BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The interim unaudited condensed consolidated financial statements included herein have been prepared by PDF Solutions, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), including the instructions to the Quarterly Report on Form

-Q and Article

of Regulation S-

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted. The interim unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary (consisting only of normal recurring adjustments), to present a fair statement of results for the interim periods presented. The operating results for any interim period are

not

necessarily indicative of the results that

may

be expected for other interim periods or the full fiscal year. The accompanying interim unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form

-K for the year ended

December 31, 2018.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after the elimination of all intercompany balances and transactions.

The condensed consolidated balance sheet at

December 31, 2018,

has been derived from the audited consolidated financial statements but does

not

include all disclosures required by accounting principles generally accepted in the United States of America.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates in these financial statements include revenue recognition, impairment of goodwill and long-lived assets, accounting for stock-based compensation expense, and income taxes. Actual results could differ from those estimates.

Reclassification of Prior Period Amount

Certain prior period amounts have been reclassified to conform to current year presentation of reporting amortization of costs capitalized to obtain revenue contracts on the Condensed Consolidated Statements of Cash Flows. This reclassification had

effect on the Company’s reported net loss or net cash provided by operating activities.

Recently Adopted Accounting Standards

Leases

February 2016,

the Financial Accounting Standards Board (or FASB) issued Accounting Standards Update (ASU)

2016

02,

Leases (Topic

842

) and subsequent amendments to the initial guidance: ASU

2017

13,

ASU

2018

10,

ASU

2018

11,

ASU

2018

and ASU

2019

(collectively, Topic

842

). Topic

842

aims to increase transparency and comparability among organizations by requiring lessees to recognize leases with a term greater than

months as a right-of-use asset (“ROU”) and corresponding lease liabilities on the balance sheet, regardless of lease classification, and requiring disclosure of key information about leasing arrangements. The lease liability should be initially measured at the present value of the remaining contractual lease payments. Subsequently, the ROU assets will be amortized generally on a straight-line basis over the lease term, and the lease liability will bear interest expense and be reduced for lease payments. Topic

842

became effective for public companies’ financial statements issued for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. A modified retrospective application is required with an option to

not

restate comparative periods in the period of adoption. The Company adopted Topic

842

January 1, 2019

using the modified retrospective approach, and financial information for the comparative period was

not

updated.

In addition, the Company elected the transition package of

three

practical expedients which allow companies

not

to reassess (i) whether agreements contain leases, (ii) the classification of leases, and (iii) the capitalization of initial direct costs. Further, the Company elected to

not

separate lease and non-lease components for all of its leases. The Company also made an accounting policy election to recognize lease expense for leases with a term of

months or less on a straight-line basis over the lease term and recognize

ROU or lease liability for those leases.

The Company’s lease portfolio consists primarily of real estate assets, which include administrative and sales offices, and its research and development laboratory and clean room. Some of these leases also require the Company to pay maintenance, utilities, taxes, insurance, and other operating expenses associated with the leased space. Based upon the nature of the items leased and the structure of the leases, the Company’s leases are classified as operating leases and continue to be classified as operating leases under the new accounting standard.

As a result of the adoption of the new lease accounting guidance, the Company recognized on

January 1, 2019:

	●	operating lease liabilities of approximately $10.5 million, which represent the present value of the remaining lease payments, as of the date of adoption, discounted using the Company’s incremental borrowing rate of 5.3%, and

	●	operating lease ROU assets of approximately $8.7 million which represent the operating lease liabilities of $10.5 million, adjusted for ( 1 ) deferred rent of approximately $0.3 million, and ( 2 ) lease incentives or tenant improvement allowance of $1.5 million.

The adoption of the new lease accounting standard did

not

have any other impact on the Company’s condensed consolidated balance sheet, and did

not

impact the Company’s operating results and cash flows. See Leases, in Note

for further information, including further discussion on the impact of adoption and changes in accounting policies relating to leases.

Income Statement – Reporting Comprehensive Income (Loss)

February 2018,

the FASB issued ASU

No.

2018

02,

Income Statement – Reporting Comprehensive Income (Topic

220

): Reclassification of Certain Tax Effect from Accumulated Other Comprehensive Income. This update allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Job Act (TCJA) enacted in

December 2017.

This update became effective for the Company for fiscal years beginning after

December 15, 2018

and interim periods within those fiscal years. The Company adopted this standard on

January 1, 2019,

and it did

not

have a material impact on its condensed consolidated financial statements and footnote disclosures.

Compensation - Stock Compensation

June 2018,

the FASB issued ASU

2018

07,

Compensation – Stock Compensation (Topic

718

), Improvements to Nonemployee Share-Based Payment Accounting. This ASU simplifies several aspects of the accounting for nonemployee share-based payment transactions resulting from expanding the scope of Topic

718,

to include share-based payment transactions for acquiring goods and services from nonemployees and making guidance consistent with the accounting for employee share-based compensation. The Company adopted this standard on

January 1, 2019,

and it did

not

have a material impact on its condensed consolidated financial statements and footnote disclosures.

FASB

pdates

ertain SEC

uidance in the Codification

July 2019,

the FASB issued ASU

No.

2019

07,

Codification Updates to SEC Sections – Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases

No.

10532,

“Disclosure Update and Simplification,” and Nos.

10231

and

10442,

“Investment Company Reporting Modernization,” and Miscellaneous Updates. This ASU codifies the SEC releases that clarify and improve the disclosure and presentation requirements of a variety of codification topics, thereby eliminating or amending certain disclosure requirements that have become redundant, duplicative, overlapping, outdated, or superseded, in light of other SEC disclosure requirement, U.S. GAAP, or changes in the information environment. The amendments and updates to the SEC Final Rule are effective upon issuance of this ASU in

July 2019.

The Company adopted this ASU in the

third

quarter of

2019,

and did

not

have a material impact on its condensed consolidated financial statements and footnote disclosures. Included also in the aforementioned SEC Final Rule is extending the disclosure requirement of presenting changes in stockholders’ equity for interim periods, which became effective to and adopted by the Company in the

first

quarter of

2019.

Management has reviewed other recently issued accounting pronouncements and has determined there are

not

any that would have a material impact on the condensed consolidated financial statements.

Accounting Standards

Not

Yet Effective

June 2016,

the FASB issued ASU

2016

13,

Financial Instruments – Credit Losses (Topic

326

): Measurement of Credit Losses on Financial Instruments (ASU

2016

) and also issued subsequent amendments to the initial guidance: ASU

2018

19,

Codification Improvements to Topic

326,

Financial Instruments – Credit Losses, ASU

2019

04,

Codification Improvements to Topic

326,

Financial Instruments – Credit Losses, Topic

815,

Derivatives and Hedging, and Topic

825,

Financial Instrument, and ASU

2019

05,

Financial Instrument – Credit Losses (Topic

326

): Targeted Transition Relief (collectively, Topic

326

). Topic

326

requires measurement and recognition of expected credit losses for financial assets held at the reporting date based on external information, or a combination of both relating to past events, current conditions, and reasonable and supportable forecasts. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and other financial assets that represent a right to receive cash. Topic

326

is effective for the Company beginning in the

first

quarter of

2020.

Early adoption is permitted. The Company has

not

yet determined the impact of this standard on its condensed consolidated financial statements.

January 2017,

the FASB issued ASU

No.

2017

04,

Intangibles – Goodwill and Other (Topic

350

). This standard eliminates step

from the annual goodwill impairment test. This update is effective for annual periods beginning after

December 15, 2019,

and interim periods within those fiscal years, with early adoption permitted, and is to be applied on a prospective basis. The Company does

not

anticipate that the adoption of this standard will have a significant impact on its condensed consolidated financial statements or the related disclosures.

August 2018,

the FASB issued ASU

No.

2018

15,

Intangibles – Goodwill and Other – Internal-Use Software (Subtopic

350

): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The new guidance clarifies the accounting for implementation costs incurred to develop or obtain internal-use software in cloud computing arrangements. Further, the standard also requires entities to expense the capitalized implementation costs of a hosting arrangement over the term of the hosting arrangement. This standard is effective for the Company beginning in the

first

quarter of

2020.

Early adoption is permitted. ASU

No.

2018

should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company has

not

yet determined the impact of this standard on its condensed consolidated financial statements.