	—	 	
Working capital	 	 	56,331	 	 	72,456	 	 	66,586	 	 	68,534	 	 	51,312	 	
Total assets	 	 	79,627	 	 	179,351	 	 	168,857	 	 	139,892	 	 	125,407	 	
Total stockholders' equity	 	 	59,770	 	 	156,470	 	 	148,219	 	 	122,681	 	 	108,798	 	

(1)
In October 2006, we completed our acquisition of all the outstanding stock of SiA. SiA developed and licensed fault detection and classification ("FDC") software applications and services. The aggregate purchase price of $36.6 million included the payment in cash of $25.5 million, the issuance of 699,000 shares of PDF common stock valued at $9.4 million and acquisition costs of $1.7 million.

(2)
In May 2007, we completed our acquisition of all the outstanding stock of Fabbrix. Fabbrix developed DFM software applications. The aggregate purchase price of $6.2 million included the payment in cash of $2.7 million, the issuance of 272,000 shares of PDF common stock valued at $2.9 million and acquisition costs of $674,000.

(3)
In October 2008, we completed our acquisition of substantially all of the assets of Triant. Triant developed and licensed FDC software applications and services. The aggregate purchase price of $1.9 million included the payment in cash of $1.6 million and acquisition costs of $312,000.

(4)
In the fourth fiscal quarter of 2008, the Company recorded an impairment of goodwill and intangible assets of $70.3 million.

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

        We analyze our customers' IC design and manufacturing processes to identify, quantify, and correct the issues that cause yield loss to improve our customers' profitability by improving time-to-market, increasing yield and reducing total design and manufacturing costs. We package our solutions in various ways to meet our customers' specific business and budgetary needs, each of which provides us various revenue streams. We receive a mix of fixed fees and variable, performance-based fees for the vast majority of our Integrated Yield Ramp offerings. The fixed fees are typically reflective of the length of time and the resources needed to characterize a customer's manufacturing process and receive preliminary results of proposed yield improvement suggestions. The variable fee, or what we call gainshare, usually depends on our achieving certain yield targets by a deadline. Variable fees are currently typically tied to wafer volume on the node size of the manufacturing facility where we performed the yield improvement. We receive license fees and service fees for related installation, integration, training, and maintenance and support services for our software that we license on a stand-alone basis.

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History

        From our incorporation in 1992 through late 1995, we were primarily focused on research and development of our proprietary manufacturing process simulation and yield and performance modeling software. From late 1995 through late 1998, we continued to refine and sell our software, while expanding our offering to include yield and performance improvement consulting services. In late 1998, we began to sell our software and consulting services, together with our newly developed proprietary technologies, under the term Design-to-Silicon-Yield solutions, reflecting our current business model. In April 2000, we expanded our research and development team and gained additional technology by acquiring AISS. AISS now operates as PDF Solutions, GmbH, a German company, which continues to develop software and provide development services to the semiconductor industry. In July 2001, we completed the initial public offering of our common stock. In 2003, we enhanced our product and service offerings, including increased software applications, through the acquisitions of IDS and WaferYield. In 2006, we further complemented our technology offering by acquiring SiA and adding its FDC software capabilities to our integrated solution. In 2007, we increased our IP solutions portfolio, particularly in logic design technology, through the acquisition of Fabbrix. In 2008, we solidified our market leading position in the FDC software market, particularly in Korea, and now provide complementary technology to our mæstria product through the acquisition of certain assets of Triant.

Industry Trend

        Subject to the current general economic downturn, demand for consumer electronics and communications devices continues to drive technological innovation in the semiconductor industry as the need for products with greater performance, lower power consumption, reduced costs and smaller size continues to grow with each new product generation. In addition, advances in computing systems and mobile devices have fueled demand for higher capacity memory chips. To meet these demands, IC manufacturers and designers are constantly challenged to improve the overall performance of their ICs by designing and manufacturing ICs with more embedded applications to create greater functionality while lowering cost per transistor. As a result, both logic and memory manufacturers have migrated to more and more advanced manufacturing nodes, capable of integrating more devices with higher performance, higher density, and lower power. As this trend continues, companies will continually be challenged to improve process capabilities to optimally produce ICs with minimal random and systematic yield loss, which is driven by the lack of compatibility between the design and its respective manufacturing process. We believe that as volume production of deep submicron ICs continues to grow, the difficulties of integrating IC designs with their respective processes and ramping new manufacturing processes will create a greater need for products and services that address the yield loss and escalating cost issues the semiconductor industry is facing today and will face in the future.

Financial Highlights

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

        Due to the current decline in our stock price and market capitalization, our fiscal 2008 net loss, expected future net losses, reduced future cash flow estimates, and slower growth rates in our industry, we recorded impairment totaling $64.0 million in fiscal 2008, representing all of our acquired goodwill. We also recorded impairment of $6.3 million relating to our acquired intangible assets, and valuation allowance on our deferred tax assets of $24.4 million.

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

        The following were our financial highlights for the year ended December 31, 2008.

•
Total revenue was $74.0 million, which was a decrease of $20.4 million, or 22%, compared to the year ended December 31, 2007. Design-to-Silicon-Yield solutions revenue was $55.1 million, which was a decrease of $15.3 million, of 22%, from the year ended December 31, 2007. The decrease in Design-to-Silicon Yield solutions revenue was primarily the result of lower bookings, as customers have delayed purchases for capacity expansion and investment in leading-edge technology. The dramatic downturn in the semiconductor industry combined with weakness in worldwide economies has been the primary contributors to this reduction. Gainshare performance incentives revenue was $18.9 million, which was a decrease of $5.2 million, or 21%, from the year ended December 31, 2007. The decrease in revenue from gainshare performance incentives was primarily the result of reduced volumes in customer manufacturing facilities.

•
Net loss for the year ended December 31, 2008 was $95.7 million, an increase of $92.8 million compared to net loss of $2.9 million for the year ended December 31, 2007. The increase in net loss was primarily attributable to an impairment on goodwill and intangible assets, decreases in revenue, and the establishment of a valuation allowance against deferred tax assets, partially offset by decreases in operating expenses, the result of cost control efforts.

•
Net loss per basic and diluted share was $3.48 for the year ended December 31, 2008 compared to $0.10 for the year ended December 31, 2007, an increase in net loss of $3.38 per basic and diluted share.

•
Cash, cash equivalents and investments decreased $3.8 million to $41.5 million during the year ended December 31, 2008, primarily due to the repurchase of $6.9 million of our common stock, the negative effect of changes in foreign currency exchange rates of $1.7 million, payments of $1.6 million for businesses acquired, and capital expenditures of $1.1 million, partially offset by net cash provided by operating activities of $7.6 million.

Acquisitions

        On May 24, 2007, we completed the acquisition of Fabbrix, Inc. ("Fabbrix"), a provider of silicon intellectual property designed to create highly manufacturable and area-efficient designs targeted for advanced technology nodes. With this acquisition, we have enhanced our strength in silicon characterization to enable a true co-optimization of the manufacturing fabric and the logic elements. Total cost for the acquisition was $6.2 million, which included $2.7 million cash, 272,000 shares of our common stock valued at $2.9 million, and $674,000 in acquisition costs. Pursuant to the terms of the acquisition, $405,000 in cash and 41,000 shares of our common stock were held in escrow as security against certain financial and other contingencies. The escrow, less amounts deducted to satisfy contingencies, was required to be released no later than on the 18 month anniversary of the acquisition and was released to the selling stockholders in November 2008. In connection with this Fabbrix acquisition, we recorded $2.2 million of goodwill and $7.8 million of identifiable intangible assets with a weighted average life of 5.4 years.

        On October 7, 2008, we completed the acquisition of substantially all of the assets of Triant's FDC business, excluding certain receivables, but including certain customer contracts and technologies. Triant developed and licensed FDC software applications and services dedicated to the semiconductor industry to enable customers to rapidly identify sources of process variations and manufacturing excursions. This

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acquisition creates additional opportunities for our leading process control solutions within the installed customer base, including leading semiconductor, flat panel display, and wafer manufacturers. Total cost for the acquisition was $1.9 million, which included $1.6 million in cash and $312,000 in acquisition costs. Pursuant to the terms of the acquisition, $374,000 in cash was held in escrow as security against certain financial and other contingencies. The cash held in escrow, less amounts deducted to satisfy contingencies was required to be released following the statutory notice to creditors associated with Triant's liquidation and wind up process. The escrow was released to Triant in February 2009. In connection with the acquisition, we recorded $1.7 million of identifiable intangible assets with a weighted average life of 3.4 years and $147,000 of goodwill. The consolidated financial statements for the year ended December 31, 2008 include the results of Triant since the date of acquisition.

        Subsequent to the acquisition of Triant, we completed our annual goodwill impairment test as prescribed under SFAS No. 142. In addition, due to the continued decline within the semiconductor industry brought on by the deteriorating global economic environment, we anticipated further declines in our future operational results. As a result, we determined these factors, among others, to be impairment indicators which triggered the necessity of an impairment analysis under SFAS No. 144 for our long-lived assets. These tests also included the goodwill and certain intangible assets recognized as part of the acquisition of Triant. This determination relating to our Triant acquisition was in part made after several public announcements were issued by a key customer of Triant's, regarding its own financial outlook and anticipated capital expenditure spending levels; which in turn caused us to revise our projected revenue from what had been expected at the date of the acquisition.

Critical Accounting Policies

        Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 1 of "Notes to Consolidated Financial Statements" includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. The following is a brief discussion of the more significant accounting policies and methods that we use.

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, software development costs, recoverability of goodwill and acquired intangible assets, estimated useful lives of acquired intangibles and the realization of deferred tax assets. Actual amounts may differ from such estimates under different assumptions or conditions.

Revenue Recognition

        We derive revenue from two sources: Design-to-Silicon-Yield Solutions and Gainshare Performance Incentives. We recognize revenue in accordance with the provisions of American Institute of Certified Public Accountants' Statement of Position ("SOP") No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts  and SOP No. 97-2, Software Revenue Recognition , as amended.

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        Design-to-Silicon-Yield Solutions—Revenue that is derived from Design-to-Silicon-Yield solutions comes from services and software licenses. We recognize revenue for each element of Design-to-Silicon-Yield solutions as follows:

        Services—We generate a significant portion of our Design-to-Silicon-Yield solutions revenue from fixed-price solution implementation service contracts delivered over a specific period of time. These contracts require accurate estimation of cost to perform obligations and overall scope of each engagement. Revenue under contracts for solution implementation services is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting. Losses on solution implementation contracts are recognized in the period when they become evident. 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.

        On occasion, we have licensed our software products as a component of our fixed price services contracts. In such instances, the software products are licensed to customers over a specified term of the agreement with support and maintenance to be provided over the license term. Under these arrangements, where vendor-specific objective evidence of fair value ("VSOE") exists for the support and maintenance element, the support and maintenance revenue is recognized separately over the term of the supporting period. The remaining fee is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting. VSOE for maintenance, in these instances, is generally established based upon a negotiated renewal rate. Under arrangements where software products are licensed as a component of its fixed-price service contract and where VSOE does not exist to allocate a portion of the total fixed-price to the undelivered elements, revenue is recognized for the total fixed-price as the lesser of either the percentage of completion method of contract accounting or ratably over the longer of either the term of the agreement or the supporting period. Costs incurred under these arrangements are deferred and recognized in proportion to revenue recognized under these arrangements.

        Revenue from related support and maintenance services is recognized ratably over the term of the support and maintenance contract, generally one year, while revenue from consulting, installation and training services is recognized as services are performed. When bundled with software licenses in multiple element arrangements, support and maintenance, consulting (other than for our fixed price solution implementations), installation, and training revenue is allocated to each element of a transaction based upon its fair value as determined by our VSOE. VSOE is generally established for maintenance based upon negotiated renewal rates while VSOE for consulting, installation, and training is established based upon our customary pricing for such services when sold separately. When VSOE does not exist to allocate a portion of the total fee to the undelivered elements, revenue is recognized ratably over the longest service period of the undelivered elements

        Software Licenses—We also license our software products separate from our integrated solution implementations. For software license arrangements that do not require significant modification or customization of the underlying software, software license revenue is recognized under the residual method when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable, (4) collectibility is probable, and (5) the arrangement does not require services that are essential to the functionality of the software. When arrangements include multiple elements such as support and maintenance, consulting (other than for our fixed price solution implementations), installation, and training, revenue is allocated to each element of a transaction based upon its fair value as determined by our VSOE and such services are recorded as services. VSOE is generally established for maintenance based upon negotiated renewal rates while VSOE for

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consulting, installation and training services is established based upon our customary pricing for such services when sold separately. When VSOE does not exist to allocate a portion of the total fee to the undelivered elements, revenue is recognized ratably over the longest period of the undelivered elements. Revenue for software licenses with extended payment terms is not recognized in excess of amounts due. For software license arrangements that require significant modification or customization of the underlying software, the software license revenue is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting, and such revenue is recorded as services.

        Gainshare Performance Incentives—When we enter into a contract to provide yield improvement services, the contract usually includes two components: (1) a fixed fee for performance by us of services delivered over a specific period of time; and (2) a gainshare performance incentives component where the customer may pay a variable fee, usually after the fixed fee period has ended. Revenue derived from gainshare performance incentives represents profit sharing and performance incentives earned based upon our customers reaching certain defined operational levels established in related solution implementation service contracts. Gainshare performance incentives periods are usually subsequent to the delivery of all contractual services and therefore have no cost to us. Due to the uncertainties surrounding attainment of such operational levels, we recognize gainshare performance incentives revenue (to the extent of completion of the related solution implementation contract) upon receipt of performance reports or other related information from our customers supporting the determination of amounts and probability of collection. Gainshare performance incentives 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 provisions for gainshare performance incentives.

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 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

        During the fourth quarter of fiscal 2008, we observed impairment indicators, relating to our long-lived assets, including the trading of common stock below our book value and a further deterioration in the semiconductor industry, brought on by the deteriorating global economic environment, which triggered the necessity of an impairment test as of December 31, 2008. As such, in accordance with SFAS No. 144, we assessed the recoverability of our long-lived assets by comparing the carrying value of those intangible assets to the undiscounted cash flows of the asset group. The analysis indicated that the carrying value of those assets exceeded the undiscounted cash flows. As such, we determined that certain acquired intangible assets were impaired. We measured the amount of impairment by calculating the amount by which the carrying value of the assets exceeded their estimated fair values, which were based on projected discounted future net cash flows. As a result of this impairment analysis, we recorded an impairment of $6.3 million during the fourth fiscal quarter of 2008.

        In accordance with SFAS No. 142, goodwill is measured and tested for impairment on an annual basis and more frequently in certain circumstances, accordingly, we have selected December 31 as the date to perform the annual testing requirements. We perform a two-step testing on goodwill impairment. The first step requires that we compare the estimated fair value of our single reporting unit to the carrying value of the reporting unit, including goodwill. If the fair value of the reporting unit is greater than the carrying,

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goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value, we are required to complete the second step which compares the implied fair value of the reporting unit goodwill with the carrying value of that goodwill An impairment is recognized in an amount equal to the excess of the carrying value of the goodwill over the implied fair value of that goodwill.

        As discussed in Note 12, Customer and Geographic Information, we consider ourselves to be in one operating segment. In addition, we have determined that our operating segment is also our reporting unit as the operating segment comprises only a single component. To determine the reporting unit's fair value, we used the income valuation approach. In determining our overall conclusion of reporting unit's fair value, we also consider the estimated values derived from the income valuation approach as compared to the valuation under the market approach as one measure that the estimated value is reasonable.

        The income approach provides an estimate of fair value based on discounted expected future cash flows. Estimates and assumptions with respect to the determination of the fair value of our reporting unit using the income approach include our operating forecasts, revenue growth rates, and risk-commensurate discount rates and costs of capital. Our estimates of revenues and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine long-range planning process.

        The market approach provides an estimate of the fair value of our reporting unit using various prices or market multiples applied to the reporting unit's operating results and then applying an appropriate control premium, which is determined by considering control premiums offered as part of acquisitions in both our market segment and comparable market segments.

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

        Allocating assets and liabilities on a fair value basis and determining the fair value of unrecorded intangible assets required that we make assumptions and estimates about the fair value of assets and liabilities where the fair values of those assets and liabilities were not readily available or observable. In addition, we made estimates regarding our forecasted revenue, expenses and cash flows, our research and development activities, our customer turnover rates, applicable discount rates and costs of capital and the marketability of our current and future technology.

        We are currently amortizing our remaining acquired intangible assets over estimated useful lives of one to seven years, which are based on the estimated period of benefit to be delivered from such assets. However, a decrease in the estimated useful lives of such assets would cause additional amortization expense or impairment on such asset in future periods.

Income Taxes

        We account for temporary differences between book and tax entries by recording deferred tax assets and liabilities in accordance with SFAS No. 109, Accounting for Income Taxes , ("SFAS No. 109"), which established financial accounting and reporting standards for the effect of income taxes. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recover is not likely, we must establish a valuation allowance. Changes in the net deferred tax assets, less offsetting valuation allowance, in a period are recorded through the income tax provision in the condensed consolidated statements of operations. For the year ended December 31, 2008, we concluded that a valuation allowance was required based on our evaluation and weighting of the positive and negative

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evidence. See Note 10 to the consolidated financial statements for further discussion. If, in the future, we determine that these deferred tax assets are more likely than not to be realized, a release of all or part, of the related valuation allowance could result in a material income tax benefit in the period such determination is made.

        In June, 2006, the Financial Accounting Standard Board ("FASB") issued Financial Interpretation No. 48,Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109  ("FIN No. 48"), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109. Additionally, the Interpretation provides guidance on measurement, de-recognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN No. 48 on January 1, 2007. See Note 10 to the consolidated financial statements for a further discussion on the income taxes.

Stock-Based Compensation

        Effective January 1, 2006, we adopted the provisions of SFAS No. 123(R). The statement eliminates the ability to account for share-based compensation transactions using APB No. 25 and requires that the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements based on estimated fair values. SFAS No. 123(R) applies to all share-based payment transactions in which we acquire goods or services by issuing our shares, share options, or other equity instruments or by incurring liabilities based on the price of our shares or that require settlement by the issuance of equity instruments. We elected to use the modified prospective transition method upon adopting this statement and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123(R). Under this transition method, stock-based compensation expense for the years ended December 31, 2006, 2007 and 2008 include compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123, Accounting for Stock-Based Compensation  ("SFAS No. 123"). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). We recognize the compensation costs of stock purchase rights and stock options granted after January 1, 2006 on a straight-line basis over the vesting periods of the applicable stock purchase rights and stock options, generally four years. Prior to adoption of SFAS No. 123(R), we presented all tax benefits resulting from stock purchase rights and stock options as operating cash flow in our statement of cash flows. In accordance with SFAS No. l23(R), the cash flows resulting from excess tax benefits are classified as financing cash flows.

        Prior to the adoption of SFAS No. 123(R), we accounted for stock-based compensation in accordance with APB No. 25, and complied 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 was amortized to expense using the graded vesting method. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107") regarding the SEC's interpretation of SFAS No. 123(R) and the valuation of share-based payments for public companies. We have applied the provisions of SAB 107 in its adoption of SFAS No. 123(R). In December 2007, the SEC issued Staff Accounting Bulletin No. 110 ("SAB 110") to amend the SEC's views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123(R). SAB 110 is effective for us beginning in the first quarter of fiscal year 2008. In the fourth fiscal quarter of 2007, the Company had enough historical data to determine its expected life. See Note 8 to the Consolidated Financial Statements for a further discussion on stock- based compensation.

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Recent Accounting Pronouncements and Accounting Changes

        See our Note 1, "Business and Significant Accounting Policies" of "Notes to Consolidated Financial Statements" included under Part IV, Item 15 of this Form 10-K for a description of recent accounting pronouncements and accounting changes, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.

Results of Operations

        The following table sets forth, for the years indicated, the percentage of total revenue represented by the line items reflected in our consolidated statements of operations:

	 	Years Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
Revenues:	 	 	 	 	 	 	 	 	 	 	
 	Design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	
 	 	Services	 	 	68	%	 	67	%	 	60	%	
 	 	Software licenses	 	 	6	 	 	7	 	 	14	 	
 	Gainshare performance incentives	 	 	26	 	 	26	 	 	26	 	
 	 	 	 	 	 	 	 	
 	 	 	Total revenues	 	 	100	 	 	100	 	 	100	 	
Cost of design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	
 	Services	 	 	39	 	 	34	 	 	36	 	
 	Software licenses	 	 	—	 	 	—	 	 	—	 	
 	Amortization and impairment of acquired technology	 	 	8	 	 	6	 	 	7	 	
 	 	 	 	 	 	 	 	
 	 	 	Total cost of design-to silicon-yield solutions	 	 	47	 	 	40	 	 	43	 	
 	 	 	 	 	 	 	 	
Gross margin	 	 	53	 	 	60	 	 	57	 	
Operating expenses:	 	 	 	 	 	 	 	 	 	 	
 	Research and development	 	 	46	 	 	38	 	 	37	 	
 	Selling, general and administrative	 	 	29	 	 	26	 	 	26	 	
 	Amortization of other acquired intangible assets	 	 	1	 	 	4	 	 	2	 	
 	Restructuring charges	 	 	5	 	 	—	 	 	—	 	
 	Impairment on goodwill and other acquired intangible assets	 	 	90	 	 	—	 	 	—	 	
 	Write-off of in-process research and development	 	 	—	 	 	—	 	 	1	 	
 	 	 	 	 	 	 	 	
 	 	 	Total operating expenses	 	 	171	 	 	68	 	 	66	 	
 	 	 	 	 	 	 	 	
Loss from operations	 	 	(118	)	 	(8	)	 	(9	)	
Interest and other income, net	 	 	—	 	 	2	 	 	4	 	
 	 	 	 	 	 	 	 	
Loss before taxes	 	 	(118	)	 	(6	)	 	(5	)	
Income tax provision (benefit)	 	 	11	 	 	(3	)	 	(4	)	
 	 	 	 	 	 	 	 	
Net loss	 	 	(129	)%	 	(3	)%	 	(1	)%	

Years Ended December 31, 2008 and 2007
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Services	 	$	50,273	 	$	63,731	 	$	(13,458	)	 	(21	)%	 	68	%	 	67	%	
 	Software licenses	 	 	4,840	 	 	6,645	 	 	(1,805	)	 	(27	)	 	6	 	 	7	 	
Gainshare performance incentives	 	 	18,924	 	 	24,087	 	 	(5,163	)	 	(21	)	 	26	 	 	26	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	74,037	 	$	94,463	 	$	(20,426	)	 	(22	)%	 	100	%	 	100	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
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        Design-to-Silicon-Yield Solutions.    Design-to-Silicon-Yield solutions revenue is derived from services (including solution implementations, software support and maintenance, consulting, and training) and software licenses, provided during our customer yield improvement engagements and solution product sales.

        Services.    Services revenue decreased $13.5 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to a decrease of $7.9 million in fixed fee integrated solutions and a decrease of $6.6 million in revenue from software related consulting services. The decreases were primarily the result of lower bookings, as customers have delayed purchases for capacity expansion and investment in leading edge technology in anticipation of a significant downturn in the semiconductor industry. The dramatic downturn in the semiconductor industry combined with the current worldwide economic downturn have been the primary contributors to this shortfall. Our services revenue may fluctuate in the future and is dependent on a number of factors, including our ability to obtain new customers.

        Software licenses.    Software licenses revenue decreased $1.8 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to customers delaying purchases for capacity expansion. The dramatic downturn in the semiconductor industry combined with the current worldwide economic downturn have been the primary contributors to this shortfall. Our software licenses revenue may fluctuate in the future and is dependent on a number of factors, including the semiconductor industry's acceptance of our products, the timing of purchases by existing customers, and our ability to attract new customers and further penetration of our current customer base.

        Gainshare Performance Incentives.    Gainshare performance incentives revenue represents profit sharing and performance incentives earned based upon our customer reaching certain defined operational levels. Revenue derived from gainshare performance incentives decreased $5.2 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to decreases in wafer volumes at our customers' sites. Revenue from gainshare performance incentives was generated from seven customers and thirteen engagements for the year ended December 31, 2008 and seven customers and twelve engagements for the year ended December 31, 2007. Our gainshare performance incentives revenue may continue to fluctuate from period to period. Gainshare performance incentives revenue is dependent on many factors that are outside our control, including among others, consumer demand for our customers' ICs, sustained yield improvements by our customers and our ability to enter into new Design-to-Silicon-Yield solutions contracts containing provisions for gainshare performance incentives.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of Design-to-Silicon-Yield Solutions	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Services	 	$	28,926	 	$	32,279	 	$	(3,353	)	 	(10	)%	 	39	%	 	34	%	
Software licenses	 	 	185	 	 	191	 	 	(6	)	 	(3	)	 	—	 	 	—	 	
Amortization and impairment of acquired technology	 	 	6,012	 	 	5,148	 	 	864	 	 	17	 	 	8	 	 	6	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	35,123	 	$	37,618	 	$	(2,495	)	 	(7	)%	 	47	%	 	40	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Costs of Design-to-Silicon-Yield Solutions.    Costs of Design-to-Silicon-Yield solutions consist of costs incurred to provide and support our services and costs recognized in connection with licensing our software.

        Services.    Services costs consist of material, labor, overhead costs, and stock-based compensation charges associated with solution implementations. Costs include purchased materials, employee compensation and benefits, travel and facilities-related costs. The costs of Design-to-Silicon-Yield

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services decreased $3.4 million for the year ended December 31, 2008 compared to the year ended December 31, 2007. The decrease was primarily due to a decrease of $2.5 million in deployment of our pdFasTest products and a decrease of $991,000 in personnel expenses in the U.S., the result of our cost control efforts. If we do not accurately estimate the resources required or the scope of work to be performed, or we 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.    Software license costs consist of costs associated with licensing third-party software sold in conjunction with our software products and expenses incurred to produce and distribute our product documentation. The costs of Design-to-Silicon-Yield solutions software licenses decreased moderately, by $6,000, for the year ended December 31, 2008 compared to the year ended December 31, 2007. We expect the cost of software licenses to fluctuate in the future as a result of royalties and license fees paid for third-party applications incorporated in our software products as a result of timing and product mix of such license sales.

        Amortization and Impairment of Acquired Technology.    Amortization and Impairment of acquired technology consists of amortization of intangibles acquired as a result of certain business combinations. Amortization of acquired technology expense decreased $2.6 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to certain intangible assets becoming fully amortized. We anticipate amortization of acquired technology to be $1.4 million in 2009, $1.3 million in 2010, $626,000 in 2011, and $261,000 in 2012. Impairment of acquired technology consisted of a $3.4 million impairment recognized in the fourth fiscal quarter of 2008.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Research and Development	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Research and development	 	$	33,994	 	$	36,074	 	$	(2,080	)	 	(6	)%	 	46	%	 	38	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Research and Development.    Research and development expenses consist primarily of personnel-related costs to support product development activities, including compensation and benefits, outside development services, travel, facilities cost allocations, and stock-based compensation charges. Research and development expenses decreased $2.1 million for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to a decrease of $1.6 million in expenses in our French subsidiary and a decrease of $1.5 million in personnel expenses in the U.S., both the result of our cost control efforts. We anticipate our expenses in research and development will fluctuate in absolute dollars from period to period as a result of cost control initiatives and the timing of when we hire new personnel based on the scope and timing of product development projects.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Selling, General and Administrative	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Selling, general and administrative	 	$	21,778	 	$	24,891	 	$	(3,113	)	 	(13	)%	 	29	%	 	26	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Selling, General and Administrative.    Selling, general and administrative expenses consist primarily of compensation and benefits for sales, marketing and general and administrative personnel in addition to outside sales commissions, legal and accounting services, marketing communications, travel and facilities cost allocations, and stock-based compensation charges. Selling, general and administrative expenses decreased $3.1 million for the year ended December 31, 2008 compared to the year ended December 31,

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2007 primarily due to a decrease of $1.1 million in personnel expenses in the U.S. and a decrease of $834,000 in outside sales commission as a result of our cost control efforts. We anticipate our selling, general and administrative expenses will fluctuate in absolute dollars from period to period as a result of cost control initiatives and the need to support sales efforts in the future.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Amortization of Other Acquired Intangible Assets	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Amortization of other acquired intangible assets	 	$	893	 	$	3,422	 	$	(2,529	)	 	(74	)%	 	1	%	 	4	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Amortization of Other Acquired Intangible Assets.    Amortization of other acquired intangible assets consists of the amortization of intangibles acquired as a result of certain business combinations. Amortization of other acquired intangible assets for the year ended December 31, 2008 decreased $2.5 million compared to the year ended December 31, 2007, primarily the result of certain intangible assets becoming fully amortized. We anticipate amortization of other acquired intangible assets to be $344,000 in 2009, $293,000 in 2010, $204,000 in 2011, $174,000 in 2012, and $105,000 in 2013 and thereafter.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Restructuring Charges	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Restructuring charges	 	$	3,401	 	$	—	 	$	3,401	 	N/A	 	 	5	%	 	—	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Restructuring Charges.    Restructuring charges of $3.4 million for the year ended December 31, 2008 were related to expenses incurred as a result of the restructuring plans announced on April 29, 2008 and October 28, 2008. Restructuring charges related to the plan announced on April 29, 2008 were $1.5 million, primarily consisting of employee severance costs of $1.4 million. Restructuring charges related to the plan announced on October 28, 2008 were $1.9 million, primarily consisting of facility abandonment costs of $985,000 and employee severance costs of $938,000.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Impairment on Goodwill and Other Acquired Intangible Assets	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Impairment on goodwill and other acquired intangible assets	 	$	66,830	 	$	—	 	$	66,830	 	N/A	 	 	90	%	 	—	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Impairment on Goodwill and Other Acquired Intangible Assets.    During the fourth fiscal quarter of 2008, we recognized an impairment of $64.0 million on our goodwill and $2.8 million on our other acquired intangible assets, as a result of management's review for potential impairment on the carrying value of such assets due to the deterioration of our operating results and the dramatic downturn in the semiconductor industry combined with weakness in worldwide economies. There was no impairment recorded during the year ended December 31, 2007.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest and Other Income, Net	 	2008	 	2007	 	$
Change	 	%
Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Interest and other income, net	 	$	353	 	$	1,891	 	$	(1,538	)	 	(81	)%	 	—	%	 	2	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
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        Interest and Other Income, Net.    Interest and other income, net, decreased $1.5 million for the year ended December 31, 2008 compared to the year ended December 31, 2007, primarily due to decreases in interest income from lower average cash, cash equivalent and investments balance and lower interest rates during the period.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income Tax Provision (Benefit)	 	2008	 	2007	 	$ Change	 	% Change	 	2008
% of
Revenue	 	2007
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Income tax provision (benefit)	 	$	8,099	 	$	(2,724	)	$	10,823	 	 	(397	)%	 	11	%	 	(3	)%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Income Tax Provision (Benefit).    Income tax provision increased $10.8 million for the year ended December 31, 2008 compared to income tax benefit of $2.7 million for the year ended December 31, 2007, primarily due to the establishment of a valuation allowance for deferred tax assets for the year ended December 31, 2008. During the nine months ended September 30, 2008, a valuation allowance was established for substantially all net deferred tax assets after management concluded that it was more likely than not that, based on the objective evidence available, our net deferred tax assets would not be fully realizable.

Years Ended December 31, 2007 and 2006
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Revenue	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Services	 	$	63,731	 	$	45,382	 	$	18,349	 	 	40	%	 	67	%	 	60	%	
 	Software licenses	 	 	6,645	 	 	10,774	 	 	(4,129	)	 	(38	)	 	7	 	 	14	 	
Gainshare performance incentives	 	 	24,087	 	 	20,028	 	 	4,059	 	 	20	 	 	26	 	 	26	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	94,463	 	$	76,184	 	$	18,279	 	 	24	%	 	100	%	 	100	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Design-to-Silicon-Yield Solutions.    

        Services.    Services revenue increased $18.3 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily as a result of the acquisition of SiA, our French subsidiary, in October 2006, and to a lesser extent due to an increase in fixed fee integrated solutions. Services revenue derived from the acquired business increased approximately $10.7 million for the year ended December 31, 2007 compared to the year ended December 31, 2006. Services revenues derived from our acquisition of SiA included $5.1 million in recognized revenue related to sales of licenses bundled with services for which VSOE did not exist for the year ended December 31, 2007 compared to $521,000 for the year ended December 31, 2006. Services revenue from fixed fee integrated solutions increased $7.1 million for the year ended December 31, 2007 compared to the year ended December 31, 2006 primarily due to new contracts signed during 2007.

        Software licenses.    Software licenses revenue decreased $4.1 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to weakness in attracting new customers in light of customer capital spending constraints.

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        Gainshare Performance Incentives.    Revenue derived from gainshare performance incentives increased $4.1 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to improved yields and related volumes at our customers' sites.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cost of Design-to-Silicon-Yield Solutions	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Services	 	$	32,279	 	$	27,418	 	$	4,861	 	 	18	%	 	34	%	 	36	%	
Software licenses	 	 	191	 	 	209	 	 	(18	)	 	(9	)	 	—	 	 	—	 	
Amortization of acquired technology	 	 	5,148	 	 	5,270	 	 	(122	)	 	(2	)	 	6	 	 	7	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	37,618	 	$	32,897	 	$	4,721	 	 	14	%	 	40	%	 	43	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Costs of Design-to-Silicon-Yield Solutions.    

        Services.    The costs of Design-to-Silicon-Yield services increased $4.9 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to an increase of $2.0 million in expenses related to additional revenues driven by our acquisition of SiA in October 2006, and an increase of $993,000 in costs associated with the deployment of our pdFasTest products at new engagements signed during the year ended December 31, 2007.

        Software Licenses.    The costs of Design-to-Silicon-Yield solutions software licenses decreased moderately $18,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006.

        Amortization of Acquired Technology.    Amortization of acquired technology expense decreased $122,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to a decrease of $1.9 million in amortization from certain intangible assets becoming fully amortized during the fiscal year 2007, partially offset by an increase of $1.8 million in amortization of technology acquired from our acquisitions of SiA in October 2006 and Fabbrix in May 2007.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Research and Development	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Research and development	 	$	36,074	 	$	27,613	 	$	8,461	 	 	31	%	 	38	%	 	37	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Research and Development.    Research and development expenses increased $8.5 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily the result of the acquisition of SiA in October 2006. Expenses in our French subsidiary increased approximately $6.0 million for the twelve months in fiscal year 2007 compared to the two months in fiscal year 2006.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Selling, General and Administrative	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Selling, general and administrative	 	$	24,891	 	$	19,814	 	$	5,077	 	 	26	%	 	26	%	 	26	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Selling, General and Administrative.    Selling, general and administrative expenses increased $5.1 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to increased operating costs as a result of the acquisition of SiA in October 2006, and to a lesser extent to increases in outside sales commissions and legal expenses incurred as a result defending our intellectual property rights. Selling, general and administrative expenses incurred by our French

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subsidiary increased $3.1 million for the twelve months in fiscal year 2007 compared to the two months in fiscal year 2006. Outside sales commission increased $644,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006 as a result of increases in revenue.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Amortization of Other Acquired Intangible Assets	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Amortization of other acquired intangible assets	 	$	3,422	 	$	1,459	 	$	1,963	 	 	135	%	 	4	%	 	2	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Amortization of Other Acquired Intangible Assets.    Amortization of other acquired intangible assets increased $2.0 million for the year ended December 31, 2007 compared to the year ended December 31, 2006 as a result of the acquisition of SiA in October 2006.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Write-off of In-Process Research and Development	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Write-off of in-process research and development	 	$	—	 	$	800	 	$	(800	)	 	(100	)%	 	—	%	 	1	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Write-off of In-process Research and Development.    Write-off of in-process research and development of $800,000 in the year ended December 31, 2006 was related to the acquisition of SiA and was associated with acquired technology that had not reached technological feasibility and for which there was no alternative future use. At December 31, 2006, the acquired technology was not being developed and did not have alternative future use. We determined the fair value of the acquired in-process technology by estimating the cash flows related to projects under development and the estimated revenues and operating profits related to those projects. The resulting estimated cash flows were discounted to their net present value. There was no such expense in 2007.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest and Other Income, Net	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Interest and other income, net	 	$	1,891	 	$	2,827	 	$	(936	)	 	(33	)%	 	2	%	 	4	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Interest and Other Income, Net.    Interest and other income, net, decreased $936,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to lower average cash, cash equivalent, and short-term investments balance during the period. During fiscal year 2007, we spent $6.0 million to repurchase treasury stock, and made payments of $4.6 million in connection with those acquisitions. We also spent $2.2 million to purchase property and equipment.
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income Tax Benefit	 	2007	 	2006	 	$
Change	 	%
Change	 	2007
% of
Revenue	 	2006
% of
Revenue	 	
 
	 	(In thousands, except for %'s)
	 	
Income tax benefit	 	$	(2,724	)	$	(3,133	)	$	409	 	 	(13	)%	 	(3	)%	 	(4	)%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        Income Tax Benefit.    Income tax benefit decreased $409,000 for the year ended December 31, 2007 compared to the year ended December 31, 2006, primarily due to a decrease of $2.1 million in tax credits claimed, partially offset by the increase of $728,000 in statutory tax benefit for the year ended December 31, 2007. In the year ended December 31, 2006, we performed a study that allowed us to claim additional research and development credits for prior years.

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Liquidity and Capital Resources

Operating Activities

        Cash flows from operating activities consist of net loss adjusted for certain non-cash items and changes in assets and liabilities. Net cash provided by operating activities was $7.6 million for the year ended December 31, 2008, an increase of $6.2 million compared to $1.4 million for the year ended December 31, 2007, primarily due to a decrease in accounts receivable, partially offset by a higher net loss after adjustment for certain non-cash items including impairment on goodwill and intangible assets, a valuation allowance for deferred taxes, and amortization of acquired intangible assets.

        Accounts receivable decreased $13.6 million as of December 31, 2008 compared to December 31, 2007 primarily due to a decline in revenue for the year ended December 31, 2008. Accounts receivable increased $11.0 million as of December 31, 2007 compared to December 31, 2006 primarily due to increased revenue for the year ended December 31, 2007 as well as the timing of billing schedules specified in the contract agreements related to both design-to-silicon-yield solutions and gainshare performance incentives. Accounts payable decreased $2.1 million as of December 31, 2008 compared to December 31, 2007 primarily due to the timing of vendor payments and decreased expenditures, the result of our cost control efforts.

Investing Activities

        Cash flows from investing activities consist of proceeds from investment maturities and sales, offset by payments for investments acquired, payments for businesses acquired, and payments for capital expenditures. Net cash used in investing activities was $2.9 million for the year ended December 31, 2008, an increase of $3.1 million compared to net cash provided by investing activities of $203,000 for the year ended December 31, 2007, primarily due to lower proceeds from investment maturities and sales, partially offset by smaller payments for businesses acquired and capital expenditures. Our payments for businesses acquired were $1.6 million for the year ended December 31, 2008 compared to $4.6 million for the year ended December 31, 2007. Our payments for purchases of property and equipment were $1.1 million for the year ended December 31, 2008 compared to $2.2 million for the year ended December 31, 2007. As of December 31, 2008, we had not invested in derivative securities.

Financing Activities

        Cash flows from financing activities consist of proceeds from sales of shares through employee equity incentive plans, payments for purchase of treasury stock, and principal payments on long-term obligations. Net cash used in financing activities was $6.6 million for the year ended December 31, 2008, an increase of $2.9 million compared to $3.7 million for the year ended December 31, 2007, primarily due to lower proceeds from the exercise of stock options and our employee stock purchase plan and higher payments for the repurchase of our common stock on the open market. Proceeds from the exercise of stock options and our employee stock purchase plan were $653,000 for the year ended December 31, 2008 compared to $2.9 million for the year ended December 31, 2007. Payments for the repurchase of our common stock were $6.9 million for the year ended December 31, 2008 compared to $6.0 million for the year ended December 31, 2007.

Liquidity

        As of December 31, 2008, our working capital was $56.3 million compared to $72.5 million as of December 31, 2007. Cash, cash equivalents, and short-term investments as of December 31, 2008 were $40.7 million, a decrease of $4.5 million compared to $45.3 million as of December 31, 2007, primarily attributable to the repurchase of $6.9 million of our common stock. We anticipate that our overall expenses, as well as planned capital expenditures, may constitute a material use of our cash resources. In addition, we may use cash resources to repurchase common stock or fund potential investments in, or

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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 our 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, particularly in current capital market environment.

        As of December 31, 2008, our investments included auction-rate securities with a fair value of $718,000, which are variable rate debt instruments whose interest rates are reset through a "dutch" auction process at regular intervals, typically every 28 days. See Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" in Part II and Note 3 to "Notes to Consolidated Financial Statements" in Part IV in this Form 10-K for further discussion.

Off-Balance Sheet Arrangements

        We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt, other than operating leases on our facilities. As of December 31, 2008, other than Euro denominated receivables, we had no foreign currency contracts outstanding.

        We indemnify certain customers from third-party claims of intellectual property infringement relating to the use of our products. Historically, costs related to these guarantees of indemnification have not been significant. We are unable to estimate the maximum potential impact of these guarantees on our future results of operations.

Contractual Obligations

        The following table summarizes our known contractual obligations (in thousands):

	 	Payments Due by Period	 	
Contractual Obligations	 	2009	 	2010-2011	 	2012-2013	 	Other	 	Total	 	
Debt principal(1)	 	$	334	 	$	501	 	$	—	 	$	—	 	$	835	 	
Debt interest	 	 	20	 	 	17	 	 	—	 	 	—	 	 	37	 	
Capital lease obligations (including interest)	 	 	38	 	 	12	 	 	—	 	 	—	 	 	50	 	
Operating lease obligations	 	 	2,939	 	 	5,179	 	 	3,984	 	 	—	 	 	12,102	 	
Unrecognized tax benefits(2)	 	 	—	 	 	—	 	 	—	 	 	3,356	 	 	3,356	 	
 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	3,331	 	$	5,709	 	$	3,984	 	$	3,356	 	$	16,380	 	

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

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

        Operating lease amounts include minimum rental payments under our operating leases for our office facilities, as well as limited computer, office equipment, and vehicles that we utilize under lease agreements. These agreements expire at various dates through 2013. Capital lease amounts include $3,000 of imputed interest. Capital leases were contracted to purchase computer, software, office equipment, and vehicles in our French subsidiary.

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Item 7A.    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. Actual results could vary materially as a result of a number of factors.

        Interest Rate Risk.    As of December 31, 2008, we had cash, cash equivalents, and short term investments of $40.7 million. Cash and cash equivalents consisted of cash, highly liquid money market instruments and commercial paper with maturities of 90 days or less. Short-term investments consisted of debt securities with maturities of more than three months but less than twelve months. 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 100 basis points from the market rates in effect at December 31, 2008 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 interest expense.

        As of December 31, 2008, we held auction-rate securities with a par value of $1.0 million. Auction-rate securities are variable rate debt instruments whose interest rates are reset through a "dutch" auction process at regular intervals, typically every 28 days. A portion of these securities are insured by third party bond insurers and are collateralized by student loans guaranteed by governmental agencies and private entities. The liquidity of the securities has been negatively impacted by the uncertainty in the credit markets and the exposure of these securities to the financial condition of bond insurance companies. All auction-rate securities we hold have been failing to sell at auction since February 2008 due to an insufficient number of bidders. We reviewed the value of these securities for impairment as of December 31, 2008, and concluded that these securities were temporarily impaired, and recorded an unrealized loss of $282,000. In future periods, the estimated fair value of our auction-rate securities could decline further based on market conditions, which could result in additional impairment.

        Foreign Currency and Exchange Risk.    Certain of our sales contracts are denominated in a currency other than the functional currency of the selling entity. Therefore, a portion of our revenue is subject to foreign currency risks. The effect of an immediate 10% adverse change in exchange rates on foreign denominated receivables as of December 31, 2008 would result in a loss of an immaterial amount. As of December 31, 2008, we did not have outstanding hedging contracts, although we may enter into such contracts in the future. We intend to monitor our foreign currency exposure. Future exchange rate fluctuations may have a material negative impact on our business.

Item 8.    Financial Statements and Supplementary Data

        The consolidated financial statements and supplementary data required by this Item 8 are listed in Item 15(a)(1) of this Form 10-K.

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        None.

Item 9A.    Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure 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 Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by this Form 10-K, have concluded that our disclosure controls and

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procedures are effective and designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported within the timeframes specified in the rules and forms of the SEC, and (ii) is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Management's Report on Internal Control over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.

        The effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report, which is included herein.

Changes in Internal Control

        There were no changes in the our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 of the Exchange Act that occurred during the our fourth fiscal quarter of 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.    Other Information.

        None.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
PDF Solutions, Inc.
San Jose, California

        We have audited the internal control over financial reporting of PDF Solutions, Inc. and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2008, of the Company and our report dated March 16, 2009, expressed an unqualified opinion on those consolidated financial statements and financial statement schedule and included an explanatory paragraph regarding the adoption of Emerging Issues Task Force Issue No. 06-02, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43  and Financial Accounting Standards Board Interpretation No. 48 Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.
 	 	 	
/s/ DELOITTE & TOUCHE LLP	 	 	
San Jose, California
March 16, 2009

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PART III

        Pursuant to Paragraph (3) of the General Instructions to Form 10-K, certain of the information required by Part III of this Form 10-K is incorporated by reference from our Proxy Statement as set forth below. The Proxy Statement is expected to be filed within 120 days of December 31, 2008.

Item 10.    Directors and Executive Officers of the Registrant.

        Information with respect to our directors appears in our Proxy Statement under "Proposal No. 1—Election of Directors—Nominees for the Board of Directors" and is incorporated herein by reference. Information with respect to our executive officers appears in Part I, Item 1—"Executive Officers" of this Form 10-K.

        Information with respect to compliance with Section 16(a) of the Exchange Act, appears in our Proxy Statement under "Section 16 Beneficial Ownership Reporting Compliance" and is incorporated herein by reference.

        Our Board of Directors has adopted a Code of Ethics ("Code of Ethics") which is applicable to our Chief Executive Officer, our Chief Financial Officer and employees of the Company. Our Code of Ethics is available on our website at www.pdf.com, on the investor relations page. You may also request a copy of our Code of Ethics in writing by sending your request to PDF Solutions, Inc., Attention: Investor Relations, 333 W. San Carlos Street, San Jose, California 95110. If we make any substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, from a provision of the Code of Ethics to our Chief Executive Officer or Chief Financial Officer, we will disclose the nature of such amendment or waiver on our website or in a current report on Form 8-K.

Item 11.    Executive Compensation.

        The information required by this item is incorporated herein by reference to the section entitled "Compensation of Executive Officers and Other Matters—Executive Compensation" in our Proxy Statement.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

        The information required by this item is incorporated herein by reference to the section entitled "Security Ownership of Certain Beneficial Owners and Management" in our Proxy Statement.

Item 13.    Certain Relationships and Related Transactions.

        The information required by this item is incorporated herein by reference to the section entitled "Certain Relationships and Related Transactions" in our Proxy Statement.

Item 14.    Principal Accounting Fees and Services.

        Information with respect to Principal Accountant Fees and Services is incorporated by reference from our Proxy Statement.

Non-Audit Services Provided by Independent Registered Public Accounting Firm

        During 2008, our independent registered public accounting firm, Deloitte & Touche LLP, performed certain international tax planning and tax compliance services that were approved by the Audit Committee of our Board of Directors.

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PART IV

Item 15.    Exhibits and Financial Statement Schedules.

        (a)   The following documents are filed as part of this report:

        (1)   Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm

See Index to Consolidated Financial Statements.

        (2)   Schedule II Valuation and Qualifying Accounts

See the Report of Independent Registered Public Accounting Firm and Schedule II.

        (3)   Exhibits

        The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this Annual Report on Form 10-K.

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PDF SOLUTIONS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
	 	Page	
PDF SOLUTIONS, INC	 	 	
 	Report of Independent Registered Public Accounting Firm	 	50	
 	Consolidated Balance Sheets as of December 31, 2008 and 2007	 	51	
 	Consolidated Statements of Operations for each of the Three Years in the Period Ended December 31, 2008	 	52	
 	Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for each of the Three Years in the Period Ended December 31, 2008	 	53	
 	Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 2008	 	54	
 	Notes to Consolidated Financial Statements	 	55	
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
PDF Solutions, Inc.
San Jose, California

        We have audited the accompanying consolidated balance sheets of PDF Solutions, Inc. and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2008. In connection with our audits of the consolidated financial statements, we have also audited the financial statements schedule, as set forth under Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PDF Solutions, Inc. and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        As discussed in Note 1 to the consolidated financial statements, effective January 1, 2007, the Company changed its method of accounting for its sabbatical program in accordance with guidance provided by Emerging Issues Task Force Issue No. 06-02, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43  and its method of measuring and recognizing tax benefits associated with uncertain tax positions in accordance with Financial Accounting Standards Board Interpretation No. 48 Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 .

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework  issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009, expressed an unqualified opinion on the Company's internal control over financial reporting.
 	 	 	
/s/ DELOITTE & TOUCHE LLP	 	 	
San Jose, California
March 16, 2009

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PDF SOLUTIONS, INC.

CONSOLIDATED BALANCE SHEETS

 
	 	December 31,	 	
 
	 	2008	 	2007	 	
 
	 	(In thousands,
except par values)
	 	
ASSETS	 	 	 	 	 	 	 	
Current assets:	 	 	 	 	 	 	 	
 	Cash and cash equivalents	 	$	31,686	 	$	35,315	 	
 	Short-term investments	 	 	9,051	 	 	9,949	 	
 	Accounts receivable, net of allowances of $254 in 2008 and 2007	 	 	24,989	 	 	38,526	 	
 	Prepaid expenses, deferred tax assets, and other current assets	 	 	5,147	 	 	5,030	 	
 	 	 	 	 	 	
 	 	Total current assets	 	 	70,873	 	 	88,820	 	
Property and equipment, net	 	 	2,675	 	 	3,621	 	
Non-current investments	 	 	718	 	 	—	 	
Goodwill	 	 	—	 	 	65,170	 	
Intangible assets, net	 	 	4,730	 	 	12,818	 	
Deferred tax assets and other non-current assets	 	 	631	 	 	8,922	 	
 	 	 	 	 	 	
 	 	 	Total assets	 	$	79,627	 	$	179,351	 	
 	 	 	 	 	 	
LIABILITIES AND STOCKHOLDERS' EQUITY	 	 	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	 	 	
 	Current portion of long-term debt	 	$	370	 	$	421	 	
 	Accounts payable	 	 	1,384	 	 	3,469	 	
 	Accrued compensation and related benefits	 	 	6,525	 	 	5,950	 	
 	Taxes payable and other accrued liabilities	 	 	3,723	 	 	2,812	 	
 	Deferred revenues	 	 	1,792	 	 	3,159	 	
 	Billings in excess of recognized revenue	 	 	748	 	 	553	 	
 	 	 	 	 	 	
 	 	Total current liabilities	 	 	14,542	 	 	16,364	 	
Long-term debt	 	 	512	 	 	907	 	
Long-term taxes payable	 	 	3,356	 	 	5,581	 	
Long-term other liabilities	 	 	1,447	 	 	29	 	
 	 	 	 	 	 	
 	 	Total liabilities	 	 	19,857	 	 	22,881	 	
 	 	 	 	 	 	
Commitments and contingencies (Notes 7 and 14)	 	 	 	 	 	 	 	
Stockholders' equity:	 	 	 	 	 	 	 	
 	Preferred stock, $0.00015 par value, 5,000 shares authorized, no shares issued and outstanding	 	 	—	 	 	—	 	
 	Common stock, $0.00015 par value, 70,000 shares authorized: shares issued 29,339 in 2008 and 29,122 in 2007; shares outstanding 25,923 in 2008 and 27,933 in 2007	 	 	4	 	 	4	 	
 	Additional paid-in capital	 	 	189,132	 	 	181,566	 	
 	Treasury stock at cost, 3,416 shares in 2008 and 1,190 shares in 2007	 	 	(18,402	)	 	(11,524	)	
 	Accumulated deficit	 	 	(112,620	)	 	(16,892	)	
 	Accumulated other comprehensive income	 	 	1,656	 	 	3,316	 	
 	 	 	 	 	 	
 	 	Total stockholders' equity	 	 	59,770	 	 	156,470	 	
 	 	 	 	 	 	
 	 	 	Total liabilities and stockholders' equity	 	$	79,627	 	$	179,351	 	
 	 	 	 	 	 	
See notes to consolidated financial statements.

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PDF SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 
	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
 
	 	(In thousands, except
per share amounts)
	 	
Revenues:	 	 	 	 	 	 	 	 	 	 	
 	Design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	
 	 	Services	 	$	50,273	 	$	63,731	 	$	45,382	 	
 	 	Software licenses	 	 	4,840	 	 	6,645	 	 	10,774	 	
 	Gainshare performance incentives	 	 	18,924	 	 	24,087	 	 	20,028	 	
 	 	 	 	 	 	 	 	
 	 	 	Total revenues	 	 	74,037	 	 	94,463	 	 	76,184	 	
 	 	 	 	 	 	 	 	
Cost of design-to-silicon-yield solutions:	 	 	 	 	 	 	 	 	 	 	
 	Services	 	 	28,926	 	 	32,279	 	 	27,418	 	
 	Software licenses	 	 	185	 	 	191	 	 	209	 	
 	Amortization and impairment of acquired technology	 	 	6,012	 	 	5,148	 	 	5,270	 	
 	 	 	 	 	 	 	 	
 	 	 	Total cost of design-to-silicon-yield solutions	 	 	35,123	 	 	37,618	 	 	32,897	 	
 	 	 	 	 	 	 	 	
Gross margin	 	 	38,914	 	 	56,845	 	 	43,287	 	
Operating expenses:	 	 	 	 	 	 	 	 	 	 	
 	Research and development	 	 	33,994	 	 	36,074	 	 	27,613	 	
 	Selling, general and administrative	 	 	21,778	 	 	24,891	 	 	19,814	 	
 	Amortization of other acquired intangible assets	 	 	893	 	 	3,422	 	 	1,459	 	
 	Restructuring charges	 	 	3,401	 	 	—	 	 	—	 	
 	Impairment on goodwill and other acquired intangible assets	 	 	66,830	 	 	—	 	 	—	 	
 	Write-off of in-process research and development	 	 	—	 	 	—	 	 	800	 	
 	 	 	 	 	 	 	 	
 	 	 	Total operating expenses	 	 	126,896	 	 	64,387	 	 	49,686	 	
 	 	 	 	 	 	 	 	
Loss from operations	 	 	(87,982	)	 	(7,542	)	 	(6,399	)	
Interest and other income, net	 	 	353	 	 	1,891	 	 	2,827	 	
 	 	 	 	 	 	 	 	
Loss before taxes	 	 	(87,629	)	 	(5,651	)	 	(3,572	)	
Income tax provision (benefit)	 	 	8,099	 	 	(2,724	)	 	(3,133	)	
 	 	 	 	 	 	 	 	
Net loss	 	$	(95,728	)	$	(2,927	)	$	(439	)	
 	 	 	 	 	 	 	 	
Net loss per share—basic and diluted	 	$	(3.48	)	$	(0.10	)	$	(0.02	)	
 	 	 	 	 	 	 	 	
Weighted average common shares—basic and diluted	 	 	27,514	 	 	28,066	 	 	26,885	 	
 	 	 	 	 	 	 	 	
See notes to consolidated financial statements.

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PDF SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)

 
	 	Common Stock	 	 
	 	 
	 	Treasury Stock	 	 
	 	Accumulated
Other
Comprehensive
Income (Loss)	 	 

	 	 	 	Additional
Paid-In
Capital	 	Deferred
Stock-Based
Compensation	 	 	 	Accumulated
Deficit	 	 	 	 

	 	Shares	 	Amount	 	 	 	 	 	Shares	 	Amount	 	 	 	 	 	Total	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 
	 	(In thousands)
	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balances, January 1, 2006	 	 	26,433	 	$	4	 	$	141,720	 	$	(27	)	 	551	 	$	(5,549	)	$	(13,451	)	$	(16	)	$	122,681	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Exercise of options	 	 	639	 	 	 	 	 	6,021	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	6,021	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Issuance of common stock in connection with employee stock purchase plan	 	 	177	 	 	 	 	 	1,752	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	1,752	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Issuance of common stock in connection with acquisition	 	 	699	 	 	 	 	 	9,362	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	9,362	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Reversal of deferred stock-based compensation expense	 	 	 	 	 	 	 	 	(27	)	 	27	 	 	 	 	 	 	 	 	 	 	 	 	 	 	—	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Stock-based compensation expense	 	 	 	 	 	 	 	 	7,351	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	7,351	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Tax benefit related to stock-based compensation expense	 	 	 	 	 	 	 	 	1,144	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	1,144	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(439	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cumulative translation adjustment	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	347	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Comprehensive loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(92	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balances, December 31, 2006	 	 	27,948	 	 	4	 	 	167,323	 	 	—	 	 	551	 	 	(5,549	)	 	(13,890	)	 	331	 	 	148,219	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Exercise of options	 	 	182	 	 	 	 	 	1,442	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	1,442	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Issuance of common stock in connection with employee stock purchase plan	 	 	170	 	 	 	 	 	1,490	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	1,490	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Issuance of common stock in connection with acquisition	 	 	272	 	 	 	 	 	2,874	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	2,874	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Purchases of treasury stock	 	 	(639	)	 	 	 	 	 	 	 	 	 	 	639	 	 	(5,975	)	 	 	 	 	 	 	 	(5,975	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Stock-based compensation expense	 	 	 	 	 	 	 	 	8,229	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	8,229	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Tax benefit related to stock-based compensation expense	 	 	 	 	 	 	 	 	208	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	208	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(2,927	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cumulative translation adjustment, net of tax effect	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	2,982	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Unrealized gain on investments	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	3	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Comprehensive income	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	58	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cumulative effect from adoption of FIN No. 48	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	771	 	 	 	 	 	771	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cumulative effect from adoption of EITF No. 06-2, net of tax effect	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(846	)	 	 	 	 	(846	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balances, December 31, 2007	 	 	27,933	 	 	4	 	 	181,566	 	 	—	 	 	1,190	 	 	(11,524	)	 	(16,892	)	 	3,316	 	 	156,470	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Exercise of options	 	 	12	 	 	 	 	 	63	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	63	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Issuance of common stock in connection with employee stock purchase plan	 	 	152	 	 	 	 	 	590	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	590	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Purchases of treasury stock	 	 	(2,226	)	 	 	 	 	 	 	 	 	 	 	2,226	 	 	(6,878	)	 	 	 	 	 	 	 	(6,878	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Restricted stock grants	 	 	52	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Stock-based compensation expense	 	 	 	 	 	 	 	 	7,228	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	7,228	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Deferred tax asset write-off upon expiration of certain stock option awards	 	 	 	 	 	 	 	 	(315	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(315	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(95,728	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cumulative translation adjustment	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(1,439	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Unrealized loss on investments	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(221	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Comprehensive loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(97,388	)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Balances, December 31, 2008	 	 	25,923	 	$	4	 	$	189,132	 	$	—	 	 	3,416	 	$	(18,402	)	$	(112,620	)	$	1,656	 	$	59,770	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
See notes to consolidated financial statements.

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PDF SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 
	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
 
	 	(In thousands)
	 	
Operating activities:	 	 	 	 	 	 	 	 	 	 	
 	Net loss	 	$	(95,728	)	$	(2,927	)	$	(439	)	
 	Adjustments to reconcile net loss to net cash provided by operating activities:	 	 	 	 	 	 	 	 	 	 	
 	 	Impairment on goodwill and intangible assets	 	 	70,250	 	 	—	 	 	—	 	
 	 	Depreciation and amortization	 	 	1,858	 	 	2,070	 	 	2,103	 	
 	 	Stock-based compensation expense	 	 	7,228	 	 	8,229	 	 	7,351	 	
 	 	Loss on sale of investment security and other	 	 	552	 	 	—	 	 	61	 	
 	 	Amortization of acquired intangible assets	 	 	3,485	 	 	8,637	 	 	6,729	 	
 	 	Tax benefit related to stock-based compensation expense	 	 	—	 	 	208	 	 	1,144	 	
 	 	Excess tax benefit from stock-based compensation expense	 	 	—	 	 	(44	)	 	(463	)	
 	 	Write-off of in-process research and development	 	 	—	 	 	—	 	 	800	 	
 	 	Deferred taxes	 	 	2,566	 	 	(5,494	)	 	(6,864	)	
 	Changes in operating assets and liabilities, net of effect of acquisition:	 	 	 	 	 	 	 	 	 	 	
 	 	Accounts receivable, net of allowances	 	 	13,593	 	 	(10,951	)	 	(3,648	)	
 	 	Prepaid expenses and other assets	 	 	1,254	 	 	(510	)	 	(67	)	
 	 	Accounts payable	 	 	(2,111	)	 	59	 	 	391	 	
 	 	Accrued compensation and related benefits	 	 	641	 	 	1,182	 	 	(2,402	)	
 	 	Taxes payable and other accrued liabilities	 	 	5,164	 	 	999	 	 	(1,766	)	
 	 	Deferred revenues	 	 	(1,383	)	 	(546	)	 	1,206	 	
 	 	Billings in excess of recognized revenue	 	 	195	 	 	458	 	 	(1,509	)	
 	 	 	 	 	 	 	 	
 	 	 	Net cash provided by operating activities	 	 	7,564	 	 	1,370	 	 	2,627	 	
 	 	 	 	 	 	 	 	
Investing activities:	 	 	 	 	 	 	 	 	 	 	
 	Purchases of available-for-sale securities	 	 	(27,094	)	 	(26,803	)	 	(45,823	)	
 	Maturities and sales of available-for-sale securities	 	 	26,940	 	 	33,818	 	 	31,700	 	
 	Purchases of property and equipment	 	 	(1,115	)	 	(2,226	)	 	(2,433	)	
 	Businesses acquired in purchase transactions, net of cash acquired	 	 	(1,604	)	 	(4,586	)	 	(18,658	)	
 	 	 	 	 	 	 	 	
 	 	 	Net cash provided by (used in) investing activities	 	 	(2,873	)	 	203	 	 	(35,214	)	
 	 	 	 	 	 	 	 	
Financing activities:	 	 	 	 	 	 	 	 	 	 	
 	Exercise of stock options	 	 	63	 	 	1,442	 	 	6,021	 	
 	Proceeds from employee stock purchase plan	 	 	590	 	 	1,490	 	 	1,752	 	
 	Purchases of treasury stock	 	 	(6,878	)	 	(5,975	)	 	—	 	
 	Principal payments on long-term obligations	 	 	(409	)	 	(324	)	 	(23	)	
 	Principal payments on notes to stockholders	 	 	—	 	 	(416	)	 	—	 	
 	Excess tax benefit from stock-based compensation expense	 	 	—	 	 	44	 	 	463	 	
 	 	 	 	 	 	 	 	
 	 	 	Net cash provided by (used in) financing activities	 	 	(6,634	)	 	(3,739	)	 	8,213	 	
 	 	 	 	 	 	 	 	
Effect of exchange rate changes on cash and cash equivalents	 	 	(1,686	)	 	1,030	 	 	319	 	
 	 	 	 	 	 	 	 	
 	 	 	Net decrease in cash and cash equivalents	 	 	(3,629	)	 	(1,136	)	 	(24,055	)	
Cash and cash equivalents, beginning of period	 	 	35,315	 	 	36,451	 	 	60,506	 	
 	 	 	 	 	 	 	 	
Cash and cash equivalents, end of period	 	$	31,686	 	$	35,315	 	$	36,451	 	
 	 	 	 	 	 	 	 	
Non-cash investing and financing activities:	 	 	 	 	 	 	 	 	 	 	
 	Stock issued for acquisitions	 	$	—	 	$	2,874	 	$	9,362	 	
 	 	 	 	 	 	 	 	
 	Purchase price adjustments	 	$	216	 	$	9	 	$	923	 	
 	 	 	 	 	 	 	 	
Supplemental disclosure of cash flow information:	 	 	 	 	 	 	 	 	 	 	
 	Cash paid during the year for:	 	 	 	 	 	 	 	 	 	 	
 	 	Taxes	 	$	2,421	 	$	634	 	$	2,808	 	
 	 	 	 	 	 	 	 	
 	 	Interest	 	$	39	 	$	48	 	$	5	 	
 	 	 	 	 	 	 	 	
See notes to consolidated financial statements.

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PDF SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies

        PDF Solutions, Inc. (the "Company" or "PDF"), provides infrastructure technologies and services to improve yield and optimize performance of integrated circuits. The Company's approach includes manufacturing simulation and analysis, combined with yield improvement methodologies to increase product yield and performance.

        Basis of Presentation—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.

        Significant Estimates—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 requires estimates in regards to total costs which may be incurred and revenues earned. Actual results could differ from these estimates.

        Certain Significant Risks and Uncertainties—The Company operates in the dynamic semiconductor and software industries, and accordingly, can be affected by a variety of factors. For example, management of the Company believes that changes in any of the following areas could have a significant negative effect on the Company in terms of its future financial position, results of operations and cash flows: regulatory changes; fundamental changes in the technology underlying software technologies; market acceptance of the Company's solutions; development of sales channels; litigation or other claims against the Company; the hiring, training and retention of key employees; successful and timely completion of development efforts; integration of newly acquired companies; and new product introductions by competitors.

        Concentration of Credit Risk—Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments, and accounts receivable. The Company maintains its cash and cash equivalents and investments with what it considers high credit quality financial institutions.

        The Company primarily sells its technologies and services to companies in Japan, Europe and North America within the semiconductor industry, which is currently experiencing a downturn with limited visibility to the extent and timing of the recoverability. As of December 31, 2008, four customers accounted for 52% of the Company's gross accounts receivable and two customers accounted for 34% of the Company's total revenue for 2008. As of December 31, 2007, three customers accounted for 53% of the Company's gross accounts receivable and two customers accounted for 35% of the Company's total revenue for 2007. As of December 31, 2006, four customers accounted for 52% of the Company's gross accounts receivable and two customers accounted for 37% of the Company's total revenue for 2006. The Company does not require collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition. The Company maintains allowances for potential credit losses. The allowance for doubtful accounts, which was based on management's best estimates, could be adjusted in the near term from current estimates depending on actual experience. Such adjustments could be material to the consolidated financial statements.

        Cash, Cash Equivalents and Short-term Investments—The Company considers all highly liquid investments with an original maturity of 90 days or less or investments with a remaining maturity of 90 days

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PDF SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

or less at the time of purchase to be cash equivalents. Investments with maturities greater than three months and less than one year are classified as short-term investments.

        Accounts Receivable—Accounts receivable includes amounts that are unbilled at the end of the period. Unbilled accounts receivable are determined on an individual contract basis and were approximately $10.5 million and $12.1 million at December 31, 2008 and 2007, respectively.

        Property and Equipment—Property and equipment are stated at cost and are depreciated or amortized using the straight-line method over the estimated useful lives of the related asset as follows:
 	 	 	
Computer and equipment	 	3 years	
Software	 	3 years	
Furniture, fixtures, and equipment	 	5-7 years	
Leasehold improvements	 	Shorter of estimated useful life or term of lease	
Assets acquired under capital lease	 	Shorter of estimated useful life or term of lease	
        Goodwill and Intangible Assets—In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142,Goodwill and Other Intangible Assets  ("SFAS No. 142"), goodwill is generated when the consideration paid for an acquisition exceeds its fair value of net tangible assets acquired. Acquired intangible assets are amortized over their useful lives unless these lives are determined to be indefinite. The Company assesses impairment on goodwill and acquired intangible assets annually and whenever events or changes in circumstances indicate they may be impaired. In valuation of its goodwill and intangible assets, the Company must make assumptions regarding estimated future cash flows to be derived from the acquired assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment for these assets. At December 31, 2008, the Company performed its annual goodwill impairment test and recorded an impairment of goodwill of $64.0 million, representing all of the Company's carrying value of goodwill. See Note 5 to the consolidated financial statements for further discussion.

        Long-lived Assets—The Company's long-lived assets, excluding goodwill, consist of property and equipment and other acquired intangibles. The Company periodically reviews its long-lived assets for impairment in accordance with SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets.  For assets to be held and used, the Company initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset group may not be recoverable. Recoverability of an asset group is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset group is expected to generate. If it is determined that an asset group is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset group exceeds its fair value. At December 31, 2008, the Company performed a review of long-lived assets at which it was determined that the carrying value of its asset group was not recoverable. Accordingly, the Company recorded an impairment of $6.3 million associated with certain acquired intangible assets. See Note 5 to the consolidated financial statements for further discussion.

        Revenue Recognition—The Company derives revenue from two sources: Design-to-Silicon-Yield Solutions, which includes Services and Software Licenses, and Gainshare Performance Incentives. The

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PDF SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

Company recognizes revenue in accordance with the provisions of American Institute of Certified Public Accountants Statement of Position ("SOP") No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts  and SOP No. 97-2, Software Revenue Recognition, as amended.

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

        Services—The Company generates a significant portion of its Design-to-Silicon-Yield solutions revenue from fixed-price solution implementation service contracts delivered over a specific period of time. These contracts require accurate estimation of cost to perform obligations and overall scope of each engagement. Revenue under contracts for solution implementation services is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting. Losses on solution implementation contracts are recognized in the period when they become evident. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated.

        On occasion, the Company has licensed its software products as a component of its fixed-price services contracts. In such instances, the software products are licensed to customers over a specified term of the agreement with support and maintenance to be provided over the license term. Under these arrangements, where vendor-specific objective evidence of fair value ("VSOE") exists for the support and maintenance element, the support and maintenance revenue is recognized separately over the term of the supporting period. The remaining fee is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting. VSOE for maintenance, in these instances, is generally established based upon a negotiated renewal rate. Under arrangements where software products are licensed as a component of its fixed-price service contract and where VSOE does not exist to allocate a portion of the total fixed-price to the undelivered elements, revenue is recognized for the total fixed-price as the lesser of either the percentage of completion method of contract accounting or ratably over the longer of either the term of the agreement or the supporting period. Costs incurred under these arrangements are deferred and recognized in proportion to revenue recognized under these arrangements.

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

        Software Licenses—The Company also licenses its software products separately from its integrated solution implementations. For software license arrangements that do not require significant

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PDF SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

modification or customization of the underlying software, software license revenue is recognized under the residual method when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the fee is fixed or determinable, (4) collectibility is probable, and (5) the arrangement does not require services that are essential to the functionality of the software. When arrangements include multiple elements such as support and maintenance, consulting (other than for its fixed price solution implementations), installation, and training, revenue is allocated to each element of a transaction based upon its fair value as determined by the Company's VSOE and such services are recorded as services. VSOE is generally established for maintenance based upon negotiated renewal rates while VSOE for consulting, installation and training services is established based upon the Company's customary pricing for such services when sold separately. When VSOE does not exist to allocate a portion of the total fee to the undelivered elements, revenue is recognized ratably over the longest period of the undelivered elements, and such revenue is recorded as services. Revenue for software licenses with extended payment terms is not recognized in excess of amounts due. For software license arrangements that require significant modification or customization of the underlying software, the software license revenue is recognized as services are performed using the cost-to-cost percentage of completion method of contract accounting, and such revenue is recorded as services. During the year ended December 31, 2006, the Company entered into a barter transaction with another software company. As the fair value of the software licenses exchanged could not be reliably estimated, the Company did not record any revenue nor cost for the transaction.

        Gainshare Performance Incentives—When the Company enters into a contract to provide yield improvement services, the contract usually includes two components: (1) a fixed fee for performance by the Company of services delivered over a specific period of time; and (2) a gainshare performance incentives component where the customer may pay a variable fee, usually after the fixed fee period has ended. Revenue derived from gainshare performance incentives represents profit sharing and performance incentives earned based upon the Company's customers reaching certain defined operational levels established in related solution implementation services contracts. Gainshare performance incentives periods are usually subsequent to the delivery of all contractual services and therefore have no cost to the Company. Due to the uncertainties surrounding attainment of such operational levels, the Company recognizes gainshare performance incentives 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.

        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 SFAS No. 86, Computer Software to be Sold, Leased or Otherwise Marketed.  Because the Company believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date.

        Research and Development—Research and development expenses are charged to operations as incurred.

        Stock-Based Compensation—Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123 (revised 2004),Share-Based Payment  ("SFAS No. 123(R)"). The statement eliminates the ability to account for share-based compensation transactions using Accounting Principles Board ("APB") Opinion

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PDF SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

No. 25,Accounting for Stock Issued to Employees ("APB No. 25") and requires that the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements based on estimated fair values. SFAS No. 123(R) applies to all share-based payment transactions in which the Company acquires goods or services by issuing its shares, share options, or other equity instruments or by incurring liabilities based on the price of the Company's shares or that require settlement by the issuance of equity instruments. The Company elected to use the modified prospective transition method upon adopting this statement and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123(R). Under this transition method, stock-based compensation expense for the year ended December 31, 2006, 2007, and 2008, includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123. Stock-based compensation expense during fiscal 2006 also includes expense for all stock-based compensation awards granted after January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognizes the compensation costs of stock purchase rights and stock options granted after January 1, 2006 on a straight-line basis over the vesting periods of the applicable stock purchase rights and stock options, generally four years. Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based compensation in accordance with APB No. 25, and complied 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 was amortized to expense using the graded vesting method. Prior to adoption of SFAS No. 123(R), the Company presented all tax benefits resulting from stock purchase rights and stock options as operating cash flows in its statement of cash flows. In accordance with SFAS No. l23(R), the cash flows resulting from excess tax benefits for awards accounted under SFAS No. 123(R) are classified as financing cash flows.

        In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107") regarding the SEC's interpretation of SFAS No. 123(R) and the valuation of share-based payments for public companies. The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R). In December 2007, the SEC issued Staff Accounting Bulletin No. 110 ("SAB 110") to amend the SEC's views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123(R). SAB 110 is effective for the Company beginning in the first quarter of fiscal year 2008. In the fourth quarter of fiscal 2007, the Company had enough historical data to determine its expected life. See Note 8 to the Consolidated Financial Statements for a further discussion on stock-based compensation.

        Restructuring Charges—The Company accounts for restructuring charges in accordance with SEC Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges , as amended. The Company accounted for (1) the leased facilities portions of its restructurings in accordance with SFAS No. 146,  Accounting for Costs Associated with Exit or Disposal Activities ; (2) the asset-related portions of its restructurings in accordance with SFAS No. 144; and (3) the severance and benefits charges in accordance with SFAS No. 112,  Employers' Accounting for Postemployment Benefits—An Amendment of FASB Statements No. 5 and 43.

        In connection with these restructuring plans, the Company has made a number of estimates and assumptions related to losses on excess facilities vacated, particularly the timing of subleases and sublease terms. Closure and space reduction costs included in the restructuring charges include payments required

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Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

under leases less any applicable estimated sublease income after the facilities are abandoned, lease buyout costs and certain contractual costs to maintain facilities during the period after abandonment.

        In addition, the Company has recorded estimated provisions for termination benefits and other restructuring costs. The Company regularly evaluates the adequacy of its restructuring accrual, and adjusts the balance based on changes in estimates and assumptions. The Company may incur future charges for new restructuring plans as well as for changes in estimates to amounts previously recorded.

        Income Taxes—The Company provides for the effect of income taxes in its consolidated financial statements in accordance with SFAS No. 109, Accounting for Income Taxes,  ("SFAS No. 109"), and Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 , ("FIN No. 48"). The Company must make significant judgments to apply the principles of SFAS No. 109 and FIN No. 48.

        In accordance with SFAS No. 109, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

        The Company then records a valuation allowance to reduce the deferred tax assets to the amount that the Company believes it is more likely than not to realize based on its judgment of all available positive and negative factors. Deferred tax assets are realized by an enterprise by having sufficient taxable income to allow the related tax benefits to reduce taxes otherwise payable. Accordingly, the taxable income must be both of an appropriate character (e.g., capital versus ordinary) and within the carry-back and carry-forward periods permitted by law. In making such assessments, the Company must make significant judgments about the possible sources of taxable income and the evidence available about each possible sources of taxable income on a jurisdiction by jurisdiction basis. As required under SFAS No. 109, the weight given to the potential effect of negative and positive evidence is commensurate with the extent to which the strength of the evidence can be objectively verified. For the year ended December 31, 2008, the Company concluded that a valuation allowance was required based on its evaluation and weighting of the positive and negative evidence. If, in the future, the Company determines that these deferred tax assets are more likely than not to be realized, a release of all or part, of the related valuation allowance could result in a material income tax benefit in the period such determination is made. See Note 10 to the consolidated financial statements for further discussion.

        Effective January 1, 2007, the Company adopted the provisions of FIN No. 48, which provides a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. Unrecognized tax benefits represent tax positions for which reserves have been established. As a result of the implementation of FIN No. 48, the Company recognized a $771,000 decrease in net liabilities for unrecognized tax benefits. This was accounted for as an adjustment to the beginning balance of the accumulated deficit on the balance sheet. As the Company does not anticipate recognizing these tax benefits over the next twelve months, it has reclassified these liabilities as long-term. Prior to the adoption of FIN No. 48, the Company recorded its tax exposure as current liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

        Foreign Currency Translation—The functional currency of the Company's foreign subsidiaries is the local currency for the respective subsidiary. The assets and liabilities are translated at the period-end exchange rate, and statements of operations are translated at the average exchange rate during the year. Gains and losses resulting from foreign currency translations are included as a component of other comprehensive income (loss). Gains and losses resulting from foreign currency transactions are included in the consolidated statement of operations.

        Comprehensive Income (Loss)—SFAS No. 130,Reporting Comprehensive Income, requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from nonowner sources. Comprehensive income (loss) is presented within the statement of stockholders' equity. Accumulated other comprehensive income as of December 31, 2008 and 2007 is comprised of (in thousands):

	 	Balance at
December 31,	 	
 
	 	2008	 	2007	 	
Unrealized gain (loss) on investments	 	$	(218	)	$	3	 	
Foreign currency translation adjustments	 	 	1,874	 	 	3,313	 	
 	 	 	 	 	 	
Accumulated other comprehensive income	 	$	1,656	 	$	3,316	 	
 	 	 	 	 	 	
        Recent Accounting Pronouncements—In December 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141 (revised 2007), Business Combinations,  ("SFAS No. 141R"). SFAS No. 141R establishes principles and requirements for how an acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree, and the goodwill acquired. SFAS No. 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141R is effective as of the beginning of an entity's fiscal year that begins after December 15, 2008, and will be adopted by the Company in the first quarter of fiscal 2009. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 141R on its financial statements.

        In March 2008, FASB, issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 , ("SFAS No. 161"). SFAS No. 161 enhances the disclosure about the Company's derivative and hedging activities. This Statement requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 does not change the accounting treatment for derivative instruments. SFAS No. 161 is effective for the Company beginning in the first quarter of fiscal year 2009. The adoption of SFAS No. 161 is not expected to have a significant impact on the Company's results of operations, cash flow or financial position.

        Accounting Changes—Effective January 1, 2007, the Company adopted the provisions of the FASB's Emerging Issues Task Force ("EITF") No. 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43  ("EITF No. 06-2"). Prior to the issuance of EITF No. 06-2 the Company accounted for sabbatical expense under SFAS No. 43, by expensing the cost of compensated

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Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

absences for sabbatical programs as incurred. EITF No. 06-2 requires companies to accrue the cost of such compensated absences over the requisite service period. The Task Force allowed the use of one of two specified methodologies for adopting the change in accounting principle: i) a cumulative-effect adjustment to retained earnings at the beginning of the year of adoption; or ii) retrospective application to all prior periods. The Company elected to use the cumulative-effect adjustment to the beginning balance of retained earnings resulting in an additional liability of $1.4 million, an additional deferred tax asset of $587,000, and an increase in the accumulated deficit of $846,000. Under this transition method, prior periods were not restated and accrued expenses as of December 31, 2008 include accrued sabbatical expense for all employees who are eligible for sabbatical leave.

        Effective January 1, 2008, the Company adopted the provisions of the FASB's SFAS No. 157,Fair Value Measurement, or SFAS No. 157, for financial assets and liabilities. SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. Additionally, the statement provides guidance on definition, measurement, methodology and use of assumptions and inputs in determining fair value. The Company applied the provisions of SFAS No. 157 to its financial assets which included its investments accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities . See Note 13 "Fair Value" below. In February 2008, the FASB issued FASB Staff Position, or FSP, 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13,  or FSP 157-1, and FSP 157-2, Effective Date of FASB Statement No. 157 , or FSP 157-2. FSP 157-1 removes certain leasing transactions from the scope of SFAS No. 157. FSP 157-2 delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 157 with respect to nonfinancial assets and liabilities on its financial statements. Nonfinancial assets and liabilities for which the Company has not applied the provisions of SFAS No. 157 include those measured at fair value in impairment testing and those initially measured at fair value in a business combination. In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,  or FSP 157-3. FSP 157-3 provides guidance for the valuation of financial assets in an inactive market, the use of internal assumptions when relevant observable data does not exist, the use of observable market information when the market is not active, and the use of market quotes when assessing the relevance of observable and unobservable data. FSP 157-3 is effective for all periods presented in accordance with SFAS No. 157. The adoption of FAS 157-3 did not have a material impact on the Company's financial results and position.

        Effective January 1, 2008, the Company adopted the provisions of the FASB's SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 , or SFAS No. 159. SFAS No. 159 permits companies to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. Entities choosing the fair value option would be required to recognize subsequent changes in the fair value of those instruments and other items directly in earnings. This standard also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The adoption of SFAS No. 159 did not have an effect on the Company's financial statements as the Company did not elect this fair value option,

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Years Ended December 31, 2008, 2007, and 2006

1. Business and Significant Accounting Policies (Continued)

nor is it expected to have a material impact on future periods as the election of this option for the Company's financial instruments is expected to be limited.

2. Acquisitions

Triant Holdings, Inc. ("Triant")

        On October 7, 2008, the Company completed the acquisition of substantially all of the assets of Triant's fault detection and classification ("FDC") business, excluding certain receivables, but including certain customer contracts and technologies. Triant developed and licensed FDC software applications and services dedicated to the semiconductor industry to enable customers to rapidly identify sources of process variations and manufacturing excursions. This acquisition creates additional opportunities for the Company's FDC business by expanding the existing installed customer base, including leading semiconductor, flat panel display, and wafer manufacturers. Total cost for the acquisition was $1.9 million, which included $1.6 million in cash and $312,000 in acquisition costs. Pursuant to the terms of the acquisition, $374,000 in cash was held in escrow as security against certain financial and other contingencies. The cash held in escrow, less amounts deducted to satisfy contingencies, was required to be released following the statutory notice to creditors associated with Triant's liquidation and wind up process. The escrow was released to Triant in February 2009. In connection with the acquisition, the Company recorded $1.7 million of identifiable intangible assets with a weighted average life of 3.4 years and $147,000 of goodwill. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations  ("SFAS No. 141"), and accordingly the Company's consolidated financial statements from October 7, 2008 include the impact of the acquisition.

        The allocation of the purchase price for this acquisition, as of the date of the acquisition, is as follows (in thousands, except amortization period):
 	 	 	 	 	 	 	 	 	 	
Allocation of Purchase Price	 	Amortization
Period
(Years)	 	Amount	 	
Fair value of tangible assets	 	 	 	 	$	135	 	
Fair value of intangible assets:	 	 	 	 	 	 	 	
 	Developed / Core technology	 	 	2	 	 	420	 	
 	Customer relationships and backlog	 	 	0.25-4	 	 	1,230	 	
 	Goodwill	 	 	N/A	 	 	147	 	
 	 	 	 	 	 	 	
 	 	Total assets acquired	 	 	 	 	 	1,932	 	
Deferred revenue	 	 	 	 	 	(16	)	
 	 	 	 	 	 	 	
 	 	Total liabilities assumed	 	 	 	 	 	(16	)	
 	 	 	 	 	 	 	
 	 	Total consideration	 	 	 	 	$	1,916	 	
 	 	 	 	 	 	 	
        The acquisition was accounted for as a purchase transaction, and accordingly, the assets and liabilities of Triant were recorded at their estimated fair values at the date of the acquisition. With the exception of the goodwill, the identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives, which vary from 0.25 to 4 years, with a weighted average life of 3.4 years. The Company

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

2. Acquisitions (Continued)

performed an impairment assessment on goodwill in the fourth fiscal quarter of 2008 and the entirety of goodwill was impaired, including the carrying value of goodwill in connection with the Triant acquisition.

        Subsequent to the acquisition of Triant, the Company completed its annual goodwill impairment test as prescribed under SFAS No. 142. In addition, due to the continued decline within the semiconductor industry brought on by the deteriorating global economic environment, the Company anticipated further declines in its future operational results. As a result, the Company determined these factors, among others, to be impairment indicators which triggered the necessity of an impairment analysis under SFAS No. 144 for the Company's long-lived assets. These tests also included the goodwill and certain intangible assets recognized as part of the acquisition of Triant. This determination relating to the Company's Triant acquisition was in part made after several public announcements were issued by a key customer of Triant's, regarding its own financial outlook and anticipated capital expenditure spending levels; which in turn caused the Company to revise its projected revenue from what had been expected at the date of the acquisition.

Fabbrix, Inc. ("Fabbrix")

        On May 24, 2007, the Company completed the acquisition of Fabbrix, a provider of silicon intellectual property designed to create highly manufacturable and area-efficient designs targeted for advanced technology nodes. With this acquisition, the Company has enhanced its strength in silicon characterization to enable co-optimization of the manufacturing fabric and the logic elements. Total cost for the acquisition was $6.2 million, which included $2.7 million cash, 272,000 shares of the Company's common stock valued at $2.9 million, and $607,000 in acquisition costs. Pursuant to the terms of the acquisition, $405,000 in cash and approximately 41,000 shares of the Company's common stock were held in escrow as security against certain financial and other contingencies. The escrow, less amounts deducted to satisfy contingencies, was required to be released no later than on the 18 month anniversary of the acquisition and was released to the selling stockholders in November 2008. The fair value of the Company's common stock was determined based on the average closing price per share of the Company's common stock over a 5-day period beginning two trading days before and ending two trading days after the terms were announced (May 23, 2007). The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, and accordingly the Company's consolidated financial statements from May 24, 2007 include the impact of the acquisition.

        In addition to the initial cash and stock consideration, up to $14.0 million in earnout consideration would be paid to the selling stockholders if qualifying orders, received during the first twelve months following the closing date, were recognized as revenue during the forty-eight months following the closing date. Earnout consideration would consist of a combination of fifty percent of such amount as a cash payment and fifty percent of such amount as shares of PDF's common stock. As of December 31, 2008, the estimable qualifying revenue did not meet the threshold and no additional consideration was paid in connection with the acquisition.

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Years Ended December 31, 2008, 2007, and 2006

2. Acquisitions (Continued)

        The allocation of the purchase price for this acquisition, as of the date of the acquisition, is as follows (in thousands, except amortization period):
 	 	 	 	 	 	 	 	 	 	
Allocation of Purchase Price	 	Amortization
Period
(Years)	 	Amount	 	
Fair value of tangible assets (including cash of $62,000)	 	 	 	 	$	406	 	
Fair value of intangible assets:	 	 	 	 	 	 	 	
 	Developed technology	 	 	5	 	 	6,430	 	
 	Patent and applications	 	 	7	 	 	1,400	 	
 	Goodwill	 	 	N/A	 	 	2,155	 	
 	 	 	 	 	 	 	
 	 	Total assets acquired	 	 	 	 	 	10,391	 	
Deferred tax liability	 	 	 	 	 	(3,210	)	
Notes to stockholders	 	 	 	 	 	(416	)	
Accrued liabilities	 	 	 	 	 	(364	)	
Accounts payable	 	 	 	 	 	(219	)	
 	 	 	 	 	 	 	
 	 	Total liabilities assumed	 	 	 	 	 	(4,209	)	
 	 	 	 	 	 	 	
 	 	Total consideration, net	 	 	 	 	$	6,182	 	
 	 	 	 	 	 	 	
        The acquisition was accounted for as a purchase transaction, and accordingly, the assets and liabilities of Fabbrix were recorded at their estimated fair values at the date of the acquisition. With the exception of the goodwill, the identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives, which vary from 5 to 7 years, with a weighted average life of 5.4 years.

        The acquisition of Fabbrix was structured as a tax-free reorganization. Therefore, the difference between the recognized fair values of the acquired net assets and their historical tax basis are not deductible for tax purposes. A deferred tax liability has been recognized for the difference between the assigned fair values of intangible assets for book purposes and the tax basis of such assets.

        The following unaudited pro forma consolidated financial data represents the combined results of operations as if Fabbrix and Triant had been combined with the Company at the beginning of the respective periods. This pro forma financial data includes the straight line amortization of intangibles over their respective estimated useful lives (in thousands, except per share data):

	 	Year Ended
December 31,	 	
 
	 	2008	 	2007	 	
Revenue	 	$	76,029	 	$	97,897	 	
Net loss	 	$	(96,734	)	$	(6,110	)	
Pro forma net loss per share—basic and diluted	 	$	(3.52	)	$	(0.22	)	
Number of shares used to compute pro forma net loss per share—basic and diluted	 	 	27,514	 	 	28,179	 	
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

2. Acquisitions (Continued)

        These results do not purport to be indicative of what would have occurred had the acquisition been made as of the beginning of the respective periods or the results of operations which may occur in future periods.

3. Investments

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

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

 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 
	 	December 31, 2007	 	
 
	 	Amortized Cost	 	Unrealized Holding Gains	 	Unrealized Holding Losses	 	Market Value	 	
Commercial paper	 	$	12,500	 	$	3	 	$	—	 	$	12,503	 	
Auction rate securities	 	 	4,450	 	 	—	 	 	—	 	 	4,450	 	
Agency discount notes	 	 	1,543	 	 	—	 	 	—	 	 	1,543	 	
 	 	 	 	 	 	 	 	 	 	
 	 	$	18,493	 	$	3	 	$	—	 	$	18,496	 	
 	 	 	 	 	 	 	 	 	 	
Included in cash and cash equivalents	 	 	 	 	 	 	 	 	 	 	$	8,547	 	
Included in short-term investments	 	 	 	 	 	 	 	 	 	 	 	9,949	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	 	 	 	 	 	 	 	 	 	$	18,496	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
        As of December 31, 2008 and 2007, all short-term investments had a maturity of one year or less. The primary objective of the Company's cash equivalent and investment activities is to preserve capital and maintain liquidity while generating appropriate returns. The Company's investment policy allows for only high-credit-quality securities. The value and liquidity of these securities are affected by market interest rates generally, as well as the ability of the issuer to make principal and interest payments when due and the normal functioning of the markets in which these securities are traded.

        The Company records net unrealized gains or losses on available-for-sale securities in other comprehensive income (loss), which is a component of stockholders' equity. As of December 31, 2008, all individual securities were in an unrealized loss position for less than twelve months. Refer to Note 13 "Fair Value" for further discussion on the Company's investments.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

4. Property and Equipment

        Property and equipment consist of (in thousands):

	 	December 31,	 	
 
	 	2008	 	2007	 	
Computer equipment	 	$	12,641	 	$	11,890	 	
Software	 	 	3,388	 	 	3,299	 	
Furniture, fixtures, and equipment	 	 	1,438	 	 	1,437	 	
Vehicles	 	 	40	 	 	36	 	
Leasehold improvements	 	 	829	 	 	558	 	
 	 	 	 	 	 	
 	 	 	18,336	 	 	17,220	 	
Accumulated depreciation and amortization	 	 	(15,661	)	 	(13,599	)	
 	 	 	 	 	 	
 	 	$	2,675	 	$	3,621	 	
 	 	 	 	 	 	
        The Company leases office equipment, computer hardware, vehicles and computer software under capital leases as defined inSFAS No. 13, Accounting for Leases.  The following is an analysis of the leased property (included in table above) under capital leases by major classes (in thousands):

	 	December 31,
2008	 	December 31,
2007	 	
Computer and office equipment	 	$	177	 	$	205	 	
Vehicles	 	 	40	 	 	36	 	
Software	 	 	49	 	 	44	 	
 	 	 	 	 	 	
 	 	 	266	 	 	285	 	
Accumulated depreciation and amortization	 	 	(232	)	 	(172	)	
 	 	 	 	 	 	
 	 	$	34	 	$	113	 	
 	 	 	 	 	 	
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

5. Goodwill and Intangible Assets

        The following table provides information relating to the intangible assets and goodwill contained within the Company's consolidated balance sheets as of December 31, 2008 and December 31, 2007 (in thousands):

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

 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 
	 	Amortization
Period
(Years)	 	December 31,
2006
Net Carrying
Amount	 	Acquisitions	 	Purchase
Price
Adjustments	 	Amortization	 	Foreign
Currency
Translation	 	December 31
2007
Net Carrying
Amount	 	
Goodwill	 	 	N/A	 	$	60,034	 	$	2,155	 	$	6	 	$	—	 	$	2,975	 	$	65,170	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Acquired identifiable intangibles:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	Acquired technology	 	 	4-5	 	$	7,901	 	$	6,430	 	$	—	 	$	(5,147	)	$	—	 	$	9,184	 	
 	Brand name	 	 	4	 	 	822	 	 	—	 	 	—	 	 	(461	)	 	—	 	 	361	 	
 	Customer relationships and backlog	 	 	1-6	 	 	4,362	 	 	—	 	 	—	 	 	(2,550	)	 	—	 	 	1,812	 	
 	Patents and applications	 	 	7	 	 	—	 	 	1,400	 	 	—	 	 	(117	)	 	—	 	 	1,283	 	
 	Other acquired intangibles	 	 	4	 	 	520	 	 	—	 	 	—	 	 	(362	)	 	20	 	 	178	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	 	 	 	$	13,605	 	$	7,830	 	$	—	 	$	(8,637	)	$	20	 	$	12,818	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        In 2007, the Company recorded an additional $2.2 million of goodwill and $7.8 million of intangible assets in connection with the acquisition of Fabbrix. The Company also recorded an adjustment of $3.0 million related to the effect of changes in exchange rates associated with recorded goodwill. In 2008, the Company recorded an additional $147,000 of goodwill and $1.7 million of intangible assets in connection with the acquisition of Triant's FDC business. The Company also recorded an adjustment of $1.1 million related to the effect of changes in exchange rates associated with recorded goodwill.

        During the fourth quarter of fiscal 2008, the Company observed impairment indicators relating to their long-lived assets, including the trading of common stock below its book value, the anticipated future decline in its operational results, and a further deterioration in the semiconductor industry in which the Company operates, which triggered the necessity of impairment test as of December 31, 2008. As such, in accordance with SFAS No. 144, the Company assessed the recoverability of its long-lived assets by comparing the carrying value of those intangible assets to the undiscounted cash flows of the asset group. The analysis indicated that the carrying value of those assets exceeded the undiscounted cash flows. As such, the Company determined that certain of the acquired intangible assets were impaired. The Company

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Years Ended December 31, 2008, 2007, and 2006

5. Goodwill and Intangible Assets (Continued)

measured the amount of impairment by calculating the amount by which the carrying value of the assets exceeded their estimated fair values, which were based on projected discounted future net cash flows. As a result of this impairment analysis, the Company recorded an impairment charge of $6.3 million during the fourth fiscal quarter of 2008.

        In accordance with SFAS No. 142, goodwill is measured and tested for impairment on an annual basis and more frequently in certain circumstances. Accordingly, the Company has selected December 31 as the date to perform the annual testing requirements. The Company performs a two-step testing on goodwill impairment. The first step requires that the Company compare the estimated fair value of its single reporting unit to the carrying value of the reporting unit's net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, the Company is required to complete the second step of impairment test to determine the fair value of goodwill. An impairment is recorded if the carrying value of the goodwill exceeds its fair value.

        As discussed in Note 12, Customer and Geographic Information, the Company considers itself to be in one operating segment. In addition, the Company has determined that its operating segment is also its reporting unit as the operating segment comprises only a single component. To determine the reporting unit's fair value, the Company used the income valuation approach. In determining its overall conclusion of reporting unit's fair value, the Company also considers the estimated value derived from the market valuation approach as compared to the valuation under the income approach as one measure that the estimated fair value is reasonable.

        The income approach provides an estimate of fair value based on discounted expected future cash flows. Estimates and assumptions with respect to the determination of the fair value of the Company's reporting unit using the income approach include the Company's operating forecasts, revenue growth rates, and risk-commensurate discount rates and costs of capital. The Company's estimates of revenues and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of the Company's routine long-range planning process.

        The market approach provides an estimate of the fair value of the Company's reporting unit using various prices or market multiples applied to the reporting unit's operating results and then applying an appropriate control premium, which is determined by considering control premiums offered as part of acquisitions in both the Company's market segment and comparable market segments.

        The Company completed its annual impairment analysis of goodwill as of December 31, 2008, including the second step prescribed by SFAS No. 142. As part of the second step of its goodwill impairment test, the Company determined the fair value of its goodwill by allocating the estimated fair value of its reporting unit to its assets and liabilities, including the estimated fair value of its unrecorded intangible assets, on a fair value basis. After allocating its assets and liabilities on a fair value basis, the Company recorded an impairment of all of its goodwill of $64.0 million.

        Allocating assets and liabilities on a fair value basis and determining the fair value of unrecorded intangible assets required that the Company make assumptions and estimates about the fair value of assets and liabilities where the fair values of those assets and liabilities were not readily available or observable. In addition, the Company made estimates regarding its forecasted revenue, expenses and cash flows, its

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Years Ended December 31, 2008, 2007, and 2006

5. Goodwill and Intangible Assets (Continued)

research and development activities, its customer turnover rates, applicable discount rates and costs of capital and the marketability of its current and future technology.

        The Company expects that annual amortization of acquired identifiable intangible assets to be as follows (in thousands):
 	 	 	 	 	
Year Ending December 31,	 	Amount	 	
2009	 	$	1,782	 	
2010	 	 	1,578	 	
2011	 	 	830	 	
2012	 	 	435	 	
2013	 	 	74	 	
Thereafter	 	 	31	 	
 	 	 	 	
Total	 	$	4,730	 	
 	 	 	 	
6. Taxes Payable and Other Accrued Liabilities

        Taxes Payable and Other accrued liabilities consist of (in thousands):

	 	December 31,	 	
 
	 	2008	 	2007	 	
Current portion of accrued restructuring	 	$	1,473	 	$	—	 	
Taxes payable and other accrued expenses	 	 	2,250	 	 	2,812	 	
 	 	 	 	 	 	
Total taxes payable and other accrued liabilities	 	$	3,723	 	$	2,812	 	
 	 	 	 	 	 	
7. Commitments and Contingencies

        Leases—The Company leases administrative and sales offices and certain equipment under noncancelable operating leases which contain various renewal options and require payment of common area costs, taxes and utilities, when applicable. These operating leases expire at various times through 2013. Rent expense was $3.2 million, $3.1 million, and $2.8 million in 2008, 2007, and 2006, respectively.

        Future minimum lease payments under noncancelable operating leases at December 31, 2008 are as follows (in thousands):
 	 	 	 	 	
Year Ended December 31,	 	 
	 	
2009	 	$	2,939	 	
2010	 	 	2,641	 	
2011	 	 	2,538	 	
2012	 	 	2,306	 	
2013	 	 	1,678	 	
 	 	 	 	
Total future minimum lease payments	 	$	12,102	 	
 	 	 	 	
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Years Ended December 31, 2008, 2007, and 2006

7. Commitments and Contingencies (Continued)

        Future minimum lease payments under capital leases are as follows as of December 31, 2008 (in thousands):
 	 	 	 	 	
Year Ended December 31,	 	 
	 	
2009	 	$	38	 	
2010	 	 	10	 	
2011	 	 	2	 	
 	 	 	 	
Net minimum lease payments	 	 	50	 	
Less: amount representing interest	 	 	(3	)	
 	 	 	 	
Present value of future minimum lease payments	 	$	47	 	
 	 	 	 	
        Debt—During 2004 and 2005, the former SiA entered into two separate debt agreements with a government-backed agency in France. Such obligations were assumed by the Company at the time of acquisition. In 2004 SiA obtained a €550,000 loan to cover research and development expenses. The loan does not carry interest and its repayment is conditioned on meeting certain revenue targets. The Company met those targets both in 2007 and 2008, and as such, will reimburse the entire loan in four payments through 2010. SiA also entered into a long-term debt agreement in 2005 for a total amount of €400,000. The debt carries a variable interest rate based on the three month average EURIBOR plus 160 basis points. As of December 31, 2008, such rate was 6.73%. The debt is reimbursable in 20 equal principal quarterly installments from January 2007 through October 2011. Neither debt agreements carry any financial covenant.

        Future minimum debt payments under the current debt agreements are as follows (in thousands):
 	 	 	 	 	 	 	 	
Year Ended December 31,	 	Principal	 	Interest	 	
2009	 	$	334	 	$	20	 	
2010	 	 	390	 	 	12	 	
2011	 	 	111	 	 	5	 	
 	 	 	 	 	 	
Total future minimum debt payments	 	$	835	 	$	37	 	
 	 	 	 	 	 	
        Indemnifications—The Company generally provides a warranty to its customers that its software will perform substantially in accordance with documented specifications typically for a period of 90 days following delivery of its products. The Company also indemnifies certain customers from third-party claims of intellectual property infringement relating to the use of its products. Historically, costs related to these guarantees have not been significant. The Company is unable to estimate the maximum potential impact of these guarantees on its future results of operations.

        Indemnification of Officers and Directors—As permitted by the Delaware general corporation law, the Company has included a provision in its certificate of incorporation to eliminate the personal liability of its officers and directors for monetary damages for breach or alleged breach of their fiduciary duties as officers or directors, other than in cases of fraud or other willful misconduct.

        In addition, the Bylaws of the Company provide that the Company is required to indemnify its officers and directors even when indemnification would otherwise be discretionary, and the Company is required

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Years Ended December 31, 2008, 2007, and 2006

7. Commitments and Contingencies (Continued)

to advance expenses to its officers and directors as incurred in connection with proceedings against them for which they may be indemnified. The Company has entered into indemnification agreements with its officers and directors containing provisions that are in some respects broader than the specific indemnification provisions contained in the Delaware general corporation law. The indemnification agreements require the Company to indemnify its officers and directors against liabilities that may arise by reason of their status or service as officers and directors other than for liabilities arising from willful misconduct of a culpable nature, to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified, and to obtain directors' and officers' insurance if available on reasonable terms. The Company has obtained directors' and officers' liability insurance in amounts comparable to other companies of the Company's size and in the Company's industry. Since a maximum obligation of the Company is not explicitly stated in the Company's Bylaws or in its indemnification agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not made payments related to these obligations, and the estimated fair value for these obligations was zero on the consolidated balance sheets as of December 31, 2008 and 2007.

8. Stockholders' Equity

        Effective January 1, 2006 the Company adopted SFAS No. 123(R). Stock-based compensation expenses before taxes related to the Company's employee stock purchase plan and stock plans were allocated as follows (in thousands):

	 	Year Ended
December 31,
2008	 	Year Ended
December 31,
2007	 	Year Ended
December 31,
2006	 	
Cost of design-to-silicon yield solutions	 	$	1,879	 	$	2,170	 	$	2,115	 	
Research and development	 	 	2,395	 	 	2,619	 	 	2,229	 	
Selling, general and administrative	 	 	2,954	 	 	3,440	 	 	3,007	 	
 	 	 	 	 	 	 	 	
 	Stock based compensation expense	 	$	7,228	 	$	8,229	 	$	7,351	 	
 	 	 	 	 	 	 	 	
        Upon its adoption of the fair value recognition provisions of SFAS No. 123(R), the Company elected to use the modified prospective transition method, and accordingly, prior periods have not been restated to reflect the impact of SFAS No. 123(R). Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Under the modified prospective transition method, stock-based compensation expense recognized in the Company's consolidated statement of operations for the years ended December 31, 2006, 2007, and 2008 included compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, and compensation expense for the share-based payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). In conjunction with the adoption of SFAS No. 123(R), the Company changed its method of attributing the value of stock-based compensation to expense from the graded vesting method to the straight-line method. Compensation expense for all share-based payment awards granted on or prior to January 1, 2006 will continue to be recognized using the graded vesting method

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Years Ended December 31, 2008, 2007, and 2006

8. Stockholders' Equity (Continued)

while compensation expense for all share-based payment awards granted subsequent to January 1, 2006 is recognized using the straight-line method. As stock-based compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2008, 2007, and 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

        The Company has elected to use the Black-Scholes-Merton option-pricing model, which incorporates various assumptions including volatility, expected life and interest rates. The expected volatility is based on the historical volatility of the Company's common stock over the most recent period commensurate with the estimated expected life of the Company's stock options. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted to employees. The interest rate assumption is based upon observed Treasury yield curve rates appropriate for the expected life of the Company's stock options.

        The fair value of options granted was estimated on the date of grant with the following weighted average assumptions:

	 	Stock Plans	 	Employee Stock Purchase Plan	 	
 
	 	2008	 	2007	 	2006	 	2008	 	2007	 	2006	 	
Expected life (in years)	 	 	5.7	 	 	5.9	 	 	5.7	 	 	1.29	 	 	0.74	 	 	0.95	 	
Volatility	 	 	58.9	%	 	57.9	%	 	60.4	%	 	64.5	%	 	55.5	%	 	50.3	%	
Risk-free interest rate	 	 	3.22	%	 	4.21	%	 	4.60	%	 	2.64	%	 	5.11	%	 	4.08	%	
Expected dividend	 	 	—	 	 	—	 	 	—	 	 	—	 	 	—	 	 	—	 	
        On December 31, 2008, the Company has in effect the following stock-based compensation plans:

        Stock Plans—In 2001, the Company terminated the 1996 and 1997 Stock Plans with respect to future option grants, and adopted the 2001 Stock Plan. Under the 2001 Stock Plan, on January 1 of each year starting with year 2002, the number of shares in the reserve will increase by the lesser of (1) 3,000,000 shares, (2) 5% of the outstanding common stock on the last day of the immediately preceding year, or (3) the number of shares determined by the board of directors. Under the 2001 Stock Plan, the Company may grant stock purchase rights and stock options to purchase shares of common stock to employees, directors and consultants. The exercise price for stock options must generally be at prices not less than the fair market value at the date of grant for incentive stock options. Stock options generally expire ten years from the date of grant and become vested and exercisable ratably over a four-year period.

        As of December 31, 2008 the Company has authorized 11.6 million shares of common stock for issuance and exercise of options, of which 4.7 million shares are available for grant. As of December 31, 2008 there were no outstanding options that had been granted outside of the Plans.

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Years Ended December 31, 2008, 2007, and 2006

8. Stockholders' Equity (Continued)

        Additional information with respect to options under the Plans, including options granted outside the Plans, is as follows:

	 	Outstanding Options	 	 

 
	 	Number of
Options
(in thousands)	 	Weighted
Average
Exercise Price
per Share	 	Weighted
Average
Remaining
Contractual
Term (years)	 	Aggregate
Intrinsic Value
(in thousands)	 	
Outstanding, January 1, 2006	 	 	5,674	 	$	11.13	 	 	 	 	 	 	 	
 	Granted (weighted average fair value of $8.35 per share)	 	 	1,947	 	 	14.25	 	 	 	 	 	 	 	
 	Exercised	 	 	(638	)	 	9.43	 	 	 	 	 	 	 	
 	Canceled	 	 	(300	)	 	13.33	 	 	 	 	 	 	 	
 	Expired	 	 	(19	)	 	11.44	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Outstanding, December 31, 2006	 	 	6,664	 	 	12.11	 	 	 	 	 	 	 	
 	Granted (weighted average fair value of $5.47 per share)	 	 	2,078	 	 	9.50	 	 	 	 	 	 	 	
 	Exercised	 	 	(182	)	 	7.92	 	 	 	 	 	 	 	
 	Canceled	 	 	(256	)	 	14.15	 	 	 	 	 	 	 	
 	Expired	 	 	(289	)	 	13.23	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Outstanding, December 31, 2007	 	 	8,015	 	 	11.42	 	 	 	 	 	 	 	
 	Granted (weighted average fair value of $3.06 per share)	 	 	748	 	 	5.47	 	 	 	 	 	 	 	
 	Exercised	 	 	(12	)	 	5.21	 	 	 	 	 	 	 	
 	Canceled	 	 	(1,451	)	 	12.80	 	 	 	 	 	 	 	
 	Expired	 	 	(2,888	)	 	13.05	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	
Outstanding, December 31, 2008	 	 	4,412	 	 	8.91	 	 	7.18	 	$	8,511	 	
 	 	 	 	 	 	 	 	 	 	 	
Vested and expected to vest	 	 	4,070	 	 	9.01	 	 	7.02	 	$	8,511	 	
 	 	 	 	 	 	 	 	 	 	 	
Options exercisable at:	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	December 31, 2006	 	 	3,419	 	$	10.64	 	 	 	 	 	 	 	
 	December 31, 2007	 	 	4,241	 	$	11.28	 	 	 	 	 	 	 	
 	December 31, 2008	 	 	2,512	 	$	9.52	 	 	5.86	 	$	8,511	 	
        The aggregate intrinsic value in the table above represents the total intrinsic value based on the Company's closing stock price of $1.44 as of December 31, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of options exercised during the year ended December 31, 2008 was $27,000.

        As of December 31, 2008, there was $6.8 million of total unrecognized compensation cost net of forfeitures related to nonvested stock options. That cost is expected to be recognized over a weighted average period of 2.7 years. The total fair value of shares vested during the year ended December 31, 2008

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Years Ended December 31, 2008, 2007, and 2006

8. Stockholders' Equity (Continued)

was $7.8 million. Additional information regarding options outstanding as of December 31, 2008 is as follows:

	 	Options Outstanding	 	Options Exercisable	 	
Range of Exercise Prices	 	Number
Outstanding
(in thousands)	 	Weighted
Average
Remaining
Contractual
Life (Years)	 	Weighted
Average
Exercise
Price per
Share	 	Number
Vested and
Exercisable
(in thousands)	 	Weighted
Average
Exercise
Price per
Share	 	
$0.53 - $0.53	 	 	—	 	 	0.9	 	$	0.53	 	 	—	 	$	0.53	 	
$1.13 - $1.13	 	 	26	 	 	2.9	 	 	1.13	 	 	26	 	 	1.13	 	
$1.88 - $1.88	 	 	17	 	 	1.4	 	 	1.88	 	 	17	 	 	1.88	 	
$2.98 - $3.78	 	 	36	 	 	6.3	 	 	3.43	 	 	21	 	 	3.78	 	
$4.70 - $7.00	 	 	1,217	 	 	6.7	 	 	5.61	 	 	609	 	 	6.14	 	
$7.50 - $11.22	 	 	2,350	 	 	7.4	 	 	9.22	 	 	1,208	 	 	9.31	 	
$14.46 - $16.87	 	 	766	 	 	7.0	 	 	13.91	 	 	631	 	 	13.94	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
$0.53 - $16.87	 	 	4,412	 	 	7.1	 	 	8.91	 	 	2,512	 	 	9.52	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        On June 10, 2008, the Company filed a tender offer on Form SC TO-I, or the Offer, with the SEC under which holders of options with exercise prices equal to or greater than $10.00 per share could tender their options in exchange for restricted stock rights granted under the 2001 Stock Plan based upon a 4.2 option shares to 1.0 restricted stock right exchange ratio. Restricted stock rights received in exchange for eligible options are subject to new vesting schedules, ranging from 15 months to 51 months, depending on when stock options exchanged were granted.

        The Company completed the Offer on August 18, 2008. As a result, the Company accepted for exchange options to purchase an aggregate of 3.3 million shares of the Company's common stock from 210 eligible participants, representing 73% of the shares subject to options that were eligible to be exchanged in the Offer as of August 18, 2008. Upon the terms and subject to the conditions set forth in the Offer, the Company issued restricted stock rights covering an aggregate of 793,000 shares of the Company's common stock in exchange for the options surrendered pursuant to the Offer.

        The fair value of the restricted stock rights awarded was measured as the total of the unrecognized compensation cost of the original options tendered and the incremental compensation cost of the restricted stock rights awarded on August 18, 2008, the date of cancellation. The incremental compensation cost was measured as the excess of the fair value of the restricted stock rights awards over the fair value of the options immediately before cancellation based on the share price and other pertinent factors at that date. The incremental cost of the 793,000 restricted stock rights awarded was $984,000. The unrecognized compensation costs of the tendered options cancelled were $5.9 million. The total fair value of the restricted stock right awarded on August 18, 2008 was $6.8 million and these costs will be amortized over the service period of the restricted stock rights.

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Years Ended December 31, 2008, 2007, and 2006

8. Stockholders' Equity (Continued)

        Nonvested shares (restricted stock units) as of December 31, 2008 and changes during the twelve months ended December 31, 2008 were as follows:

	 	Shares
(in thousands)	 	Weighted-Average
Grant-Date
Fair Value	 	
Nonvested, January 1, 2008	 	 	133	 	$	10.73	 	
Granted	 	 	793	 	 	8.54	 	
Vested	 	 	(52	)	 	10.73	 	
Forfeited	 	 	(22	)	 	12.91	 	
 	 	 	 	 	 	 	
Nonvested, December 31, 2008	 	 	852	 	$	8.64	 	
 	 	 	 	 	 	 	
        As of December 31, 2008, there was $4.6 million of total unrecognized compensation cost related to restricted stock rights. That cost is expected to be recognized over a weighted average period of 3.5 years. The total compensation expense related to shares expected to vest during year ended December 31, 2008 was $630,000.

        Employee Stock Purchase Plan—In July 2001, the Company adopted an Employee Stock Purchase Plan, ("Purchase Plan") under which eligible employees can contribute up to 10% of their compensation, as defined in the Purchase Plan, towards the purchase of shares of PDF common stock at a price of 85% of the lower of the fair market value at the beginning of the offering period or the end of each six-month offering period. Under the Purchase Plan, on January 1 of each year, starting with 2002, the number of shares reserved for issuance will automatically increase by the lesser of (1) 675,000 shares, (2) 2% of the Company's outstanding common stock on the last day of the immediately preceding year, or (3) the number of shares determined by the board of directors. As of December 31, 2008, 2.8 million shares of the Company's common stock have been reserved for issuance under the Purchase Plan. During years 2008, 2007, and 2006, 152,000, 170,000, and 176,000 were issued at a weighted average price of $3.87, $8.75, and $9.95 per share, respectively and as of December 31, 2008, 1.5 million shares were available for future issuance under the Purchase Plan. The weighted average estimated fair value of shares granted under the Purchase Plan during 2008, 2007, and 2006 was $2.84, $4.09, and $4.10, respectively.

        Stock Repurchase Program—On March 26, 2003, the Company's Board of Directors approved a share repurchase program to purchase up to $10.0 million of its outstanding common stock. The program was completed in August 2007 with 988,000 shares repurchased at the average price of $10.12. On October 29, 2007, the Board of Directors approved a new program to repurchase up to an additional $10.0 million of the Company's common stock on the open market. The right of repurchase stock under this program will expire on October 29, 2010. As of December 31, 2008, 2.4 million shares have been repurchased at the average price of $3.46 under this program and $1.6 million remained available for repurchase.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

8. Stockholders' Equity (Continued)

        The stock repurchase activity for the year ended December 31, 2008 is summarized as follows (in thousands, except per share amounts):

	 	Shares Repurchased	 	Weighted-Average
Price per Share	 	Amount Repurchased	 	
Cumulative balance at January 1, 2008	 	 	201	 	$	7.57	 	$	1,523	 	
Repurchase of common stock	 	 	2,226	 	 	3.09	 	 	6,878	 	
 	 	 	 	 	 	 	 	 	
Cumulative balance at December 31, 2008	 	 	2,427	 	 	3.46	 	$	8,401	 	
 	 	 	 	 	 	 	 	 	
9. Restructuring

        During the year ended December 31, 2008, the Company recorded restructuring charges of $3.4 million, related to expenses incurred as the result of restructuring plans the Company announced on April 29, 2008 and October 28, 2008, in an effort to better allocate its resources to improve its operational results in light of the current market conditions.

        For the plan announced on April 29, 2008, the Company recorded restructuring charges of $1.5 million during the three months ended June 30, 2008, which primarily consisted of employee severance costs of $1.4 million. For the plan announced on October 28, 2008, the Company recorded restructuring charges of $1.9 million during the three months ended December 31, 2008, which primarily consisted of facility exit costs of $985,000 and employee severance costs of $909,000. The following table summarizes the activities of these restructuring liabilities (in thousands):
 	 	 	 	 	 	 	 	
Restructuring Announced on April 29, 2008	 	Severance	 	Professional
and Other Fees	 	
Balance at January 1, 2008	 	$	—	 	$	—	 	
Restructuring charges	 	 	1,350	 	 	121	 	
Payments	 	 	(1,290	)	 	(121	)	
 	 	 	 	 	 	
Balance at December 31, 2008	 	$	60	 	$	—	 	
 	 	 	 	 	 	
        As of December 31, 2008, the remaining accrual of $60,000 for severance was included in other accrued liabilities and is expected to be paid out in the first fiscal quarter of 2009.
 	 	 	 	 	 	 	 	 	 	 	
Restructuring Announced on October 28, 2008	 	Severance	 	Facility Exit	 	Professional
and Other Fees	 	
Balance at January 1, 2008	 	$	—	 	$	—	 	$	—	 	
Restructuring charges	 	 	909	 	 	1,251	 	 	36	 	
Adjustment of deferred rent	 	 	—	 	 	(266	)	 	—	 	
Non-cash adjustment	 	 	36	 	 	266	 	 	—	 	
Payments	 	 	(85	)	 	(143	)	 	(5	)	
 	 	 	 	 	 	 	 	
Balance at December 31, 2008	 	$	860	 	$	1,108	 	$	31	 	
 	 	 	 	 	 	 	 	
        As of December 31, 2008, of the remaining accrual of $2.1 million, $1.5 million was included in taxes payable and other accrued liabilities and $587,000 was included in long-term other liabilities. Accrued

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

9. Restructuring (Continued)

severance of $860,000 and accrued professional and other fees are expected to be paid out in the first fiscal quarter of 2009. Accrued facility exit will be paid in accordance with the payment schedule through 2013.

10. Income Taxes

	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
 
	 	(In thousands)
	 	
U.S.	 	 	 	 	 	 	 	 	 	 	
 	Current	 	$	4,031	 	$	(1,470	)	$	631	 	
 	Deferred	 	 	2,566	 	 	(1,744	)	 	(4,050	)	
Foreign	 	 	 	 	 	 	 	 	 	 	
 	Current	 	 	172	 	 	260	 	 	204	 	
 	Withholding	 	 	1,330	 	 	758	 	 	335	 	
 	Deferred	 	 	—	 	 	(528	)	 	(253	)	
 	 	 	 	 	 	 	 	
Total provision (benefit)	 	$	8,099	 	$	(2,724	)	$	(3,133	)	
 	 	 	 	 	 	 	 	
        During the year ended December 31, 2008, 2007, and 2006, income (loss) before taxes from U.S. operations was ($88.1) million, ($14.2) million, and ($3.2) million, respectively, and income (loss) before taxes from foreign operations was $471,000, $8.6 million, and ($393,000), respectively. The income (loss) before taxes from U.S. operations for year 2007 included $6.4 million intercompany sale of intangibles by a foreign subsidiary to PDF Solutions, Inc.

        The income tax provision (benefit) differs from the amount estimated by applying the statutory federal income tax rate (35%) for the following reasons (in thousands):

	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
Federal statutory tax benefit	 	$	(30,670	)	$	(1,978	)	$	(1,250	)	
State tax expense (benefit)	 	 	(5,467	)	 	(615	)	 	(632	)	
Stock compensation expense	 	 	(210	)	 	1,537	 	 	1,697	 	
Write-off of in-process research and development	 	 	—	 	 	—	 	 	280	 	
Impairment on goodwill and intangible assets	 	 	16,202	 	 	—	 	 	—	 	
Tax credits	 	 	(162	)	 	(1,512	)	 	(3,633	)	
Foreign tax, net	 	 	3,942	 	 	22	 	 	477	 	
Valuation allowance	 	 	24,428	 	 	—	 	 	—	 	
Other	 	 	36	 	 	(178	)	 	(72	)	
 	 	 	 	 	 	 	 	
Total	 	$	8,099	 	$	(2,724	)	$	(3,133	)	
 	 	 	 	 	 	 	 	
        The Company has state net operating loss carry-forwards ("NOLs") of approximately $12.3 million. State NOL restrictions vary by state. The California portion of state loss is suspended for 2008 and 2009. The California loss can be carried forward 20 years for tax years beginning on or after January 1, 2008 and will expire in 2029.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

10. Income Taxes (Continued)

        In addition, as of December 31, 2008, the Company had federal and state research and experimental and other tax credit carry-forwards of approximately $7.9 million and $8.0 million, respectively. The federal credits begin to expire in 2025, while the state credits have no expiration. The extent to which the federal and state credit carry forwards can be used to offset future tax liabilities, respectively, may be limited, depending on the extent of ownership changes within any three-year period as provided in the Tax Reform Act of 1986 and the California Conformity Act of 1987.

        Based on the available objective evidence, both positive and negative, including the recent history of losses, forecasted U.S. pre tax income (loss), and the net operating losses that can be carried back to prior taxable years, management concluded as of December 31, 2008, that it is more likely than not that the Company's net deferred tax assets would not be fully realizable. Accordingly, the Company established a valuation allowance covering substantially all its net deferred tax assets.

        The components of the net deferred tax assets (liability) are comprised of (in thousands):

	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	
Net operating loss carry forward	 	$	936	 	$	251	 	
Research and development and other credit carry forward	 	 	10,453	 	 	8,824	 	
Accruals deductible in different periods	 	 	3,437	 	 	3,223	 	
Intangible assets	 	 	5,003	 	 	—	 	
Stock-based compensation	 	 	5,066	 	 	2,186	 	
Valuation allowance	 	 	(24,428	)	 	—	 	
 	 	 	 	 	 	
Deferred tax assets	 	 	467	 	 	14,484	 	
Deferred tax liabilities—intangible assets	 	 	—	 	 	(4,350	)	
 	 	 	 	 	 	
Total	 	$	467	 	$	10,134	 	
 	 	 	 	 	 	
        The Company adopted the provisions of FIN No. 48 at the beginning of fiscal 2007. FIN No. 48 provides a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.

        Unrecognized tax benefits represent tax positions for which reserves have been established. The cumulative effect of adopting FIN No. 48 on January 1, 2007 is recognized as a change in accounting principle, recorded as an adjustment to the opening balance of accumulated deficit on the adoption date. As a result of the implementation of FIN No. 48, the Company recognized a decrease of $771,000 in accumulated deficit.

        Upon adoption of FIN No. 48, the Company has reclassified these liabilities as long-term. Prior to the adoption of FIN No. 48, the Company recorded its tax exposure as current liabilities. The Company includes interest and penalties related to unrecognized tax benefits within the Company's income tax provision (benefit). As of December 31, 2008 and 2007, the Company had $562,000 and $566,000, respectively, accrued for payment of interest and penalties related to unrecognized tax benefits. The Company derecognized $4,000 of interest and penalties related to unrecognized tax benefits in its income tax provision for the year ended December 31, 2008.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

10. Income Taxes (Continued)

        The Company's total amount of unrecognized tax benefits as of December 31, 2008 was $8.2 million, as compared to $7.9 million as of December 31, 2007, of which $2.8 million, if recognized, would affect the Company's effective tax rate. As of December 31, 2008, the Company has recognized a net amount of $3.4 million as long-term taxes payable for unrecognized tax benefits in its consolidated balance sheets. The Company does not expect the change in unrecognized tax benefits over the next twelve months to materially impact its results of operations and financial position.

        The Company conducts business globally and, as a result, files numerous consolidated and separate income tax returns in the U.S. federal, various state and foreign jurisdictions. Because the Company used some of the tax attributes carried forward from previous years to tax years that are still open, statutes of limitation remain open for all tax years to the extent of the attributes carried forward into tax year 2001 for federal tax purposes and tax year 2002 for California tax purposes. With few exceptions, the Company is no longer subject to income tax examinations in its major foreign subsidiaries' jurisdictions for years before 2004. During the second fiscal quarter of 2008, the Company received the final German tax authority audit report for the years 2002 through 2004. The Company reviewed the results of the audit, noting no material adjustments to the prior years' tax returns.

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

	 	December 31, 2008	 	
Gross unrecognized tax benefits at January 1, 2008	 	$	7,860	 	
 	Decreases in tax positions for prior years	 	 	(212	)	
 	Increases in tax positions for prior years	 	 	131	 	
 	Increases in tax positions for current year	 	 	943	 	
 	Lapse in statute of limitations	 	 	(507	)	
 	 	 	 	
Gross unrecognized tax benefits at December 31, 2008	 	$	8,215	 	
 	 	 	 	
11. Net Loss Per Share

        Basic and diluted net loss per share are computed by dividing net loss by weighted average common shares outstanding for the period (excluding outstanding stock options and shares subject to repurchase). The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands except per share amount):

	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
Net loss	 	$	(95,728	)	$	(2,927	)	$	(439	)	
 	 	 	 	 	 	 	 	
 	Denominator for basic and diluted calculation:	 	 	 	 	 	 	 	 	 	 	
 	 	Weighted average common shares outstanding	 	 	27,514	 	 	28,066	 	 	26,885	 	
 	 	 	 	 	 	 	 	
Net loss per share—basic and diluted	 	$	(3.48	)	$	(0.10	)	$	(0.02	)	
 	 	 	 	 	 	 	 	
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

12. Customer and Geographic Information

        The Company has adopted the disclosure requirements of SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information, which establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or group, in deciding how to allocate resources and in assessing performance.

        The Company's chief operating decision maker, the chief executive officer, reviews discrete financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. Accordingly the Company considers itself to be in one operating segment, specifically the licensing and implementation of yield improvement solutions for integrated circuit manufacturers.

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

	 	Year Ended December 31,	 	
Customer	 	2008	 	2007	 	2006	 	
A	 	 	18	%	 	19	%	 	12	%	
B	 	 	16	%	 	16	%	 	25	%	
        The Company had accounts receivable from individual customers in excess of 10% of gross accounts receivable as follows:

	 	December 31,	 	
Customer	 	2008	 	2007	 	
A	 	 	12	%	 	27	%	
B	 	 	17	%	 	15	%	
C	 	 	11	%	 	11	%	
D	 	 	12	%	 	—	%	
        Revenue from customers by geographic area is as follows (in thousands):

	 	Year Ended December 31,	 	
 
	 	2008	 	2007	 	2006	 	
 
	 	Revenues	 	Percentage of
Revenues	 	Revenues	 	Percentage of
Revenues	 	Revenues	 	Percentage of
Revenues	 	
Asia	 	$	40,592	 	 	55	%	$	51,466	 	 	55	%	$	38,129	 	 	50	%	
United States	 	 	19,808	 	 	27	 	 	29,682	 	 	31	 	 	29,850	 	 	39	 	
Europe	 	 	13,637	 	 	18	 	 	13,315	 	 	14	 	 	8,205	 	 	11	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total	 	$	74,037	 	 	100	%	$	94,463	 	 	100	%	$	76,184	 	 	100	%	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
        As of December 31, 2008 and 2007, long-lived assets related to PDF SAS (formerly SiA), located in France, totaled $336,000 and $446,000, respectively. The majority of the Company's remaining long-lived assets are in the United States.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

13. Fair Value

        Effective January 1, 2008, the Company adopted SFAS No. 157 (as impacted by FSP 157-1, FSP 157-2, and FSP 157-3) with respect to fair value measurements of (1) nonfinancial assets and liabilities that are recognized or disclosed at fair value in the Company's consolidated financial statements on a recurring basis (at least annually) and (2) all financial assets and liabilities. The adoption was limited to financial assets, which primarily relate to cash, cash equivalent, and available-for-sale securities and did not have material impact on the Company's financial condition, results of operations or cash flows.

        Under SFAS No. 157, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. SFAS No. 157 refers to the multiple assumptions used to value financial instruments as inputs, and establishes hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity's pricing based upon its own market assumptions. These inputs are ranked according to a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.

        Level 1—Inputs are quoted prices in active markets for identical assets or liabilities.

        Level 2—Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.

        Level 3—Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

        The following table represents the Company's assets measured at fair value on a recurring basis as of December 31, 2008 and the basis for that measurement (in thousands):
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Assets	 	Total	 	Quoted Prices in
Active Markets for
Identical Assets
(Level 1)	 	Significant Other
Observable Inputs
(Level 2)	 	Significant
Unobservable Inputs
(Level 3)	 	
Money market mutual funds	 	$	11,829	 	$	11,829	 	$	—	 	$	—	 	
Commercial paper	 	 	2,047	 	 	—	 	 	2,047	 	 	—	 	
Agency obligations	 	 	6,612	 	 	—	 	 	6,612	 	 	—	 	
Auction-rate securities	 	 	718	 	 	—	 	 	—	 	 	718	 	
Corporate securities	 	 	392	 	 	—	 	 	392	 	 	—	 	
 	 	 	 	 	 	 	 	 	 	
Total	 	$	21,598	 	$	11,829	 	$	9,051	 	$	718	 	
 	 	 	 	 	 	 	 	 	 	
        The Company holds investments in auction-rate securities, or ARS, which are variable rate debt instruments whose interest rates are reset through a "dutch" auction process at regular intervals, typically every 28 days. All ARS are backed by pools of student loans guaranteed by governmental agencies and private entities, and were rated AAA/Aaa at the date of acquisition. The liquidity and fair value of these securities has been reduced by the uncertainty in the credit markets and the exposure of these securities to

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

13. Fair Value (Continued)

the financial condition of bond insurance companies, as evidenced by the rating downgrade of MBIA (bond insurer on one of the Company's ARS) from Aaa to A2, by Moody's Investor Services on June 19, 2008. All ARS have failed to sell at auction since February 2008, and as a result, their interest rates were reset to the maximum LIBOR + 150 basis points. The only activity since February 2008 was the repurchase of $500,000 of ARS at par by issuers. As a result of these auction failures, there was limited active market with observable prices for these securities as of December 31, 2008, and therefore the Company computed the fair value of these securities based on a discounted cash flow model, using significant Level 3 inputs, to take into account the lack of liquidity. The Company does not believe that the student loans backing these securities, the principal of these assets, is at risk. Furthermore, the Company is able to hold these securities until the credit markets recover and these securities resume pricing at or near par. As a result, the Company recorded a temporary impairment to other comprehensive income and classified these securities as non-current investments. The valuation may be revised in future periods as market conditions evolve.

        The following represents the reconciliation of the beginning and ending balance of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2008 (in thousands):

	 	Available-For-Sale Securities	 	
Beginning balance at January 1, 2008	 	$	—	 	
 	Total gains and losses (realized / unrealized):	 	 	 	 	
 	 	Included in earnings	 	 	—	 	
 	 	Included in other comprehensive income	 	 	(282	)	
 	Purchases, issuances, and settlements	 	 	(500	)	
 	Transfers, in Level 3	 	 	1,500	 	
 	 	 	 	
Ending balance at December 31, 2008	 	$	718	 	
 	 	 	 	
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at December 31, 2008	 	$	—	 	
 	 	 	 	
14. Litigation

        The Company is not currently party to any material legal proceedings.

15. Employee Benefit Plan

        During 1999, the Company established a 401(k) tax-deferred savings plan, whereby eligible employees may contribute up to 15% of their eligible compensation with a maximum amount subject to IRS guidelines in any calendar year. Company contributions to this plan are discretionary; no such Company contributions have been made since the inception of this plan.

16. Related Party Transactions

        Immediately prior to the merger with Fabbrix (the "Merger"), Mr. Lucio L. Lanza, a director and Chairman of the Board of the Company, served as President, Chief Executive Officer and Chairman of the

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Years Ended December 31, 2008, 2007, and 2006

16. Related Party Transactions (Continued)

Board of Fabbrix. Mr. Lanza also held shares of capital stock of Fabbrix, both individually and through his venture capital firm, Lanza techVentures. In connection with the Merger, Mr. Lanza received $353,000 in cash and 36,000 shares of the Company's common stock in exchange for his Fabbrix shares. Lanza techVentures received $1.2 million in cash and 122,000 shares of the Company's common stock at the closing of the Fabbrix acquisition (the "Closing") in exchange for its Fabbrix shares. In addition, out of the merger consideration, Lanza techVentures received $416,000 in cash as repayment of certain bridge loans previously made to Fabbrix. To consider a transaction with Fabbrix, the Company's Board established a special committee consisting exclusively of independent directors (the "Special Committee"). The Special Committee reviewed, evaluated and directed the negotiation of the transaction and the Merger Agreement and recommended to the Company's Board that the Company enter into the Merger Agreement. Mr. Lanza did not participate on behalf of the Company in any actions with respect to the transaction and the Merger Agreement, and did not participate in any deliberations or other activities of the Special Committee.

        In view of the NASDAQ independent director rules and other applicable requirements, the Company's Board determined that Mr. Lanza was no longer independent under those rules and therefore, Mr. Lanza resigned from the Audit, Compensation, and Nominating and Corporate Governance Committees of the Company's Board effective at the Closing. Mr. Lanza continues to serve as Chairman of the Company's Board of Directors. The Company replaced Mr. Lanza with other independent Board Members to fill the vacancies on the Company's Audit, Compensation, and Nominating and Corporate Governance Committees. The Company's Board also appointed a Lead Independent Director. With the resignation of Sue Billat from the Company's Board in August 2008, however, the Company became non-compliant with NASDAQ continued listing requirements regarding Board and Audit Committee composition.

        Mr. Andrzej Strojwas, the Company's Chief Technologist was a stockholder of Fabbrix immediately prior to the Merger. In connection with the Merger, Mr. Strojwas received $53,000 in cash and 5,000 shares of the Company's common stock.

        At the end of first anniversary following the closing date, the estimable qualifying revenue did not meet the threshold for earnout consideration, no additional consideration was paid or will be paid to Mr. Lanza, Mr. Strojwas, and Lanza techVentures.

17. Subsequent Events

        As a result of the continued economic downturn, the Company announced an additional restructuring plan to better align its resources in light of the related market outlook. The details of such plan have not been finalized but is expected to be completed during the three months ended March 31, 2009 and will effect all functional areas and geographies.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years Ended December 31, 2008, 2007, and 2006

18. Selected Quarterly Financial Data (Unaudited)

	 	Year Ended December 31, 2008	 	
 
	 	Q1	 	Q2	 	Q3	 	Q4	 	
 
	 	(In thousands, except for per share amounts)
	 	
Total revenue	 	$	20,347	 	$	21,114	 	$	18,765	 	$	13,811	 	
Gross margin	 	$	11,950	 	$	13,216	 	$	10,982	 	$	2,766	(2)	
Total operating expenses	 	$	15,569	 	$	16,446	 	$	13,430	 	$	81,451	(3)	
Net loss	 	$	(2,513	)	$	(1,940	)	$	(12,224)	(1)	$	(79,051	)	
Net loss per basic and diluted share	 	$	(0.09	)	$	(0.07	)	$	(0.44	)	$	(2.92	)	

 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 
	 	Year Ended December 31, 2007	 	
 
	 	Q1	 	Q2	 	Q3	 	Q4	 	
 
	 	(In thousands, except for per share amounts)
	 	
Total revenue	 	$	22,142	 	$	23,698	 	$	24,068	 	$	24,555	 	
Gross margin	 	$	12,800	 	$	14,979	 	$	14,637	 	$	14,429	 	
Total operating expenses	 	$	15,227	 	$	16,473	 	$	15,782	 	$	16,905	 	
Net income (loss)	 	$	(2,355	)	$	(701	)	$	(939	)	$	1,068	 	
Net income (loss) per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	
Basic	 	$	(0.08	)	$	(0.02	)	$	(0.03	)	$	0.04	 	
Diluted	 	$	(0.08	)	$	(0.02	)	$	(0.03	)	$	0.04	 	

(1)
During the third fiscal quarter of 2008, the Company recorded a valuation allowance of $7.5 million to reduce its net deferred tax assets as management determined that it is more likely than not that the Company's net deferred tax assets would not be fully realizable. See Note 10 Income Taxes to the consolidated financial statements.

(2)
During the fourth fiscal quarter of 2008, the Company recorded an impairment of $3.4 million on its acquired technology as a result of the impairment assessment performed in the fourth fiscal quarter of 2008. See Note 5 Goodwill and Intangible Assets to the consolidated financial statements.

(3)
During the fourth fiscal quarter of 2008, the Company recorded an impairment of $66.8 million on goodwill and other acquired intangible assets as a result of the impairment assessment performed in the fourth fiscal quarter of 2008. See Note 5 Goodwill and Intangible Assets to the consolidated financial statements.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) 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.
 	 	 	 	 	
 	 	PDF SOLUTIONS, INC.	

 	
By:	
 	
/s/ JOHN K. KIBARIAN

John K. Kibarian
President and Chief Executive Officer	

 	
By:	
 	
/s/ KEITH A. JONES

Keith A. Jones
Chief Financial Officer and Vice President, Finance	
Date: March 16, 2009
POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John K. Kibarian and Keith A. Jones, jointly and severally, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes may do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 	 	 	
Signature	 	Title	
/s/ JOHN K. KIBARIAN

John K. Kibarian	 	Director, President and Chief Executive Officer
(Principal Executive Officer)	

/s/ KEITH A. JONES

Keith A. Jones	
 	
Chief Financial Officer and Vice President, Finance
(Principal Financial and Accounting Officer)	

/s/ KIMON MICHAELS

Kimon Michaels	
 	
Director, Vice President, Design for Manufacturability	

/s/ LUCIO L. LANZA

Lucio L. Lanza	
 	
Chairman of the Board of Directors	

/s/ R. STEPHEN HEINRICHS

R. Stephen Heinrichs	
 	
Director, Lead Independent Director	

/s/ TOM CAULFIELD

Tom Caulfield	
 	
Director	

/s/ ALBERT Y. C. YU

Albert Y. C. Yu	
 	
Director	
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SCHEDULE II

PDF SOLUTIONS, INC.

VALUATION AND QUALIFYING ACCOUNTS

Years Ended December 31, 2008, 2007, and 2006

(In thousands)

 
	 	Balance at
Beginning
of Period	 	Charged
to Costs
and Expenses	 	Balance
Assumed
in Acquisition	 	Deductions/
Write-offs
of Accounts	 	Balance
at End
of Period	 	
Allowance for doubtful accounts	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	2008	 	$	254	 	$	—	 	$	—	 	$	—	 	$	254	 	
 	2007	 	$	294	 	$	—	 	$	—	 	$	(40	)	$	254	 	
 	2006	 	$	254	 	$	—	 	$	40	 	$	—	 	$	294	 	
Valuation allowance for deferred tax assets	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	2008	 	$	—	 	$	24,428	 	$	—	 	$	—	 	$	24,428	 	
87

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INDEX TO EXHIBITS

Exhibit
Number	 	Description	
 	2.01	 	Amended and Restated Agreement and Plan of Reorganization, dated September 2, 2003, by and among PDF Solutions, Inc., IDS Software Acquisition Corp., PDF Solutions, LLC and IDS Software Systems Inc (incorporated by reference to registrant's Current Report on Form 8-K filed September 25, 2003.)	

2.02	
 	
Agreement and Plan of Reorganization, dated May 23, 2007, among PDF Solutions, Inc., Fabbrix, Inc. and PDF Acquisition Corp. (incorporated herein by reference to registrant's Current Report on Form 8-K filed May 24, 2007.)	

3.01	
 	
Third Amended and Restated Certificate of Incorporation of PDF Solutions, Inc. (incorporated herein by reference to registrant's Registration Statement on Form S-1/A filed July 9, 2001.)	

3.02	
 	
Amended and Restated Bylaws of PDF Solutions, Inc. (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed August 9, 2005.)	

4.01	
 	
Specimen Stock Certificate (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed September 6, 2001.)	

4.02	
 	
Second Amended and Restated Rights Agreement dated July 6, 2001 (incorporated herein by reference to registrant's Registration Statement on Form S-1/A filed July 9, 2001.)	

10.01	
 	
Form of Indemnification Agreement between PDF Solutions, Inc. and certain of its executive officers and directors (incorporated herein by reference to registrant's Registration Statement on Form S-1 filed August 7, 2000.)	

10.02	
 	
PDF Solutions, Inc. 1996 Stock Option Plan and related agreements (incorporated herein by reference to registrant's Registration Statement on Form S-1 filed August 7, 2000.)*	

10.03	
 	
PDF Solutions, Inc. 1997 Stock Plan and related agreements (incorporated herein by reference to registrant's Registration Statement on Form S-1 filed August 7, 2000.)*	

10.04	
 	
PDF Solutions, Inc. 2001 Stock Plan (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed May 10, 2007) and related agreements (incorporated herein by reference to registrant's Registration Statement on Form S-1/A filed on July 9, 2001.)*	

10.05	
 	
PDF Solutions, Inc. 2001 Employee Stock Purchase Plan (incorporated herein by reference to registrant's Registration Statement on Form S-8 filed January 14, 2003.)*	

10.06	
 	
IDS Software, Inc. 2001 Stock Option/Stock Issuance Plan and related agreements (incorporated herein by reference to registrant's Registration Statement on Form S-8 filed October 17, 2003.)*	

10.07	
 	
Offer letter to P. Steven Melman from PDF Solutions, Inc. dated July 9, 1998 (incorporated herein by reference to registrant's Registration Statement on Form S-1 filed August 7, 2000.)*	

10.08	
 	
Offer letter to Cornelius D. Hartgring from PDF Solutions, Inc. dated August 29, 2002 (incorporated herein by reference to registrant's Annual Report on Form 10-K filed March 26, 2003.) *	
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Exhibit
Number	 	Description	
 	10.09	 	Fourth Amendment to Office Lease and Second Amendment to Lease between PDF Solutions, Inc. and Metropolitan Life Insurance Company dated as of March 19, 2003 (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed May 14, 2003.)	

10.10	
 	
Carmel Corporate Plaza Office Lease between PDF Solutions, Inc. and 15015 Avenue of Science Associates LLC dated as of April 1, 2003 (incorporated by reference to registrant's Quarterly Report on Form 10-Q filed May 14, 2003.)	

10.11	
 	
Andre Hawit Employment Offer letter agreement dated September 24, 2003 by and between PDF Solutions Inc. and Andre Hawit (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed November 14, 2003.)*	

10.12	
 	
Offer letter to Keith A. Jones from PDF Solutions, Inc. dated October 10, 2005 (incorporated herein by reference to registrant's Current Report on Form 8-K filed December 19, 2005.)*	

10.13	
 	
Riverpark Tower Office Lease between PDF Solutions, Inc. and Legacy Partners I Riverpark I, LLC, dated June 29, 2007 (incorporated herein by reference to registrant's Annual Report on Form 10-K filed March 17, 2008.)	

10.14	
 	
Offer letter to Joy Leo from PDF Solutions, Inc. dated July 14, 2008 (incorporated herein by reference to registrant's Quarterly Report on Form 10-Q filed August 11, 2008.)	

10.15	
 	
Asset Purchase Agreement entered into August 27, 2008 by and among Triant Holdings, Inc., Triant Technologies (2005) Inc., and PDF Solutions, Inc. (incorporated herein by reference to registrant's Current Report on Form 8-K filed September 2, 2008.)	

10.16	
 	
Amendment to Offer Letter, between Keith A. Jones and PDF Solutions, Inc., dated December 29, 2008.*	

10.17	
 	
Form of Indemnification Agreement between PDF Solutions, Inc. and certain of its senior executive officers and directors.*	

21.01	
 	
Subsidiaries of Registrant.	

23.01	
 	
Consent of Independent Registered Public Accounting Firm.	

24.01	
 	
Power of Attorney (see Signature Page).	

31.01	
 	
Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	

31.02	
 	
Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	

32.01	
 	
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.†	

32.02	
 	
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.†	

*
Indicates management contract or compensatory plan or arrangement.

†
Furnished herewith.

89

Exhibit 10.16

PDF Solutions, Inc.
333 West San Carlos Street, Suite 700, San Jose, CA 95110 USA
 Telephone: 408 280 7900, Fax: 408 280 7915
www.pdf.com
 
December 29, 2008
 
Keith Jones
 
Dear Keith:
 
You and PDF Solutions, Inc. (“PDF” or the “Company”), signed an offer letter, dated October 10, 2005 (the “Offer Letter”).  This letter agreement amends the Offer Letter in order for the cash severance payments under the Offer Letter to be exempt from or comply with Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”).  Except as otherwise amended in this letter agreement, the Offer Letter remains in full force and effect.
 
This letter agreement amends and restates Section 5 of the Offer Letter to read in its entirety as follows:
 
“5.           Termination.  In the event that you experience an involuntary separation, as defined in Treasury Regulation 1.409A-1(h) (“Separation”), by the Company for a reason that is other than for (i) cause, (ii) death or (iii) Permanent Disability (as defined below), provided that you satisfy the Conditions (as defined below) within the Deadline (as defined below), then the Company will provide you with the following severance:  (i) your base salary for a period of six (6) months following your Separation (the “Salary Continuation Period”), which will be payable at the then regular payroll rates over the Salary Continuation Period in accordance with the Company’s standard payroll schedule, commencing on the Company’s first regular payroll date that is at least five (5) days after the Conditions have been satisfied and the Release’s effective date; (ii) monthly premiums to continue your (and, if applicable, your eligible spouse and dependents) Company health insurance under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”) for the period equal in length to the Salary Continuation Period, commencing on the first day that you (and your dependents) lose health care coverage under the Company’s health plans; provided that you (or, if applicable, your eligible spouse and dependents) timely elect to continue your health insurance under COBRA and are, and continue to be, eligible for such benefits; and, (iii) acceleration of the vesting of all of your stock options outstanding as of the date of your Separation such that you vest, effective as of the date of your Separation, in the number of shares you would have vested in had you continued to provide services to the Company for an additional six (6) months

 
following your Separation.  As a condition to receiving the benefits stated in this paragraph, you hereby agree to release the Company from potential claims through the date of Separation and to return all Company property within thirty (30) days following the Separation (collectively, the “Conditions”), and you will be required, and you hereby agree, to sign a standard general release of claims in a form prescribed by the Company (the “Release”) within thirty (30) days following the Separation (the “Deadline”).
 
For purposes of Code Section 409A, each payment that is paid under the preceding paragraph is hereby designated as a separate payment.  Notwithstanding anything to the contrary, each of the payments provided in connection with your Separation is intended to be exempt from Code Section 409A pursuant to Treasury Regulation Section 1.409A-1(b)(9)(iii) and to the extent it is exempt pursuant to such section, it will in any event be paid no later than the last day of your second taxable year following the taxable year in which your Separation has occurred; provided that, to the extent that any of such payments and any other payments paid to you in connection with your Separation does not qualify to be exempt from Code Section 409A pursuant to Treasury Regulation Section 1.409A-1(b)(9)(iii) or otherwise exceeds the limit set forth in Treasury Regulation Section 1.409A-1(b)(9)(iii)(A) or any similar limit promulgated by the Treasury or the IRS, the portion of the payments that does not qualify or otherwise exceeds such limit, as determined by the Company in its sole discretion, will be paid by no later than the fifteenth (15th) day of the third (3rd) month following the end of your first (1st) tax year in which your Separation occurs, or, if later, the fifteenth (15th) day of the third (3rd) month following the end of the Company’s first (1st) tax year in which your Separation occurs, as provided in Treasury Regulation Section 1.409A-1(b)(4).
 
Notwithstanding the above, if any of the payments provided in connection with your Separation does not qualify for any reason to be exempt from Code Section 409A pursuant to Treasury Regulation Section 1.409A-1(b)(9)(iii) or Treasury Regulation Section 1.409A-1(b)(4) and you are deemed by the Company at the time of your Separation to be a “specified employee,” as defined in Code Section 409A, each such payment will not be made or commence until the date which is the first (1st) business day of the seventh (7th) month after your Separation and the installments that otherwise would have been paid during the first six (6) months after your Separation will be paid in a lump sum on the first (1st) business day of the seventh (7th) month after your Separation. Such deferral will only be effected to the extent required to avoid adverse tax treatment to you, including (without limitation) the additional twenty percent (20%) federal tax for which you would otherwise be liable under Section 409A(a)(1)(B) of the Code in the absence of such deferral.
 
For purposes of this letter agreement, “Permanent Disability” means your inability to perform the essential functions of your position with or without reasonable accommodation for a period of one hundred and twenty (120) consecutive days because of your physical or mental impairment.”
 
2

 
This amendment to the Offer Letter may be executed by fax copies and scanned images (exchanged via electronic mail) in two or more counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument.  To indicate your acceptance of this amendment to the Offer Letter, please sign and date this letter in the space provided below and return it to me.
 
 	Very truly yours,	
 	 	
 	PDF SOLUTIONS, INC.	

 	John K. Kibarian	
 	Chief Executive Officer & President	

THE FOREGOING TERMS AND CONDITIONS	 	
ARE HEREBY AGREED TO AND ACCEPTED:	 	

Signed:	 	 	
 	 	
Print Name: Keith A. Jones	 	
 	 	
Date: December         , 2008	 	

3

Exhibit 10.17
 
PDF SOLUTIONS, INC.
 
INDEMNIFICATION AGREEMENT
 
This Indemnification Agreement (this “Agreement”) is made as of                     , by and between PDF Solutions, Inc., a Delaware corporation (the “ Company ”), and                                          (“ Indemnitee ”).
 
RECITALS
 
The Company and Indemnitee recognize the increasing difficulty in obtaining liability insurance for directors, officers and key employees, the significant increases in the cost of such insurance and the general reductions in the coverage of such insurance.  The Company and Indemnitee further recognize the substantial increase in corporate litigation in general, subjecting directors, officers and key employees to expensive litigation risks at the same time as the availability and coverage of liability insurance has been severely limited.  Indemnitee does not regard the current protection available as adequate under the present circumstances, and Indemnitee may not be willing to continue to serve in Indemnitee’s current capacity with the Company without additional protection.  The Company desires to attract and retain the services of highly qualified individuals, such as Indemnitee, and to indemnify its directors, officers and key employees so as to provide them with the maximum protection permitted by law.
 
AGREEMENT
 
In consideration of the mutual promises made in this Agreement, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Company and Indemnitee hereby agree as follows:
 
1.                                      Indemnification.
 
(a)          Third-Party Proceedings.  To the fullest extent permitted by applicable law, the Company shall indemnify Indemnitee, if Indemnitee was, is or is threatened to be made, a party to or a participant (as a witness or otherwise) in any Proceeding (other than a Proceeding by or in the right of the Company to procure a judgment in the Company’s favor), against all Expenses, judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) actually and reasonably incurred by Indemnitee in connection with such Proceeding if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company and, in the case of a criminal Proceeding, had no reasonable cause to believe Indemnitee’s conduct was unlawful.
 
(b)          Proceedings By or in the Right of the Company.  To the fullest extent permitted by applicable law, the Company shall indemnify Indemnitee, if Indemnitee was, is or is threatened to be made a party to or a participant (as a witness or otherwise) in any Proceeding by or in the right of the Company to procure a judgment in the Company’s favor, against all

 
Expenses actually and reasonably incurred by Indemnitee in connection with such Proceeding if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, except that no indemnification shall be made in respect of any claim, issue or matter as to which Indemnitee shall have been finally adjudicated by court order or judgment to be liable to the Company unless and only to the extent that the Court of Chancery or the court in which such Proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for such expenses which such court shall deem proper.
 
(c)          Success on the Merits.  To the fullest extent permitted by applicable law and to the extent that Indemnitee has been successful on the merits or otherwise in defense of any Proceeding referred to in Section 1(a) or Section 1(b) or the defense of any claim, issue or matter therein, in whole or in part, the Company shall indemnify Indemnitee against all Expenses actually and reasonably incurred by Indemnitee in connection therewith.  Without limiting the generality of the foregoing, if Indemnitee is successful on the merits or otherwise as to one or more but less than all claims, issues or matters in a Proceeding, the Company shall indemnify Indemnitee against all Expenses actually and reasonably incurred by Indemnitee in connection with such successfully resolved claims, issues or matters to the fullest extent permitted by applicable law.  If any Proceeding is disposed of on the merits or otherwise (including a disposition without prejudice), without (1) the disposition being adverse to Indemnitee, (ii) an adjudication that Indemnitee was liable to the Company, (iii) a plea of guilty by Indemnitee, (iv) an adjudication that Indemnitee did not act in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, and (v) with respect to any criminal Proceeding, an adjudication that Indemnitee had reasonable cause to believe Indemnitee’s conduct was unlawful, Indemnitee shall be considered for the purposes hereof to have been wholly successful with respect thereto.
 
(d)          Witness Expenses.  To the fullest extent permitted by applicable law and to the extent that Indemnitee is a witness or otherwise asked to participate in any Proceeding to which Indemnitee is not a party, the Company shall indemnify Indemnitee against all Expenses actually and reasonably incurred by Indemnitee in connection with such Proceeding.
 
2.                                      Indemnification Procedure.
 
(a)          Advancement of Expenses.  To the fullest extent permitted by applicable law, the Company shall advance all Expenses actually and reasonably incurred by Indemnitee in connection with a Proceeding within thirty (30) days after receipt by the Company of a statement requesting such advances from time to time, whether prior to or after final disposition of any Proceeding.  Such advances shall be unsecured and interest free and shall be made without regard to Indemnitee’s ability to repay the Expenses and without regard to Indemnitee’s ultimate entitlement to indemnification under the other provisions of this Agreement.  Indemnitee shall be entitled to continue to receive advancement of Expenses pursuant to this Section 2(a) unless and until the matter of Indemnitee’s entitlement to indemnification hereunder has been finally adjudicated by court order or judgment from which no further right of appeal exists.  Indemnitee hereby undertakes to repay such amounts advanced only if, and to the extent that, it ultimately is determined that Indemnitee is not entitled to be indemnified by the Company under the other provisions of this Agreement.  Indemnitee shall qualify for advances upon the execution and
 
2

 
delivery of this Agreement, which shall constitute the requisite undertaking with respect to repayment of advances made hereunder and no other form of undertaking shall be required to qualify for advances made hereunder other than the execution of this Agreement.
 
(b)          Notice and Cooperation by Indemnitee.  Indemnitee shall promptly notify the Company in writing upon being served with any summons, citation, subpoena, complaint, indictment, information or other document relating to any Proceeding or matter for which indemnification will or could be sought under this Agreement.  Such notice to the Company shall include a description of the nature of, and facts underlying, the Proceeding, shall be directed to the Chief Executive Officer of the Company and shall be given in accordance with the provisions of Section 10(d) below.  In addition, Indemnitee shall give the Company such additional information and cooperation as the Company may reasonably request.  Indemnitee’s failure to so notify, provide information and otherwise cooperate with the Company shall not relieve the Company of any obligation which it may have to Indemnitee under this Agreement, except to the extent that the Company is adversely affected by such failure.
 
(c)          Determination of Entitlement.  Notwithstanding any other provision in this Agreement, no determination as to entitlement to indemnification under this Agreement shall be required to be made prior to the final disposition of the Proceeding.  Subject to the foregoing, promptly after receipt of a statement requesting payment with respect to the indemnification rights set forth in Section 1, to the extent required by applicable law, the Company shall take the steps necessary to authorize such payment in the manner set forth in Section 145 of the General Corporation Law of Delaware.  If a claim under this Agreement, under any statute, or under any provision of the Company’s Certificate of Incorporation or Bylaws providing for indemnification or advancement of Expenses, is not paid in full by the Company within thirty (30) days after a written request for payment thereof has first been received by the Company, Indemnitee may, but need not, at any time thereafter bring an action against the Company in the Delaware Court of Chancery to recover the unpaid amount of the claim and, subject to Section 9, Indemnitee shall also be entitled to be paid for all Expenses actually and reasonably incurred by Indemnitee in connection with bringing such action.  It shall be a defense to any such action (other than an action brought to enforce a claim for advancement of Expenses under Section 2(a)) that Indemnitee has not met the standards of conduct which make it permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed.  In making a determination with respect to entitlement to indemnification hereunder, the person or persons or entity making such determination shall presume that Indemnitee is entitled to indemnification under this Agreement and the Company shall have the burden of proof to overcome that presumption with clear and convincing evidence to the contrary.  The termination of any Proceeding by judgment, order, settlement, conviction, or upon a plea of  nolo contendere  or its equivalent, shall not, of itself, create a presumption that Indemnitee did not act in good faith and in a manner which Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, or, in the case of a criminal Proceeding, that Indemnitee had reasonable cause to believe that Indemnitee’s conduct was unlawful.  In addition, it is the parties’ intention that if the Company contests Indemnitee’s right to indemnification, the question of Indemnitee’s right to indemnification shall be for the court to decide, and neither the failure of the Company (including its Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) to have made a determination that indemnification of Indemnitee is proper in the circumstances because Indemnitee has met the applicable standard
 
3

 
of conduct required by applicable law, nor an actual determination by the Company (including its Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) that Indemnitee has not met such applicable standard of conduct, shall create a presumption that Indemnitee has or has not met the applicable standard of conduct.  If any requested determination with respect to entitlement to indemnification hereunder has not been made within ninety (90) days after the final disposition of the Proceeding, the requisite determination that Indemnitee’s entitlement to indemnification shall be deemed to have been made.
 
(d)          Payment Directions.  To the extent payments are required to be made hereunder, the Company shall, in accordance with Indemnitee’s request (but without duplication), (i) pay such Expenses on behalf of Indemnitee, (b) advance to Indemnitee funds in an amount sufficient to pay such Expenses, or (c) reimburse Indemnitee for such Expenses.
 
(e)          Notice to Insurers.  If, at the time of the receipt of a notice of a claim pursuant to Section 2(b) hereof, the Company has director and officer liability insurance in effect, the Company shall give prompt notice of the commencement of such Proceeding to the insurers in accordance with the procedures set forth in the respective policies.  The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of Indemnitee, all amounts payable as a result of such Proceeding in accordance with the terms of such policies.
 
(f)           Defense of Claim and Selection of Counsel.  In the event the Company shall be obligated under Section 2(a) hereof to advance Expenses with respect to any Proceeding, the Company, if appropriate, shall be entitled to assume the defense of such Proceeding, with counsel reasonably acceptable to Indemnitee, upon the delivery to Indemnitee of written notice of its election so to do.  After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to Indemnitee under this Agreement for any fees of counsel subsequently incurred by Indemnitee with respect to the same Proceeding, provided that (i) Indemnitee shall have the right to employ counsel in any such Proceeding at Indemnitee’s expense; and (ii) if (A) the employment of counsel by Indemnitee has been previously authorized by the Company, (B) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and Indemnitee in the conduct of any such defense or (C) the Company shall not, in fact, have employed counsel to assume the defense of such Proceeding, then the fees and expenses of Indemnitee’s counsel shall be at the expense of the Company.  In addition, if there exists a potential, but not an actual conflict of interest between the Company and Indemnitee, the actual and reasonable legal fees and expenses incurred by Indemnitee for separate counsel retained by Indemnitee to monitor the Proceeding (so that such counsel may assume Indemnitee’s defense if the conflict of interest between the Company and Indemnitee becomes an actual conflict of interest) shall be deemed to be Expenses that are subject to indemnification hereunder.  The existence of an actual or potential conflict of interest, and whether such conflict may be waived, shall be determined pursuant to the rules of attorney professional conduct and applicable law.  The Company shall not be required to obtain the consent of Indemnitee for the settlement of any Proceeding the Company has undertaken to defend if the Company assumes full and sole responsibility for each such settlement; provided, however, that the Company shall be required to obtain Indemnitee’s prior written approval, which shall not be unreasonably withheld, before
 
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entering into any settlement which (1) does not grant Indemnitee a complete release of liability, (2) would impose any penalty or limitation on Indemnitee, or (3) would admit any liability or misconduct by Indemnitee.
 
3.                                      Additional Indemnification Rights.
 
(a)          Scope.  Notwithstanding any other provision of this Agreement, the Company hereby agrees to indemnify Indemnitee to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by the other provisions of this Agreement, the Company’s Certificate of Incorporation, the Company’s Bylaws or by statute.  In the event of any change, after the date of this Agreement, in any applicable law, statute, or rule which expands the right of a Delaware corporation to indemnify a member of its board of directors or an officer, such changes shall be deemed to be within the purview of Indemnitee’s rights and the Company’s obligations under this Agreement.  In the event of any change in any applicable law, statute or rule which narrows the right of a Delaware corporation to indemnify a member of its board of directors or an officer, such changes, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement shall have no effect on this Agreement or the parties’ rights and obligations hereunder.
 
(b)          Nonexclusivity.  The indemnification provided by this Agreement shall not be deemed exclusive of any rights to which Indemnitee may be entitled under the Company’s Certificate of Incorporation, its Bylaws, any agreement, any vote of stockholders or disinterested members of the Company’s Board of Directors, the General Corporation Law of Delaware, or otherwise, both as to action in Indemnitee’s official capacity and as to action in another capacity while holding such office.
 
(c)          Interest on Unpaid Amounts.  If any payment to be made by the Company to Indemnitee hereunder is delayed by more than ninety (90) days from the date the duly prepared request for such payment is received by the Company, interest shall be paid by the Company to Indemnitee at the legal rate under Delaware law for amounts which the Company indemnifies or is obligated to indemnify for the period commencing with the date on which Indemnitee actually incurs such Expense or pays such judgment, fine or amount in settlement and ending with the date on which such payment is made to Indemnitee by the Company.
 
(d)          Third-Party Indemnification.  The Company hereby acknowledges that Indemnitee has or may from time to time obtain certain rights to indemnification, advancement of expenses and/or insurance provided by one or more third parties (collectively, the “ Third-Party Indemnitors ”).  The Company hereby agrees that it is the indemnitor of first resort ( i.e.,  its obligations to Indemnitee are primary and any obligation of the Third-Party Indemnitors to advance expenses or to provide indemnification for the same expenses or liabilities incurred by Indemnitee are secondary), and that the Company will not assert that the Indemnitee must seek expense advancement or reimbursement, or indemnification, from any Third-Party Indemnitor before the Company must perform its expense advancement and reimbursement, and indemnification obligations, under this Agreement.  No advancement or payment by the Third-Party Indemnitors on behalf of Indemnitee with respect to any claim for which Indemnitee has sought indemnification from the Company shall affect the foregoing.  The Third-Party Indemnitors shall be subrogated to the extent of such advancement or payment to all of the rights
 
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of recovery which Indemnitee would have had against the Company if the Third-Party Indemnitors had not advanced or paid any amount to or on behalf of Indemnitee.  If for any reason a court of competent jurisdiction determines that the Third-Party Indemnitors are not entitled to the subrogation rights described in the preceding sentence, the Third-Party Indemnitors shall have a right of contribution by the Company to the Third-Party Indemnitors with respect to any advance or payment by the Third-Party Indemnitors to or on behalf of the Indemnitee.
 
4.                                      Partial Indemnification.  If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of the Expenses, judgments, fines or amounts paid in settlement, actually and reasonably incurred in connection with a Proceeding, but not, however, for the total amount thereof, the Company shall nevertheless indemnify Indemnitee for the portion of such Expenses, judgments, fines and amounts paid in settlement to which Indemnitee is entitled.
 
5.                                      Director and Officer Liability Insurance.
 
(a)          D&O Policy.  The Company shall, from time to time, make the good faith determination whether or not it is practicable for the Company to obtain and maintain a policy or policies of insurance with reputable insurance companies providing the directors and officers of the Company with coverage for losses from wrongful acts, or to ensure the Company’s performance of its indemnification obligations under this Agreement.  Among other considerations, the Company will weigh the costs of obtaining such insurance coverage against the protection afforded by such coverage.  In all policies of director and officer liability insurance, Indemnitee shall be named as an insured in such a manner as to provide Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company’s directors, if Indemnitee is a director; or of the Company’s officers, if Indemnitee is not a director of the Company but is an officer; or of the Company’s key employees, if Indemnitee is not an officer or director but is a key employee.  Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain such insurance if the Company determines in good faith that such insurance is not reasonably available, if the premium costs for such insurance are disproportionate to the amount of coverage provided, if the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or if Indemnitee is covered by similar insurance maintained by a parent or subsidiary of the Company.
 
(b)          Tail Coverage.  In the event of a Change of Control or the Company’s becoming insolvent (including being placed into receivership or entering the federal bankruptcy process and the like), the Company shall maintain in force any and all insurance policies then maintained by the Company in providing insurance (directors’ and officers’ liability, fiduciary, employment practices or otherwise) in respect of Indemnitee, for a period of six years thereafter.
 
6.                                      Severability.  Nothing in this Agreement is intended to require or shall be construed as requiring the Company to do or fail to do any act in violation of applicable law.  The Company’s inability, pursuant to court order, to perform its obligations under this Agreement shall not constitute a breach of this Agreement.  If this Agreement or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee to the full extent permitted by any applicable
 
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portion of this Agreement that shall not have been invalidated, and the balance of this Agreement not so invalidated shall be enforceable in accordance with its terms.
 
7.                                      Exclusions.  Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement:
 
(a)          Claims Initiated by Indemnitee.  To indemnify or advance Expenses to Indemnitee with respect to Proceedings initiated or brought voluntarily by Indemnitee and not by way of defense, except with respect to Proceedings brought to establish, enforce or interpret a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145 of the General Corporation Law of Delaware, but such indemnification or advancement of Expenses may be provided by the Company in specific cases if the Board of Directors finds it to be appropriate; provided, however, that the exclusion set forth in the first clause of this subsection shall not be deemed to apply to any investigation initiated or brought by Indemnitee to the extent reasonably necessary or advisable in support of Indemnitee’s defense of a Proceeding to which Indemnitee was, is or is threatened to be made, a party;
 
(b)          Lack of Good Faith.  To indemnify Indemnitee for any Expenses incurred by Indemnitee with respect to any Proceeding instituted by Indemnitee to establish, enforce or interpret a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145 of the General Corporation Law of Delaware, if a court of competent jurisdiction determines that each of the material assertions made by Indemnitee in such proceeding was not made in good faith or was frivolous;
 
(c)          Insured Claims.  To indemnify Indemnitee for Expenses to the extent such Expenses have been paid directly to Indemnitee by an insurance carrier under an insurance policy maintained by the Company; or
 
(d)          Certain Exchange Act Claims.  To indemnify Indemnitee in connection with any claim made against Indemnitee for (i) an accounting of profits made from the purchase and sale (or sale and purchase) by Indemnitee of securities of the Company within the meaning of Section 16(b) of the Exchange Act or any similar successor statute or any similar provisions of state statutory law or common law, or (ii) any reimbursement of the Company by Indemnitee of any bonus or other incentive-based or equity-based compensation or of any profits realized by Indemnitee from the sale of securities of the Company, as required in each case under the Exchange Act (including any such reimbursements that arise from an accounting restatement of the Company pursuant to Section 304 of the Sarbanes-Oxley Act of 2002 (the “ Sarbanes-Oxley Act ”), or the payment to the Company of profits arising from the purchase and sale by Indemnitee of securities in violation of Section 306 of the Sarbanes-Oxley Act); provided, however, that to the fullest extent permitted by applicable law and to the extent Indemnitee is successful on the merits or otherwise with respect to any such Proceeding, the Expenses actually and reasonably incurred by Indemnitee in connection with any such Proceeding shall be deemed to be Expenses that are subject to indemnification hereunder.
 
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8.                                      Contribution Claims.
 
(a)           If the indemnification provided in Section 1 is unavailable in whole or in part and may not be paid to Indemnitee for any reason other than those set forth in Section 7, then in respect to any Proceeding in which the Company is jointly liable with Indemnitee (or would be if joined in such Proceeding), to the fullest extent permitted by applicable law, the Company, in lieu of indemnifying Indemnitee, shall pay, in the first instance, the entire amount incurred by Indemnitee, whether for Expenses, judgments, fines or amounts paid in settlement, in connection with any Proceeding without requiring Indemnitee to contribute to such payment, and the Company hereby waives and relinquishes any right of contribution it may have at any time against Indemnitee.
 
(b)           With respect to a Proceeding brought against directors, officers, employees or agents of the Company (other than Indemnitee), to the fullest extent permitted by applicable law, the Company shall indemnify Indemnitee from any claims for contribution that may be brought by any such directors, officers, employees or agents of the Company (other than Indemnitee) who may be jointly liable with Indemnitee, to the same extent Indemnitee would have been entitled to such indemnification under this Agreement if such Proceeding had been brought against Indemnitee.
 
9.                                      No Imputation.  The knowledge and/or actions, or failure to act, of any director, officer, agent or employee of the Company or the Company itself shall not be imputed to Indemnitee for purposes of determining any rights under this Agreement.
 
10.                                Determination of Good Faith.  For purposes of any determination of good faith, Indemnitee shall be deemed to have acted in good faith if Indemnitee’s action is based on the records or books of account of the Enterprise, including financial statements, or on information supplied to Indemnitee by the officers of the Enterprise in the course of their duties, or on the advice of legal counsel for the Enterprise or the Board of Directors of the Enterprise or any counsel selected by any committee of the Board of Directors of the Enterprise or on information or records given or reports made to the Enterprise by an independent certified public accountant or by an appraiser, investment banker, compensation consultant, or other expert selected with reasonable care by the Enterprise or the Board of Directors of the Enterprise or any committee thereof.  The provisions of this Section 10 shall not be deemed to be exclusive or to limit in any way the other circumstances in which the Indemnitee may be deemed to have met the applicable standard of conduct.  Whether or not the foregoing provisions of this Section are satisfied, it shall in any event be presumed that Indemnitee has at all times acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company.
 
11.                                Defined Terms and Phrases.  For purposes of this Agreement, the following terms shall have the following meanings:
 
(a)           “Beneficial Owner” and “Beneficial Ownership” shall have the meanings set forth in Rule 13d-3 promulgated under the Exchange Act as in effect on the date hereof.
 
(b)           “Change of Control” shall be deemed to occur upon the earliest of any of the following events:
 
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(i)            Acquisition of Stock by Third Party.  Any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing fifteen percent (15%) or more of the combined voting power of the Company’s then outstanding securities entitled to vote generally in the election of directors, unless (1) the change in the relative Beneficial Ownership of the Company’s securities by any Person results solely from a reduction in the aggregate number of outstanding shares of securities entitled to vote generally in the election of directors, or (2) such acquisition was approved in advance by the Continuing Directors and such acquisition would not constitute a Change of Control under part (iii) of this definition.
 
(ii)           Change in Board of Directors.  Individuals who, as of the date of this Agreement, constitute the Company’s Board of Directors (the “ Board ”), and any new director whose election by the Board or nomination for election by the Company’s stockholders was approved by a vote of at least two thirds of the directors then still in office who were directors on the date of this Agreement (collectively, the “ Continuing Directors ”), cease for any reason to constitute at least a majority of the members of the Board.
 
(iii)          Corporate Transaction.  The effective date of a reorganization, merger, or consolidation of the Company (a “ Business Combination ”), in each case, unless, following such Business Combination:  (1) all or substantially all of the individuals and entities who were the Beneficial Owners of securities entitled to vote generally in the election of directors immediately prior to such Business Combination beneficially own, directly or indirectly, more than 51% of the combined voting power of the then outstanding securities of the Company entitled to vote generally in the election of directors resulting from such Business Combination (including a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the securities entitled to vote generally in the election of directors and with the power to elect at least a majority of the Board or other governing body of the surviving entity; (2) no Person (excluding any corporation resulting from such Business Combination) is the Beneficial Owner, directly or indirectly, of 15% or more of the combined voting power of the then outstanding securities entitled to vote generally in the election of directors of such corporation except to the extent that such ownership existed prior to the Business Combination; and (3) at least a majority of the Board of Directors of the corporation resulting from such Business Combination were Continuing Directors at the time of the execution of the initial agreement, or of the action of the Board of Directors, providing for such Business Combination.
 
(iv)          Liquidation.  The approval by the Company’s stockholders of a complete liquidation of the Company or an agreement or series of agreements for the sale or disposition by the Company of all or substantially all of the Company’s assets, other than factoring the Company’s current receivables or escrows due (or, if such approval is not required, the decision by the Board to proceed with such a liquidation, sale or disposition in one transaction or a series of related transactions).
 
(v)           Other Events.  There occurs any other event of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or a
 
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response to any similar item or any similar schedule or form) promulgated under the Exchange Act whether or not the Company is then subject to such reporting requirement.
 
(c)           “Company” shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that if Indemnitee is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, trustee, general partner, managing member, fiduciary, employee or agent of any other enterprise, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving corporation as Indemnitee would have with respect to such constituent corporation if its separate existence had continued.
 
(d)           “Enterprise” means the Company and any other enterprise that Indemnitee was or is serving at the request of the Company as a director, officer, partner (general, limited or otherwise), member (managing or otherwise), trustee, fiduciary, employee or agent.
 
(e)           “Exchange Act” means the Securities Exchange Act of 1934, as amended.
 
(f)            “Expenses” shall include all direct and indirect costs, fees and expenses of any type or nature whatsoever, including all attorneys’ fees and costs, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, fees of private investigators and professional advisors, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, any federal, state, local or foreign taxes imposed on Indemnitee as a result of the actual or deemed receipt of any payment under this Agreement (including taxes that may be imposed upon the actual or deemed receipt of payments under this Agreement with respect to the imposition of federal, state, local or foreign taxes), fax transmission charges, secretarial services and all other disbursements, obligations or expenses in connection with prosecuting, defending, preparing to prosecute or defend, investigating, being or preparing to be a witness in, settlement or appeal of, or otherwise participating in a Proceeding.  Expenses also shall include any of the forgoing expenses incurred in connection with any appeal resulting from any Proceeding, including the principal, premium, security for, and other costs relating to any costs bond, supersedes bond, or other appeal bond or its equivalent.  Expenses also shall include any interest, assessment or other charges imposed thereon and costs incurred in preparing statements in support of payment requests hereunder.  Expenses, however, shall not include amounts paid in settlement by Indemnitee or the amount of judgments or fines against Indemnitee.
 
(g)           “Person” shall have the meaning as set forth in Section 13(d) and 14(d) of the Exchange Act as in effect on the date hereof; provided, however, that “Person” shall exclude: (i) the Company; (ii) any direct or indirect majority owned subsidiaries of the Company; (iii) any employee benefit plan of the Company or any direct or indirect majority owned subsidiaries of the Company or of any corporation owned, directly or indirectly, by the Company’s stockholders in substantially the same proportions as their ownership of stock of the Company (an “ Employee Benefit Plan ”); and (iv) any trustee or other fiduciary holding securities under an Employee Benefit Plan.
 
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(h)           “Proceeding” shall include any actual, threatened, pending or completed action, suit, arbitration, mediation, alternate dispute resolution mechanism, investigation, inquiry, administrative hearing or any other actual, threatened or completed proceeding, whether brought by a third party, a government agency, the Company or its Board of Directors or a committee thereof, whether in the right of the Company or otherwise and whether of a civil (including intentional or unintentional tort claims), criminal, administrative, legislative or investigative (formal or informal) nature, including any appeal therefrom, in which Indemnitee was, is, will or might be involved as a party, potential party, non-party witness or otherwise by reason of the fact that Indemnitee is or was a director, officer, employee or agent of the Company, by reason of any action (or failure to act) taken by Indemnitee or of any action (or failure to act) on Indemnitee’s part while acting as a director, officer, employee or agent of the Company, or by reason of the fact that Indemnitee is or was serving at the request of the Company as a director, officer, partner (general, limited or otherwise), member (managing or otherwise), trustee, fiduciary, employee or agent of any other enterprise, in each case whether or not serving in such capacity at the time any liability or expense is incurred for which indemnification, reimbursement or advancement of expenses can be provided under this Agreement.
 
(i)            In addition, references to “other enterprise” shall include another corporation, partnership, limited liability company, joint venture, trust, employee benefit plan or any other enterprise; references to “ fines ” shall include any excise taxes assessed on Indemnitee with respect to an employee benefit plan; references to “ serving at the request of the Company ” shall include any service as a director, officer, employee or agent of the Company which imposes duties on, or involves services by Indemnitee with respect to an employee benefit plan, its participants, or beneficiaries; and if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan, Indemnitee shall be deemed to have acted in a manner “ not opposed to the best interests of the Company ” as referred to in this Agreement; references to “ include ” or “ including ” shall mean include or including, without limitation; and references to Sections, paragraphs or clauses are to Sections, paragraphs or clauses in this Agreement unless otherwise specified.
 
12.                                Attorneys’ Fees.  In the event that any Proceeding is instituted by Indemnitee under this Agreement to enforce or interpret any of the terms hereof, the Company shall indemnify Indemnitee against all Expenses actually and reasonably incurred by Indemnitee in connection with such Proceeding, unless a court of competent jurisdiction determines that each of the material assertions made by Indemnitee as a basis for such Proceeding were not made in good faith or were frivolous.  In the event of a Proceeding instituted by or in the name of the Company under this Agreement or to enforce or interpret any of the terms of this Agreement, the Company shall indemnify Indemnitee against all Expenses actually and reasonably incurred by Indemnitee in connection with such Proceeding (including with respect to Indemnitee’s counterclaims and cross-claims made in such action), unless a court of competent jurisdiction determines that each of Indemnitee’s material defenses to such action were made in bad faith or were frivolous.
 
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13.                                Miscellaneous.
 
(a)          Governing Law.  This Agreement and all acts and transactions pursuant hereto and the rights and obligations of the parties hereto shall be governed, construed and interpreted in accordance with the laws of the State of Delaware, without giving effect to principles of conflicts of law.
 
(b)          Entire Agreement; Binding Effect.  Without limiting any of the rights of Indemnitee described in Section 3(b), this Agreement sets forth the entire agreement and understanding of the parties relating to the subject matter herein and merges all prior discussions and supersedes any and all previous agreements between them covering the subject matter herein.  The indemnification provided under this Agreement applies with respect to events occurring before or after the effective date of this Agreement, and shall continue to apply even after Indemnitee has ceased to serve the Company in any and all indemnified capacities.
 
(c)          Amendments and Waivers.  No modification of or amendment to this Agreement, nor any waiver of any rights under this Agreement, shall be effective unless in writing signed by the parties to this Agreement.  The failure by either party to enforce any rights under this Agreement shall not be construed as a waiver of any rights of such party.
 
(d)          Notices.  Any notice, demand or request required or permitted to be given under this Agreement shall be in writing and shall be deemed sufficient when delivered personally or sent by fax or 48 hours after being sent by nationally-recognized courier or deposited in the U.S. mail, as certified or registered mail, with postage prepaid, and addressed to the party to be notified at such party’s address or fax number as set forth below or as subsequently modified by written notice.
 
(e)          Counterparts.  This Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument.
 
(f)           Successors and Assigns.  This Agreement shall be binding upon the Company and its successors (including any direct or indirect successor by purchase, merger, consolidation or otherwise to all or substantially all of the business and/or assets of the Company) and assigns, and inure to the benefit of Indemnitee and Indemnitee’s heirs, executors, administrators, legal representatives and assigns.  The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.
 
(g)          No Employment Rights.  Nothing contained in this Agreement is intended to create in Indemnitee any right to continued employment.
 
(h)          Company Position.  The Company shall be precluded from asserting, in any Proceeding brought for purposes of establishing, enforcing or interpreting any right to indemnification under this Agreement, that the procedures and presumptions of this Agreement
 
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are not valid, binding and enforceable and shall stipulate in any such court that the Company is bound by all the provisions of this Agreement and is precluded from making any assertion to the contrary.
 
(i)           Subrogation.  In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company to effectively bring suit to enforce such rights.
 
[Signature Page Follows]
 
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The parties have executed this Agreement as of the date first set forth above.
 
 	 	THE COMPANY:	
 	 	 	
 	 	PDF SOLUTIONS, INC.	
 	 	 	
 	 	By:	 	
 	 	(Signature)	
 	 	 	
 	 	Name:	 	
 	 	Title:	 	
 	 	 	
 	 	Address:	
 	 	333 West San Carlos Street	
 	 	Suite 700	
 	 	San Jose, California 95110	
 	 	Fax: (408) 280-7915	
 	 	 	
AGREED TO AND ACCEPTED:	 	 	
 	 	 	
INDEMNITEE:	 	 	

(PRINT NAME)	 	 	 	
(Signature)	 	 	
 	 	 	
Address:	 	 	 	

Fax:	 	 	 	

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EXHIBIT 21.01

SUBSIDIARIES OF REGISTRANT

Name of Entity	 	Jurisdiction of Incorporation
or Organization	
PDF Solutions GmbH	 	Germany	
PDF Solutions KK	 	Japan	
PDF Solutions S.A.S. 	 	France	
PDF Solutions Semiconductor Technology (Shanghai) Co. Ltd. 	 	China	
PDF Solutions Semiconductor Technology (Korea) Limited	 	Korea	
PDF Solutions International Services, Inc. 	 	Delaware	
PDF Solutions Asia Services, Inc. 	 	Delaware	
PDF Solutions Semiconductor Technology Taiwan Ltd. 	 	Taiwan	
PDF Solutions Pacific Services, Inc. 	 	Delaware	
PDF Solutions Semiconductor Technology (Singapore) Pte. Ltd. 	 	Singapore	

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EXHIBIT 21.01
SUBSIDIARIES OF REGISTRANT

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Exhibit 23.01

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

        We consent to the incorporation by reference in Registration Statement Nos. 333-66758, 333-102509, 333-109809, 333-112728, 333-133332, 333-141660, and 333-149281 on Form S-8 and Registration Statement Nos. 333-140268 and 333-143989 on Form S-3 of our reports dated March 16, 2009, relating to the consolidated financial statements and financial statement schedule of PDF Solutions, Inc. and subsidiaries (the "Company") (which report expresses an unqualified opinion and includes an explanatory paragraph regarding the adoption of Emerging Issues Task Force Issue No. 06-02, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43  and Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ), and the effectiveness of the Company's internal control over financial reporting, appearing in this Annual Report on Form 10-K of the Company for the year ended December 31, 2008.
 	 	 	
/s/ DELOITTE & TOUCHE LLP
	 	 	
San Jose, California
March 16, 2009

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Exhibit 23.01
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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EXHIBIT 31.01

CERTIFICATIONS

I, John K. Kibarian, certify that:

        1.     I have reviewed this annual report on Form 10-K of PDF Solutions, Inc.;

        2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

        3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the period presented in this report;

        4.     The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

        (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

        (c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        (d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

        5.     The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

        (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

        (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 	 	 	
 	 	/s/ JOHN K. KIBARIAN

John K. Kibarian
President and Chief Executive Officer
(Principal Executive Officer)
	
Date: March 16, 2009

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EXHIBIT 31.01
CERTIFICATIONS

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EXHIBIT 31.02

CERTIFICATIONS

I, Keith A. Jones, certify that:

        1.     I have reviewed this annual report on Form 10-K of PDF Solutions, Inc.;

        2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

        3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

        4.     The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

        (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

        (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

        (c)   Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

        (d)   Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

        5.     The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

        (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

        (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
 	 	 	
 	 	/s/ KEITH A. JONES

Keith A. Jones
Chief Financial Officer and Vice President, Finance
(Principal Financial Officer)	
Date: March 16, 2009

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EXHIBIT 31.02
CERTIFICATIONS

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EXHIBIT 32.01

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of PDF Solutions, Inc. (the "Company") on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission on March 16, 2009 (the "Report"), I, John K. Kibarian, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

        (1)   The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)   The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 	 	 	
 	 	/s/ JOHN K. KIBARIAN

John K. Kibarian
President and Chief Executive Officer
(Principal Executive Officer)	
Date: March 16, 2009

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EXHIBIT 32.01
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

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EXHIBIT 32.02

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of PDF Solutions, Inc. (the "Company") on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission on March 16, 2009 (the "Report"), I, Keith A. Jones, Chief Financial Officer and Vice President, Finance of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

        (1)   The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)   The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 	 	 	
 	 	/s/ KEITH A. JONES

Keith A. Jones
Chief Financial Officer and Vice President, Finance
(Principal Financial Officer)	
Date: March 16, 2009

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EXHIBIT 32.02
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002