REVENUE RECOGNITION

January 1, 2018,

the Company adopted Topic

606,

using the modified retrospective transition method applied to those contracts which were

not

completed as of

January 1, 2018.

Under this method, the Company evaluated contracts that were in effect at the beginning of fiscal

2018

as if those contracts had been accounted for under Topic

606

from the beginning of their terms. Upon adoption, the Company recognized the cumulative effect of adopting this guidance as an adjustment to accumulated deficit on the date of initial application. The comparative information in prior periods has

not

been restated and continues to be reported under the accounting standards in effect for those periods.

The Company also considered the impact of subtopic ASC

340

40.

Prior to the adoption of Topic

606,

the Company expensed commission costs and related fringe benefits as incurred. Under ASC

340

40,

the Company is required to capitalize and amortize the incremental costs of obtaining or fulfilling a contract over the period of the expected benefit. Incremental costs of obtaining and fulfilling a contract are recognized as an asset if the costs are expected to be recovered.

The most significant impacts of the adoption of Topic

606

are as follows:

●

At the adoption date, the Company recorded a net decrease of

$4.4

million to accumulated deficit related to the acceleration of revenue required by the adoption of Topic

606

using the modified retrospective method and the capitalization of incremental sales commission costs, net of related deferred tax impact. Under the modified retrospective method, a portion of revenue for uncompleted contracts, which would have been recognized in future periods under Topic

605,

was accelerated and recognized as an adjustment to accumulated deficit as of the date of adoption. As a result, the beginning balance on

January 1, 2018

of accounts receivable increased by

$0.8

million, contract assets were established at

$1.9

million and deferred revenue decreased by

$2.5

million. The Company capitalized

$0.5

million of incremental sales commission costs at the adoption date directly related to obtaining customer contracts and will amortize these costs over the lives of the contracts for which such commissions are paid.

●

For fiscal

2018,

revenue generated under Topic

606

is expected to be slightly lower than revenue would have been under Topic

605.

This is the result of a combination of factors, including the reduction of deferred revenue that under Topic

605

would continue to be recognized as revenue in

2018

and beyond, as well as changes in the timing of revenue recognition as discussed below. The actual effect on revenue recognized for the

first

and

second

quarter of fiscal

2018

was

not

significant.

The adoption of Topic

606

impacted the Company’s accounting for certain commercial software multi-element arrangements (“MEA”) that combine software-related deliverables, which

may

include software contracts with varying terms and service elements. Topic

605

required establishing vendor specific objective evidence of fair value ("VSOE"), for undelivered elements to recognize revenue separately for each of the different elements. Topic

606

requires the Company to allocate consideration to each separate different performance obligation through the use of stand-alone selling prices (“SSPs”) and to recognize the revenue as if those performance obligations had been sold on a standalone basis, either at a point-in-time or over time. The most significant impact of this change relates to the Company’s accounting for software license revenue. For the Company’s Exensio big data solution software which is licensed under a time-based license model, the Company will recognize a portion of revenue on these types of contracts at the time of delivery rather than ratably over the term of the license. For perpetual software license contracts, the Company will allocate consideration to the different performance obligations based on their SSPs rather than using the VSOE for undelivered elements as required under Topic

605.

In addition, under the Company’s previous accounting practices, revenue was recognized from Gainshare performance incentive agreements in the period of receipt of related Gainshare acknowledgement reports, generally

one

quarter in arrears from the period in which the underlying sales (usage) occurred. Under Topic

606,

the Company is now required to record Gainshare revenue in the same period in which the usage occurs. Because the Company generally does

not

Under Topic

605,

the Company recognized revenue for professional services, including revenue from fixed price solution implementation service contracts, either on a percentage of completion method or time and materials method. Under Topic

606,

revenue related to these professional services will remain substantially unchanged.

The following table summarizes the effects of adopting Topic

606

on the Company’s condensed consolidated balance sheet as of

June 30, 2018:

	As reported under Topic 606			Adjustments			Balances under Topic 605
	(In thousands)
Accounts receivable, net of allowance	$	53,919		$	621		$	54,540
Prepaid expenses and other current assets		8,660			(3,546	)		5,114
Deferred tax assets		17,747			316			18,063
Other non-current assets		8,943			(78	)		8,865
Deferred revenues – current portion		9,369			1,858			11,227
Long-term income taxes payable		4,652			(1,032	)		3,620
Other non-current liabilities		994			785			1,779
Accumulated deficit		(25,256	)		(4,298	)		(29,554	)

The impact of adopting Topic

606

to revenues, cost of revenues and net income for the

three

and

six

months ended

June 30, 2018

was

not

significant. There was

significant impact to the basic and diluted net income (loss) per share.

The Company’s net cash provided by operating activities for the

three

and

six

months ended

June 30, 2018

did

not

change due to the adoption of Topic

606.

The following table summarizes the effects of adopting Topic

606

on the financial statement line items of the Company’s condensed consolidated statement of cash flows for the

six

months ended

June 30, 2018:

	As reported under Topic 606			Adjustments			Balances under Topic 605
	(In thousands)
Net income	$	(2,520	)	$	55		$	(2,465	)
Changes in operating assets and liabilities:
Accounts receivable, net of allowance		4,479			(1,413	)		3,066
Prepaid expenses and other current assets		(1,204	)		1,154			(50	)
Other non-current assets		1,597			79			1,676
Deferred revenue		2,745			125			2,870

The Company derives revenue from

two

sources: Design-to-silicon-yield solutions and Gainshare performance incentives.

Revenue is recognized when control of products or services is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those promised products or services.

The Company determines revenue recognition through the following

five

steps:

●

Identification of the contract, or contracts, with a customer

●

Identification of the performance obligations in the contract

●

Determination of the transaction price

●

Allocation of the transaction price to the performance obligations in the contract

●

Recognition of revenue when, or as, performance obligations are satisfied

The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

The Company enters into contracts that can include various combinations of licenses, products and services, some of which are distinct and are accounted for as separate performance obligations. For contracts with multiple performance obligations, the Company allocates the transaction price of the contract to each performance obligation, generally on a relative basis using its standalone selling price.

Nature of Products and Services

Design-to-silicon-yield solutions — The Company recognizes revenue for each element 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. Revenue under project–based contracts for solution implementation services 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. Due to the nature of the work performed in these arrangements, the estimation of costs or hours at completion is complex, subject to many variables and requires significant judgment. Key factors reviewed by the Company to estimate costs to complete each contract are future labor and product costs and expected productivity efficiencies. If circumstances arise that change the original estimates of revenues, costs,

or extent of progress toward completion, revisions to the estimates are made. These revisions

may

result in increases or decreases in estimated revenues or costs. 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 (cumulative catch-up method).

On occasion, the Company includes its products as a component of its fixed-price service contracts. In such instances, the Company determines whether the services performed and products included, are distinct. In most cases, the arrangement is a single performance obligation and therefore follows the pattern of transfer as the service is provided. The Company applies a measure of progress (typically hours-to-hours or cost-to-cost) to any fixed consideration. As a result, revenue is generally recognized over the period the services are performed using percentage of completion method. This results in revenue recognition that corresponds with the value to the client of the services transferred to date relative to the remaining services promised.

The Company also licenses our Design-for-Inspection ("DFI") system as a separate component of fixed-price service contracts. The Company allocates revenue to all deliverables based on their standalone selling prices, or SSP. In such instances, the Company applies judgment to estimate the range of SSPs for each performance obligation.

The Company licenses some of its software products separately from solution implementations, primarily its Exensio big data platform and related products. The majority of these products are delivered as on premise software licenses, while others can be delivered entirely or partially through Software-as-a-Service (SaaS) or cloud delivery models. Revenue from perpetual (

one

-time charge) license software is recognized at the time of the inception of the arrangement when control transfers to the client, if the software license is distinct from the services offered by the Company. Revenue from post-contract support subscription is recognized over the contract term on a straight-line basis, because the Company is providing a service of standing ready to provide support, when-and-if needed, and is providing unspecified software upgrades on a when-and-if available basis over the contract term. Revenue from time-based license software is allocated to each performance obligation and is recognized either at a point in time or over time. The license component is recognized at the time of the delivery of the software license, with the post-contract support subscription component being recognized ratably over for the committed term of the contract. Revenue from software hosting or SaaS arrangements that allow for the use of a hosted software product or service over a contractually determined period of time without taking possession of software are accounted for as subscriptions and recognized as revenue ratably, on a straight-line basis, over the coverage period beginning on the date the service is made available to customers.

Gainshare Performance Incentives — When the Company enters into a contract to provide yield improvement services, the contract usually includes

two

components: (

) a fixed fee for performance by the Company of services delivered over a specific period of time; and (

) a Gainshare performance incentive component where the customer pays a variable fee, usually after the fixed fee period has ended, related to the usage of the Company's intellectual property. Revenue derived from Gainshare performance incentives is contingent upon the Company’s customers reaching certain defined production yield levels. Gainshare performance incentive periods are usually subsequent to the delivery of all contractual services and performance obligations. The Company records Gainshare revenue as a usage-based royalty based on customers' usage of intellectual property and records it in the same period in which the usage occurs.

The following table summarizes the effects of adopting Topic

606

on the financial statement line items of the Company’s condensed consolidated statements of operations for the

three

months ended

June 30, 2018:

	As reported under Topic 606			Adjustments			Balances under Topic 605
				(In thousands)
Design-to-silicon-yield solutions	$	15,266		$	12		$	15,278
Total revenue		21,119			12			21,131
Gross margin		10,202			12			10,214
Selling, general and administrative		5,919			(73	)		5,846
Total operating expenses		13,127			(73	)		13,054
Income (loss) from operations		(2,925	)		85			(2,840	)
Income (loss) before taxes		(2,535	)		85			(2,450	)
Net income (loss)		(2,096	)		85			(2,011	)

The following table summarizes the effects of adopting Topic

606

on the financial statement line items of the Company’s condensed consolidated statements of operations for the

six

months ended

June 30, 2018:

	As reported under Topic 606			Adjustments			Balances under Topic 605
				(In thousands)
Design-to-silicon-yield solutions	$	33,456		$	(18	)	$	33,438
Total revenue		45,856			(18	)		45,838
Gross margin		23,457			(18	)		23,439
Selling, general and administrative		12,294			(73	)		12,221
Total operating expenses		26,856			(73	)		26,783
Income (loss) from operations		(3,399	)		55			(3,344	)
Income (loss) before taxes		(3,340	)		55			(3,285	)
Net income (loss)		(2,520	)		55			(2,465	)

Disaggregation of revenue

In accordance with ASC

606

50,

the Company disaggregates revenue from contracts with customers into geographical regions, major contract performance obligations and timing of transfer of goods and services. The Company determined that disaggregating revenue into these categories achieves the disclosure objective to depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.

The following table shows the revenues from contracts with customers by the nature of transactions for the

three

and

six

months ended

June 30, 2018:

	Three Months Ended		Six Months Ended
	June 30, 2018		June 30, 2018
Product and licenses	$	6,828	$	14,315
Support and Services		14,200		31,190
Other		90		351
Total	$	21,119	$	45,856

Product and licenses include a portion of time-based software which is recognized in the period, perpetual software and Gainshare performance incentives. The remaining portions of revenue from these contracts correspond to services or other types of performance obligations reported as either services revenue or other revenue.

Under Topic

606,

the Company’s performance obligations are satisfied either over-time or at a point-in-time. Revenue from performance obligations, satisfied over time and at a point-in-time, accounted for approximately

68%

and

32%

for the

three

and

six

months ended

June 30, 2018,

respectively. International revenues accounted for approximately

57%

and

58%

of our total revenues for the

three

and

six

months ended

June 30, 2018,

respectively, compared to

62%

and

57%

for the

three

and

six

months ended

June 30, 2017,

respectively. See Note

Customer and Geographic Information.

Significant Judgments

More judgments and estimates are required under Topic

606

than were required under Topic

605.

Due to the complexity of certain contracts, the actual revenue recognition treatment required under Topic

606

for the Company’s arrangements

may

be dependent on contract-specific terms and

may

vary in some instances.

In services arrangements, the Company typically satisfies the performance obligation and recognizes revenue over time. In Design-to-silicon-yield service arrangements, the performance obligation is satisfied over time either because the client controls the asset as it is created (e.g., when the asset is built at the customer site) or because the Company’s performance does

not

create an asset with an alternative use and the Company has an enforceable right to payment plus a reasonable profit for performance completed to date. In most other services arrangements, the performance obligation is satisfied over time because the client simultaneously receives and consumes the benefits provided as the Company performs the services.

For revenue under project–based contracts for fixed-price solution implementation services, revenue is recognized as services are performed using a percentage-of-completion method based on costs or labor-hours input method, whichever is the most appropriate measure of the progress towards completion of the contract. Due to the nature of the work performed in these arrangements, the estimation of percentage of completion method is complex, subject to many variables and requires significant judgment. Key factors reviewed by the Company to estimate costs to complete each contract are future labor and product costs and expected productivity efficiencies. If circumstances arise that change the original estimates of revenues, costs, or extent of progress toward completion, revisions to the estimates are made. These revisions

may

result in increases or decreases in estimated revenues or costs, and such revisions are reflected in revenue on a cumulative catch-up basis in the period in which the circumstances that gave rise to the revision become known.

The Company’s contracts with customers often include promises to transfer products, licenses and services, including professional services, technical support services, and rights to unspecified updates to a customer. Determining whether products, licenses and services are distinct performance obligations that should be accounted for separately, or

not

distinct and thus accounted for together, requires significant judgment. The Company rarely licenses or sells products on a standalone basis, so the Company is required to estimate the range of SSPs for each performance obligation. In instances where SSP is

not

directly observable because the Company does

not

sell the license, product or service separately, the Company determines the SSP using information that

may

include market conditions and other observable inputs. The Company, in some cases, has more than

one

SSP for individual performance obligations. In these instances, the Company

may

use information such as the size of the customer and geographic region of the customer in determining the SSP.

The Company is required to record Gainshare royalty revenue in the same period in which the usage occurs. Because the Company generally does

not

receive the acknowledgment reports during a given quarter within the time frame necessary to adequately review the reports and include the actual amounts in quarterly results for such quarter, the Company accrues the related revenue based on estimates of customer's underlying sales achievement. The Company estimation process can be based on historical data, trends, seasonality, changes in the contract rate, knowledge of the changes in the industry and changes in the customer’s manufacturing environment learned through discussions with customers and sales personnel. As a result of accruing revenue for the quarter based on such estimates, adjustments will be required in the following quarter to true-up revenue to the actual amounts reported.

Contract Balances

The Company performs its obligation under a contract with a customer by transferring products or services in exchange for consideration from the customer. The timing of the Company’s performance often differs from the timing of the customer’s payment, which results in the recognition of a receivable, a contract asset or a contract liability. The Company classifies the right to consideration in exchange for products or services transferred to a client as either a receivable or a contract asset. A receivable is a right to consideration that is unconditional as compared to a contract asset which is a right to consideration that is conditional upon factors other than the passage of time. The majority of the Company’s contract assets represent unbilled amounts related to fixed-price solution implementation service contracts when the costs or labor-hours input method of revenue recognition is utilized and revenue recognized exceeds the amount billed to the client, and the right to consideration is subject to milestone completion or client acceptance. The contract assets are generally classified as current and are recorded on a net basis with deferred revenue (i.e., contract liabilities) at the contract level. The contract assets is included in prepaid expenses and other in the condensed consolidated balance sheets. At

June 30, 2018

and

January 1, 2018,

contract assets of

$3.2

million and

$1.9

million, respectively, are included in prepaid expenses and other current assets in the condensed consolidated balance sheets. The change in the contract assets balance during the period relates to the recording of revenues for which the right to consideration is subject to milestone completion or client acceptance and movement of previously recorded contract assets to receivables as the right to consideration becomes unconditional. Deferred revenues consist substantially of amounts invoiced in advance of revenue recognition and is recognized as the revenue recognition criteria are met. Deferred revenues that will be recognized during the succeeding

twelve

month period is recorded as current deferred revenues and the remaining portion is recorded as non- current deferred revenues. This balance was recorded in the other non-current liabilities in the accompanying condensed consolidated balance sheets. Non-current portion of deferred revenue was

$0.5

million and

$0.9

million, respectively, as of

June 30, 2018

and

January 1, 2018.

During the

three

and

six

months ended

June 30, 2018,

the Company recognized

$5.0

million and

$7.6

million, respectively, of revenue that was included in the deferred revenue balance, as adjusted for Topic

606,

at the beginning of

2018.

June 30, 2018,

the aggregate amount of the transaction price allocated to the remaining performance obligations related to customer contracts that were unsatisfied or partially unsatisfied was approximately

$45.3

million. Given the applicable contract terms, the majority of this amount is expected to be recognized as revenue over the next

years, with the remainder in the following

years. This amount does

not

include contracts to which the customer is

not

committed, nor contracts with original expected lengths of

one

year or less, nor contracts for which we recognize revenue equal to the amount we have the right to invoice for services performed, or future sales-based or usage-based royalty payments in exchange for a license of intellectual property. This amount is subject to change due to future revaluations of variable consideration, terminations, other contract modifications, or currency adjustments. The estimated timing of the recognition of remaining unsatisfied performance obligations is subject to change and are affected by changes to the scope, change in timing of delivery of products and services, or contract modifications.

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within

days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that its contracts generally do

not

include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing the Company’s products and services, and

not

to facilitate financing arrangements.

The amount of revenue recognized in the

three

and

six

months ended

June 30, 2018

from performance obligations satisfied (or partially satisfied) in previous periods was (

$0.2

) million and

$0.3

million, respectively. This amount primarily represents changes of estimated percentage-of –completion based contracts and changes in estimated Gainshare performance incentives for those customers that reported actual Gainshare revenue with some time lag.

Costs to obtain or fulfill a contract

The Company capitalizes the incremental costs to obtain or fulfill a contract with a customer, including direct sales commissions and related fees, when it expects to recover those costs. As a result, these costs will need to be capitalized and amortized over an appropriate period, which

may

exceed the initial contract term. The incremental costs of obtaining a contract are costs that would

not

have been incurred if the contract had

not

been obtained. The Company uses the portfolio method to recognize the amortization expense related to these capitalized costs related to initial contracts and renewals and such expense is recognized over the period associated with the revenue of the related portfolio. Total capitalized direct sales commission costs as of

June 30, 2018

were

$0.5

million and the amortization of these assets were

$0.1

million and

$0.2

million during the

three

and

six

months ended

June 30, 2018,

respectively. There was

impairment loss in relation to the costs capitalized for the periods presented. Certain eligible initial project costs are capitalized when the costs relate directly to the contract, the costs generate or enhance resources of the company that will be used in satisfying the performance obligation in the future, and the costs are expected to be recovered. These costs primarily consist of transition and set-up costs related to the installation of systems and processes and other deferred fulfillment costs eligible for capitalization. Capitalized costs are amortized consistent with the transfer to the client of the services to which the asset relates and recorded as a component of cost of revenues. The Company also incurred certain 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 identification of a contract arrangement. The Company also defers costs from arrangements that required us to defer the revenues, typically due to the pattern of transfer of the performance obligations in the contract. These costs are recognized in proportion to the related revenue. At the end of the 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

longer have future benefits and are

longer recoverable. Deferred costs balance was

$0.4

million and

$0.6

million as of

June 30, 2018

and

December 31, 2017,

respectively. The balance was included in prepaid expenses and other current assets and other non-current assets in the accompanying condensed consolidated balance sheets.