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

FORM 10-Q

 
☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  	
 
For the Quarterly Period ended March 31, 2016 
    
or
 
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  	
     
For the transition period from _______________ to ______________                                 
 
Commission File Number 000-31311

PDF SOLUTIONS, INC.
(Exact name of Registrant as Specified in its Charter)
 
Delaware 	25-1701361 	
(State or Other Jurisdiction of	(I.R.S. Employer	
Incorporation or Organization)	Identification No.)	
  	  	
333 West San Carlos Street, Suite 1000 	  	
San Jose, California 	95110 	
(Address of Principal Executive Offices)	(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 ☑ No ☐
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No  ☐
 
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.
 
☐ Large accelerated filer	☑ Accelerated filer	☐ Non-accelerated  filer	☐ Smaller reporting company	
  	  	(Do not check if a smaller reporting company)	  	
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
 
The number of shares outstanding of the Registrant’s Common Stock as of April 28, 2016 was 31,236,483.

1

 
 
TABLE OF CONTENTS
 
  	Page 	
PART I  FINANCIAL INFORMATION 	  	
Item 1. Financial Statements (Unaudited)	3	
Condensed Consolidated Balance Sheets	3	
Condensed Consolidated Statements of Operations and Comprehensive Income	4	
Condensed Consolidated Statements of Cash Flows	5	
Notes to Condensed Consolidated Financial Statements	6	
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16	
Item 3. Quantitative and Qualitative Disclosures About Market Risk	24	
Item 4. Controls and Procedures	25	
PART II  OTHER INFORMATION 	  	
Item 1. Legal Proceedings	25	
Item 1A. Risk Factors	25	
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	25	
Item 3. Defaults Upon Senior Securities	25	
Item 4. Mine Safety Disclosures	25	
Item 5. Other Information	25	
Item 6. Exhibits	26	
SIGNATURES 	27	
INDEX TO EXHIBITS 	28	

2

 
 
PART I — FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except par value)
 
 	 	March 31,
2016	 	 	December 31,
2015	 	
ASSETS	 	 	 	 	 	 	 	 	
Current assets:	 	 	 	 	 	 	 	 	
Cash and cash equivalents	 	$	129,398	 	 	$	126,158	 	
Accounts receivable, net of allowance of $352 and $299, respectively	 	 	29,323	 	 	 	33,438	 	
Prepaid expenses and other current assets	 	 	3,479	 	 	 	3,655	 	
Total current assets	 	 	162,200	 	 	 	163,251	 	
Property and equipment, net	 	 	13,236	 	 	 	11,325	 	
Goodwill	 	 	215	 	 	 	215	 	
Intangible assets, net	 	 	4,815	 	 	 	5,028	 	
Deferred tax assets	 	 	10,186	 	 	 	10,299	 	
Other non-current assets	 	 	7,565	 	 	 	1,651	 	
Total assets	 	$	198,217	 	 	$	191,769	 	
LIABILITIES AND STOCKHOLDERS’ EQUITY	 	 	 	 	 	 	 	 	
Current liabilities:	 	 	 	 	 	 	 	 	
Accounts payable	 	$	2,016	 	 	$	1,293	 	
Accrued compensation and related benefits	 	 	4,289	 	 	 	4,812	 	
Accrued and other current liabilities	 	 	1,853	 	 	 	2,382	 	
Deferred revenues – current portion	 	 	6,358	 	 	 	4,702	 	
Billings in excess of recognized revenue	 	 	114	 	 	 	1,267	 	
Total current liabilities	 	 	14,630	 	 	 	14,456	 	
Long-term income taxes payable	 	 	2,468	 	 	 	2,540	 	
Other non-current liabilities	 	 	464	 	 	 	466	 	
Total liabilities	 	 	17,562	 	 	 	17,462	 	
Commitments and contingencies (Note 9)	 	 	 	 	 	 	 	 	
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 37,599 and 37,476, respectively; shares outstanding 31,234 and 31,111, respectively	 	 	5	 	 	 	5	 	
Additional paid-in-capital	 	 	269,944	 	 	 	266,008	 	
Treasury stock at cost, 6,365 shares in both 2016 and 2015	 	 	(50,392	)	 	 	(50,383	)	
Accumulated deficit	 	 	(37,718	)	 	 	(39,780	)	
Accumulated other comprehensive loss	 	 	(1,184	)	 	 	(1,543	)	
Total stockholders’ equity	 	 	180,655	 	 	 	174,307	 	
Total liabilities and stockholders’ equity	 	$	198,217	 	 	$	191,769	 	
 
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited). 

3

 
 
PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(unaudited)
(in thousands, except per share amounts)
 
 	 	Three Months Ended March 31,	 	
 	 	2016	 	 	2015	 	
 	 	 	 	 	 	 	 	 	
Revenues:	 	 	 	 	 	 	 	 	
Design-to-silicon-yield solutions	 	$	18,578	 	 	$	18,152	 	
Gainshare performance incentives	 	 	6,503	 	 	 	8,665	 	
Total revenues	 	 	25,081	 	 	 	26,817	 	
 	 	 	 	 	 	 	 	 	
Costs of Design-to-silicon-yield solutions	 	 	 	 	 	 	 	 	
Direct costs of Design-to-silicon-yield solutions	 	$	10,110	 	 	 	8,804	 	
Amortization of acquired technology	 	 	96	 	 	 	—	 	
Total cost of Design-to-silicon-yield solutions	 	 	10,206	 	 	 	8,804	 	
Gross profit	 	 	14,875	 	 	 	18,013	 	
 	 	 	 	 	 	 	 	 	
Operating expenses:	 	 	 	 	 	 	 	 	
Research and development	 	 	6,311	 	 	 	4,088	 	
Selling, general and administrative	 	 	5,124	 	 	 	4,456	 	
Amortization of other acquired intangible assets	 	 	117	 	 	 	—	 	
Total operating expenses	 	 	11,552	 	 	 	8,544	 	
 	 	 	 	 	 	 	 	 	
Income from operations	 	 	3,323	 	 	 	9,469	 	
Interest and other income (expense), net	 	 	(236	)	 	 	51	 	
Income before income taxes	 	 	3,087	 	 	 	9,520	 	
Income tax provision	 	 	1,025	 	 	 	3,553	 	
Net income	 	$	2,062	 	 	$	5,967	 	
 	 	 	 	 	 	 	 	 	
Net income per share:	 	 	 	 	 	 	 	 	
Basic	 	$	0.07	 	 	$	0.19	 	
Diluted	 	$	0.07	 	 	$	0.18	 	
 	 	 	 	 	 	 	 	 	
Weighted average common shares:	 	 	 	 	 	 	 	 	
Basic	 	 	31,168	 	 	 	31,336	 	
Diluted	 	 	31,722	 	 	 	32,291	 	

Net income	 	$	2,062	 	 	$	5,967	 	
Other comprehensive income (loss):	 	 	 	 	 	 	 	 	
Foreign currency translation adjustments, net of tax	 	 	360	 	 	 	(748	)	
Comprehensive income	 	$	2,422	 	 	$	5,219	 	
 
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited). 

4

 
 
PDF SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands) 
   
 	 	Three Months Ended
March 31,	 	
 	 	2016	 	 	2015	 	
Operating activities:	 	 	 	 	 	 	 	 	
Net income	 	$	2,062	 	 	$	5,967	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Depreciation and amortization	 	 	765	 	 	 	605	 	
Stock-based compensation expense	 	 	2,666	 	 	 	2,199	 	
Amortization of acquired intangible assets	 	 	213	 	 	 	—	 	
Deferred taxes	 	 	108	 	 	 	416	 	
Loss on disposal of property and equipment	 	 	107	 	 	 	—	 	
Purchases of treasury stock in connection with tax withholdings on restricted stock grants	 	 	(9	)	 	 	(2	)	
Provision for (reversal of) allowance for doubtful accounts	 	 	53	 	 	 	(82	)	
Unrealized loss (gain) on foreign currency forward contract	 	 	(23	)	 	 	84	 	
Tax benefit related to stock-based compensation expense	 	 	349	 	 	 	1,858	 	
Excess tax benefit from stock-based compensation	 	 	(330	)	 	 	(1,754	)	
Changes in operating assets and liabilities:	 	 	 	 	 	 	 	 	
Accounts receivable	 	 	4,062	 	 	 	8,615	 	
Prepaid expenses and other assets	 	 	(5,739	)	 	 	(315	)	
Accounts payable	 	 	250	 	 	 	(988	)	
Accrued compensation and related benefits	 	 	(564	)	 	 	(2,024	)	
Accrued and other liabilities	 	 	(833	)	 	 	(415	)	
Deferred revenues	 	 	1,674	 	 	 	1,455	 	
Billings in excess of recognized revenues	 	 	(1,153	)	 	 	—	 	
Net cash provided by operating activities	 	 	3,658	 	 	 	15,619	 	
Investing activities:	 	 	 	 	 	 	 	 	
Purchases of property and equipment	 	 	(1,780	)	 	 	(1,145	)	
Net cash used in investing activities	 	 	(1,780	)	 	 	(1,145	)	
Financing activities:	 	 	 	 	 	 	 	 	
Proceeds from exercise of stock options	 	 	182	 	 	 	3,128	 	
Proceeds from employee stock purchase plan	 	 	777	 	 	 	680	 	
Excess tax benefit from stock-based compensation	 	 	330	 	 	 	1,754	 	
Purchases of treasury stock	 	 	—	 	 	 	(3,605	)	
Net cash provided by financing activities	 	 	1,289	 	 	 	1,957	 	
Effect of exchange rate changes on cash and cash equivalents	 	 	73	 	 	 	(15	)	
Net change in cash and cash equivalents	 	 	3,240	 	 	 	16,416	 	
Cash and cash equivalents, beginning of period	 	 	126,158	 	 	 	115,464	 	
Cash and cash equivalents, end of period	 	$	129,398	 	 	$	131,880	 	
Supplemental disclosure of cash flow information:	 	 	 	 	 	 	 	 	
Cash paid during the period for:	 	 	 	 	 	 	 	 	
Taxes	 	$	281	 	 	$	1,941	 	
 	 	 	 	 	 	 	 	 	
Property and equipment received and accrued in accounts payable and accrued and other liabilities	 	$	1,218	 	 	$	749	 	
 
See accompanying Notes to Condensed Consolidated Financial Statements (unaudited).

5

 
 
PDF SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1. BASIS OF PRESENTATION
 
Basis of Presentation
 
The interim unaudited condensed consolidated financial statements included herein have been prepared by PDF Solutions, Inc. (“the Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), including the instructions to the Quarterly Report on 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 interim unaudited condensed 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 interim unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
 
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after the elimination of all intercompany balances and transactions.
 
The condensed consolidated balance sheet at December 31, 2015, has been derived from the audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.
 
Use of Estimates  —  The preparation of financial statements in conformity with generally accepted accounting principles in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates in these financial statements include revenue recognition for fixed-price solution implementation service contracts, stock-based compensation expense and accounting for income taxes. Actual results could differ from those estimates.
 
Revenue Recognition  — The Company derives revenue from two sources: Design-to-silicon-yield solutions and Gainshare performance incentives.
 
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 of Design-to-silicon-yield solutions as follows:
 
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 reliable estimation of costs to perform obligations and the overall scope of each engagement. Revenue under project–based contracts for solution implementation services is recognized as services are performed using percentage of completion method of contract accounting based on costs or labor-hours input method, whichever is the most appropriate measure of the progress towards completion of the contract. Losses on fixed-price solution implementation contracts are recognized in the period when they become probable. Revisions in profit estimates are reflected in the period in which the conditions that require the revisions become known and can be estimated. Revenue under time and materials contracts for solution implementation services are recognized as the services are performed. On occasion, the Company licenses its software products as a component of its fixed-price service 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 at each customer's option over the license term. The amount of product and service revenue recognized in a given period is affected by the Company’s judgment as to whether an arrangement includes multiple deliverables and, if so, the Company’s determination of the fair value of each deliverable. In general, vendor-specific objective evidence of selling price (“VSOE”) does not exist for the Company’s solution implementation services and software products and because the Company’s services and products include our unique technology, the Company is not able to determine third-party evidence of selling price (“TPE”). Therefore, in such circumstances the Company uses best estimated selling prices (“BESP”) in the allocation of arrangement consideration. In determining BESP, the Company applies significant judgment as the Company’s weighs a variety of factors, based on the facts and circumstances of the arrangement. The Company typically arrives at BESP for a product or service that is not sold separately by considering company-specific factors such as geographies, internal costs, gross margin objectives, pricing practices used to establish bundled pricing, and existing portfolio pricing and discounting. After fair value is established for each deliverable, the total transaction amount is allocated to each deliverable based upon its relative fair value. Fees allocated to solution implementation services are recognized using the percentage of completion method of contract accounting. Fees allocated to software and related support and maintenance are recognized under software revenue recognition guidance. 

6

 
 
The Company defers certain pre-contract costs incurred for specific anticipated contracts. Deferred costs consist primarily of direct costs to provide solution implementation services in relation to the specific anticipated contracts. The Company recognizes such costs as a component of cost of revenues, the timing of which is dependent upon persuasive evidence of contract arrangement assuming all other revenue recognition criteria are met. At the end of reporting period, the Company evaluates its deferred costs for their probable recoverability. The Company recognizes impairment of deferred costs when it is determined that the costs no longer have future benefits and are no longer recoverable. 
 
The Company also licenses its software products separately from its 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) collectability 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 revenue. VSOE for maintenance is generally established 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 software is licensed for a specified term, fees for support and maintenance are generally bundled with the license fee over the entire term of the contract. The Company is unable to establish VSOE of fair value for maintenance services that are generally bundled with term licenses. In these cases, the Company recognizes revenue ratably over the term of the contract.
 
Revenue from Software-as-a-Service (SaaS) that allows for the use of a hosted software product or service over a contractually determined period of time without taking possession of software is accounted for as a subscription and recognized as revenue ratably over the coverage period beginning on the date the service is first made available to customers.
 
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 percentage of completion method of contract accounting, and such revenue is recorded as services revenue.
 
Deferred revenues consist primarily of amounts invoiced in advance of revenue recognition and are recognized as the revenue recognition criteria are met. Deferred revenues that will be recognized during the succeeding 12-month period are recorded as current deferred revenues and the remaining portion is recorded as non- current deferred revenues. The non-current portion of deferred revenue was $0.3 million as of both March 31, 2016 and December 31, 2015. This balance was recorded in the other non-current liabilities in the accompanying condensed consolidated balance sheets.
 
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 incentive component where the customer may pay a contingent variable fee, usually after the fixed fee period has ended. Revenue derived from Gainshare performance incentives represents profit sharing and performance incentives earned contingent upon the Company’s 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 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.
 
2. RECENT ACCOUNTING PRONOUNCEMENTS
 
There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s consolidated financial statements and footnote disclosures, from those disclosed in the Company’s 2015 Annual Report on Form 10-K, except for the following:

7

 
 
In February 2016, the Financial Accounting Standards Board (or FASB) issued Accounting Standards Update (or ASU) No. 2016-2, Leases (Topic 842).  The update requires that most leases, including operating leases, be recorded on the balance sheet as an asset and a liability, initially measured at the present value of the lease payments.  Subsequently, the lease asset will be amortized generally on a straight-line basis over the lease term, and the lease liability will bear interest expense and be reduced for lease payments.  The amendments in this update are effective for public companies’ financial statements issued for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.
 
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This update clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The amendments in this update are effective for public companies’ financial statements issued for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.
 
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This standard makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation and the financial statement presentation of excess tax benefits or deficiencies. ASU 2016-09 also clarifies the statement of cash flows presentation for certain components of share-based awards. The update is effective for interim and annual reporting periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.
 
In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The amendments in this update affect entities with transactions included within the scope of Topic 606. The core principle of the guidance in Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this Update do not change the core principle of the guidance in Topic 606. Rather, the amendments in this update clarify the following two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas. The amendments in this update are effective for public companies’ financial statements issued for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.
 
3. BALANCE SHEET COMPONENTS 
 
Accounts receivable include amounts that are unbilled at the end of the period that are expected to be billed and collected within 12-month period. Unbilled accounts receivable are determined on an individual contract basis. Unbilled accounts receivable, included in accounts receivable, totaled $9.4 million and $11.5 million as of March 31, 2016 and December 31, 2015, respectively. Unbilled accounts receivable that are not expected to be billed and collected during the succeeding 12-month period are recorded in other non-current assets and totaled $6.2 million and $0.1 million as of March 31, 2016 and December 31, 2015, respectively. The increase in other non-current asset is due to the increase in the long-term unbilled portion of one of the Company’s Design-to-silicon-yield solutions contracts. 
 
Property and equipment consists of (in thousands): 
 
 	 	March 31,
2016	 	 	December 31,
2015	 	
Property and equipment, net:	 	 	 	 	 	 	 	 	
Computer equipment	 	$	9,906	 	 	$	9,188	 	
Software	 	 	1,842	 	 	 	1,713	 	
Furniture, fixtures and equipment	 	 	963	 	 	 	907	 	
Leasehold improvements	 	 	1,132	 	 	 	1,126	 	
Test equipment	 	 	7,547	 	 	 	7,214	 	
Construction-in-progress	 	 	6,204	 	 	 	4,777	 	
 	 	 	27,594	 	 	 	24,925	 	
Less: accumulated depreciation	 	 	(14,358	)	 	 	(13,600	)	
Total	 	$	13,236	 	 	$	11,325	 	

8

 
 
Depreciation and amortization expense was $0.8 million and $0.6 million for the three months ended March 31, 2016 and 2015, respectively.
 
As of both March 31, 2016 and December 31, 2015, the carrying amount of goodwill was $0.2 million. The following is a rollforward of the Company's goodwill balance (in thousands):
 
 	 	March 31,
2016	 	
Balance as of December 31, 2015	 	$	215	 	
Adjustment	 	 	—	 	
Balance as of March 31, 2016	 	$	215	 	

Intangible assets balance was $4.8 million and $5.0 million as of March 31, 2016 and December 31, 2015, respectively. Intangible assets as of March 31, 2016 and December 31, 2015 consist of the following (in thousands):
 
 	 	 	 	 	 	 	March 31, 2016	 	 	December 31, 2015	 	
 	 	Amortization
Period
(Years)	 	 	Gross
Carrying
Amount	 	 	Accumulated
Amortization	 	 	Net
Carrying
Amount	 	 	Gross 
Carrying 
Amount	 	 	Accumulated
Amortization	 	 	Net 
Carrying 
Amount	 	
Acquired identifiable intangibles:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Customer relationships	 	 1	-	9	 	 	$	5,920	 	 	$	(3,617	)	 	$	2,303	 	 	$	5,920	 	 	$	(3,547	)	 	$	2,373	 	
Developed technology	 	 4	-	6	 	 	 	14,100	 	 	 	(12,072	)	 	 	2,028	 	 	 	14,100	 	 	 	(11,976	)	 	 	2,124	 	
Tradename	 	 2	-	4	 	 	 	610	 	 	 	(545	)	 	 	65	 	 	 	610	 	 	 	(533	)	 	 	77	 	
Backlog	 	 	1	 	 	 	 	100	 	 	 	(71	)	 	 	29	 	 	 	100	 	 	 	(46	)	 	 	54	 	
Patent	 	 7	-	10	 	 	 	1,800	 	 	 	(1,410	)	 	 	390	 	 	 	1,800	 	 	 	(1,400	)	 	 	400	 	
Other acquired intangibles	 	 	4	 	 	 	 	255	 	 	 	(255	)	 	 	-	 	 	 	255	 	 	 	(255	)	 	 	-	 	
Total	 	 	 	 	 	 	$	22,785	 	 	$	(17,970	)	 	$	4,815	 	 	$	22,785	 	 	$	(17,757	)	 	$	5,028	 	
  
The weighted average amortization period for acquired identifiable intangible assets was 7.01 years as of March 31, 2016. For the three months ended March 31, 2016 and 2015, intangible asset amortization expense was $0.2 million and zero, respectively. The Company expects annual amortization of acquired identifiable intangible assets to be as follows (in thousands):
 
Period Ending March 31,	 	 	 	 	
2016 (remaining 9 months)	 	$	592	 	
2017	 	 	728	 	
2018	 	 	701	 	
2019	 	 	701	 	
2020	 	 	701	 	
2021 and thereafter	 	 	1,392	 	
Total future amortization expense	 	$	4,815	 	
  
Intangible assets are amortized over their useful lives unless these lives are determined to be indefinite. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. During the three months ended March 31, 2016, there were no indicators of impairment related to the Company’s intangible assets.

9

 
 
4. STOCKHOLDERS’ EQUITY
 
Stock-based compensation is estimated at the grant date based on the award’s fair value and is recognized on a straight-line basis over the vesting periods, generally four years .  Stock-based compensation expenses before taxes related to the Company’s stock plans and employee stock purchase plan were allocated as follows (in thousands): 
 
 	 	Three Months
Ended March 31,	 	
 	 	2016	 	 	2015	 	
Cost of Design-to-silicon-yield solutions	 	$	1,085	 	 	$	887	 	
Research and development	 	 	706	 	 	 	491	 	
Selling, general and administrative	 	 	875	 	 	 	821	 	
Stock-based compensation expenses	 	$	2,666	 	 	$	2,199	 	
 
On March 31, 2016, the Company had the following stock-based compensation plans:
 
Stock Plans — At the annual meeting of stockholders on November 16, 2011, the Company’s stockholders approved the 2011 Stock Incentive Plan, which was first amended and restated at the 2013 annual meeting of stockholders on May 28, 2013, when the Company’s stockholders approved the First Amended and Restated 2011 Stock Incentive Plan and then subsequently amended it at the 2014 annual meeting of stockholders on May 27, 2014, when the Company’s stockholders approved the Second Amended and Restated 2011 Incentive Plan (as amended, the “2011 Plan”). Under the 2011 Plan, the Company may award stock options, stock appreciation rights, stock grants or stock units covering shares of the Company's common stock to employees, directors, non-employee directors and contractors. The aggregate number of shares reserved for awards under this plan is 6,550,000 shares, plus up to 3,500,000 shares previously issued under the 2001 Plan that are forfeited or repurchased by the Company or shares subject to awards previously issued under the 2001 Plan that expire or that terminate without having been exercised or settled in full on or after November 16, 2011. In case of awards other than options or stock appreciation rights, the aggregate number of shares reserved under the plan will be decreased at a rate of 1.33 shares issued pursuant to such awards. The exercise price for stock options must generally be at prices no less than the fair market value at the date of grant. Stock options generally expire ten years from the date of grant and become vested and exercisable over a four-year period.
 
On April 8, 2016, the Company’s Board of Directors amended the 2011 Plan, subject to stockholder approval to increase the number of shares reserved for awards under it to a total of 7,800,000 shares, which is an increase of an additional 1,250,000 shares.
 
 In 2001, the Company adopted a 2001 Stock Plan (the “2001 Plan”). In 2003, in connection with its acquisition of IDS Systems Inc., the Company assumed IDS’ 2001 Stock Option / Stock Issuance Plan (the “IDS Plan”).  Both the 2001Plan and the IDS Plan expired in 2011.  Stock options granted under the 2001 and IDS Plans generally expire ten years from the date of grant and become vested and exercisable over a four-year period. Although no new awards may be granted under the 2001 or IDS Plans, awards made under the 2001 and IDS Plans that are currently outstanding remain subject to the terms of each plan, as applicable.
 
The Company estimated the fair value of share-based awards granted under the Stock Plan during the period using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions, resulting in the following weighted average fair values: 
 
 	 	Three Months
Ended March 31,	 	
 	 	2016	 	 	2015	 	
Expected life (in years)	 	 	4.42	 	 	 	4.51	 	
Volatility	 	 	44.74	%	 	 	46.48	%	
Risk-free interest rate	 	 	1.21	%	 	 	1.25	%	
Expected dividend	 	 	—	 	 	 	—	 	
Weighted average fair value per share of options granted during the period	 	$	4.08	 	 	$	6.38	 	
  
As of March 31, 2016, 7.0 million shares of common stock were reserved to cover stock-based awards under the 2011 Plan, of which 3.1 million shares were available for future grant. The number of shares reserved and available under the 2011 Plan includes 0.4 million shares that were subject to awards previously made under the 2001 Plan and were forfeited, expired or repurchased by the Company after adoption of the 2011 Plan through March 31, 2016.  As of March 31, 2016, there were no outstanding awards that had been granted outside of the 2011, 2001 or the IDS Plans (collectively, the "Stock Plans").  

10

 
 
Stock option activity under the Company’s Stock Plans during the three months ended March 31, 2016, was as follows:
 
 	 	Number of
Options
(in
thousands)	 	 	Weighted
Average
Exercise
Price
per Share	 	 	Weighted
Average
Remaining
Contractual
Term
(years)	 	 	Aggregate
Intrinsic
Value
(in
thousands)	 	
Outstanding, January 1, 2016	 	 	1,764	 	 	$	7.88	 	 	 	 	 	 	 	 	 	
Granted (weighted average fair value of $4.08 per share)	 	 	29	 	 	$	10.77	 	 	 	 	 	 	 	 	 	
Exercised	 	 	(24	)	 	$	7.57	 	 	 	 	 	 	 	 	 	
Canceled	 	 	(2	)	 	$	19.67	 	 	 	 	 	 	 	 	 	
Expired	 	 	(2	)	 	$	13.93	 	 	 	 	 	 	 	 	 	
Outstanding, March 31, 2016	 	 	1,765	 	 	$	7.91	 	 	 	4.93	 	 	$	10,024	 	
Vested and expected to vest, March 31, 2016	 	 	1,755	 	 	$	7.88	 	 	 	4.91	 	 	$	10,011	 	
Exercisable, March 31, 2016	 	 	1,592	 	 	$	7.38	 	 	 	4.55	 	 	$	9,746	 	
   
The aggregate intrinsic value in the table above represents the total intrinsic value based on the Company’s closing stock price of $13.38 per share as of March 31, 2016. The total intrinsic value of options exercised during the three months ended March 31, 2016, was $0.1 million.
 
As of March 31, 2016, there was $0.8 million of total unrecognized compensation cost related to unvested stock options. That cost is expected to be recognized over a weighted average period of 2.5 years. The total fair value of shares vested during the three months ended March 31, 2016, was $0.3 million.
 
Nonvested restricted stock units activity during the three months ended March 31, 2016, was as follows:
 
 	 	Shares
(in thousands)	 	 	Weighted
Average
Grant Date
Fair Value Per
Share	 	
Nonvested, January 1, 2016	 	 	1,166	 	 	$	17.03	 	
Granted	 	 	29	 	 	$	10.77	 	
Vested	 	 	(16	)	 	$	16.84	 	
Forfeited	 	 	(6	)	 	$	17.75	 	
Nonvested, March 31, 2016	 	 	1,173	 	 	$	16.87	 	
 
As of March 31, 2016, there was $15.6 million of total unrecognized compensation cost related to nonvested restricted stock units. That cost is expected to be recognized over a weighted average period of 2.5 years. Restricted stock units do not have rights to dividends prior to vesting.
 
 Employee Stock Purchase Plan — In July 2001, the Company adopted a ten-year Employee Stock Purchase Plan (as amended, “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 the purchase period. The Purchase Plan consists of twenty-four-month offering periods with four six-month purchase periods in each offering period. Under the Purchase Plan, on January 1 of each year, 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. At the annual meeting of stockholders on May 18, 2010, the Company’s stockholders approved an amendment to the Purchase Plan to extend it through May 17, 2020. 

11

 
 
 The Company estimated the fair value of purchase rights granted under the Purchase Plan during the period using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions, resulting in the following weighted average fair values:
 
 	 	Three months
Ended March 31,	 	
 	 	2016	 	 	2015	 	
Expected life (in years)	 	 	1.25	 	 	 	1.25	 	
Volatility	 	 	44.15	%	 	 	54.21	%	
Risk-free interest rate	 	 	0.50	%	 	 	0.26	%	
Expected dividend	 	 	—	 	 	 	—	 	
Weighted average fair value of purchase rights granted under the Purchase Plan	 	$	3.56	 	 	$	6.19	 	
 
During the three months ended March 31, 2016 and 2015, a total of 84,000 and 51,000 shares, respectively, were issued at a weighted-average purchase price of $9.21 and $13.32 per share, respectively, under the Purchase Plan. As of March 31, 2016, there was $1.5 million of unrecognized compensation cost related to the Purchase Plan. That cost is expected to be recognized over a weighted average period of 1.83 years. As of March 31, 2016, 2.7 million shares were available for future issuance under the Purchase Plan.
   
Stock Repurchase Program —On October 21, 2014, the Board of Directors adopted a program, effective immediately, to repurchase up to $25.0 million of the Company’s common stock both on the open market and in privately negotiated transactions over the next two years. No repurchases of common stock were made under this program during the three months ended March 31, 2016. As of March 31, 2016, 1,089,773 shares had been repurchased at an average price of $13.33 per share under this program for a total purchase of $14.5 million, and $10.5 million remained available for future repurchases.  
 
5. INCOME TAXES
 
Income tax provision decreased $2.5 million for the three months ended March 31, 2016, to $1.0 million as compared to an income tax provision of $3.5 million for the three months ended March 31, 2015. The Company’s effective tax rate was 33.2% and 37.3% for the three months ended March 31, 2016, and March 31, 2015, respectively.  The Company’s effective tax rate decreased in the three months ended March 31, 2016, as compared to the same period in 2015, primarily due to the permanent reinstatement of the U.S. federal research tax credit. On December 18, 2015, the President of the United States signed into law the Protecting Americans from Tax Hikes Act of 2015 which permanently reinstated the research tax credit retroactive to January 1, 2015. As a result of the new legislation, the Company recognized a benefit in the first quarter of 2016 and no benefit in the first quarter of 2015. The income tax provision for the three months ended March 31, 2016 was lower than the provision at the statutory rate primarily due to changes in unrecognized tax benefits. 
   
The Company’s total amount of unrecognized tax benefits, excluding interest and penalties, as of March 31, 2016, was $11.0 million, of which $6.6 million, if recognized, would decrease the Company’s effective tax rate. The Company’s total amount of unrecognized tax benefits, excluding interest and penalties, as of December 31, 2015, was $11.0 million, of which $6.5 million, if recognized, would affect the Company's effective tax rate. As of March 31, 2016, the Company has recorded unrecognized tax benefits of $2.5 million, including interest and penalties, as long-term taxes payable in its condensed consolidated balance sheet. The remaining $9.0 million has been recorded net of our deferred tax assets, of which $4.5 million is subject to a full valuation allowance. 
 
The valuation allowance was approximately $6.3 million and $6.2 million as of March 31, 2016 and December 31, 2015, respectively, which was related to California R&D tax credits and California net operating losses related to our acquisition of Syntricity that we currently do not believe are more likely than not to be ultimately realized.
 
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 2002 for federal and California tax purposes. The State of New York is currently conducting an audit of the Company’s prior income tax returns. The Company is not subject to income tax examinations in any other of its major foreign subsidiaries’ jurisdictions.

12

 
 
6. NET INCOME PER SHARE
 
Basic net income per share is computed by dividing net income by weighted average number of common shares outstanding for the period (excluding outstanding stock options and shares subject to repurchase). Diluted net income per share is computed using the weighted-average number of common shares outstanding for the period plus the potential effect of dilutive securities which are convertible into common shares (using the treasury stock method), except in cases in which the effect would be anti-dilutive. Under the treasury stock method, the amount that the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of the tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.  The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income per share (in thousands except per share amount): 
 
 	 	Three Months Ended March 31,	 	
 	 	2016	 	 	2015	 	
Numerator:	 	 	 	 	 	 	 	 	
Net income	 	$	2,062	 	 	$	5,967	 	
Denominator:	 	 	 	 	 	 	 	 	
Basic weighted-average shares outstanding	 	 	31,168	 	 	 	31,336	 	
Effect of dilutive options and restricted stock	 	 	554	 	 	 	955	 	
Diluted weighted average shares outstanding	 	 	31,722	 	 	 	32,291	 	
 	 	 	 	 	 	 	 	 	
Net income per share - Basic	 	$	0.07	 	 	$	0.19	 	
Net income per share - Diluted	 	$	0.07	 	 	$	0.18	 	
 
 The following table sets forth potential shares of common stock that are not included in the diluted net income per share calculation above because to do so would be anti-dilutive for the periods indicated (in thousands):  
 
 	 	Three Months Ended March 31,	 	
 	 	2016	 	 	2015	 	
Outstanding options	 	 	284	 	 	 	55	 	
Nonvested restricted stock units	 	 	1,026	 	 	 	414	 	
Employee Stock Purchase Plan	 	 	460	 	 	 	264	 	
Total	 	 	1,770	 	 	 	733	 	
   
7. CUSTOMER AND GEOGRAPHIC INFORMATION
 
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 regularly 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 companies designing and/or manufacturing integrated circuits. 
 
The Company had revenues from individual customers in excess of 10% of total revenues as follows: 
 
 	 	Three Months Ended March 31,	 	
Customer	 	2016	 	 	2015	 	
A	 	 	50	%	 	 	44	%	
B	 	 	14	%	 	 	28	%	
C	 	 	*	%	 	 	11	%	

*	represents less than 10%	

13

 
 
The Company had gross accounts receivable from individual customers in excess of 10% of gross accounts receivable as follows: 
 
Customer	 	March 31,
2016	 	 	December 31,
2015	 	
A	 	 	51	%	 	 	65	%	
B	 	 	10	%	 	 	*	%	

*	represents less than 10% 	
 
Revenues from customers by geographic area based on the location of the customers’ work sites are as follows (in thousands):
 
 	 	Three Months Ended March 31,	 	
 	 	2016	 	 	2015	 	
 	 	Revenues	 	 	Percentage
of
Revenues	 	 	Revenues	 	 	Percentage
of
Revenues	 	
United States	 	$	12,121	 	 	 	48	%	 	$	10,315	 	 	 	38	%	
South Korea	 	 	3,313	 	 	 	13	 	 	 	6,918	 	 	 	26	 	
Germany	 	 	3,035	 	 	 	12	 	 	 	6,264	 	 	 	24	 	
Rest of the world	 	 	6,612	 	 	 	27	 	 	 	3,320	 	 	 	12	 	
Total revenue	 	$	25,081	 	 	 	100	%	 	$	26,817	 	 	 	100	%	
   
Long-lived assets, net by geographic area are as follows (in thousands):
 
 	 	March 31,
2016	 	 	December 31,
2015	 	
United States	 	$	12,720	 	 	$	10,752	 	
Rest of the world	 	 	516	 	 	 	573	 	
Total long-lived assets, net	 	$	13,236	 	 	$	11,325	 	
 
8. FAIR VALUE MEASUREMENTS
 
Fair value is 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. The multiple assumptions used to value financial instruments are referred to as inputs, and a hierarchy for inputs used in measuring fair value is established, 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 March 31, 2016, 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	 	$	26,390	 	 	$	26,390	 	 	$	—	 	 	$	—	 	

14

 
 
The following table represents the Company’s assets measured at fair value on a recurring basis as of December 31, 2015, 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	 	$	26,371	 	 	$	26,371	 	 	$	—	 	 	$	—	 	
    
The Company enters into foreign currency forward contracts to reduce the exposure to foreign currency exchange rate fluctuations on certain foreign currency denominated monetary assets and liabilities, primarily on third-party accounts payables and intercompany balances. The primary objective of the Company’s hedging program is to reduce volatility of earnings related to foreign currency exchange rate fluctuations. The counterparty to these foreign currency forward contracts is a large global financial institution that the Company believes is creditworthy, and therefore, the Company believes the credit risk of counterparty nonperformance is not significant. These foreign currency forward contracts are not designated for hedge accounting treatment. Therefore, the change in fair value of these contracts is recorded into earnings as a component of other income (expense), net, and offsets the change in fair value of the foreign currency denominated assets and liabilities, which is also recorded in other income (expense), net. For the three months ended March 31, 2016 and 2015, the Company recognized a realized gain of $0.3 million and a realized loss of $0.7 million on the contracts, respectively, which was recorded in interest and other income (expense), net in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Income. 
 
The Company carries these derivatives financial instruments on its Consolidated Balance Sheets at their fair values. The Company’s foreign currency forward contracts are classified as Level 2 because it is not actively traded and the valuation inputs are based on quoted prices and market observable data of similar instruments. As of March 31, 2016, the Company had one outstanding forward contract with a notional amount of $7.2 million and recorded $39,000 other current liabilities associated with this outstanding forward contract. As of December 31, 2015, the Company had one outstanding forward contract with a notional amount of $6.7 million and had recorded $62,000 other current liabilities associated with the outstanding forward contract.  
 
9. COMMITMENTS AND CONTINGENCIES
 
 Leases
 
The Company leases administrative and sales offices and certain equipment under noncancelable operating leases, which contain various renewal options and, in some cases, require payment of common area costs, taxes and utilities. These operating leases expire at various times through 2024. Rent expense was $0.6 million and $0.5 million for the three months ended March 31, 2016 and 2015, respectively.
 
Future minimum lease payments under noncancelable operating leases at March 31, 2016, are as follows (in thousands): 
 
Period Ending March 31,	 	Amount	 	
2016 (remaining nine months)	 	$	1,501	 	
2017	 	 	1,684	 	
2018	 	 	1,069	 	
2019	 	 	267	 	
2020	 	 	196	 	
2021 and thereafter	 	 	63	 	
Total future minimum lease payments	 	$	4,780	 	

15

 
 
Litigation — From time to time, the Company is subject to various claims and legal proceedings that arise in the ordinary course of business. The Company accrues for losses related to litigation when a potential loss is probable and the loss can be reasonably estimated in accordance with FASB requirements. During the reported period, the Company was not party to any material legal proceedings, thus no loss was probable and no amount was accrued at March 31, 2016.   
  
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. All statements other than statements of historical fact may be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “could,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential”, “target” or “continue,” the negative effect of terms like these or other similar expressions. Any statement concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible actions taken by us or our subsidiaries, which may be provided by us are also forward-looking statements. These forward-looking statements are only predictions. Forward-looking statements are based on current expectations and projections about future events and are inherently subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those anticipated or projected. All forward-looking statements included in this document are based on information available to us on the date of filing and we further caution investors that our business and financial performance are subject to substantial risks and uncertainties. We assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risk factors set forth in Item 1A of this Quarterly Report on Form 10-Q as well as in Item 1. “Business” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission on March 1, 2016. All references to “we”, “us”, “our”, “PDF”, “PDF Solutions” or “the Company” refer to PDF Solutions, Inc. 
  
 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 yield improvement solutions. 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 solutions. 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.
 
 Industry Trend
 
Consistent with the trend since 2010, we expect that the largest logic foundries will continue to invest significantly in leading edge nodes and capacity throughout 2016. Leading foundries continue to invest in new technologies such as multi-patterned lithography and 3-D transistor architecture, which provide opportunities to increase our business.
 
The capacity utilization of our customers on 28nm declined during 2015, which caused our Gainshare revenue to decline significantly in the same period. Although capacity utilization improved at the end of 2015 and the first quarter of 2016, we believe that 28nm capacity utilization may not continue to increase substantially (or at all) for 2016, which would have a negative impact on our Gainshare revenue.

16

 
 
Generally, the 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.   
 
Customer Contracts
 
Although a substantial portion of our total revenues are concentrated in a small number of customers, the total revenues for each of these customers in any period is the result of Design-to-silicon-yield solutions and Gainshare performance incentives revenues recognized in the period under multiple, separate contracts, with no interdependent performance obligations. These contracts were all entered into in the ordinary course of our business and contain general terms and conditions that are standard across most of our yield improvement solutions customers, including providing services typically targeted to one manufacturing process node, for example the 28 or 20 nanometer node. Fluctuations in future results may occur if any of these customers renegotiate pre-existing contractual commitments due to adverse changes in their own business. See the additional discussion in Part I, Item 1, "Customers," on page 9 of our Annual Report on Form 10-K for the year ended December 31, 2015, and in Item 1A, "Risk Factors," on pages 12 through 19 of our Annual Report on Form 10-K for the year ended December 31, 2015, for related information on the risks associated with customer concentration and Gainshare performance incentives revenue.
 
 Financial Highlights  
 
Financial highlights for the three months ended March 31, 2016, were as follows: 
 
 	•	Total revenues for the three months ended March 31, 2016, were $25.1 million, a decrease of $1.7 million, or 6%, compared to $26.8 million for the three months ended March 31, 2015. Design-to-silicon-yield solutions revenue for the three months ended March 31, 2016, was $18.6 million, an increase of $0.4 million, or 2%, when compared to Design-to-silicon yield solutions revenue of $18.1 million for the three months ended March 31, 2015. The increase in Design-to-silicon-yield solutions was primarily driven by growth of our Exensio big data solution. Gainshare performance incentives revenue for the three months ended March 31, 2016, was $6.5 million, a decrease of $2.2 million, or 25%, compared to $8.7 million for the three months ended March 31, 2015. The decrease in revenue from Gainshare performance incentives was primarily the result of lower net volumes reported at 28nm engagements, partially offset by the Gainshare from a 14nm engagement. 	
  
  	• 	Net income for the three months ended March 31, 2016, was $2.1 million, compared to $6.0 million for the three months ended March 31, 2015. The decrease in net income was primarily attributable to a decrease in gross margin of $3.1 million and an increase in total operating expenses of $3.0 million, offset by a decrease in income tax provision of $2.5 million. The decrease in gross margin is primarily due to lower Gainshare revenue. The increase in operating expense is primarily driven by a ramp up in the development activity related to our Design-For-Inspection (DFI) solution initiative. The decrease in income tax provision was primarily due to lower taxable income.	
 
  	• 	Net income per basic and diluted share was $0.07 for the three months ended March 31, 2016, compared to net income per basic and diluted share of $0.19 and $0.18, respectively, for the three months ended March 31, 2015.	
  
  	• 	Cash and cash equivalents increased $3.2 million from $126.2 million at December 31, 2015, to $129.4 million at March 31, 2016, primarily due to $4.9 million of cash provided from operating and financing activities during the period, offset by $1.8 million of cash used in investing activities.	

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Critical Accounting Policies
 
There were no significant changes in our critical accounting policies. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2015. 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 conditions, results of operations and cash flows 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, stock-based compensation 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, which include services and software licenses, and Gainshare performance incentives.
 
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 Design-to-silicon-yield solutions as follows:
 
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 reliable estimation of costs to perform obligations and the overall scope of each engagement. Revenue under project–based contracts for solution implementation services is recognized as services are performed using percentage of completion method of contract accounting based on costs or labor-hours input method, whichever is the most appropriate measure of the progress towards completion of the contract. Losses on solution implementation contracts are recognized in the period when they become probable. 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 contracts were executed. Any such reductions in contract margin could have a material negative impact on our operating results.  Revenue under certain time and materials contracts for solution implementation services is recognized as the services are performed.
 
On occasion, we license our software products as a component of our fixed price service 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 at each customer's option over the license term. The amount of product and service revenue recognized in a given period is affected by our judgment as to whether an arrangement includes multiple deliverables and, if so, our determination of the fair value of each deliverable. In general, vendor-specific objective evidence of selling price (“VSOE”)  does not exist for our solution implementation services and software products and because our services and products include our unique technology, we are not able to determine third-party evidence of selling price (“TPE”). Therefore, in such circumstances, we use best estimated selling prices (“BESP”) in our allocation of arrangement consideration. In determining BESP, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. We typically arrive at BESP for a product or service that is not sold separately by considering company-specific factors such as geographies, internal costs, gross margin objectives, pricing practices used to establish bundled pricing, and existing portfolio pricing and discounting. After fair value is established for each deliverable, the total transaction amount is allocated to each deliverable based upon its relative fair value. Fees allocated to solution implementation services are recognized using the percentage of completion method of contract accounting. Fees allocated to software and related support and maintenance are recognized under software revenue recognition guidance.  
 
We defer certain pre-contract costs incurred for specific anticipated contracts. Deferred costs consist primarily of direct costs to provide solution implementation services in relation to the specific anticipated contracts. We recognize such costs as a component of cost of revenues, the timing of which is dependent upon the revenue recognition policy by contract. At the end of reporting period, we evaluate our deferred costs for their probable recoverability. We recognize impairment of deferred costs when it is determined that the costs no longer have future benefits and are no longer recoverable.

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We also license our software products separately from our solution implementation services. 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) collectability 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 revenues. VSOE for maintenance is generally established 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. When software is licensed for a specified term, fees for support and maintenance are generally bundled with the license fee over the entire term of the contract. The Company is unable to establish VSOE of fair value for maintenance services that are generally bundled with term licenses. In these cases, the Company recognizes revenue ratably over the term of the contract.
 
Revenue from Software-as-a-Service (SaaS) that allows for the use of a hosted software product or service over a contractually determined period of time without taking possession of software is accounted for as a subscription and recognized as revenue ratably over the coverage period beginning on the date the service is first made available to customers.
 
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 percentage of completion method of contract accounting, and such revenue is recorded as services revenue.
 
Deferred revenues consist primarily of amounts invoiced in advance of revenue recognition and are recognized as the revenue recognition criteria are met. Deferred revenues that will be recognized during the succeeding 12-month period are recorded as current deferred revenues and the remaining portion is recorded as non- current deferred revenues.
 
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 contingent variable fee, usually after the fixed fee period has ended. Revenues derived from Gainshare performance incentives represent profit sharing and performance incentives earned contingent 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 revenues (to the extent of completion of the related solution implementation services) 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, which can include 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.
 
Stock-Based Compensation
  
Stock-based compensation is estimated at the grant date based on the award’s fair value and is recognized on a straight-line basis over the vesting periods, generally four years. As stock-based compensation expense recognized is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
 
We have 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 our common stock over the most recent period commensurate with the estimated expected life of 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 stock options.

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Income Taxes
 
We are required to assess the likelihood that our deferred tax assets will be recovered from future taxable income and if we believe that they are not likely to be realizable before the expiration dates applicable to such assets then, to the extent we believe that recovery is not likely, 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. The valuation allowance was approximately $6.3 million and $6.2 million as of March 31, 2016 and December 31, 2015, respectively, which was related to California R&D tax credits and California net operating losses related to acquisition that we currently do not believe to be more likely than not to be ultimately realized. If we conclude at a future financial reporting period that there has been a change in our ability to realize our California R&D credit and net operating loss carry forward deferred tax assets, and it is at such time no longer “more–likely-than-not” that we will realize the tax credits before applicable expiration dates, our tax provision will increase in the period in which we make such determination.
 
Our income tax calculations are based on application of the respective U.S. federal, state or foreign tax law. Our tax filings, however, are subject to audit by the respective tax authorities. Accordingly, we recognize tax liabilities based upon our estimate of whether, and the extent to which, additional taxes will be due when such estimates are more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. To the extent the final tax liabilities are different than the amounts originally accrued, the increases or decreases are recorded as income tax expense or benefit in the consolidated statements of operations. 
 
Goodwill and Intangible Assets
 
We record goodwill when the purchase consideration of an acquisition exceeds the fair value of the net tangible and identified intangible assets as of the date of acquisition. We perform an annual impairment assessment of goodwill during the fourth quarter of each calendar year or more frequently if required to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in the overall industry demand, that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do not indicate that the fair value of a reporting unit is below its carrying amount, then goodwill is not considered to be impaired and no further testing is required. If further testing is required, we perform a two-step process. The first step involves comparing the fair value of its reporting unit to its carrying value, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the second step of the test is performed by comparing the carrying value of the goodwill in the reporting unit to its implied fair value. An impairment charge is recognized for the excess of the carrying value of goodwill over its implied fair value. For the purpose of impairment testing, we have determined that we have one reporting unit. There was no impairment of goodwill for the period ended March 31, 2016.
 
Our long-lived assets, excluding goodwill, consist of property and equipment and intangible assets. We periodically review our long-lived assets for impairment .  For assets to be held and used, we initiate our 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. During the three months ended March 31, 2016, there was no impairment related to our long-lived assets.
 
Recent Accounting Pronouncements and Accounting Changes
 
See Note 2 of “Notes to Condensed Consolidated Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q 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.   

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Results of Operations
 
The following table sets forth, for the periods indicated, the percentage of total revenues represented by the line items reflected in our condensed consolidated statements of operations:  
 
 	 	Three Months Ended March 31,	 	
 	 	2016	 	 	2015	 	
Revenues:	 	 	 	 	 	 	 	 	
Design-to-silicon-yield solutions	 	 	74	%	 	 	68	%	
Gainshare performance incentives	 	 	26	 	 	 	32	 	
Total revenues	 	 	100	%	 	 	100	%	
Costs of Design-to-silicon-yield solutions	 	 	 	 	 	 	 	 	
Direct costs of Design-to-silicon-yield solutions	 	 	40	 	 	 	33	 	
Amortization of acquired technology	 	 	1	 	 	 	—	 	
Total costs of Design-to-silicon-yield solutions	 	 	41	 	 	 	33	 	
Gross profit	 	 	59	 	 	 	67	 	
Operating expenses:	 	 	 	 	 	 	 	 	
Research and development	 	 	25	 	 	 	15	 	
Selling, general and administrative	 	 	20	 	 	 	17	 	
Amortization of other acquired intangible assets	 	 	1	 	 	 	—	 	
Total operating expenses	 	 	46	 	 	 	32	 	
Income from operations	 	 	13	 	 	 	35	 	
Interest and other income (expense), net	 	 	(1	)	 	 	—	 	
Income before taxes	 	 	12	 	 	 	35	 	
Income tax provision	 	 	4	 	 	 	13	 	
Net income	 	 	8	%	 	 	22	%	
 
Comparison of the Three Months Ended March 31, 2016 and 2015
 
 	 	Three Months Ended
March 31,	 	 	$	 	 	%	 	
Revenues	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Design-to-silicon-yield solutions	 	$	18,578	 	 	$	18,152	 	 	$	426	 	 	 	2	%	
Gainshare performance incentives	 	 	6,503	 	 	 	8,665	 	 	 	(2,162	)	 	 	(25	)%	
Total revenues	 	$	25,081	 	 	$	26,817	 	 	$	(1,736	)	 	 	(6	)%	
    
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 as well as during solution product sales.  Design-to-silicon-yield solutions revenue increased $0.4 million for the three months ended March 31, 2016, compared to the three months ended March 31, 2015, which was primarily driven by the growth of our Exensio big data solution. Our Design-to-silicon-yield solutions revenue may fluctuate in the future and is dependent on a number of factors, including the semiconductor industry’s continued acceptance of our solutions, the timing of purchases by existing customers, and our ability to attract new customers and penetrate new markets including photovoltaic and LED, and further penetration of our current customer base. Fluctuations in future results may also occur if any of our significant customers renegotiate pre-existing contractual commitments due to adverse changes in their own business.
 
Gainshare Performance Incentives. Gainshare performance incentives revenues represent profit sharing and performance incentives earned contingent upon our customers reaching certain defined operational levels. Revenue derived from Gainshare performance incentives decreased $2.2 million for the three months ended March 31, 2016, compared to the three months ended March 31, 2015.  The decrease was primarily the result of lower net volumes reported at 28nm engagement, partially offset by the Gainshare from a 14nm engagement. 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, continued production of ICs by our customers at facilities at which we generate Gainshare, 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.   
 
 	 	Three Months Ended
March 31,	 	 	$	 	 	%	 	
Costs of Design-to-silicon-yield solutions	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Direct costs of Design-to-silicon-yield solutions	 	$	10,110	 	 	$	8,804	 	 	$	1,306	 	 	 	15	%	
Amortization of acquired technology	 	 	96	 	 	 	—	 	 	 	96	 	 	 	—	%	
Total costs of Design-to-silicon-yield solutions	 	$	10,206	 	 	$	8,804	 	 	$	1,402	 	 	 	16	%	

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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 costs consist of material, employee compensation and related benefits, overhead costs, travel and facilities-related costs. Software license costs consist of costs associated with licensing third-party software sold in conjunction with our software products. Direct costs of Design-to-silicon-yield solutions for the three months ended March 31, 2016 increased $1.3 million compared to the three months ended March 31, 2015, primarily due to a $0.5 million increase in personnel-related expense due to increase in headcount, a $0.1 million increase in subcontractor cost, a $0.1 million increase in third party software license costs, a $0.1 million increase in shipping costs on testers and servers shipped to customers, a $0.1 million increase in facility expense, and $0.1 million increase in depreciation expense of test equipment. Amortization of acquired technology for the three months ended March 31, 2016 was due to the amortization of acquired technology from the Syntricity acquisition.
  
 	 	Three Months Ended	 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	$	 	 	%	 	
Research and Development	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Research and development	 	$	6,311	 	 	$	4,088	 	 	$	2,223	 	 	 	54	%	
 
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, and stock-based compensation charges. Research and development expenses increased $2.2 million for the three months ended March 31, 2016, compared to the three months ended March 31, 2015, primarily due to a $1.4 million increase in personnel-related expense mainly due to an increase in headcount, a $0.5 million increase in subcontractor expense, and a $0.3 million increase in facility expense. The increased investment in research and development is primarily driven by a ramp up in the development activity related to our DFI solution initiative and is expected to continue during 2016. 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 personnel as a result of the size and the timing of product development projects. 
 
 	 	Three Months Ended	 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	$	 	 	%	 	
Selling, General and Administrative	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Selling, general and administrative	 	$	5,124	 	 	$	4,456	 	 	$	668	 	 	 	15	%	
 
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of compensation and benefits for sales, marketing and general and administrative personnel, legal and accounting services, marketing communications, travel and facilities cost allocations, and stock-based compensation charges. Selling, general and administrative expenses increased $0.7 million for the three months ended March 31, 2016, compared to the three months ended March 31, 2015, primarily due to a $0.5 million increase in personnel-related expense as a result of increased headcount from Syntricity acquisition in the third quarter of fiscal year of 2015 and hiring in our software solution business, a $0.1 million increase in accounting and legal expense, and a $0.1 million increase in doubtful accounts, a result of higher level of receivable balance. 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 to support increased selling efforts in the future.  
 
 	 	Three Months Ended	 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	$	 	 	%	 	
Amortization of Other Acquired Intangible Assets	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(In thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Amortization of other acquired intangible assets	 	$	117	 	 	$	—	 	 	$	117	 	 	 	—	%	
 
Amortization of Other Acquired Intangible Assets. Amortization of other acquired intangible assets consists of amortization of intangibles acquired as a result of certain business combinations. The amortization of other acquired intangible assets for the three months ended March 31, 2016 is related to amortization of acquired intangible assets from the Syntricity acquisition. 

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 	 	Three Months Ended	 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	$	 	 	%	 	
Interest and Other Income (Expense), Net	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Interest and other income (expense), net	 	$	(236	)	 	$	51	 	 	$	(287	)	 	 	(563	)%	
  
Interest and Other Income (expense), net.  Interest and other income (expense), net changed $0.3 million for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. The change was primarily due to fluctuations in foreign exchange rates. We anticipate interest and other income (expense) will fluctuate in future periods as a result of our projected use of cash and fluctuations of foreign exchange rates.
  
 	 	Three Months Ended	 	 	 	 	 	 	 	 	 	
 	 	March 31,	 	 	$	 	 	%	 	
Income Tax Provision	 	2016	 	 	2015	 	 	Change	 	 	Change	 	
(in thousands, except for percentages)	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Income tax provision	 	$	1,025	 	 	$	3,553	 	 	$	(2,528	)	 	 	(71	)%	
 
Income Tax Provision. Income tax provision decreased $2.5 million for the three months ended March 31, 2016, compared to three months ended March 31, 2015, primarily due to a decrease in level of income.
 
Liquidity and Capital Resources
 
Operating Activities
 
Cash flows provided by operating activities was $3.7 million for the three months ended March 31, 2016. This resulted from net income of $2.1 million, an adjustment of $3.9 million for non-cash charges and a cash decrease of $2.3 million reflected in the net change of operating assets and liabilities. Non-cash charges consisted primarily of stock-based compensation of $2.7 million, depreciation and amortization of $0.8 million, tax benefit from stock-based compensation of $0.3 million, amortization of acquired intangible assets of $0.2 million, deferred tax assets of $0.1 million and loss on disposal of property and equipment of $0.1 million, offset by excess tax benefit from stock-based compensation of $0.3 million. Cash flow decreases resulting from the net change in operating assets and liabilities primarily consisted of a $5.8 million increase in prepaid expense and other assets, $1.2 million of decrease in billing in excess of recognized revenues, a $0.8 million decrease in accrued and other liability primarily due to payment of earn-out consideration related to Syntricity acquisition, $0.6 million decrease in accrued compensation and related benefits, offset by a $4.1 million decrease in accounts receivable, $1.7 million increase in deferred revenue and $0.3 million increase in accounts payable. The $1.2 million combined cash flow decrease resulting from the decrease in accounts receivable, the increase in deferred revenue, the increase in prepaid expense and other assets and the decrease in billings in excess of recognized revenues, was primarily due to the timing of billing milestones and payments received.
 
Cash flows provided by operating activities was $15.6 million for the three months ended March 31, 2015. This resulted from net income of $6.0 million, an adjustment of $3.3 million for non-cash charges and a cash increase of $6.3 million reflected in the net change of operating assets and liabilities. Non-cash charges consisted primarily of stock-based compensation of $2.2 million, deferred taxes of $0.4 million, tax benefit related to stock-based compensation plan of $1.9 million, depreciation and amortization of $0.6 million, partially offset by excess tax benefit from stock-based compensation of $1.8 million. Cash flow increases resulting from the net change in operating assets and liabilities primarily consisted of $8.6 million decrease in accounts receivable, primarily driven by strong collections, a $1.4 million net increase in deferred revenue, offset by a $2.0 million decrease in accrued compensation and related benefits, driven by the payment of variable compensation during the period, a $1.0 million decrease in accounts payable due to timing of payment of third party services, a $0.4 million decrease in accrued and other liabilities and a $0.3 million increase in prepaid expense and other assets. The $10.1 million combined cash flow increase resulting from the decrease in accounts receivable and the increase in deferred revenue was primarily due to the timing of billing milestones and payments received.    
  
Investing Activities
           
Cash flows used in investing activities of $1.8 million and $1.1 million for the three months ended March 31, 2016 and 2015, respectively, consisted of payments for capital expenditures, primarily test equipment.
 
Financing Activities
 
Cash flows provided by financing activities of $1.3 million for the three months ended March 31, 2016, consisted primarily of $0.8 million of proceeds from our Employee Stock Purchase Plan, $0.2 million of proceeds from the exercise of stock options, and $0.3 million of excess tax benefit from stock-based compensation.

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Cash flows provided by financing activities of $2.0 million for the three months ended March 31, 2015, consisted primarily of $3.1 million of proceeds from the exercise of stock options, $0.7 million of proceeds from our Employee Stock Purchase Plan, and $1.8 million of excess tax benefit from stock-based compensation, offset by $3.6 million of cash used to repurchase 199,912 shares of our common stock at an average price of $18.03 per share.
 
Liquidity
 
As of March 31, 2016, our working capital, defined as total current assets less total current liabilities, was $147.6 million, compared with $148.8 million as of December 31, 2015. Cash and cash equivalents were $129.4 million as of March 31, 2016, compared to $126.2 million as of December 31, 2015.  As of March 31, 2016 and December 31, 2015, cash and cash equivalents held by our foreign subsidiaries were $1.8 million and $2.2 million, respectively. 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 continue to fund our R&D efforts, repurchase common stock or fund potential investments in, or acquisitions of complementary products, technologies or businesses. We believe that our existing cash resources and anticipated funds from operations will satisfy our cash requirements to fund our operating activities, capital expenditures and other obligations for at least the next twelve months.  
 
Off-Balance Sheet Agreements 
 
We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt.   
 
 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) as of March 31, 2016:
 
 	 	Payments Due by Period	 	
Contractual
Obligations (1)	 	2016
(remaining
nine
months)	 	 	2017	 	 	2018	 	 	2019	 	 	2020	 	 	2021 and thereafter	 	 	Total	 	
Operating lease obligations	 	$	1,501	 	 	$	1,684	 	 	$	1,069	 	 	$	267	 	 	$	196	 	 	$	63	 	 	$	4,780	 	

 	(1)	The contractual obligation table above excludes liabilities for uncertain tax positions of $2.5 million, which are not practicable to assign to any particular years, due to the inherent uncertainty of the tax positions.  See Note 5 of “Notes to Consolidated Financial Statements” for further discussion.	
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. We do not currently own any equity investments, nor do we expect to own any in the foreseeable future. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors.
  
Interest Rate Risk.   As of March 31, 2016, we had cash and cash equivalents of $129.4 million. Cash and cash equivalents consisted of cash and highly liquid money market instruments. 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 March 31, 2016, 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.

24

 
 
Foreign Currency and Exchange Risk.   Certain of our payables for our international offices are denominated in the local currency, including the Euro, Yen and RMB. Therefore, a portion of our operating expenditures is subject to foreign currency risks. We enter into foreign currency forward contracts to reduce the exposure to foreign currency exchange rate fluctuations on certain foreign currency denominated monetary assets and liabilities. We do not use foreign currency forward contracts for speculative or trading purposes. We record these forward contracts at fair value. The counterparty to these foreign currency forward contracts is a large global financial institution that we believe is creditworthy, and therefore, we believe the credit risk of counterparty non-performance is not significant. The change in fair value of these contracts is recorded into earnings as a component of other income (expense), net and offsets the change in fair value of foreign currency denominated monetary assets and liabilities, which is also recorded in other income (expense), net. As of March 31, 2016, we had one outstanding forward contract with a notional amount of $7.2 million. The foreign currency exchange rate movement of plus-or-minus 10% will result in the change in fair value of this contract of plus-or-minus $0.7 million.  
 
Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our principal executive officer and principal financial and accounting officer, evaluated the effectiveness of our "disclosure controls and procedures" as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as of March 31, 2016, in connection with the filing of this Quarterly Report on Form 10-Q. Based on that evaluation as of March 31, 2016, our principal executive officer and principal financial and accounting officer concluded that our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in rules and forms of the SEC and accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.    
 
 Changes in Internal Control over Financial Reporting
 
There were no changes in the Company's internal control over financial reporting during the three months ended March 31, 2016, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 
 
PART II — OTHER INFORMATION
 
Item 1. Legal Proceedings
 
From time to time, we are subject to various claims and legal proceedings that arise in the ordinary course of business. We accrue for losses related to litigation when a potential loss is probable and the loss can be reasonably estimated in accordance with FASB requirements. During the reported period, we were not a party to any material legal proceedings, thus no loss was probable and no amount was accrued at March 31, 2016.
 
Item 1A. Risk Factors
 
Item 1A, “Risk Factors,” on pages 12 through 19 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, provides information on the significant risks associated with our business. There have been no subsequent material changes to these risks.   
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 
 
None
 
Item 3. Defaults Upon Senior Securities
 
None.  
 
Item 4. Mine Safety Disclosures
 
None. 
 
Item 5. Other Information
 
None. 

25

 
 
Item 6. Exhibits
 
Exhibit
Number 	  	 
Description 	
 	 	 	
10.10	 	Employment Agreement, dated February 16, 2016, between PDF Solutions Semiconductor Technology Korea Limited and Kwan-Hyun Kim (incorporated by reference to registrant’s current report on Form 8-K filed March 3, 2016).	
 	 	 	
31.01	  	Certification of the principal executive officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	
  	  	  	
31.02	  	Certification of the principal financial and accounting 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.	
  	  	  	
101.INS 	  	XBRL Instance Document.	
  	  	  	
101.SCH    	  	XBRL Taxonomy Extension Schema Document.	
  	  	  	
101.CAL	  	XBRL Taxonomy Extension Calculation Linkbase Document.	
  	  	  	
101.DEF	  	XBRL Taxonomy Extension Definition Linkbase Document.	
  	  	  	
101.LAB 	  	XBRL Taxonomy Extension Label Linkbase Document.	
  	  	  	
101.PRE 	  	XBRL Taxonomy Extension Presentation Linkbase Document. 	

26

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

Date: May 3, 2016	By:	/s/ JOHN K. KIBARIAN	  	
  	  	John K. Kibarian	  	
  	  	President and Chief Executive Officer	  	
  	  	(principal executive officer)	  	

Date: May 3, 2016	By:	/s/ GREGORY C. WALKER	  	
  	  	Gregory C. Walker	  	
  	  	Vice President, Finance and Chief Financial Officer	  	
  	  	(principal financial and accounting officer)	  	

27

 
 
INDEX TO EXHIBITS
 
Exhibit
Number 	  	 
Description 	
  	  	  	
10.10	 	Employment Agreement, dated February 16, 2016, between PDF Solutions Semiconductor Technology Korea Limited and Kwan-Hyun Kim (incorporated by reference to registrant’s current report on Form 8-K filed March 3, 2016).	
 	 	 	
31.01	  	Certification of the principal executive officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	
  	  	  	
31.02	  	Certification of the principal financial and accounting 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.	
  	  	  	
101.INS 	  	XBRL Instance Document.	
  	  	  	
101.SCH    	  	XBRL Taxonomy Extension Schema Document.	
  	  	  	
101.CAL	  	XBRL Taxonomy Extension Calculation Linkbase Document.	
  	  	  	
101.DEF	  	XBRL Taxonomy Extension Definition Linkbase Document.	
  	  	  	
101.LAB 	  	XBRL Taxonomy Extension Label Linkbase Document.	
  	  	  	
101.PRE 	  	XBRL Taxonomy Extension Presentation Linkbase Document. 	

28

Exhibit 31.01
 
CERTIFICATIONS
 
 I, John K. Kibarian, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q 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.
 
  	By:	/s/ JOHN K. KIBARIAN	  	
  	  	John K. Kibarian	  	
  	  	President and Chief Executive Officer 	  	
  	  	(principal executive officer) 	  	
 
Date: May 3, 2016

Exhibit 31.02
 
CERTIFICATIONS
 
I, Gregory C. Walker, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q 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.
 
  	By:	/s/ GREGORY C. WALKER	  	
  	  	Gregory C. Walker	  	
  	  	Vice President, Finance and Chief Financial Officer  	  	
  	  	(principal financial and accounting officer)  	  	
 
Date: May 3, 2016

 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 Quarterly Report of PDF Solutions, Inc. (the “Company”) on Form 10-Q for the quarter ended March 31, 2016, as filed with the Securities and Exchange Commission on May 3, 2016 (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.
 
  	By:	 /s/ JOHN K. KIBARIAN	  	
  	  	John K. Kibarian	  	
  	  	President and Chief Executive Officer 	  	
  	  	(principal executive officer) 	  	
 
Date: May 3, 2016

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 Quarterly Report of PDF Solutions, Inc. (the “Company”) on Form 10-Q for the quarter ended March 31, 2016 as filed with the Securities and Exchange Commission on May 3, 2016 (the “Report”), I, Gregory C. Walker, Vice President, Finance and Chief Financial Officer, 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.
 
  	By:	/s/ GREGORY C. WALKER	  	
  	  	Gregory C. Walker	  	
  	  	Vice President, Finance and Chief Financial Officer  	  	
  	  	(principal financial and accounting officer)  	  	
 
Date: May 3, 2016