What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-09 compared with 2022-11-10 · 142 added, 157 removed, 191 unchanged (61% of the section changed)

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expectations regarding global economic trends;

the impact of rising inflation and global interest rates, expectations regarding recent and future acquisitions;

the impact of rising global inflation and interest rates, expectations regarding recent and future acquisitions;

current semiconductor industry trends;

expectations of the success and market acceptance of our intellectual property and our solutions;

the continuing impact of COVID-19 on the semiconductor industry and our business, supply chain disruptions, possible impacts from the evolving trade regulatory environment and geopolitical tensions and our ability to obtain additional financing if needed.

expectations of continued adoption of our solutions by new and existing customers;

project milestones or delays and performance criteria achieved;

cost and schedule of new product development;

the provision of technology and services prior to the execution of a final contract;

the continuing impact of COVID-19 on the semiconductor industry and our operations or supply and demand for our products;

supply chain disruptions;

the success of the Company’s strategic growth opportunities and partnerships;

the Company’s ability to successfully integrate acquired businesses and technologies;

whether the Company can successfully convert backlog into revenue;

customers’ production volumes under contracts that provide Gainshare;

possible impacts from the evolving trade regulatory environment and geopolitical tensions and our ability to obtain additional financing if needed.

These forward-looking statements are only predictions.

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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.

We assume no obligation to update publicly any such forward-looking statements.

In evaluating these statements, you should specifically consider various factors, including the risk factors set forth in Item 1.

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All references to “we”, “us”, “our”, “PDF”, “PDF Solutions” or “the Company” refer to PDF Solutions, Inc.

Cimetrix, CV, DFI, Exensio, PDF Solutions and the PDF Solutions logo are trademarks or registered trademarks of PDF Solutions, Inc.

Cimetrix, CV, DFI, Exensio, PDF Solutions, and the PDF Solutions, Exensio, and Cimetrix logos are trademarks or registered trademarks of PDF Solutions, Inc.

or its subsidiaries.

We provide comprehensive data solutions designed to empower organizations across the semiconductor ecosystem to improve the yield and quality of their products and operational efficiency for increased profitability.

Our offerings include proprietary software, professional services based on proven methodologies and using third-party cloud-hosting platforms for software-as-a-service (“SaaS”), electrical measurement hardware tools, and physical intellectual property (“IP”) for integrated circuit (“IC”) designs.

We derive revenues from two sources, Analytics and Integrated Yield Ramp, by monetizing our offerings through contract fees for on-premise licenses, SaaS, and other professional services and a value-based, variable fee or royalty, which we call Gainshare, on some Characterization services engagements.

Our products and services have been sold to integrated device manufacturers (“IDMs”), fabless semiconductor companies, foundries, equipment manufacturers, electronics manufacturing suppliers (“EMS”), original device manufacturers (“ODMs”), out-sourced semiconductor assembly and test (“OSATs”), and system houses.

We offer products and services designed to empower organizations across the semiconductor ecosystem to connect, collect, manage, and analyze data about design, equipment, manufacturing, and test to improve the yield and quality of their products.

We derive revenues from two sources:

Analytics and Integrated Yield Ramp Our offerings combine proprietary software, professional services using proven methodologies and third-party cloud-hosting platforms for software-as-a-service (“SaaS”), electrical measurement hardware tools, and physical intellectual property (“IP”) for integrated circuit (“IC”) designs.

We primarily monetize our offerings through license fees and contract fees for professional services and SaaS.

In some cases, especially on our historical IYR engagements, we also receive a value-based variable fee or royalty, which we call Gainshare.

Our products, services, and solutions have been sold to integrated device manufacturers (“IDMs”), fabless semiconductor companies, foundries, out-sourced semiconductor assembly and test (“OSATs”), capital equipment manufacturers and system houses.

We are headquartered in Santa Clara, California and also operate worldwide with offices in Canada, China, France, Germany, Italy, Japan, Korea, and Taiwan.

Industry Trends

The ongoing COVID-19 pandemic has significantly affected how we and our customers operate our businesses.

We continue to closely monitor the COVID-19 situation with a focus on our employees’ safety as our employees, who were working in-office prior to COVID-19, have continued to return to working in-office for a certain number of days each week, subject to any current and future local restrictions.

In addition, our personnel worldwide can be subject to various country-to-country travel restrictions, which limits the ability of some employees to travel to other offices or customer sites.

We believe the lack of an ability to meet in person during most of 2021 and to some degree the first half of 2022 made it harder for us to sell complex or new technologies to some customers during these periods.

As we continue to meet with these customers in person, we believe we may improve traction with them.

To date, we have been able to provide uninterrupted access to our products and services due to our globally distributed workforce, many of whom were working remotely prior to the pandemic,

and our pre-existing infrastructure, which supports secure access to our internal systems.

The total duration and full extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the ultimate severity and transmission rate of the virus and its variants, the extent and effectiveness of containment actions and vaccinations, and the impact of these and other factors on our employees, customers, partners, and suppliers.

To date, one effect of the COVID-19 pandemic is a global shortage in semiconductors due primarily to supply chain disruptions and many companies, including in the automotive industry, have announced shortages in production.

Although this shortage has not materially affected our business, this trend may affect our future business opportunities, particularly future Gainshare and Cimetrix run-time licenses, if our customers’ production volumes decrease.

Certain other trends may affect our Analytics revenue specifically.

In particular, the confluence of Industry 4.0 (i.e., the fourth industrial revolution, or the automation and data exchange in manufacturing technologies and processes) and cloud computing (i.e., the on-demand availability of computing resources and data storage without direct active management by the user) is driving increased innovation in semiconductor and electronics manufacturing and analytics, as well as in the organization of IT networks and computing at semiconductor and electronics companies across the ecosystem.

Certain trends may affect our Analytics revenue specifically.

In particular, the confluence of Industry 4.0 (i.e.

the fourth industrial revolution, or the automation and data exchange in manufacturing technologies and processes) and cloud computing (i.e.

the on-demand availability of computing resources and data storage without direct active management by the user) is

driving increased innovation in semiconductor and electronics manufacturing and analytics, as well as in the organization of information technology (“IT”) networks and computing at semiconductor and electronics companies across the ecosystem.

First, the ubiquity of wireless connectivity and sensor technology enables any manufacturing company to augment its factories and visualize its entire production line.

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We expect China’s investment in semiconductors to continue.

In order for these trends to provide opportunities for us to increase our business leveraging electrical characterization, Chinese semiconductors manufacturers will need to increase their production volumes on advanced technology nodes and continue to engage foreign suppliers, subject to compliance with changing U.S.

export restrictions.

Compliance with changing U.S.

export restrictions limit our possible business with Chinese semiconductor manufacturers on advanced nodes.

As a result of these market developments, we have chosen to focus our resources and investments in products, services, and solutions for analytics.

There are other business trends that may affect our business opportunities generally.

For instance, the demand for consumer electronics, communications devices, and high-performance computing 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 continue to fuel demand for higher capacity memory chips.

There are other global or business trends that may affect our business opportunities generally as follows:

● Continuing impact of the COVID-19 pandemic .

Although COVID-19 pandemic restrictions are being eased worldwide, the pandemic continues to affect how we and our customers operate our businesses.

Our personnel worldwide have in the past been and, in the future, may become subject to various country-to-country travel restrictions, which limits the ability of some employees to travel to other offices or customer sites.

We believe the lack of an ability to meet in person during most of 2020, 2021 and to some degree the first half of 2022 made it harder for us to sell complex or new technologies to some customers during these periods.

As we continue now again to meet with these customers in person, we believe we may improve traction with them.

One effect of the COVID-19 pandemic is a global shortage in semiconductors due primarily to supply chain disruptions and some market segments, including automotive semiconductors, continue to have shortages in production.

Although COVID-19 related shortages have not materially affected our business, this trend may affect our future business opportunities, particularly future Gainshare and Cimetrix run-time licenses, if our customers’ production volumes decrease.

● Impacts from inventory cycles .

With the easing of COVID-19 pandemic restrictions, the demand for semiconductors from hardware sales supporting work-from-home has waned.

In addition, the strength of the subsequent economic recovery has varied by region.

A result has been increased semiconductor inventories for several product segments.

The industry has experienced reduced semiconductor fab utilization rates, and semiconductor capital equipment orders.

If these trends persist, the overall reduction in demand may affect our Analytics revenue and our Integrated Yield Ramp gainshare revenue.

● Continuing demand for consumer electronics .

The demand for consumer electronics, communications devices, and high-performance computing 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 continue to fuel

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 power and cost per transistor.

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We believe that these difficulties will continue to create a need for our products and services that address yield loss across the IC product life cycle.

For further instance, the ongoing Russo-Ukrainian war is negatively impacting the global supply chain generally, e.g., reducing the production of millions of new cars and trucks, which indirectly impacts the global semiconductor

market, and also affecting global energy markets and causing shortages and rising prices of semiconductors directly.

● Impacts on the global chip supply chain .

The ongoing Russo-Ukrainian war has negatively impacted the global supply chain and global energy markets, which has resulted in inflation, supply chain shortages and rising prices.

Ukraine and Russia are both top suppliers of neon gas that is used in lasers and chip manufacturing, and Russia is a major producer of palladium, a rare metal used in computer components, sensors, and fuel cells.

Limitations on the supply of these two elements can severely affect the global supply chain, which is already scarce in semiconductors.

Limitations on the supply of these two elements can severely affect the global supply chain, which is already scarce.

Russia also supplies much of the world’s premium nickel, which is used by electronics manufacturers to make batteries.

If these trends continue or worsen, we may face a shortage of critical components for our own tools and our business may suffer if the business of our customers decreases.

Rising prices of semiconductors may mean increased royalties to us and increased Integrated Yield Ramp revenue.

We are also actively monitoring the macroeconomic environment, including the potential impact of inflationary pressures and increasing global interest rates, for impacts on our material, labor and other costs.

If these trends continue or worsen, we or our customers may face a shortage of critical components.

These macroeconomic impacts, including inflationary pressures and increasing global interest rates, could also increase our material, labor, and other costs.

● Changing export controls and sanctions .

government continues to expand and intensify export controls and sanctions.

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government issued an interim final rule (87 Fed.

62186) with additional export control regulations that may be relevant to our business.

62186) with additional export control restrictions.

Among several changes, the U.S.

government imposed restrictions on supply to any P.R.C.

fabrication facility that produces certain advanced logic or memory ICs, when the supply involves a product or technology (“Item”) that is “subject to the EAR” or involves a “U.S.

person” in providing, facilitating providing, or servicing an Item that is “not subject to the EAR.” Another change is a restriction on supply of an item “subject to the EAR” destined for use in P.R.C.

development or production of certain IC manufacturing equipment.

fabrication facility that produces certain advanced logic or memory ICs, when the supply involves a commodity, software or technology (“Item”) that is “subject to the EAR” or when the supply involves a “U.S.

person” even if the Item is not “subject to the EAR.” Another change is a restriction on supply of an item “subject to the EAR” destined for use in the development or production of certain IC manufacturing equipment and certain parts and components of such equipment in the P.R.C.

Industry members, including our Company, continue to generate questions and evaluate the effects of the new regulations.

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In addition, the U.S.

government expanded the “foreign direct product rule,” together with EAR jurisdiction and restrictions, to additional foreign-produced Items of certain types or in connection with additional restricted parties in the P.R.C.

government expanded the “foreign direct product rules,” and thus EAR jurisdiction and restrictions, to additional foreign-produced Items and in connection with additional restricted parties in the P.R.C.

Based on our current assessments, we expect the impact of these expanded trade restrictions on our business to be limited.

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The uncertainty caused by these recent regulations and the potential for additional future restrictions could, nonetheless, negatively affect our future sales in the P.R.C.

● Geopolitical tensions .

Geopolitical tension between the U.S.

continues to increase, with both governments taking actions and making statements that lean in the direction of confrontation, including on the issue of Taiwan.

Growing tension also increases risk of unintended mishap, mistake, or accident leading to escalation and global supply chain disruption.

Growing tension also increases the risk of unintended mishap, mistake, or accident leading to escalation and global supply chain disruption.

The continuing tension between the U.S.

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Financial Highlights

Financial highlights for the three months ended September 30, 2022, are as follows:

● Total revenues were $39.9 million, an increase of $10.3 million, or 35%, compared to the three months ended September 30, 2021.

Analytics revenue was $32.9 million, an increase of $5.7 million, or 21%, compared to the three months ended September 30, 2021.

The increase in Analytics revenue was driven by increases in revenue from CV systems and DFI systems across multiple contracts and customers, and increases in revenues from Cimetrix and Exensio software licenses.

Integrated Yield Ramp revenue increased $4.6 million, or 196%, compared to the three months ended September 30, 2021, primarily due to an increase in Gainshare royalty from increased customer wafer shipments at non-leading edge nodes and hours worked on fixed fee engagements.

● Costs of revenues increased $1.5 million, compared to the three months ended September 30, 2021, primarily due to increases in personnel-related costs, cloud-delivery costs and subcontractor costs.

These increases were partially offset by decreases in facilities and information technology-related costs including depreciation expenses.

● Net income was $1.4 million, compared to a $2.4 million loss for the three months ended September 30, 2021.

The increase in net income was primarily attributable to an increase in total revenues and other income from net foreign currency exchange gain, partially offset by increases in costs of revenues and operating expenses related primarily to our research and development, sales and marketing activities, and general and administrative expenses, which were primarily related to increases in personnel-related costs, cloud-services related costs, subcontractor costs, and an increase in income tax expense.

Financial highlights for the nine months ended September 30, 2022, are as follows:

● Total revenues were $108.0 million, an increase of $26.9 million, or 33%, compared to the nine months ended September 30, 2021.

Analytics revenue was $94.4 million, an increase of $28.3 million, or 43%, compared to the nine months ended September 30, 2021.

Integrated Yield Ramp revenue decreased $1.4 million, or 9%, compared to the nine months ended September 30, 2021, primarily due to the end of Gainshare periods, partially offset by an increase in hours worked on fixed fee engagements.

● Costs of revenues increased $3.6 million, compared to the nine months ended September 30, 2021, primarily due to increases in personnel-related costs, cloud-delivery costs, and subcontractor costs.

These increases were partially offset by decreases in facilities and information technology-related costs, including depreciation expenses, software royalties, and license expenses.

● Net loss was $3.9 million, compared to a $14.5 million loss for the nine months ended September 30, 2021.

The decrease in net loss was primarily attributable to an increase in total revenues and other income from net foreign currency exchange gain, partially offset by increases in costs of revenues and operating expenses related primarily to our research and development, sales and marketing activities, and general and administrative expenses, which were primarily related to increases in personnel-related costs, cloud-services related costs and subcontractor costs, and an increase in income tax expense.

● Cash, cash equivalents and short-term investments decreased $24.1 million to $116.1 million at September 30, 2022, from $140.2 million at December 31, 2021, primarily due to cash used to repurchase shares of common stock and payment for taxes related to net share settlement of equity awards, and for the purchase of property and equipment, partially offset by proceeds from the exercise of stock options, proceeds from purchases under our employee stock purchase plans and cash provided by operating activities.

Critical Accounting Policies and Estimates

Financial highlights for the three months ended March 31, 2023, are as follows:

● Total revenues were $40.8 million, an increase of $7.3 million, or 22%, compared to the three months ended March 31, 2022.

Analytics revenue was $36.3 million, an increase of $5.9 million, or 19%, compared to the three months ended March 31, 2022.

The increase in Analytics revenue was driven by increases in revenue from CV and DFI systems and an increase in revenue from Exensio software licenses, partially offset by a decrease in revenues from Cimetrix software licenses.

Integrated Yield Ramp revenue increased $1.4 million, or 44%, compared to the three months ended March 31, 2022, primarily due to an increase in Gainshare from increased customer wafer shipments at non-leading edge nodes.

● Costs of revenues increased $0.4 million, compared to the three months ended March 31, 2022, primarily due to increases in personnel-related costs, third-party cloud-delivery costs and subcontractor costs.

These increases were partially offset by decreases in facilities and information technology-related costs.

● Net income was $0.4 million, compared to a net loss of $4.2 million for the three months ended March 31, 2022.

The increase in net income was primarily attributable to an increase in total revenues and interest income and decreases in research and development expenses and income tax expense, partially offset by increases in costs of revenues and sales and marketing activities, and general and administrative expenses, which were primarily related to increases in personnel-related costs, legal fees related to the arbitration proceeding over a disputed customer contract, travel expenses, and an increase in foreign currency transaction exchange losses.

● Cash, cash equivalents, and short-term investments at March 31, 2023 were $133.5 million, compared to $139.2 million as of December 31, 2022, a decrease of $5.7 million, primarily due to payments of accrued bonuses, taxes related to net share settlement of equity awards, and purchase of property and equipment, partially offset by cash collection from customers, proceeds from the exercise of stock options, and proceeds from purchases under our employee stock purchase plan.

Critical Accounting Estimates

See Note 1, Basis of Presentation And Summary of Significant Accounting Policies , to our condensed consolidated financial statements in 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 condensed consolidated financial statements, and 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, 2022, filed with the SEC on March 1, 2023.

There were no material changes during the nine months ended September 30, 2022, to the items that we disclosed as our critical accounting policies and estimates in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021.

There were no material changes during the three months ended March 31, 2023, to the items that we disclosed as our critical accounting policies and estimates in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2022.

The following is a brief discussion of the more significant accounting policies and methods that we use.

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We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.

The most significant estimates and assumptions relate to revenue recognition, valuation of long-lived assets including goodwill and intangible assets, and the realization of deferred tax assets.

The most significant estimates and assumptions relate to revenue recognition, valuation of long-

lived assets including goodwill and intangible assets, and the realization of deferred tax assets.

Actual amounts may differ from such estimates under different assumptions or conditions.

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Integrated Yield Ramp Revenue

Integrated Yield Ramp revenue is derived from our Integrated Yield Ramp engagements that include Gainshare royalties or other performance incentives based on customers’ yield achievement.

Revenue under these project–based contracts, which are delivered over a specific period of time typically for a fixed fee component paid on a set schedule, is recognized as services are performed using a percentage of completion method based on costs or labor-inputs, whichever is the most appropriate measure of the progress towards completion of the contract.

Integrated Yield Ramp revenue is derived from our yield ramp engagements that include Gainshare or other performance incentives based on customers’ yield achievement.

Revenue under these project–based contracts, which are delivered over a specific period of time typically for a fixed fee component paid on a set schedule, is recognized as services are performed using a percentage of completion method based on costs or labor-hours inputs, whichever is the most appropriate measure of the progress towards completion of the contract.

Where there are distinct performance obligations, we allocate revenue to all deliverables based on their SSPs and allocate the transaction price of the contract to each performance obligation on a relative basis using SSP.

Similar to the services provided in connection with DFI systems and CV systems that are contributing to Analytics revenue, due to the nature of the work performed in these arrangements, the estimation of percentage of completion method is complex and subject to many variables that require significant judgment.

The Gainshare royalty contained in the Integrated Yield Ramp contracts is a variable fee related to continued usage of our IP after the fixed-fee service period ends, based on the customers’ yield achievement.

The Gainshare contained in the yield ramp contracts is a variable fee related to continued usage of our IP after the fixed-fee service period ends, based on the customers’ yield achievement.

Revenue derived from Gainshare is contingent upon our customers reaching certain defined production yield levels.

Gainshare royalty periods are generally subsequent to the delivery of all contractual services and performance obligations.

Gainshare periods are generally subsequent to the delivery of all contractual services and performance obligations.

We record Gainshare as a usage-based royalty derived from customers’ usage of intellectual property and record it in the same period in which the usage occurs.

We are required to assess whether it is “more-likely-than-not” that we will realize our deferred tax assets.

We are required to assess whether it is “more-likely-than-not” that we will realize our deferred tax assets (“DTAs”).

If we believe that they are not likely to be fully realizable before the expiration dates applicable to such assets, then to the extent we believe that recovery is not likely, we must establish a valuation allowance.

Based on all available evidence, both positive and negative, we determined a full valuation allowance was still appropriate for our U.S.

federal and state net deferred tax assets (“DTAs”), primarily driven by a cumulative loss incurred over the 12-quarter period ended September 30, 2022, and the likelihood that we may not utilize tax attributes before they expire.

The valuation allowance was approximately $51.6 million as of September 30, 2022, and December 31, 2021.

federal and state net DTAs, primarily driven by a cumulative loss incurred over the 12-quarter period ended March 31, 2023, and the likelihood that we may not utilize tax attributes before they expire.

The valuation allowance was approximately $59.2 million as of March 31, 2023, and December 31, 2022.

We will continue to evaluate the need for a valuation allowance and may change our conclusion in a future period based on changes in facts (e.g., 12-quarter cumulative profit, significant new revenue, etc.).

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Changes in the net DTAs, less offsetting valuation allowance, in a period are recorded through the income tax provision and could have a material impact on the condensed consolidated statements of comprehensive income (loss).

Our income tax calculations are based on application of applicable U.S.

federal, state, or foreign tax law.

Our income tax calculations are based on the application of applicable U.S.

federal, state, and/or foreign tax law.

Our tax filings, however, are subject to audit by the respective tax authorities.

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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 condensed consolidated statements of comprehensive income (loss).

At September 30, 2022, no deferred taxes have been provided on undistributed earnings from our international subsidiaries.

As of March 31, 2023, no deferred taxes have been provided on undistributed earnings from our international subsidiaries.

We intend to reinvest the earnings of our non-U.S.

subsidiaries in those operations indefinitely.

As such, we have not provided for any foreign withholding taxes on the earnings of foreign subsidiaries as of September 30, 2022.

As such, we have not provided for any foreign withholding taxes on the earnings of foreign subsidiaries as of March 31, 2023.

The earnings of our foreign subsidiaries are taxable in the U.S.

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corporations with average adjusted financial statement income over a three-year period in excess of $1 billion.

While the details of the computation of the tax and implementation of the incentives will be subject to regulations that have not yet been released by the U.S.

Department of the Treasury, the Company does not expect the Act to materially impact its financial statements.

While the details of the computation of the tax and implementation of some of the incentives will be subject to regulations that have not yet been released by the U.S.

Department of the Treasury, the Company does not expect the Act to materially impact its consolidated financial statements.

The Creating Helpful Incentives to Produce Semiconductors Act (the “CHIPS Act”) was signed into U.S.

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CHIPS Act is intended to increase domestic competitiveness in semiconductor manufacturing capacity, increase research and development in computing, artificial intelligence, clean energy, and nanotechnology through federal government programs and incentives over the next ten years.

CHIPS Act includes an advanced manufacturing tax credit equal to 25% of qualified investments in property purchased for an advanced manufacturing facility.

The CHIPS Act includes an advanced manufacturing tax credit equal to 25% of qualified investments in property purchased for an advanced manufacturing facility.

We are evaluating the potential benefits of CHIPS Act to our business.

Stock-Based Compensation

We account for stock-based compensation using the fair value method, which requires us to measure stock-based compensation based on the grant-date fair value of the awards and recognize the compensation expense over the requisite service period.

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.

The fair value of our restricted stock units is equal to the market value of our common stock on the date of the grant.

These awards are subject to time-based vesting which generally occurs over a period of four years.

The fair value of our stock options is estimated using 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 our stock options.

The expected life is based on historical experience and on the terms and conditions of the stock options granted.

The interest rate assumption is based upon observed Treasury yield curve rates appropriate for the expected life of our stock options.

Valuation of Long-lived Assets including Goodwill and Intangible Assets

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If the carrying amount exceeds its fair value, an impairment loss would be recognized equal to the amount of excess, limited to the amount of total goodwill.

There was no impairment of goodwill for the three and nine months ended September 30, 2022.

There was no impairment of goodwill for the three months ended March 31, 2023.

Our long-lived assets, excluding goodwill, consist of property, equipment, and intangible assets.

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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.

There was no impairment of long-lived assets for the three and nine months ended September 30, 2022.

There was no impairment of long-lived assets for the three months ended March 31, 2023.

Recent Accounting Pronouncements and Accounting Changes

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Results of Operations

Discussion of Financial Data for the Three and Nine Months ended September 30, 2022

Discussion of Financial Data for the Three Months ended March 31, 2023 and 2022

Revenues, Costs of Revenues, and Gross Margin

Three Months Ended

Nine Months Ended

September 30,

(Dollars in thousands)

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Analytics Revenue

Analytics revenue increased $5.7 million for the three months ended September 30, 2022, compared to the three months ended September 30, 2021.

The increase in Analytics revenue was primarily driven by increases in revenues from CV systems and DFI systems across multiple contracts and customers, and increases in revenues from Cimetrix and Exensio software licenses.

Analytics revenue increased $28.3 million for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021.

Analytics revenue increased $5.9 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022.

The increase in Analytics revenue was primarily driven by increases in revenues from CV and DFI systems and an increase in revenue from Exensio software licenses, partially offset by a decrease in revenue from Cimetrix software licenses.

Integrated Yield Ramp Revenue

Integrated Yield Ramp revenue increased $4.6 million for the three months ended September 30, 2022, compared to the prior year period, primarily due to an increase in Gainshare royalty from increased customer wafer shipments at non-leading edge nodes and hours worked on fixed fee engagements.

Integrated Yield Ramp revenue decreased $1.4 million for the nine months ended September 30, 2022, compared to the prior year period, due to the end of Gainshare periods, partially offset by an increase in hours worked on fixed fees engagements.

Our Integrated Yield Ramp revenue may continue to fluctuate from period to period primarily due to the contribution of Gainshare royalty, which 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 contracts containing Gainshare.

Our Analytics and Integrated Yield Ramp revenues may fluctuate in the future and are dependent on a number of factors, including the semiconductor industry’s continued acceptance of our products, services and solutions, the timing of purchases by existing and new customers, cancellations by existing customers, and our ability to attract new customers and penetrate

new markets, and further penetration of our current customer base.

Integrated Yield Ramp revenue increased $1.4 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to an increase in Gainshare from increased customer wafer shipments at non-leading edge nodes.

Our Integrated Yield Ramp revenue may continue to fluctuate from period to period primarily due to the contribution of Gainshare, which 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 whether we enter into new contracts containing Gainshare.

Our Analytics and Integrated Yield Ramp revenues may also fluctuate in the future and are dependent on a number of factors, including the semiconductor industry’s continued acceptance of our products, services and solutions, the timing of purchases by existing and new customers, cancellations by existing customers, and our ability to attract new customers and penetrate new markets, supply chain challenges 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, including due to adverse changes in their own business.

Costs of Revenues

Costs of revenues consist primarily of costs incurred to provide and support our services, costs recognized in connection with licensing our software, and amortization of acquired technology.

Service costs include material, personnel-related costs and related benefits including stock-based compensation expense, subcontractor costs, overhead costs, travel and allocated facilities-related costs.

Software license costs consist of costs associated with cloud-delivery related expenses and licensing third-party software used by us in providing services to our customers in solution engagements or sold in conjunction with our software products.

The increase in costs of revenues of $1.5 million for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, was primarily due to (i) a $0.9 million increase in personnel-related costs due to worldwide merit increases, increases in benefit costs, stock-based compensation expense, and bonus expense, (ii) a $0.4 million increase in cloud-delivery costs, and (iii) a $0.2 million increase in subcontractor costs.

These were partially offset by a $0.2 million decrease in facilities and information technology-related costs including depreciation expense.

The increase in costs of revenues of $3.6 million for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, was primarily due to (i) a $2.6 million increase in personnel-related costs due to worldwide merit increases, increases in benefit costs, stock-based compensation expense, and bonus expense, (ii) a $1.2 million increase in cloud-delivery costs, and (iii) a $0.6 million increase in subcontractor costs.

These were partially offset by (i) a $0.7 million decrease in facilities and information technology-related costs including depreciation expense and (ii) a $0.1 million decrease in software royalties and license expenses.

Gross margin increased 6 percentage points for the three months ended September 30, 2022, to 69%, compared to 63% for the three months ended September 30, 2021.

The higher gross margin during the three months ended September 30, 2022 was primarily due to higher total revenue when compared to the year-ago period.

Gross margin increased 7 percentage points for the nine months ended September 30, 2022, to 67%, compared to 60% for the nine months ended September 30, 2021.

The higher gross margin during the nine months ended September 30, 2022 was primarily due to higher total revenue and decreases in certain costs of revenues, as discussed above, which decreased the costs of revenues as a percentage of total revenues, when compared to the year-ago period.

Costs of revenues consist primarily of costs incurred to provide and support our services, costs recognized in connection with licensing our software, IT and facilities-related costs and amortization of acquired technology.

Service costs include material, personnel-related costs including compensation, employee benefits, bonus and stock-based compensation expense, subcontractor costs, overhead costs, travel, and allocated facilities-related costs.

Software license costs consist of costs associated with third-party cloud-delivery related expenses and licensing third-party software used by us in providing services to our customers in solution engagements or sold in conjunction with our software products.

The increase in costs of revenues of $0.4 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, was primarily due to (i) a $0.2 million increase in personnel-related costs due to stock-based compensation expense, (ii) a $0.1 million increase in third-party cloud-delivery costs, and (iii) a $0.1 million increase in subcontractor costs.

These were partially offset by a $0.2 million decrease in facilities and IT-related costs.

Gross margin increased 5 percentage points for the three months ended March 31, 2023, to 71%, compared to 66% for the three months ended March 31, 2022.

The higher gross margin during the three months ended March 31, 2023, was primarily due to higher total revenue, including Gainshare, when compared to the year-ago period.

Operating Expenses:

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Research and development expenses consist primarily of personnel-related costs including compensation, benefits and stock-based compensation expense, outside development services, third-party cloud-services related cost, travel, and facilities cost allocations, to support product development activities.

Research and development expenses increased for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to (i) a $2.7 million increase in personnel-related costs primarily resulting from increases in stock-based compensation expense, headcount, bonus expense, benefit costs, and worldwide merit increases, (ii) a $0.6 million increase in subcontractor expenses primarily related to DFI systems and Cimetrix software, (iii) a $0.1 million increase in facilities and information technology-related costs including depreciation expense, and (iv) a $0.1 million increase in travel expenses.

Research and development expenses increased for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to (i) a $7.3 million increase in personnel-related costs primarily resulting from increases in stock-based compensation expense, headcount, bonus expense, benefit costs, and worldwide merit increases, (ii) a $1.1 million increase in subcontractor expenses primarily related to CV systems and Exensio and Cimetrix software, and (iii) a $0.5 million increase in facilities and information technology-related costs including depreciation expense, and (iv) a $0.3 million increase in travel expense.

Research and development expenses consist primarily of personnel-related costs including compensation, employee benefits, bonus and stock-based compensation expense, outside development services, travel, third-party cloud-services related costs, IT and facilities cost allocations to support product development activities.

Research and development expenses decreased $1.0 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to (i) a $1.7 million decrease in personnel-related costs primarily resulting from a lower stock-based and other compensation expenses, partially offset by worldwide salary increases, (ii) a $0.2 million decrease in facilities and IT-related costs including depreciation expense.

These were partially offset by (i) a $0.5 million increase in subcontractor expenses primarily related to DFI systems and Exensio and Cimetrix software, (ii) a $0.2 million increase in travel expenses, and (iii) a $0.1 million increase in third-party cloud-services related costs.

We anticipate our expenses in research and development will fluctuate in absolute dollars from period to period as a result of the size and the timing of product development projects.

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Selling, general, and administrative expenses consist primarily of compensation, benefits and stock-based compensation expense for sales, marketing and general and administrative personnel, legal and accounting services, marketing communications expenses, third-party cloud-services related costs, travel and facilities cost allocations.

Selling, general, and administrative expenses increased for the three months ended September 30, 2022, compared to the three months ended September 30, 2021, primarily due to (i) a $2.2 million increase in personnel-related costs mainly resulting from increases in stock-based compensation expense, headcount, bonus and commission expenses, benefit costs, and worldwide merit increases, (ii) a $0.2 million increase in facilities and information technology-related costs, including third-party cloud-services related costs, (iii) a $0.3 million increase in travel and other expenses, and (iv) a $0.2 million increase in legal fees related to the arbitration proceeding over a disputed customer contract.

These were partially offset by a $0.5 million decrease in subcontractor expenses.

Selling, general, and administrative expenses increased for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, primarily due to (i) a $4.0 million increase in personnel-related costs mainly resulting from increases in stock-based compensation expense, headcount, bonus and commission expense, benefit costs, and worldwide merit increases, (ii) a $0.4 million increase in facilities and information technology-related costs including depreciation expense, (iii) a $0.4 million increase in third-party cloud-services related costs, and (iv) a $0.2 million increase in travel expenses.

These were partially offset by a (i) a $0.7 million decrease in subcontractor expenses, and (ii) a $0.2 million decrease in legal fees related to the arbitration proceeding over a disputed customer contract.

Selling, general, and administrative expenses consist primarily of personnel-related costs including compensation, employee benefits, bonus, commission and stock-based compensation expense for sales, marketing, and general and administrative personnel, legal, tax and accounting services, marketing communications expenses, third-party cloud-services related costs, travel, IT, and facilities cost allocations.

Selling, general, and administrative expenses increased $4.8 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to (i) a $2.9 million increase in personnel-related costs mainly resulting from increases in headcount, stock-based compensation expense, worldwide salary increases, commission expenses, and employee benefit costs, (ii) a $1.7 million increase in legal fees related to the arbitration proceeding over a disputed customer contract, (iii) a $0.3 million increase in facilities and IT-related costs including depreciation expense, and

(iv) a $0.2 million increase in travel expenses.

These were partially offset by (i) a $0.2 million decrease in third-party cloud-services related costs and (ii) a $0.1 million decrease in subcontractor expenses.

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.

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Interest and other expense (income), net, primarily consists of interest income and foreign currency transaction exchange gains and losses.

Interest and other expense (income), net increased for the three and nine months ended September 30, 2022, compared to the year-ago periods, primarily due to a higher foreign currency exchange gain resulting from a net favorable fluctuation in foreign exchange rates and interest income.

Interest and other expense (income), net increased $0.6 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to a higher interest income, partially offset by higher foreign currency exchange loss resulting from a net unfavorable fluctuation in foreign exchange rates.

Income Tax Expense

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Income tax expense

Income tax expense increased for the three and nine months ended September 30, 2022, compared to the three and nine months ended September 30, 2021, primarily due to increases in foreign withholding taxes and changes in the geographic mix of worldwide income, which is subject to taxation at different statutory tax rates.

Income tax expense decreased for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, primarily due to changes in the year-to-date recognition of worldwide pre-tax income (loss) in relation to their forecasted amounts for full years.

Any significant change in our future effective tax rates could adversely impact our consolidated financial position, results of operations and cash flows.

Our future tax rates may be adversely affected by a number of factors including increase in expenses not deductible for tax purposes, tax legislations in the United States and in foreign countries where we are subject to tax jurisdictions, the geographic composition of our pre-tax income, the amount of our pre-tax income as business activities fluctuate, our ability to use tax attributes such as research and development tax credits and net operation losses, the tax effects of employee stock activity, audit examinations with adverse outcomes, changes in generally accepted accounting principles and the effectiveness of our tax planning strategies.

Our future tax rates may be adversely affected by a number of factors including increase in expenses not deductible for tax purposes, new or changing tax legislation in the United States and in foreign countries where we are subject to tax jurisdictions, the geographic composition of our pre-tax income, the amount of our pre-tax income as business activities fluctuate, our ability to use tax attributes such as research and development tax credits and net operation losses, the tax effects of employee stock activity, audit examinations with adverse outcomes, changes in accounting principles generally accepted in the United States of America and the effectiveness of our tax planning strategies.

Liquidity and Capital Resources

As of September 30, 2022, our working capital, defined as total current assets less total current liabilities, was $128.1 million, compared to $144.7 million as of December 31, 2021.

Total cash and cash equivalents, and short-term investments were $116.1 million as of September 30, 2022, compared to cash and cash equivalents of $140.2 million as of December 31, 2021.

As of September 30, 2022, and December 31, 2021, cash and cash equivalents held by our foreign subsidiaries were $6.9 million and $5.3 million, respectively.

As of March 31, 2023, our working capital, defined as total current assets less total current liabilities, was $138.9 million, compared to $135.2 million as of December 31, 2022.

Total cash, cash equivalents, and short-term investments were $133.5 million as of March 31, 2023, compared to cash and cash equivalents of $139.2 million as of December 31, 2022.

As of March 31, 2023, and December 31, 2022, cash and cash equivalents held by our foreign subsidiaries were $10.0 million and $8.8 million, respectively.

We believe that our existing cash resources and anticipated funds from operations will satisfy our cash requirements to fund our operating activities, capital expenditures, other obligations for at least the next twelve months.

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For risk discussion about the continuing impact of global COVID-19 pandemic on our operations or demand for our products, refer to Part I, Item 1A, “Risk Factors” of our Annual Report for the year ended December 31, 2022, filed with the SEC on March 1, 2023.

Repurchase of Company’s Common Stock

On June 4, 2020, the Company’s Board of Directors adopted a stock repurchase program (the “2020 Program”) to repurchase up to $25.0 million of the Company’s common stock both on the open market and in privately negotiated transactions, including through Rule 10b5-1 plans, over the next two years.

During the nine months ended September 30, 2022, the Company repurchased 218,858 shares under the 2020 Program at an average price of $26.40 per share, for a total price of $5.8 million.

Through April 10, 2022, under the 2020 Program, the Company repurchased a total of 470,070 shares at an average price of $21.91 per share, for a total price of $10.3 million.

On April 11, 2022, the Board of Directors terminated the 2020 stock repurchase program, and adopted a new program (the “2022 Program”) to repurchase up to $35.0 million of the Company’s common stock both on the open market and in privately negotiated transactions, from time to time, over the next two years.

During the nine months ended September 30, 2022, the Company repurchased 714,600 shares under the 2022 Program at an average price of $23.36 per share, for a total price of $16.7 million.

Cash Flow Data

The following table summarizes our cash flows for the periods presented:

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Net increase in cash, cash equivalents, and restricted cash

Net Cash Flows Provided by Operating Activities

Cash flows provided by operating activities during the nine months ended September 30, 2022, consisted of net loss, adjusted for certain non-cash items which primarily consisted of depreciation and amortization, stock-based compensation expense, amortization of acquired intangible expense, amortization of costs capitalized to obtain revenue contracts and net change in operating assets and liabilities.

The $4.2 million increase in cash flows from operating activities for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, was driven primarily by a $10.6 million decrease in net loss, a $11.4 million decrease in net change from operating assets and liabilities, and a $5.0 million increase in non-cash adjustments to net loss, which mainly resulted from an increase in stock-based compensation expense of $5.1

million and an increase in amortization of costs capitalized to obtain revenue contracts of $0.6 million, partially offset by a decrease in depreciation and amortization of $0.6 million.

The major contributors to the net change in operating assets and liabilities for the nine months ended September 30, 2022, were as follows:

● Accounts receivable increased by $15.0 million, primarily due to contractual invoicing activity partially offset by collections from customers;

● Prepaid expense and other current assets increased by $2.8 million, primarily due to the timing of billing of contract assets related to fixed-price service contracts, and increase in deferred commission expense, partially offset by a decrease in prepaid expenses related to third party software licenses and cloud-subscription related costs and a decrease in income tax receivable;

● Other non-current assets decreased by $1.5 million primarily due to the amortization of non-current prepaid expenses, deferred costs to obtain contracts with customers and lower unbilled accounts receivable;

● Accounts payable decreased by $2.9 million primarily due to the timing of payments of vendor invoices;

● Accrued and other liabilities increased by $2.6 million primarily due to the timing of vendor invoices and accrued income taxes;

● Accrued compensation and related benefits increased by $3.6 million primarily due to accrued bonuses, unused vacation, and accrued sales commissions, partially offset by a decrease in accrual due to exercise of purchase rights under employee stock purchase plans;

● Deferred revenue increased by $2.3 million, primarily due to the timing of billing and revenue recognition.

Net Cash Flows Provided by Investing Activities

Cash provided by investing activities increased by $41.1 million for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021.

For the nine months ended September 30, 2022, cash provided by investing activities primarily related to proceeds from maturities and sales of short-term investments of $136.0 million, partially offset by purchases of short-term investments of $45.8 million, and purchases of and prepayments for property and equipment of $6.7 million primarily related to our DFI systems and CV systems.

For the nine months ended September 30, 2021, cash provided by investing activities primarily related to proceeds from maturities and sales of short-term investments of $136.0 million, offset by purchases of short-term investments of $91.0 million and property and equipment of $2.7 million primarily related to our DFI systems.

Net change in cash and cash equivalents

Net Cash Flows Provided by (Used in) Operating Activities

Cash flows used in operating activities during the three months ended March 31, 2023, consisted of net income, adjusted for certain non-cash items which primarily consisted of depreciation and amortization, stock-based compensation expense, amortization of acquired intangible expense, amortization of costs capitalized to obtain revenue contracts and net change in operating assets and liabilities.

The $4.0 million decrease in cash flows provided by (used in) operating activities for the three months ended March 31, 2023, compared to the three months ended March 31, 2022, was driven primarily by a $7.8 million decrease in net change from operating assets and liabilities and a $0.7 million decrease in non-cash adjustments to net income (loss), which mainly resulted from a decrease in stock-based compensation expense of $0.7 million, partially offset by an increase in net income of $4.5 million.

The major contributors to the net change in operating assets and liabilities for the three months ended March 31, 2023, were as follows:

● Accounts receivable increased by $4.9 million, primarily due to higher contractual invoicing activity and an increase in unbilled accounts receivables due to the timing of billing and revenue recognition, partially offset by collections from customers;

● Prepaid expense and other current assets increased by $1.0 million, primarily due to an increase in income tax receivable, deferred commission, prepaid expenses related to third party software licenses, partially offset by lower contract assets;

● Accounts payable increased by $1.3 million primarily due to the timing of payments of vendor invoices;

● Accrued compensation and related benefits decreased by $3.1 million primarily due to the payment of accrued bonuses and exercise of purchase rights under employee stock purchase plan, partially offset by an increase in accrued payroll taxes;

● Deferred revenue increased by $0.7 million and billings in excess of recognized revenues decreased by $1.5 million, primarily due to the timing of billing and revenue recognition.

Net Cash Flows Provided by (Used in) Investing Activities

Net cash used in investing activities was $2.3 million for the three months ended March 31, 2023, compared to net cash provided by investing activities of $12.3 million for the three months ended March 31, 2022.

For the three months ended March 31, 2023, cash used in investing activities primarily related to purchases of short-term investments of $6.4 million and purchases of property and equipment of $2.9 million primarily related to our DFI systems and CV systems, partially offset by proceeds from maturities and sales of short-term investments of $7.0 million.

For the three months ended March 31, 2022, cash provided by investing activities primarily related to proceeds from maturities and sales of short-term investments of $35.0 million, partially offset by purchases of short-term investments of $21.0 million and property and equipment of $1.8 million primarily related to our DFI systems.

Net Cash Flows Used in Financing Activities

Net cash used in financing activities increased by $18.7 million for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021.

For the nine months ended September 30, 2022, net cash used in financing activities primarily consisted of $22.5 million for the repurchase of shares of our common stock and $5.8 million in cash payments for taxes related to net share settlement of equity awards, partially offset by $4.1 million of proceeds from our employee stock purchase plans and exercise of stock options.

For the nine months ended September 30, 2021, net cash used in financing activities primarily consisted of $4.5 million for the repurchase of shares of our common stock and $3.3 million in cash payments for taxes related to net share settlement of equity awards, partially offset by $2.3 million of proceeds from our employee stock purchase plan and exercise of stock options.

Net cash used in financing activities was $2.1 million for the three months ended March 31, 2023, compared to $7.0 million for the three months ended March 31, 2022.

For the three months ended March 31, 2023, net cash used in financing activities primarily consisted of $4.1 million in cash payments for taxes related to net share settlement of equity awards, partially offset by $2.0 million of proceeds from our employee stock purchase plans and exercise of stock options.

For the three months ended March 31, 2022, net cash used in financing activities primarily consisted of $5.8 million for the repurchase of shares of our common stock and $3.4 million in cash payments for taxes related to net share settlement of equity awards, partially offset by $2.2 million of proceeds from our employee stock purchase plans and exercise of stock options.

Related Party Transactions

Refer to Note 3, Strategic Partnership Agreement with Advantest and Related Party Transactions , to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q, for a discussion on related party transactions between the Company and Advantest.

Refer to Note 3, Strategic Partnership Agreement with Advantest and Related Party Transactions , to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q, for the discussion about related party transactions between the Company and Advantest (as defined therein).

Off-Balance Sheet Agreements

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Item 2. Management’s Discussion and Analysis