DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

PDF Solutions, Inc. (the “Company” or “PDF”), provides differentiated data and analytics solutions to the semiconductor and electronics industries. The Company offers an end-to-end analytics platform that empowers engineers and data scientists across the semiconductor ecosystem to rapidly improve the yield, quality, and profitability of their products.

Basis of Presentation

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

Reclassification of Prior Period Amount

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

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

Change in Presentation

In the

fourth

quarter of fiscal

2019,

in order to improve the transparency of our revenue reporting, the Company updated its Consolidated Statements of Comprehensive Loss to change its historical presentation of revenue categories. Previously, the Company presented revenue on

two

lines: Solutions and Gainshare performance incentives. Included within Solutions, was revenue from software and related revenue, SaaS solutions, Design-for-Inspection (DFI™) licenses, and fixed-price project-based solution implementation services. The previous Gainshare performance incentive category included only revenue from performance incentive programs. The Company now presents revenue in the following categories: Analytics and Integrated Yield Ramp. Integrated Yield Ramp is comprised of all revenue from the Company’s IYR services engagements that include performance incentives based on customers’ yield achievement, i.e. both fixed-fees and Gainshare royalty from such engagements. Analytics comprises all other revenue, including from the Company’s licenses and services for Exensio Software, Exensio SaaS, DFI and CV systems that do

not

include performance incentives based on customers’ yield achievement.

The change in presentation of revenue does

not

change the Company’s net revenues or total cost of net revenues. The following table shows reclassified amounts to conform to the current period’s presentation (in thousands):

	Year Ended December 31, 2018
			Change in
	Previously		Presentation		Current
	Reported		Reclassification		Presentation
Revenues:
Design-to-silicon-yield solutions	$	60,081	$	(60,081)		N/A
Gainshare performance incentives		25,713		(25,713)		N/A
Analytics		N/A		38,502	$	38,502
Integrated Yield Ramp		N/A		47,292		47,292
Total revenues	$	85,794	$	—	$	85,794

Since certain costs of revenues are attributed to both Analytics and Integrated Yield Ramp revenue categories, the Company believes it is more appropriate and meaningful to present the Consolidated Statements of Comprehensive Loss under a

one

-step presentation format that excludes any measure of gross margin. In the

fourth

quarter of fiscal

2019,

the Company elected to change its Consolidated Statements of Comprehensive Loss presentation from a

two

-step presentation, where total costs of revenues was deducted from total revenues to report a gross profit line, to a

one

-step presentation, where total costs and expenses are deducted from total revenues. The change in presentation does

not

change previously presented amounts for costs of revenues, operating expenses and other expenses (income), or loss before income taxes.

Use of Estimates

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

Concentration of Credit Risk

Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents with what it considers high credit quality financial institutions.

The Company primarily sells its technologies and services to companies in Asia, Europe and North America within the semiconductor industry. As of

December 31, 2019

three

customers accounted for

53%

of the Company’s gross accounts receivable and

one

customer accounted for

31%

of the Company’s revenues for

2019

. As of

December 31, 2018

two

customers accounted for

56%

of the Company’s gross accounts receivable and

one

customer accounted for

37%

of the Company’s revenues for

2018

. See Note

for further details. The Company does

not

require collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers’ financial condition. The Company maintains allowances for potential credit losses. The allowance for doubtful accounts, which was based on management’s best estimates, could be adjusted in the near term from current estimates depending on actual experience. Such adjustments could be material to the consolidated financial statements.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of

days or less to be cash equivalents.

Accounts Receivable

Accounts receivable include amounts that are unbilled at the end of the period that are expected to be billed and collected within

-month period. Unbilled accounts receivable is determined on an individual contract basis. Unbilled accounts receivable, included in accounts receivable, totaled

$7.4

million and

$22.2

million as of

December 31, 2019

and

2018

, respectively. Unbilled accounts receivable that are

not

expected to be billed and collected during the succeeding

-month period are recorded in other non-current assets and totaled

$4.1

million and

$5.3

million as of

December 31, 2019

and

2018

, respectively. The Company performs ongoing credit evaluations of its customers’ financial condition. An allowance for doubtful accounts is maintained for probable credit losses based upon the Company’s assessment of the expected collectability of the accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance.

Allowance for doubtful accounts are summarized below (in thousands):

	Balance at Beginning of Period		Charged to Costs and Expenses		Deductions/ Write-offs of Accounts		Balance at End of Period
Allowance for doubtful accounts
2019	$	332	$	—	$	119	$	213
2018	$	374	$	—	$	42	$	332

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives (in years) of the related asset as follows:

Computer equipment		3
Software		3
Furniture, fixtures, and equipment		3 - 10
Laboratory and test equipment		3 - 10
Leasehold improvements		Shorter of estimated useful life or term of lease

Long-lived Assets

The Company’s long-lived assets, excluding goodwill, consist of property and equipment and intangible assets. The Company periodically reviews its long-lived assets for impairment

For assets to be held and used, the Company initiates its review whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset group

may

not

be recoverable. Recoverability of an asset group is measured by comparison of its carrying amount to the expected future undiscounted cash flows that the asset group is expected to generate. If it is determined that an asset group is

not

recoverable, an impairment loss is recorded in the amount by which the carrying amount of the asset group exceeds its fair value.

Goodwill

The Company records goodwill when the purchase consideration of an acquisition exceeds the fair value of the net tangible and identified intangible assets as of the date of acquisition. The Company performs an annual impairment assessment of its goodwill during the

fourth

quarter of each calendar year or more frequently if required to determine if any events or circumstances exist, such as an adverse change in business climate or a decline in the overall industry demand, that would indicate that it would more likely than

not

reduce the fair value of a reporting unit below its carrying amount, including goodwill. If events or circumstances do

not

indicate that the fair value of a reporting unit is below its carrying amount, goodwill is

not

considered to be impaired and

further testing is required. If further testing is required, the Company performs a

two

-step process. The

first

step involves comparing the fair value of its reporting unit to its carrying value, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the

second

step of the test is performed by comparing the carrying value of the goodwill in the reporting unit to its implied fair value. An impairment charge is recognized for the excess of the carrying value of goodwill over its implied fair value. For the purpose of impairment testing, the Company has determined that it has

one

reporting unit. There has been

impairment of goodwill for any periods presented.

Software Development Costs

Internally developed software includes software developed to meet our internal needs to provide certain services to the customers. These capitalized costs consist of internal compensation related costs and external direct costs incurred during the application development stage and are amortized over their useful lives, generally

five

six

years. The costs to develop software that is marketed externally have

not

been capitalized as we believe our current software development process is essentially completed concurrent with the establishment of technological feasibility. As such, all related software development costs are expensed as incurred and included in research and development expense in our Consolidated Statements of Comprehensive Loss.

Research and Development

Research and development expenses consist primarily of personnel-related costs to support product development activities, including compensation and benefits, outside development services, travel, facilities cost allocations, and stock-based compensation charges. Research and development expenses are charged to operations as incurred.

Stock-Based Compensation

Stock-based compensation is estimated at the grant date based on the award’s fair value and is recognized on a straight-line basis over the vesting period, generally

four

years. The Company has elected to use the Black-Scholes-Merton option-pricing model, which incorporates various assumptions including volatility, expected life and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted. The interest rate assumption is based upon observed Treasury yield curve rates appropriate for the expected life of the Company’s stock options. 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.

Income Taxes

The Company's provision for income tax comprises its current tax liability and change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities. The measurement of current and deferred tax assets and liabilities is based on provisions of enacted tax laws; the effect of future changes in tax laws or rates are

not

anticipated. Valuation allowances are provided to reduce deferred tax assets to an amount that in management’s judgment is more likely than

not

to be recoverable against future taxable income.

U.S. taxes are provided on earnings of non-U.S. subsidiaries, to the extent such earnings are deemed to be permanently invested. The Company's income tax calculations are based on application of applicable U.S. federal, state or foreign tax laws. The Company’s tax filings, however, are subject to audit by the respective tax authorities. Accordingly, the Company recognizes tax liabilities based upon its estimate of whether, and the extent to which, additional taxes will be due when such estimates are more-likely-than-

not

to be sustained. An uncertain income tax position will

not

be recognized if it has less than a

50%

likelihood of being sustained. To the extent the final tax liabilities are different from the amounts originally accrued, the increases or decreases are recorded as income tax expense or benefit in the Consolidated Statements of Comprehensive Loss.

Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income by weighted average number of common shares outstanding for the period (excluding outstanding stock options and shares subject to repurchase). Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding for the period plus the potential effect of dilutive securities which are convertible into common shares (using the treasury stock method), except in cases in which the effect would be anti-dilutive. Dilutive potential common shares consist of incremental common shares issuable upon exercise of stock options, upon vesting of restricted stock units (RSUs), contingently issuable shares for all periods and assumed issuance of shares under the Company’s employee stock purchase plan.

dilutive potential common shares are included in the computation of any diluted per share amount when a loss from continuing operations was reported by the Company.

Foreign Currency Translation

The functional currency of the Company’s foreign subsidiaries is the local currency for the respective subsidiary. The assets and liabilities are translated at the period-end exchange rate, and statements of comprehensive loss are translated at the average exchange rate during the year. Gains and losses resulting from foreign currency translations are included as a component of other comprehensive loss. Gains and losses resulting from foreign currency transactions are included in the Consolidated Statements of Comprehensive Loss.

Derivative Financial Instruments

The Company operates internationally and is exposed to potentially adverse movements in foreign currency exchange rates. The Company enters into foreign currency forward contracts to reduce the exposure to foreign currency exchange rate fluctuations on certain foreign currency denominated monetary assets and liabilities. The Company does

not

use foreign currency contracts for speculative or trading purposes. The Company records these forward contracts at fair value. The counterparty to these foreign currency forward contracts is a financial institution that the Company believes is creditworthy, and therefore, we believe the credit risk of counterparty non-performance is

not

significant. These foreign currency forward contracts are

not

designated for hedge accounting treatment. Therefore, the change in fair value of these derivatives is recorded into earnings as a component of interest and other income (expense), net and offsets the change in fair value of the foreign currency denominated monetary assets and liabilities, which are also recorded in interest and other income (expense), net. The duration of these forward contracts is usually between

two

three

months.

Litigation

From time to time, the Company is subject to various claims and legal proceedings that arise in the ordinary course of business. The Company accrues for losses related to litigation when a potential loss is probable and the loss can be reasonably estimated in accordance with FASB requirements. As of

December 31, 2019

, the Company is

not

a party to any material legal proceedings, thus

loss was probable and

amount was accrued.

Recently Adopted Accounting Standards

Leases

February 2016,

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 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 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 consolidated financial statements and footnote disclosures.

FASB Updates Certain Securities and Exchange Commission (SEC) Guidance 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 were 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 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 consolidated financial statements.

Recent Accounting Standards or Updates

Not

Yet Effective

June 2016,

the FASB issued ASU

No.

2016

13,

Financial Instruments – Credit Losses (Topic

326

): Measurement of Credit Losses on Financial Instruments (ASU

2016

), which 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. ASU

No.

2016

replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. Subsequent to the issuance of ASU

No.

2016

13,

the FASB issued ASU

No.

2018

19,

Codification Improvements to Topic

326,

Financial Instruments – Credit Losses, ASU

No.

2019

04,

Codification Improvements to Topic

326,

Financial Instruments – Credit Losses, Topic

815,

Derivatives and Hedging, and Topic

825,

Financial Instrument, ASU

No.

2019

05,

Financial Instruments – Credit Losses (Topic

326

) Targeted Transition Relief, ASU

No.

2016

13,

the FASB issued ASU

No.

2019

Financial Instruments-Credit Losses (Topic

326

), Derivatives and Hedging (Topic

815

), and Leases (Topic

842

), and ASU

No.

2019

Codification Improvements to Topic

326,

Financial Instruments-Credit Losses. The subsequent ASUs do

not

change the core principle of the guidance in ASU

No.

2016

13.

Instead, these amendments are intended to clarify and improve operability of certain topics included within ASU

No.

2016

13.

Additionally, ASU

No.

2019

defers the effective date for the adoption new standard on credit losses for public filers that are considered small reporting companies (“SRC”) as defined by the SEC to fiscal years beginning after

December 15, 2022,

including interim periods within those fiscal years, which will be fiscal

2023

for the Company if it continue to be classified as a SRC. The subsequent amendments will have the same effective date and transition requirements as ASU

No.

2016

13.

Early adoption is permitted. Topic

326

requires a modified retrospective approach by recording a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. While the Company is currently evaluating the impact of Topic

326,

the Company does

not

expect the adoption of this guidance to have a material impact on its consolidated financial statements and the related disclosure.

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 the Company beginning in the

first

quarter of

2020.

Early adoption is permitted, and is to be applied on a prospective basis. The Company does

not

anticipate that the adoption of this ASU will have a significant impact on its 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 does

not

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

December 2019,

the FASB issued ASU

No.

2019

12,

Income Taxes (Topic

740

) related to simplifying the accounting for income taxes. The guidance is effective for the Company beginning in the

first

quarter of

2021

on a prospective basis. Early adoption is permitted. The Company is currently evaluating the impact of this ASU, and does

not

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

January 2020,

the FASB issued ASU

No.

2020

-Investments-Equity Securities (Topic

321

), Investments-Equity Method and Joint Ventures (Topic

323

), and Derivatives and Hedging (Topic

815

)-Clarifying the Interactions between Topic

321,

Topic

323,

and Topic

815.

This ASU clarifies the interaction between accounting standards related to equity securities (ASC

321

), equity method investments (ASC

323

), and certain derivatives (ASC

815

). The amendments in this ASU are effective for fiscal years beginning after

December 15, 2020.

The Company does

not

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