UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period ended September 30, 2005

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

For the transition period from                      to                     

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 Principal Executive Offices)		95110 (Zip Code)

(408) 280-7900
(Registrant’s Telephone Number, Including Area Code)

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

Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes þ No o

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

The number of shares outstanding of the Registrant’s Common Stock as of November 4, 2005 was 26,264,741.

 

 

TABLE OF CONTENTS

				Page
PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Unaudited Consolidated Balance Sheets			2
		Unaudited Consolidated Statements of Operations			3
		Unaudited Consolidated Statements of Cash Flows			4
		Notes to Unaudited Consolidated Financial Statements			5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			30
Item 4.		Controls and Procedures			31
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings			32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			32
Item 3.		Defaults Upon Senior Securities			32
Item 4.		Submission of Matters to a Vote of Security Holders			32
Item 5.		Other Information			32
Item 6.		Exhibits			33
SIGNATURES					34
INDEX TO EXHIBITS
EXHIBIT 21.01
EXHIBIT 31.01
EXHIBIT 31.02
EXHIBIT 32.01
EXHIBIT 32.02

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements.

PDF SOLUTIONS, INC.

		September 30,				December 31,
		2005				2004
ASSETS
Current assets:
Cash and cash equivalents		$	59,341			$	45,660
Accounts receivable, net of allowances of $254 in 2005 and 2004			17,627				15,978
Prepaid expenses and other current assets			2,399				2,685
Deferred tax assets			2,265				1,586
Total current assets			81,632				65,909
Property and equipment, net			3,525				3,321
Goodwill			39,886				39,886
Intangible assets, net			11,288				15,791
Other assets			448				500
Total assets		$	136,779			$	125,407
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,443			$	1,023
Accrued compensation and related benefits			4,296				3,209
Other accrued liabilities			1,767				2,593
Taxes payable			4,961				3,286
Deferred revenue			2,378				2,905
Billings in excess of recognized revenue			2,425				1,581
Total current liabilities			17,270				14,597
Long-term liabilities			272				311
Deferred tax liabilities			847				1,701
Total liabilities			18,389				16,609
Stockholders’ equity:
Preferred stock, $0.00015 par value per share, 5,000 shares authorized, no shares issued and outstanding in 2005 and 2004			—				—
Common stock, $0.00015 par value per share, 70,000 shares authorized, shares issued and outstanding: 26,193 in 2005 and 25,645 in 2004			4				4
Additional paid-in-capital			139,676				134,191
Treasury stock, at cost, 551 shares in 2005 and 506 in 2004			(5,549	)			(4,806	)
Deferred stock-based compensation			(45	)			(148	)
Notes receivable from stockholders			—				(550	)
Accumulated deficit			(15,703	)			(19,975	)
Accumulated other comprehensive income			7				82
Total stockholders’ equity			118,390				108,798
Total liabilities and stockholders’ equity		$	136,779			$	125,407

See notes to unaudited consolidated financial statements

PDF SOLUTIONS, INC.

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2005				2004				2005				2004
Revenue:
Design-to-silicon-yield solutions:
Integrated solutions		$	13,834			$	13,224			$	38,658			$	36,082
Software licenses			1,533				812				8,179				3,162
Gain share			3,090				2,414				8,069				5,051
Total revenue			18,457				16,450				54,906				44,295
Costs and expenses:
Cost of design-to-silicon-yield solutions:
Direct costs of design-to-silicon-yield solutions:
Integrated solutions			6,382				5,881				17,898				15,541
Software licenses			15				6				273				69
Amortization of acquired core technology			1,266				1,266				3,798				3,943
Research and development			5,474				4,940				16,465				14,980
Selling, general and administrative			3,971				3,801				12,174				11,220
Stock-based compensation amortization*			19				134				93				681
Amortization of other acquired intangible assets			235				351				705				1,171
Total costs and expenses			17,362				16,379				51,406				47,605
Income (loss) from operations			1,095				71				3,500				(3,310	)
Interest and other income			463				150				1,085				441
Income (loss) before taxes			1,558				221				4,585				(2,869	)
Tax provision (benefit)			22				86				313				(702	)
Net income (loss)		$	1,536			$	135			$	4,272			$	(2,167	)
Net income (loss) per share:
Basic		$	0.06			$	0.01			$	0.17			$	(0.09	)
Diluted		$	0.06			$	0.01			$	0.16			$	(0.09	)
Weighted average common shares:
Basic			26,101				25,293				25,887				25,310
Diluted			27,779				25,983				27,298				25,310
* Stock-based compensation amortization:
Cost of design-to-silicon-yield solutions		$	—			$	2			$	—			$	39
Research and development			11				130				85				606
Selling, general and administrative			8				2				8				36
		$	19			$	134			$	93			$	681

See notes to unaudited consolidated financial statements

PDF SOLUTIONS, INC.

		Nine Months Ended
		September 30,				September 30,
		2005				2004
Operating activities:
Net income (loss)		$	4,272			$	(2,167	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			1,690				1,905
Stock-based compensation expense			93				681
Amortization of acquired intangible assets			4,503				5,114
Deferred taxes			(1,533	)			(1,381	)
Changes in operating assets and liabilities:
Accounts receivable			(1,649	)			(3,599	)
Prepaid expenses and other assets			146				165
Accounts payable			310				748
Accrued compensation and related benefits			1,087				1,018
Other accrued liabilities			(826	)			16
Taxes payable			1,675				414
Deferred revenue			(527	)			46
Billings in excess of recognized revenue			844				2,342
Net cash provided by operating activities			10,085				5,302
Investing activities:
Purchases of property and equipment			(1,784	)			(1,228	)
Net cash used in investing activities			(1,784	)			(1,228	)
Financing activities:
Proceeds from exercise of stock options			4,687				1,450
Proceeds from employee stock purchase plan			808				689
Collection of notes receivable from stockholders			—				2,475
Repurchase of common stock			—				(4,806	)
Principal payments on long-term obligations			(40	)			(39	)
Net cash provided by (used in) financing activities			5,455				(231	)
Effect of exchange rate changes on cash and cash equivalents			(75	)			(14	)
Net increase in cash and cash equivalents			13,681				3,829
Cash and cash equivalents, beginning of period			45,660				39,110
Cash and cash equivalents, end of period		$	59,341			$	42,939
Supplemental disclosure of cash flow information —
Cash paid during the period for:
Taxes		$	153			$	267
Interest			—			$	1
Supplemental disclosure of non-cash activity:
Deferred stock compensation		$	10				—
Repurchase of common stock in exchange for shareholder note receivable		$	742				—
Purchase of property and equipment on account		$	210			$	68

See notes to unaudited consolidated financial statements

PDF SOLUTIONS, INC.

1. BASIS OF PRESENTATION

     The interim unaudited consolidated financial statements included herein have been prepared by PDF Solutions, Inc. (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), including the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The unaudited interim consolidated financial statements reflect, in the opinion of management, all adjustments necessary, (consisting only of normal recurring adjustments) to present a fair statement of results for the interim periods presented. The operating results for any interim period are not necessarily indicative of the results that may be expected for other interim periods or the full fiscal year. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

     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.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. A significant portion of the Company’s revenues require estimates with respect to total costs which may be incurred and revenues earned. Actual results could differ from these estimates.

Revenue Recognition

     The Company derives revenue from two sources: Design-to-Silicon-Yield solutions and gain share. The 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 — Design-to-Silicon-Yield solutions revenue is derived from integrated solutions and software licenses. Revenue recognition for each element of Design-to-Silicon-Yield solutions is summarized as follows:

     Integrated Solutions — The Company generates a significant portion of its revenue from fixed-price contracts delivered over a specific period of time. These contracts require the accurate estimation of the cost to perform obligations and the overall scope of each engagement. Revenue under contracts for solution implementation services is recognized as the services are performed using the cost-to-cost percentage of completion method of contract accounting. Losses on solution implementation contracts are recognized when determined. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated. On occasion, the Company has licensed its software products as a component of its fixed price integrated solutions implementations. In such instances, the software products are licensed to the customer over the 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”) does not exist to allocate a portion of the total fee to the undelivered elements, revenue is recognized ratably over the term of the agreement. Costs incurred under these arrangements are deferred and recognized in proportion to revenue recognized under these arrangements.

     Revenue from 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 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 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 term of the underlying element for which VSOE does not exist.

     Software Licenses — The Company also licenses its software products separately from its integrated solution implementations. In such cases revenue is recognized under the residual method when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv) collectibility is probable and 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 the Company’s VSOE and such services are recorded as integrated solutions. 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. No revenue has been recognized for software licenses with extended payment terms in excess of amounts due.

     Gain Share — Gain share revenue represents profit sharing and performance incentives earned based upon the Company’s customer reaching certain defined operational levels. Upon achieving such operational levels, the Company receives either a fixed fee and/or variable fee based on the units manufactured by the customer. Due to the uncertainties surrounding attainment of such operational levels, the Company recognizes gain share revenue (to the extent of completion of the related solution implementation contract) upon receipt of performance reports or other related information from the customer supporting the determination of amounts and probability of collection.

Stock-Based Compensation

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

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

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2005				2004				2005				2004
Net income (loss) as reported:		$	1,536			$	135			$	4,272			$	(2,167	)
Add: stock-based employee compensation expense included in reported net income (loss) under APB No. 25			19				89				93				636
Deduct: total employee stock-based compensation determined under fair value based method for all awards, net of related tax effects			(1,636	)			(2,264	)			(4,396	)			(4,959	)
Pro forma net loss		$	(81	)		$	(2,040	)		$	(31	)		$	(6,490	)
Basic net income (loss) per share:
As reported		$	0.06			$	0.01			$	0.17			$	(0.09	)
Proforma		$	(0.00	)		$	(0.08	)		$	(0.00	)		$	(0.26	)
Diluted net income (loss) per share:
As reported		$	0.06			$	0.01			$	0.16			$	(0.09	)
Proforma		$	(0.00	)		$	(0.08	)		$	(0.00	)		$	(0.26	)

          During the nine months ended September 30, 2004, the Company recorded $45,000 in compensation expense for the fair value of options granted to a non-employee associated with the grant of 10,000 options to purchase common shares. Such options were granted at an exercise price of $9.04 per share, the fair market value on the grant date and were fully vested at the date of grant. Such options were valued using the Black-Scholes option pricing model with the following assumptions: contractual life of 2.5 years; risk-free interest rate of 4.14%; volatility of 80%; and no dividends during the expected term. Additionally, during the nine months ended September 30, 2004 the Company recorded $158,000 of compensation associated with the acceleration of vesting of certain options to a former employee of the Company. The compensation expense reflected the intrinsic value of such options at time of acceleration.

          In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (R), Share-Based Payment (“SFAS No. 123(R)”), which revised SFAS No. 123. Under the provision of SFAS No. 123(R), all companies will be required to expense the estimated fair value of equity instruments including stock options and similar awards. The accounting provisions of SFAS No. 123(R) will be effective for the Company beginning on January 1, 2006.

2. RECENT ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (R), Share-Based Payment (“SFAS No. 123 (R)”), an amendment of SFAS No. 123 and SFAS No. 95, Statement of Cash Flows. 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. SFAS No. 123 (R) applies to all share-based payment transactions in which an entity acquires goods or services by issuing its shares, share options, or other equity instruments or by incurring liabilities based on the price of an entity’s shares or that require settlement by the issuance of equity instruments. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) 107 (“SAB No. 107”) which expresses views of the SEC staff regarding the application of SFAS No. 123 (R). Among other things, SAB No. 107 provides interpretive guidance related to the interaction between SFAS No. 123 (R) and certain SEC rules and regulations, as well as provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies.

In April 2005, the SEC amended the compliance dates for SFAS No. 123 (R) to provide that the provisions of this statement will be effective for the Company beginning on January 1, 2006. Although the Company is currently assessing the application of SFAS No. 123 (R), the Company believes that the adoption of this statement will have a material impact on its financial position, results of operations and cash flows.

     On June 1, 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS No. 154”). This statement applies to all voluntary changes in accounting principles and changes required by an accounting pronouncement where no specific transition provisions are included. SFAS No. 154 requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 carries forward the guidance set forth in Opinion 20 for reporting the correction of an error included in previously issued financial statements. The provisions of SFAS No. 154 are effective for accounting changes and correction of errors made in fiscal periods beginning January 1, 2006. The Company does not believe that the adoption of this statement will have a material impact on its financial position, results of operations or cash flows.

     Reclassifications — Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation.

3. ACCOUNTS RECEIVABLE

          Accounts receivable include amounts that are unbilled at the end of the period. Unbilled accounts receivable are determined on an individual contract basis and were approximately $3.5 million and $2.8 million at September 30, 2005 and December 31, 2004, respectively.

4. NET INCOME (LOSS) PER SHARE

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

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2005				2004				2005				2004
Net income (loss)		$	1,536			$	135			$	4,272			$	(2,167	)
Denominator:
Weighted average common shares outstanding			26,101				25,320				25,891				25,393
Weighted average common shares outstanding subject to repurchase			—				(27	)			(4	)			(83	)
Denominator for basic calculation, weighted average shares			26,101				25,293				25,887				25,310
Weighted average shares subject to repurchase			—				27				4				—
Stock options outstanding			1,678				663				1,407				—
Denominator for diluted calculation, weighted average shares			27,779				25,983				27,298				25,310
Net income (loss) per share — basic		$	0.06			$	0.01			$	0.17			$	(0.09	)
Net income (loss) per share — diluted		$	0.06			$	0.01			$	0.16			$	(0.09	)

     The following table sets forth potential shares of common stock that are not included in the diluted net income (loss) per share calculation above because to do so would be anti-dilutive for the periods indicated (in thousands):

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2005				2004				2005				2004
Shares of common stock subject to repurchase			—				—				—				83
Common stock options			157				998				546				878
			157				998				546				961

5. COMPREHENSIVE INCOME (LOSS)

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

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2005				2004				2005				2004
Net income (loss)		$	1,536			$	135			$	4,272			$	(2,167	)
Foreign currency translation adjustments			(6	)			(8	)			(75	)			(14	)
Comprehensive income (loss)		$	1,530			$	127			$	4,197			$	(2,181	)

6. GOODWILL AND PURCHASED INTANGIBLE ASSETS

          The Company applies the provisions of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”) in accounting for goodwill and other intangible assets acquired in business combinations. SFAS No. 142 requires goodwill to be tested for impairment under certain circumstances, written down when impaired, and requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. The following table provides information relating to the intangible assets and goodwill contained within the Company’s consolidated balance sheets as of September 30, 2005 and December 31, 2004 (in thousands):

		September 30, 2005
						Purchase Price				Accumulated				Net Carrying
		Cost				Adjustments				Amortization				Amount
Goodwill		$	41,282			$	(834	)		$	(562	)		$	39,886
Acquired identifiable intangibles:
Acquired core technology		$	21,602			$	(500	)		$	(11,615	)		$	9,487
Brand name			2,000				—				(1,042	)			958
Other acquired intangibles			2,460				—				(1,617	)			843
Total		$	26,062			$	(500	)		$	(14,274	)		$	11,288

		December 31, 2004
						Purchase Price				Accumulated				Net Carrying
		Cost				Adjustments				Amortization				Amount
Goodwill		$	41,282			$	(834	)		$	(562	)		$	39,886
Acquired identifiable intangibles:
Acquired core technology		$	21,602			$	(500	)		$	(7,817	)		$	13,285
Brand name			2,000				—				(667	)			1,333
Other acquired intangibles			2,460				—				(1,287	)			1,173
Total		$	26,062			$	(500	)		$	(9,771	)		$	15,791

          SFAS No. 142 requires that goodwill be tested for impairment on an annual basis and more frequently in certain circumstances. Accordingly, the Company has selected December 31, to perform the annual testing requirements. As of December 31, 2004, the Company completed its annual testing requirements and determined that the carrying value of goodwill had not been impaired.

          During the year ended December 31, 2003, the Company recorded a non-cash adjustment of $172,000, relating to the reversal of excess accruals for acquisition-related expenses. Such adjustment resulted in a reduction of goodwill. During the year ended December 31, 2004, the Company recorded a non-cash adjustment of $704,000 relating to the reversal of estimated tax liabilities, which were resolved. Such adjustment resulted in a reduction of goodwill. Additionally, during the twelve months ended December 31, 2004, the Company recorded a non-cash adjustment of $42,000 relating to a change in estimate on abandoned leased facilities assumed during the acquisition of IDS Software Systems, Inc. (“IDS”). This adjustment resulted in an increase in goodwill.

          During the year ended December 31, 2004, the Company recorded a non-cash adjustment of $500,000 associated with a reversal of contingent incentive performance amounts originally recorded to acquired core technology in connection with the acquisition of WaferYield, Inc. (“WaferYield”).

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

Year Ending December 31,		Amount
2005 (remaining three months)		$	1,501
2006			6,004
2007			3,783
Total		$	11,288

7. 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:

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
Customer		2005				2004				2005				2004
A			11	%			15	%			11	%			18	%
C			8	%			12	%			9	%			12	%
G			1	%			12	%			1	%			13	%
J			9	%			6	%			13	%			10	%
M			4	%			6	%			11	%			4	%
P			20	%			7	%			11	%			4	%

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

Customer		September 30, 2005				December 31, 2004
A			14	%			13	%
C			6	%			14	%
P			20	%			5	%

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

		Three Months								Nine Months
		Ended September 30,								Ended September 30,
		2005				2004				2005				2004
Asia		$	9,522			$	10,772			$	32,400			$	28,239
United States			6,729				3,752				16,804				11,695
Europe			2,206				1,926				5,702				4,361
Total		$	18,457			$	16,450			$	54,906			$	44,295

          As of September 30, 2005 and December 31, 2004, long-lived assets related to PDF Solutions GmbH (formerly AISS), located in Germany, totaled $908,000 and $795,000, respectively, of which $659,000 and $659,000, respectively, relates to acquired intangibles and goodwill. The majority of the Company’s remaining long-lived assets are in the United States.

8. STOCK REPURCHASE PROGRAM

          In February 2003, the Board of Directors approved a program to repurchase up to $10.0 million of the Company’s common stock in the open market. During the three months ended September 30, 2005, the Company repurchased 44,942 shares of common stock from a Director of the Company at the closing price on the date of repurchase, which was $16.52 per share, in exchange for the repayment of a stockholder note receivable in the amount of approximately $742,000 consisting of the principal amount of the note and accrued interest. As of September 30, 2005, the Company has repurchased an aggregate of 550,521 shares at a weighted average price of $10.08 per share for a total cost of $5.5 million since the inception of the program. Under this authorization, the Company may continue to make additional stock repurchases from time to time, depending on market conditions, stock price and other factors. At September 30, 2005, $4.5 million remained available under the program to repurchase additional shares.

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

Forward-Looking Statements

          The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative effect of terms like these or other comparable terminology. These statements are only predictions. These statements involve known and unknown risks and uncertainties and other factors that may cause actual events or results to differ materially. All forward-looking statements included in this document are based on information available to us on the date of filing, and we assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the caption “Certain Risks Which May Affect Our Future Results” set forth at the end of this Item 2 and set forth at the end of Item 7 in our Annual Report on Form 10-K for the year ended December 31, 2004. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

Overview

          Our technologies and services enable semiconductor companies to improve the yield and performance of integrated circuits, or ICs, by integrating the design and manufacturing processes. We believe that our solutions improve a semiconductor company’s time-to-market, yield and ultimately product profitability. Our solutions combine proprietary manufacturing process simulation software, yield and performance modeling software, design-for-manufacturability software, test chips, a proprietary electrical wafer test system, yield and performance enhancement methodologies, yield management systems, and professional services. We analyze yield loss

mechanisms to identify, quantify and correct the issues that cause yield loss, as an integral part of the IC design process. This drives IC design and manufacturing improvements that enable our customers to have higher initial yields and achieve and exceed targeted IC yield and performance throughout product life cycles. Our solution is designed to increase the initial yield when a design first enters a manufacturing line, to increase the rate at which that yield improves, and to allow subsequent product designs to be added to manufacturing lines more quickly and easily.

          The result of implementing our solutions is the creation of value that can be measured based on improvements to our customers’ actual yield. We align our financial interests with the yield and performance improvements realized by our customers, and receive revenue based on this value. To date, we have sold our technologies and services to semiconductor companies including leading integrated device manufacturers, fabless semiconductor companies and foundries.

          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, as 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, now operating as PDF Solutions, GmbH, 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 further enhanced our product and service offerings through the acquisitions of IDS and WaferYield.

Industry Trend

          Demand for consumer electronics continues to drive technological innovation as the need for products which have greater performance, lower power consumption, reduced costs and smaller size continues to grow with each new product generation. To meet this demand, IC manufacturers and designers are constantly challenged to improve the overall performance of ICs by designing and manufacturing ICs with more embedded applications to create greater functionality. As a result, in 2004 and through 2005 more and more companies have expanded or advanced their design and manufacturing processes to develop and produce deep submicron ICs containing component sizes measured at 130 nanometers and below. As this trend continues, companies will continually be challenged to improve process capabilities to optimally produce ICs with minimal systematic and yield loss, which is driven by the lack of compatibility between the design and its respective manufacturing process. We believe as volume production of deep submicron ICs continues to grow, the difficulties of integrating IC designs with their respective processes will create a greater need for products and services that address the performance yield loss issues the semiconductor industry is facing today and will face in the future.

Financial Highlights

          Financial highlights for the three months ended September 30, 2005 were as follows:

•		Total revenue for the three months ended September 30, 2005, was $18.5 million, an increase of 12% compared to the three months ended September 30, 2004. Revenue from Design-to-Silicon-Yield integrated solutions for the three months ended September, 2005, increased to $13.8 million compared to $13.2 million for the three months ended September 30, 2004. This increase was the result of an overall increase in the total contract value of our solution implementation and of an increase in software maintenance revenues. Revenue from Design-to-Silicon-Yield software licenses for the three months ended September 30, 2005 increased to $1.5 million compared to $812,000 for the three months ended September 30, 2004. This increase was due to greater adoption of our software applications from our installed base of customers. Gain share revenue for the three months ended September 30, 2005 increased to $3.1 million compared to $2.4 million for the three months ended September 30, 2004. Our gain share revenue may continue to fluctuate from quarter to quarter as a result of each customer’s contractual performance measures for achieving gain share as well as each customer’s production volumes in any given period.
•		We reported net income of $1.5 million for the three months ended September 30, 2005, compared to net income of $135,000 for the three months ended September 30, 2004. The increase in net income was primarily attributable to increased revenues more than offsetting the increase in expenses. The increase in expenses was mainly due to a growth in headcount and was partially offset by the slight decrease in stock-based compensation amortization and in the amortization of other acquired intangible assets. We will continue to monitor and control costs, relative to our revenue growth.

•

Net income per share was $0.06 for the three months ended September 30, 2005 compared to net income per share of $0.01 for the three months ended September 30, 2004, an improvement of $0.05 per share.

          Financial highlights for the nine months ended September 30, 2005 were as follows:

•		Total revenue for the nine months ended September 30, 2005, was $54.9 million, an increase of 24% compared to the nine months ended September 30, 2004. Revenue from Design-to-Silicon-Yield integrated solutions for the nine months ended September 30, 2005, increased to $38.7 million compared to $36.1 million for the nine months ended September 30, 2004. This increase was the result of increases in the total contract value of our solution implementations and in software maintenance revenues from the prior period. Revenue from Design-to-Silicon-Yield software licenses for the nine months ended September 30, 2005 increased to $8.2 million compared to $3.2 million for the nine months ended September 30, 2004. This increase was due to greater adoption of our software applications from our installed base of customers. Gain share revenue for the nine months ended September 30, 2005 increased to $8.1 million compared to $5.1 million for the nine months ended September 30, 2004.
•		We reported net income of $4.3 million for the nine months ended September 30, 2005, compared to a net loss of $2.2 million for the nine months ended September 30, 2004. The increase in net income was primarily attributable to increased revenues more than offsetting the increase in expenses. The increase in expenses was mainly due to a growth in headcount and was partially offset by the decrease in stock-based compensation amortization and in the amortization of other acquired intangible assets. We will continue to monitor and control costs, relative to our revenue growth.
•		Net income per share was $0.16 for the nine months ended September 30, 2005 compared to a net loss per share of $0.09 for the nine months ended September 30, 2004, an improvement of $0.25 per share.
•		Cash increased $13.7 million, to $59.3 million, during the nine months ended September 30, 2005. Net cash provided by operating activities and used in investing activities for the nine months ended September 30, 2005 totaled $10.1 million and $1.8 million, respectively. Net cash provided by financing activities for the nine months ended September 30, 2005 totaled $5.5 million.
•		During the nine months ended September 30, 2005, we released shares for distribution which had remained held in escrow in connection with the IDS 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. The notes to the unaudited consolidated financial statements include 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 base 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 gain share. 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.

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

     Integrated Solutions — We generate a significant portion our revenue from fixed-price contracts delivered over a specific period of time. These contracts require the accurate estimation of the cost to perform obligations and the overall scope of each engagement. Revenue under contracts for solution implementation services is recognized as the services are performed using the cost-to-cost percentage of completion method of contract accounting. Losses on solution implementation contracts are recognized when determined. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated. If we do not accurately estimate the resources required or the scope of work to be performed, or do not manage the projects properly within the planned period of time or satisfy our obligations under contracts, resulting contract margins could be materially different than those anticipated when the contract was executed. Any such reductions in contract margin could have a material negative impact on our operating results.

     On occasion, we have licensed our software products as a component of our fixed price solutions implementations. In such instances, the software products are licensed to the customer over the 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”) does not exist to allocate a portion of the total fee to the undelivered elements, revenue is recognized ratably over the term of the agreement. Costs incurred under these arrangements are deferred and recognized in proportion to revenue recognized under these arrangements.

     Revenue from 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 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 term of the underlying element for which VSOE does not exist.

     Software Licenses — We also license our software products separate from our integrated solutions. In such cases revenue is recognized under the residual method when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, (iv) collectibility is probable and 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 integrated solutions. VSOE is generally established for maintenance based upon negotiated renewal rates while VSOE for consulting, installation and training services is established based upon our customary pricing for such services when sold separately. No revenue has been recognized for software licenses with extended payment terms in excess of amounts due.

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

Software Development Costs

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

Goodwill and Acquired Intangible Assets

          As of September 30, 2005, we had $51.2 million of goodwill and intangible assets. In assessing the recoverability of our goodwill and intangible assets, we must make assumptions regarding estimated future cash flows and other factors. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets, which would have a material adverse effect on our operating results. We evaluate goodwill for impairment pursuant to the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. We have selected December 31 as the date upon which to perform our annual testing for impairment. As of December 31, 2004, we completed our annual testing requirements and determined that the carrying value of goodwill had not been impaired.

          We are currently amortizing our acquired intangible assets over estimated useful lives of 4 years, which is 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 an impairment of such asset in future periods.

Realization of Deferred Tax Assets

          Realization of deferred tax assets is dependent on our ability to generate future taxable income and utilize tax-planning strategies. We have recorded a deferred tax asset in the amount that is more likely than not to be realized based on current estimations and assumptions. We evaluate the need for a valuation allowance on a quarterly basis. Any resulting changes to the valuation allowance will result in an adjustment to income in the period the determination is made.

Results of Operations

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Revenue:
Design-to-silicon-yield solutions:
Integrated solutions			75	%			80	%			70	%			82	%
Software licenses			8				5				15				7
Gain share			17				15				15				11
Total revenue			100				100				100				100
Costs and expenses:
Cost of design-to-silicon-yield solutions:
Direct costs of design-to-silicon-yield solutions
Integrated solutions			35				36				33				35
Software licenses			—				—				—				—
Amortization of acquired core technology			7				8				7				9
Research and development			30				30				30				34
Selling, general and administrative			22				23				22				25
Stock-based compensation amortization			—				1				—				2
Amortization of other acquired intangible assets			1				2				1				3
Total costs and expenses			95				100				93				108
Income (loss) from operations			5				—				7				(8	)
Interest and other income, net			3				1				2				1
Income (loss) before taxes			8				1				9				(7	)
Tax provision (benefit)			—				—				1				(2	)
Net income (loss)			8	%			1	%			8	%			(5	)%

Comparison of the Three Months Ended September 30, 2005 and 2004

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
										$				%				% of				% of
Revenue		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Design-to-silicon-yield solutions
Integrated solutions		$	13,834			$	13,224			$	610				5	%			75	%			80	%
Software licenses			1,533				812				721				89	%			8	%			5	%
Gain share			3,090				2,414				676				28	%			17	%			15	%
Total		$	18,457			$	16,450			$	2,007				12	%			100	%			100	%

          Design-to-Silicon-Yield Solutions. Design-to-Silicon-Yield solutions revenue is derived from integrated solutions (including solution implementations, software support and maintenance and training) and software licenses, provided during our customer yield improvement engagements and solution product sales.

      Integrated solutions. The increase in integrated solutions revenue of $610,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily attributable to an overall increase in the total contract value of our solution implementations and to an increase in software maintenance revenues as a result of our increased application customer base. Our integrated solutions revenue may fluctuate in the future and is dependent on a number of factors including our ability to obtain new customers at emerging technology nodes.

     Software licenses. The increase in software licenses revenue of $721,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was due to greater adoption of our software applications, principally from our existing customers, who continue to expand their usage of our software products. Software license revenue may fluctuate in the future and is dependent upon a number of factors including the semiconductor industry’s acceptance of our products, our ability to attract new customers and further penetration of our current customer base.

          Gain Share. Gain share revenue represents profit sharing and performance incentives earned based upon our customer reaching certain defined operational levels. Gain share revenue grew approximately $676,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004. The increase in gain share revenue was primarily due to a greater number of engagements contributing to gain share at newer technology nodes, as well as a greater number of wafer starts at our customers’ sites. Our gain share revenue may continue to fluctuate from period to period. Gain share revenue is dependent on many factors that are outside our control, including among others, continued production of ICs by our customers, sustained yield improvements by our customers and our ability to enter into new Design-to-Silicon-Yield solutions contracts containing gain share provisions.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
Cost of Design-to-Silicon										$				%				% of				% of
Yield Solutions		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Direct costs of design-to-silicon- yield solutions
Integrated solutions		$	6,382			$	5,881			$	501				9	%			35	%			36	%
Software licenses			15				6				9				150	%			—				—
Amortization of acquired core technology			1,266				1,266				—				—				7	%			8	%
Total		$	7,663			$	7,153			$	510				7	%			42	%			44	%

     Direct Costs of Design-to-Silicon-Yield Solutions. Direct costs of Design-to-Silicon-Yield solutions consists of costs incurred to provide and support our integrated solutions and costs recognized in connection with licensing our software.

     Integrated solutions. Integrated solutions costs consist of material, labor and overhead costs associated with solution implementations. Costs include purchased material, employee compensation and benefits, travel and facilities-related costs. The increase in direct costs of Design-to-Silicon-Yield integrated solutions of $501,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily attributable to increased personnel-related costs and increased purchases of materials used in customer engagements. 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 increase in direct costs of Design-to-Silicon-Yield solutions software licenses of $9,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily attributable to an increase in license fees and royalties incurred associated with third party software licenses sold in conjunction with our software. 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.

     Amortization of Acquired Core Technology. Amortization of acquired core technology consists of the amortization of intangibles acquired as a result of certain business combinations. The amortization of acquired core technology expense remained unchanged at $1.3 million for both the three months ended September 30, 2005 and the three months ended September 30, 2004. We anticipate amortization of acquired core technology to be $1.3 million for the remaining three months in 2005, $5.1 million in 2006 and $3.2 million in 2007.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
										$				%				% of				% of
Research and Development		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Research and development		$	5,474			$	4,940			$	534				11	%			30	%			30	%

          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 and facilities cost allocations. The increase in research and development expenses of $534,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily due to increased personnel-related expenses, a result of our growth in headcount. We anticipate that we will continue to commit considerable resources to research and development in the future and that these expenses may increase in absolute dollars.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
Selling, General and										$				%				% of				% of
Administrative		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Selling, general and administrative		$	3,971			$	3,801			$	170				4	%			22	%			23	%

     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. The increase in selling, general and administrative expenses of $170,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily due to increases in personnel-related costs, as a result of our growth in headcount, and professional fees, partially offset by a decrease in outside sales commissions. We expect that selling, general and administrative expenses will increase in absolute dollars to support increased selling and administrative efforts in the future as we expand our operations to support our growing customer base.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
Stock-Based Compensation										$				%				% of				% of
Amortization		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Stock-based compensation amortization		$	19			$	134			$	(115	)			(86	)%			—				1	%

          Stock-Based Compensation Amortization. The Company recognizes deferred stock-based compensation expense under the provisions of APB No. 25 Accounting for Stock Issued to Employees, using the graded vesting method for amortization purposes. The decrease in stock-based compensation amortization of $115,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily due to the effects of the graded vesting method of amortization which results in higher amortization expense during the initial periods following the respective option grants and due to the recognition of $45,000 associated with the grant of 10,000 fully-vested stock options to a non-employee during the three months ended September 30, 2004. We anticipate amortization of stock-based compensation to continue to decrease throughout 2005.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
Amortization of Other										$				%				% of				% of
Acquired Intangible Assets		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Amortization of other acquired intangible assets		$	235			$	351			$	(116	)			(33	)%			1	%			2	%

          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 decreased $116,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004, as a result of certain intangible assets being fully amortized in prior periods. We anticipate amortization of these other acquired intangible assets to continue to decrease in future periods.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004
Interest and Other										$				%				% of				% of
Income, Net		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Interest and other income, net		$	463			$	150			$	313				209	%			3	%			1	%

          Interest and Other Income, Net. The increase in interest and other income, net of $313,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily due to increased interest earned on higher average cash and cash equivalent balances during the period coupled with higher interest rates earned during the period.

		Three Months Ended September 30,												Three Months Ended September 30,
																		2005				2004%
										$				%				% of				of
Tax Provision		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Tax provision for income taxes		$	22			$	86			$	(64	)			(74	)%			—				—

          Tax Provision. The decrease in the tax provision of $64,000 for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was primarily due to a an decrease in the expected tax rate as a result of increased credits and other tax benefits earned.

Comparison of the Nine Months Ended September 30, 2005 and 2004

		Nine Months Ended September 30,												Nine Months Ended September 30,
																		2005				2004
										$				%				% of				% of
Revenue		2005				2004				Change				Change				Revenue				Revenue
(In thousands, except for %’s)
Design-to-silicon-yield solutions
Integrated solutions		$	38,658			$	36,082			$	2,576				7	%			70	%			82	%
Software licenses			8,179				3,162				5,017				159	%			15	%			7	%
Gain share			8,069				5,051				3,018				60	%			15	%			11	%
Total		$	54,906			$	44,295			$	10,611				24	%			100	%			100	%