ACM Research, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, or our Annual Report. The following discussion contains forward‑looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward‑looking statements. Factors that could cause or contribute to these differences include those discussed in Part I, Item 1A. “Risk Factors” in our Annual Report and in Part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, as well as those discussed below and elsewhere in this report, particularly in the section titled “Item 1A. Risk Factors” in Part II below. Corporate Background ACM Research was incorporated in California in 1998 and redomesticated in Delaware in 2016. We perform strategic planning, marketing, and financial activities at our global corporate headquarters in Fremont, California. ACM Research is neither a PRC operating company nor do we conduct our operations in the PRC through the use of VIEs. Initially we focused on developing tools for chip manufacturing process steps involving the integration of ultra‑low‑K materials and copper. In the early 2000s we sold tools based on stress-free copper polishing technology. In 2007 we began to focus our development efforts on single-wafer wet-cleaning solutions for the front-end chip fabrication process. Since that time, we have strategically built our technology base and expanded our product offerings: • In 2009 we introduced SAPS megasonic technology, which can be applied in wet wafer cleaning at numerous steps during the chip fabrication process. • In 2016 we introduced TEBO technology, which can be applied at numerous steps during the fabrication of small node conventional two-dimensional and three-dimensional patterned wafers. • In August 2018 we introduced the Ultra-C Tahoe wafer cleaning tool, which delivers high cleaning performance with significantly less sulfuric acid than typically consumed by conventional high temperature single-wafer cleaning tools. • In March 2019 we introduced (a) the Ultra ECP AP or Advanced Wafer Level Packaging tool, a back-end assembly tool used for bumping, or applying copper, tin and nickel to wafers at the die-level prior to packaging, and (b) the Ultra ECP MAP or Multi Anode Plating tool, a front-end process tool that utilizes our proprietary technology to deliver world-class electrochemical copper planting for copper interconnect applications. • In April 2020 we introduced the Ultra Furnace , our first system developed for multiple dry processing applications. • In May 2020 we introduced the Ultra C Family of semi-critical cleaning systems, including the Ultra C b for backside clean, the Ultra C wb automated wet bench, and the Ultra C s scrubber. To help us establish and build relationships with chip manufacturers in the PRC, in 2006 we moved our operational center to Shanghai and began to conduct our business through our subsidiary ACM Shanghai. Since that time, we have expanded our geographic presence: • In 2011 we formed a wholly-owned subsidiary in the PRC, ACM Research (Wuxi), Inc. , which now is a wholly-owned subsidiary of ACM Shanghai, to manage sales and service operations. • In June 2017 we formed a subsidiary in Hong Kong, CleanChip Technologies Limited , which now is a wholly-owned subsidiary of ACM Shanghai, to act on our behalf in Asian markets outside the PRC by, for example, serving as a trading partner between ACM Shanghai and its customers, procuring raw materials and components, performing sales and marketing activities, and making strategic investments. 39 Table of Contents • In December 2017 we formed a subsidiary in the Republic of Korea, ACM Research Korea CO., LTD. , which now is an indirect wholly-owned subsidiary of ACM Shanghai, to serve our customers based in the Republic of Korea and perform sales and marketing and R&D activities. • In March 2019 ACM Shanghai formed a wholly-owned subsidiary in the PRC, Shengwei Research (Shanghai), Inc ., or ACM Shengwei, to manage activities related to the addition of future long-term production capacity. • In June 2019 CleanChip Technologies Limited formed a wholly-owned subsidiary in California, ACM Research (CA), Inc., to provide procurement services on behalf of ACM Shanghai. • In August 2021 we formed a wholly-owned subsidiary in Singapore, ACM Research (Singapore) PTE, Ltd., to perform sales, marketing, and other business development activities. • In February 2022, ACM Shanghai formed a wholly-owned subsidiary in China, ACM Research (Beijing), Inc., to perform sales, marketing and other business development activities. • In March 2022, ACM formed a wholly-owned subsidiary in South Korea, Hanguk ACM CO., LTD , to perform business development and other related activities. We currently conduct the majority of our product development, support and services, and substantially all of our manufacturing, at ACM Shanghai. Our Shanghai operations position us to be near many of our current and potential new customers in the PRC (including Taiwan), South Korea and throughout Asia, providing convenient access and reduced shipping and manufacturing costs. • ACM Shanghai’s initial factory is located in the Pudong Region of Shanghai and has a total of 36,000 square feet of available floor space. • ACM Shanghai’s second production facility is located in the Chuansha district of Pudong, approximately 11 miles from our initial factory. In September 2018 we announced the opening of the first building of the second production facility. The first building initially had a total of 50,000 square feet of available floor space for production capacity, which was increased by 50,000 square feet in the second quarter of 2020. In February 2021 ACM Shanghai leased a second building immediately adjacent to the second factory, which increased the available floor space for production by another 100,000 square feet, bringing the total available floor space for production capacity of second production facility to 200,000 square feet. • In July 2020 ACM Shanghai began a multi-year construction project to build a development and production center in the Lingang region of Shanghai. The new facility is expected to have a total of 1,000,000 square feet of available floor space for production capacity, with initial production of the first building to begin in the mid-2023 timeframe. • In January 2022 ACM Shanghai completed the purchase of a housing facility in the Lingang region of Shanghai to assist in employee retention and recruitment in connection with its new R&D center and factory currently under construction. 40 Table of Contents The following chart depicts our corporate organization as of September 30, 2022: A detailed description of how cash is transferred through our organization is set forth under “Note 2 – Summary of Significant Accounting Policies – Cash and Cash Equivalents” to the Consolidated Financial Statements of this report. Risks Associated with Corporate Structure We are subject to a number of legal and operational risks associated with our corporate structure, including as the result of a substantial portion of our operations being conducted in the PRC. Consequences of any of those risks could result in a material adverse change in our operations or cause the value of ACM Research Class A common stock to significantly decline in value or become worthless. Please carefully read the information included in “Part II. Item 1A – Risk Factors” of this report and our Annual Report on Form 10-K for the year ended December 31, 2021 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, in particular the risk factors addressing the following issues: • If any PRC central government authority were to determine that existing PRC laws or regulations require that ACM Shanghai obtain the authority’s permission or approval to continue the listing of ACM Research’s Class A common stock in the United States or if those existing PRC laws and regulations, or interpretations thereof, were to change to require such permission or approval, or if we inadvertently conclude that permissions or approvals are not required, ACM Shanghai may be unable to obtain the required permission or approval or may only be able to obtain such permission or approval on terms and conditions that impose material new restrictions and limitations on operation of ACM Shanghai, either of which could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects and on the trading price of ACM Research Class A common stock, which could decline in value or become worthless. • PRC central government authorities may intervene in, or influence, ACM Shanghai’s PRC-based operations at any time, and those authorities’ rules and regulations in the PRC can change quickly with little or no advance notice. • The PRC central government may determine to exert additional control over offerings conducted overseas or foreign investment in PRC-based issuers, which could result in a material change in operations of ACM Shanghai and the value of ACM Research Class A common stock. Permissions or Approvals to Operate in the PRC The business of ACM Shanghai is subject to complex laws and regulations in the PRC that can change quickly with little or no advance notice. To date, beyond the COVID-19-related restrictions in 2022, we have not experienced such intervention or influence by PRC central government authorities or a change in those authorities’ rules and regulations that have had a material impact on ACM Shanghai or ACM Research. 41 Table of Contents ACM Research is not a PRC operating company, and we do not conduct our operations in the PRC through the use of a variable interest entity, or VIE, or any other structure designed for the purpose of avoiding PRC legal restrictions on direct foreign investments in PRC-based companies. ACM Research has a direct ownership interest in ACM Shanghai as the result of its holding 82.5% of the outstanding shares of ACM Shanghai. Stockholders of ACM Research may never directly own equity interests in ACM Shanghai. As a result, we have determined that our corporate structure or any other matters relating to our business operations require that we obtain any permissions or approvals from the China Securities Regulatory Commission, the Cyberspace Administration of China, or any other PRC central government authority in order to continue to list shares of Class A common stock of ACM Research on the Nasdaq Global Select Market. This determination was based on the facts aforementioned and the PRC Company Law, PRC Securities Law, cybersecurity regulations and other relevant laws, regulations and regulatory requirements in the PRC currently in effect. However, if this determination proves to be incorrect, then it could have a material adverse effect on ACM Research. See “Part II. Item IA, Risk Factors— If any PRC central government authority were to determine that existing PRC laws or regulations require that ACM Shanghai obtain the authority’s permission or approval to continue the listing of ACM Research’s Class A common stock in the United States or if those existing PRC laws and regulations, or interpretations thereof, were to change to require such permission or approval, ACM Shanghai may be unable to obtain the required permission or approval or may only be able to obtain such permission or approval on terms and conditions that impose material new restrictions and limitations on operation of ACM Shanghai, either of which could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects and on the trading price of ACM Research Class A common stock.” In addition, in the ordinary course of business, ACM Shanghai is required to obtain certain operating permits and licenses necessary for it to operate in the PRC, including business licenses, certifications relating to quality management standards, import- and export-related qualifications from customs, as well as environmental and construction permits, licenses and approvals relating to construction projects. We believe ACM Shanghai has all such required permits and licenses. However, from time to time the PRC government issues new regulations, which may require additional actions on the part of ACM Shanghai to comply. If ACM Shanghai does not, or is unable to, obtain any such additional permits or licenses, ACM Shanghai may be subjected to restrictions and penalties imposed by the relevant PRC regulatory authorities, it could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects and on the trading price of ACM Research Class A common stock. See “Part II. Item 1A—Risk Factors—Risks Related to International Aspects of Our Business—PRC central government authorities may intervene in, or influence, ACM Shanghai’s PRC-based operations at any time, and those authorities’ rules and regulations in the PRC can change quickly with little or no advance notice” for more information. Our Independent Registered Public Accounting Firm The U.S. Holding Foreign Companies Accountable Act (the “HFCA Act”) requires that the Public Company Accounting Oversight Board (the “PCAOB”) determine whether it is unable to inspect or investigate completely registered public accounting firms located in a non-U.S. jurisdiction because of a position taken by one or more authorities in that jurisdiction. BDO China Shu Lun Pan Certified Public Accountants LLP (“BDO China”) had been our independent registered public accounting firm in recent years, including for the year ended December 31, 2021. On December 16, 2021, the PCAOB reported its determination that it was unable to inspect or investigate completely registered public accounting firms headquartered in the PRC and Hong Kong, including BDO China, because of positions taken by PRC authorities in those jurisdictions. On March 30, 2022, based on this determination, ACM Research was transferred to the SEC’s “Conclusive list of issuers identified under the HFCA.” See “Part II. Item 1A, Risk Factors— We could be adversely affected if we are unable to comply with recent and proposed legislation and regulations regarding improved access to audit and other information and audit inspections of accounting firms operating in the PRC” of this report for more information. Under current regulations, if ACM Research were to be included on this list three consecutive times due to our independent auditor being located in a jurisdiction that does not allow for PCAOB inspections, the SEC could prohibit trading in our securities and cause our securities to be delisted in the U.S., and their value may significantly decline or become worthless. Further, the “Accelerating HFCAA” could reduce the applicable threshold from three consecutive appearances to two consecutive appearances on the list. However, on June 30, 2022, stockholders of ACM Research ratified the appointment of Armanino LLP as our independent auditor for the fiscal year ending December 31, 2022. Armanino LLP is neither headquartered in the PRC or Hong Kong nor is it subject to the determinations announced by the PCAOB, and subsequent to the filing of our 2022 annual report, we do not believe ACM Research will appear on the “Conclusive” list for a second time. 42 Table of Contents Overview We supply advanced, innovative capital equipment developed for the global semiconductor industry. Fabricators of advanced integrated circuits, or chips, can use our wet-cleaning and other front-end processing tools in numerous steps to improve product yield, even at increasingly advanced process nodes. We have designed these tools for use in fabricating foundry, logic and memory chips, including dynamic random-access memory, or DRAM, and 3D NAND-flash memory chips. We also develop, manufacture and sell a range of advanced packaging tools to wafer assembly and packaging customers. Revenue from wet-cleaning and other front-end processing tools totaled $117.9 million, or 88.2% of total revenue, for the three months ended September 30, 2022, as compared to $49.4 million, or 73.8% of total revenue, for the same period in 2021. Revenue from wet-cleaning and other front-end processing tools totaled $229.2 million, or 81.8% of total revenue, for the nine months ended September 30, 2022, as compared to $127.3 million, or 77.3% of total revenue, for the same period in 2021. Selling prices for our wet-cleaning and other front-end processing tools range from $0.7 million to more than $5 million. Our customers for wet-cleaning and other front-end processing tools have included Huali Microelectronics Corporation, The Huahong Group, Semiconductor Manufacturing International Corporation, or SMIC, Shanghai SK Hynix Inc., Yangtze Memory Technologies Co., Ltd, and ChangXin Memory Technologies. Revenue from advanced packaging, other back-end processing tools, services and spares totaled $15.8 million, or 11.8% of total revenue, for the three months ended September 30, 2022, as compared to $17.6 million, or 26.2% of total revenue, for the same period in 2021. Revenue from advanced packaging, other back-end processing tools, services and spares totaled $51.1 million, or 18.2% of total revenue, for the nine months ended September 30, 2022, as compared to $37.3 million, or 22.7% of total revenue, for the same period in 2021. Selling prices for these tools range from $0.5 million to $4 million. Our customers for advanced packaging, and other processing tools have included: Jiangyin Changdian Advanced Packaging Co. Ltd., a PRC-based wafer bumping packaging house that is a subsidiary of JCET Group Co., Ltd.; Nantong Tongfu Microelectronics Co., Ltd., a PRC-based chip assembly and testing company that is a subsidiary of Nantong Fujitsu Microelectronics Co., Ltd.; Nepes Co., Ltd., a semiconductor packaging company based in South Korea which acquired the operations of Deca Technologies’ Philippines manufacturing facility in 2020; and Wafer Works Corporation, a PRC-based wafer supplier. We estimate, based on third-party reports and on customer and other information, that our current product portfolio addresses approximately $8 billion of the global wafer equipment market. By product line, we estimate an approximately $3.7 billion market opportunity is addressed by our wafer cleaning equipment, $2.9 billion by our furnace equipment, $730 million by our electro-chemical plating or ECP equipment, and more than $650 million by our stress-free polishing, advanced packaging, wafer processing, and other processing equipment. By major equipment segment, Gartner estimates a 2021 worldwide semiconductor wafer fab equipment, or WFE, market size of $88.1 billion, of which $4.1 billion is for wafer cleaning equipment (auto wet stations, single-wafer spray processors, batch spray processors, and other clean process equipment), $3.4 billion is for furnace equipment (tube CVD, oxidation/diffusion furnace, and batch atomic layer deposition), and $764 million is for electro-chemical deposition, or ECD. Based on Gartner’s estimates, total available global market for these equipment segments increased by 30.1% from $6.4 billion in 2020 to $8.3 billion in 2021, and is expected to increase by 8.3% to $8.9 billion in 2022. These segments are part of the worldwide semiconductor WFE market, which based on Gartner’s estimates increased by 35.6% from $64.9 billion in 2020 to $88.1 billion in 2021, and is expected to increase by 10.7% to $97.5 billion in 2022. 43 Table of Contents We have focused our selling efforts on establishing a referenceable base of leading foundry, logic and memory chip makers, whose use of our products can influence decisions by other manufacturers. We believe this customer base has helped us penetrate the mature chip manufacturing markets and build credibility with additional industry leaders. We have used a “demo-to-sales” process to place evaluation equipment, or “first tools,” with a number of selected customers. Since 2009 we have delivered more than 335 wet-cleaning and other front-end processing tools, more than 270 of which have been accepted by customers and thereby generated revenue to us. The balance of the delivered tools are awaiting customer acceptance should contractual conditions be met. To date, a substantial majority of our sales of single-wafer wet-cleaning equipment for front-end manufacturing have been to customers located in Asia, and we anticipate that a substantial majority of our revenue from these products will continue to come from customers located in this region for the foreseeable future. We have begun to add to our efforts to further address customers in North America, Western Europe and Southeast Asia by expanding our direct sales and services teams and increasing our global marketing activities. Our U.S. operation includes sales, marketing and services personnel to expand and support major new customer initiatives for the products of ACM Shanghai to additional regions beyond mainland China. As of September 30, 2022, we have delivered one tool for evaluation to a U.S. lab of a global semiconductor capital equipment vendor, and two tools to the U.S. facility of a major U.S. semiconductor manufacturer. Both of these evaluations are supported by our U.S. services team. We are focused on building a strategic portfolio of intellectual property to support and protect our key innovations. Our tools have been developed using our key proprietary technologies: • Space Alternated Phase Shift, or SAPS, technology for flat and patterned (deep via or deep trench with stronger structure) wafer surfaces. SAPS technology employs alternating phases of megasonic waves to deliver megasonic energy in a highly uniform manner on a microscopic level. We have shown SAPS technology to be more effective than conventional megasonic and jet spray technologies in removing random defects across an entire wafer, with increasing relative effectiveness at more advanced production nodes. • Timely Energized Bubble Oscillation, or TEBO, technology for patterned wafer surfaces at advanced process nodes . TEBO technology has been developed to provide effective, damage-free cleaning for 2D and 3D patterned wafers with fine feature sizes. We have demonstrated the damage-free cleaning capabilities of TEBO technology on patterned wafers for feature nodes as small as 1xnm (16 to 19 nanometers, or nm), and we have shown TEBO technology can be applied in manufacturing processes for patterned chips with 3D architectures having aspect ratios as high as 60‑to‑1. • Tahoe technology for cost and environmental savings. Tahoe technology delivers high cleaning performance using significantly less sulfuric acid and hydrogen peroxide than is typically consumed by conventional high-temperature single-wafer cleaning tools. • ECP technology for advanced metal plating. Our Ultra ECP ap, or Advanced Packaging, technology was developed for back-end assembly processes to deliver a more uniform metal layer at the notch area of wafers prior to packaging. Our Ultra ECP map, or Multi-Anode Partial Plating, technology was developed for front-end wafer fabrication processes to deliver advanced electrochemical copper plating for copper interconnect applications. Ultra ECP map offers improved gap-filling performance for ultra-thin seed layer applications, which is critical for advanced nodes at 28nm, 14nm and beyond. In 2020 we introduced and delivered a range of new tools intended to broaden our revenue opportunity with global semiconductor manufacturers. Product extensions include the Ultra SFP ap tool for advanced packaging solutions, the Ultra C VI 18-chamber single wafer cleaning tool for advanced memory devices, and the Ultra ECP 3d platform for through-silicon-via, or tsv, application. New product lines include the Ultra fn Furnace, our first dry processing tool, and a suite of semi-critical cleaning systems which include single wafer back side cleaning, scrubber, and auto bench cleaning tools. 44 Table of Contents We have been issued more than 411 patents in the United States, the People’s Republic of China, or PRC, Japan, Singapore, South Korea and Taiwan. We conduct a substantial majority of our product development, manufacturing, support and services in the PRC, with additional product development and subsystem production in South Korea. Substantially all of our integrated tools are built to order at our manufacturing facilities in the Pudong region of Shanghai, which now encompass a total of 236,000 square feet of floor space for production capacity, with 100,000 square feet having been added in 2021 with the lease of a second building in the Pudong region of Shanghai. In May 2020 ACM Shanghai, through its wholly-owned subsidiary Shengwei Research (Shanghai), Inc., entered into an agreement for a land use right in the Lingang region of Shanghai. In 2020 Shengwei Research (Shanghai), Inc. began a multi-year construction project for a new 1,000,000 square foot development and production center that will incorporate state-of-the-art manufacturing systems and automation technologies, and will provide floor space to support significantly increased production capacity and related research and development, or R&D, activities. We expect to complete construction of the first Lingang manufacturing building and commence initial production in the mid-2023 timeframe. Our experience has shown that chip manufacturers in the PRC and throughout Asia demand equipment meeting their specific technical requirements and prefer building relationships with local suppliers. We will continue to seek to leverage our local presence in the PRC and South Korea through our subsidiaries to address the growing market for semiconductor manufacturing equipment in the region by working closely with regional chip manufacturers to understand their specific requirements, encourage them to adopt our technologies, and enable us to design innovative products and solutions to address their needs. Recent Developments COVID–19 The worldwide COVID-19 health pandemic and related government and private sector responsive actions have adversely affected the economies and financial markets of many countries and specifically have negatively impacted the Company’s business operations, including in the PRC and the United States. The continuation of the COVID-19 pandemic could continue to result in economic uncertainty and global economic policies that could reduce demand for the Company’s products and its customers’ chips and have a material adverse impact on the Company’s business, operating results and financial condition. For an explanation of some of the risks we potentially face, please read carefully the information provided under “Item 1A. Risk Factors—Risks Related to the COVID–19 Pandemic,” of part I of this report. The following summary reflects our expectations and estimates based on information known to us as of the date of this filing: • Operations : We conduct substantially all of our product development, manufacturing, support and services in the PRC through ACM Shanghai, and those activities have been directly impacted by COVID–19 and related restrictions on transportation and public appearances. In March 2022, several regions in China began to experience elevated levels of COVID-19 infections, and the PRC government instituted policies to restrict the spread of the virus. The policies began with an increase of “spot quarantines,” under which a positive polymerase chain reaction (PCR) or other test would result in the quarantining of individual buildings, groups of buildings, or even full neighborhoods. The policies were later expanded to full-city quarantines, including in the City of Shanghai, where substantially all of ACM Shanghai’s operations are located. COVID-19 related restrictions in Shanghai began to limit employee access to, and logistics activities of, ACM Shanghai’s offices and production facilities in the Pudong district of Shanghai in March 2022, and therefore limited ACM Shanghai’s ability to ship finished products to customers and to produce new products. Spot quarantines in mid-March 2022 began to impact a number of ACM Shanghai’s employees and led to a closure of ACM Shanghai’s administrative and R&D offices in Zhangjiang in the Pudong district. A subsequent quarantine of the entire Pudong region of Shanghai was imposed in late March 2022 and impacted the operation of ACM Shanghai’s Chuansha production facility. Furthermore, a number of our customers have substantial operations based in operations areas of the PRC, including in the City of Shanghai, subject to the full-city restrictions, which began limiting the operations of those customers since the first quarter of 2022, including inhibiting their ability to receive, implement and operate new tools for their manufacturing facilities. As a result, in some cases, ACM Shanghai has been required to defer shipments of finished products to these customers because of operational and logistics limitations affecting customers rather than, or in addition to, ACM Shanghai. 45 Table of Contents In late April 2022, ACM Shanghai began to resume some operations at the Chuansha manufacturing site using the “closed loop method,” in which a limited collection of workers remains together as a group between a single hotel, the ACM Shanghai facility, and a dedicated bus transportation route, also referred to as “two spots and one line,” and had resumed substantially all of its Chuansha manufacturing site operations by the end of the second quarter of 2022. In mid-June 2022, substantially all of ACM Shanghai’s R&D and administrative employees at its Zhangjiang facility were allowed to return to work under strict safety protocols after a period of restricted access to the building that for many employees was partially mitigated by being able to work from home. ACM Shanghai has established several policies to help avoid or limit future outbreaks among employees and thus protect employee safety and limit the possibility of a facility reclosing. We anticipate that the effects of the PRC restrictions may continue for several months, with a gradual return of PRC operations, production capacity, and global logistics as Shanghai and other areas in the PRC begin to reopen. We cannot assure that closures or reductions of PRC operations or production, whether of ACM Shanghai or of some of its key customers, may not be extended in upcoming months as the result of business interruptions arising from protective measures being taken by the PRC and other governmental agencies or of other consequences of COVID-19. Our corporate headquarters are located in Fremont, California in the San Francisco Bay Area and are the subject of a number of state and county public health directives and orders. These actions have not negatively impacted our business to date, however, because of the limited number of employees at our headquarters and the nature of the work they generally perform. To date we have not experienced absenteeism of management or other key employees, other than certain of our executive officers being delayed in traveling between the PRC, our California office, and other global locations. • Customers: Our customers’, including the customers of ACM Shanghai, business operations have been, and are continuing to be, subject to business interruptions arising from the COVID–19 pandemic. Historically substantially all of our revenue has been derived from customers located in the PRC and surrounding areas that have been impacted by COVID–19. Two customers that accounted for 48.9% of our revenue in 2021 are based in the PRC, and three customers that accounted for 75.8% of our revenue in 2020, and 73.8% of our revenue in 2019 are based in the PRC and South Korea. One of those customers, Yangtze Memory Technologies Co., Ltd. — which accounted for 20.2% of our 2021 revenue, 26.8% of our 2020 revenue, and 27.5% of our 2019 revenue — is based in Wuhan. While Yangtze Memory Technologies Co., Ltd. and other key customers continued to operate their fabrication facilities without interruption during and after the first quarter of 2020, some customers have been forced to restrict access of service personnel and deliveries to and from their facilities. We have experienced longer and in some cases more costly shipping expenses in the delivery of tools to certain customers. • Suppliers : Our global supply chain includes components sourced from the PRC, Japan, Taiwan, the United States and Europe. While, to date, we have not experienced material issues with our supply chain beyond the logistics related to the Shanghai facilities of ACM Shanghai, supply chain constraints have intensified due to COVID-19, contributing to global shortages in the supply of semiconductors and other materials, and in some cases the pricing of materials used in the production of our own tools. As with our customers, we continue to be in close contact with our key suppliers to help ensure we are able to identify any potential supply issues that may arise. 46 Table of Contents • Projects : Our strategy includes a number of plans to support the growth of our core business, including ACM Shanghai’s acquisition of a land use right in the Lingang area of Shanghai where ACM Shanghai began construction of a new R&D center and factory in July 2020. The extent to which COVID–19 impacts these projects will depend on future developments that are highly uncertain, but to date, the timing of these ongoing projects has not been delayed or significantly disrupted by COVID–19 or related government measures. During the first six months of 2022, the Company experienced a negative impact to revenue and shipments as a result of restricted access and logistics to its Shanghai-based production and administrative facilities. Thirteen tools amounting to $13 million in revenue and $24 million in shipments that could not be shipped to customers in the three-months ended March 30, 2022 were subsequently shipped in the three months ended June 30, 2022. As a result of the restrictions, the Company experienced a modest increase to operational costs due to increased logistics costs and inefficiencies that resulted from the restrictions, and an increase in cash used in operations due in part to an increase in accounts receivables that resulted from a shift of shipments towards the latter part of the period. During the three and nine-months ended September 30, 2022, the Company experienced general inefficiencies in administrative, research and development and other activities due to some employees who were required to quarantine ‘in place’ at their residence due presumably to the detected possible exposure to COVID infections. In many cases, the employees were able to work remotely to mitigate the effects. The Company anticipates the PRC’s zero-covid policy will impact its PRC operations for the foreseeable future in the form of regular testing and/or required quarantines-in-place. The Company cannot assure that closures or reductions of operations or production, whether of ACM Shanghai or of some of its key customers, may not be extended or re-introduced during the remainder of 2022 as the result of business interruptions arising from protective measures being taken by the PRC and other governmental agencies or of other consequences of COVID-19. PRC Government Research and Development Funding ACM Shanghai has received seven special government grants. The first grant, which was awarded in 2008, relates to the development and commercialization of 65nm to 45nm stress-free polishing technology. The second grant was awarded in 2009 to fund interest expense on short-term borrowings. The third grant was made in 2014 and relates to the development of electro copper-plating technology. The fourth grant was made in June 2018 and related to development of polytetrafluoroethylene. The fifth grant was made in 2020, and relates to the development of Tahoe single bench cleaning technologies. As of December 31, 2021, the fourth and fifth grants had been fully utilized. The sixth grant was made in 2020, and relates to the development of other cleaning technologies. The seventh grant was made in 2021, and relates to the development of the R&D and production center in the Lin-gang Special Area of Shanghai. These governmental authorities provide significant funding, although ACM Shanghai and ACM Shengwei is also required to invest certain amounts in the projects. The governmental grants contain certain operating conditions, and we are required to go through a government due diligence process once the project is complete. The grants therefore are recorded as long-term liabilities upon receipt, although we are not required to return any funds ACM Shanghai receives. Grant amounts are recognized in our statements of operations and comprehensive income as follows: • Government subsidies relating to current expenses are recorded as reductions of those expenses in the periods in which the current expenses are recorded. For the nine months ended September 30, 2022 and 2021, related government subsidies recognized as reductions of relevant expenses in the consolidated statements of operations and comprehensive income (loss) were $0.3 million and $7.1 million, respectively. • Government subsidies related to depreciable assets are credited to income over the useful lives of the related assets for which the grant was received. For the nine months ended September 30, 2022 and 2021, related government subsidies recognized as other income in the consolidated statements of operations and comprehensive income (loss) were $232,000 and $136,000, respectively. 47 Table of Contents Unearned government subsidies received are deferred for recognition and recorded as other long-term liabilities (see Note 13 in the Notes to Condensed Consolidated Financial Statements included herein under “Item 1. Financial Statements.”) in the balance sheet until the criteria for such recognition are satisfied. Net Income Attributable to Non-Controlling Interests In 2019 ACM Shanghai sold a total number of shares representing 8.3% of its outstanding ACM Shanghai shares, after which ACM Research held the remaining 91.7% of ACM Shanghai’s outstanding shares. In 2021 ACM Shanghai sold a total number shares representing an additional 10% of its outstanding ACM Shanghai shares in its STAR IPO, after which ACM Research held the remaining 82.5% of ACM Shanghai’s outstanding shares. As a result, we reflect the portion of our net income allocable to the minority holders of ACM Shanghai shares as net income attributable to non-controlling interests. Critical Accounting Policies and Estimates There were no significant changes in our critical accounting policies or significant judgments or estimates during the three months ended September 30, 2022 to augment the critical accounting estimates disclosed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report, other than those described in the notes to the condensed consolidated financial statements included in this report. For information regarding the impact of recently adopted accounting standards, refer to note 2 to the condensed consolidated financial statements included in this report. Recent Accounting Pronouncements A discussion of recent accounting pronouncements is included in our Annual Report and is updated in note 2 to the condensed consolidated financial statements included in this report. Results of Operations The following table sets forth our results of operations for the periods presented, as percentages of revenue. Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue 50.7 55.7 53.7 57.8 Gross margin 49.3 44.3 46.3 42.2 Operating expenses: Sales and marketing 9.8 9.5 9.8 10.6 Research and development 11.7 11.7 15.8 12.9 General and administrative 4.1 5.5 5.6 6.7 Total operating expenses, net 25.6 26.7 31.2 30.3 Income from operations 23.7 17.6 15.1 11.9 Interest income (expense), net 1.2 (0.2 ) 1.8 (0.3 ) Realized gain from sale of trading securities 0.8 0.0 0.4 0.0 Unrealized gain (loss) on trading securities (3.9 ) (1.4 ) (3.4 ) 1.1 Other income (expense), net 5.4 (0.4 ) 3.5 (0.4 ) Equity income in net income of affiliates 0.9 0.6 0.6 0.6 Income before income taxes 28.1 16.2 18.0 12.9 Income tax benefit (expense) (7.8 ) 0.4 (5.0 ) 1.8 Net income 20.3 16.6 13.0 14.8 Less: Net income attributable to non-controlling interests 4.5 1.5 3.2 1.3 Net income attributable to ACM Research, Inc. 15.8 % 15.1 % 9.8 % 13.5 % 48 Table of Contents Comparison of Three Months Ended September 30, 2022 and 2021 Revenue Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 ` (in thousands) Revenue $ 133,709 $ 67,013 99.5 % $ 66,696 Single wafer cleaning, Tahoe and semi-critical cleaning equipment $ 99,720 $ 49,448 101.7 % $ 50,272 ECP (front-end and packaging), furnace and other technologies 24,521 8,200 NM 16,321 Advanced packaging (excluding ECP), services & spares 9,468 9,365 1.1 % 103 Total Revenue by Product Category $ 133,709 $ 67,013 99.5 % $ 66,696 Wet-cleaning and other front-end processing tools $ 117,941 $ 49,448 138.5 % $ 68,493 Advanced packaging, other processing tools, services and spares 15,768 17,565 -10.2 % -1,797 Total Revenue Front and Back-End $ 133,709 $ 67,013 99.5 % $ 66,696 Revenue increased by $66.7 million in the three months ended September 30, 2022 as compared to the same period in 2021. The increase was driven primarily by higher sales of single wafer cleaning, Tahoe and semi-critical cleaning equipment, and increased contribution from newer ECP (front-end and packaging), furnace and other technologies. The impact to our Shanghai production operations from COVID-19-related restrictions was lower for the period as compared to the impact experienced during the first six months of 2022. The increased demand from PRC-based customers is due in part to their longer term commitment to increase production capacity to achieve a greater share of the mainland China semiconductor market. Cost of Revenue and Gross Margin Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Cost of revenue $ 67,742 $ 37,328 81.5 % $ 30,414 Gross profit 65,967 29,685 122.2 % 36,282 Gross margin 49.3 % 44.3 % 11.4 % 504 Cost of revenue increased $30.4 million and gross profit increased $36.3 million in the three months ended September 30, 2022 as compared to the corresponding period in 2021 due to the increased sales volume, and an increase in gross margin. The increased gross margin versus the prior-year period was primarily due to a higher mix of ECP (front-end and packaging), furnace, and other technologies, and a positive impact due to a change in the RMB to US dollar currency exchange rate. Gross margin may vary from period to period, primarily related to the level of utilization and the timing and mix of revenue. We expect gross margin to be between 40.0% and 45.0% for the foreseeable future, with direct manufacturing costs approximating 50.0% to 55.0% of revenue and overhead costs totaling 5.0% of revenue. 49 Table of Contents Operating Expenses Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Sales and marketing expense $ 13,133 $ 6,363 106.4 % $ 6,770 Research and development expense 15,678 7,856 99.6 % 7,822 General and administrative expense 5,520 3,671 50.4 % 1,849 Total operating expenses $ 34,331 $ 17,890 91.9 % $ 16,441 Sales and marketing expense increased by $6.8 million in the three months ended September 30, 2022 as compared to the corresponding period in 2021, and reflected an increase of $3.4 million due to higher costs of tools built for promotional purposes for current or potential new customers, an increase of $3.0 million due to increased costs for personnel, commissions, outside services, travel & entertainment and other costs, and an increase of $0.4 million due to warranty accruals. Sales and marketing expense consists primarily of: • compensation of personnel associated with pre- and after-sale services and support and other sales and marketing activities, including stock-based compensation; • sales commissions paid to independent sales representatives; • fees paid to sales consultants; • cost of trade shows; • costs of tools built for promotional purposes for current or potential new customers; • travel and entertainment; and • allocated overhead for rent and utilities. We expect that, for the foreseeable future, sales and marketing expenses will increase in dollars, as we incur additional costs associated with growing our customer base in mainland China and regions outside of mainland China. Research and development expense increased by $7.8 million in the three months ended September 30, 2022 as compared to the corresponding period in 2021, reflecting an increase of $3.4 million in costs of components, costs of tools built for product development purposes, and costs of other research and development supplies, and an increase of $3.0 million for personnel, stock-based compensation, and travel & entertainment costs to support product development, and an increase of $1.4 million for outside services and other R&D related expenses. Research and development expense represented 11.7% and 11.7% of our revenue in the three months ended September 30, 2022 and 2021, respectively. Without reduction by grant amounts received from PRC governmental authorities (see “—Government Research and Development Funding”), gross research and development expense totaled $15.9 million, or 11.9% of total revenue, in the three months ended September 30, 2022 as compared to $9.3 million, or 13.8% of revenue, in the corresponding period in 2021. Research and development expense relates to the development of new products and processes and encompasses our research, development and customer support activities. Research and development expense consists primarily of: • compensation of personnel associated with our research and development activities, including stock based compensation; • costs of components and other research and development supplies; • costs of tools built for product development purposes; • travel expense associated with the research of technical requirements for product development purposes and testing of concepts under consideration; • amortization of costs of software used for research and development purposes; and 50 Table of Contents • allocated overhead for rent and utilities. We expect that, for the foreseeable future, research and development expenses will increase in dollars, as we incur additional costs to expand our product portfolio to address additional production steps and expand our research and development team to new regions. General and administrative expense increased $1.8 million in the three months ended September 30, 2022 as compared to the corresponding period in 2021. General and administrative expense consists primarily of: • compensation of executive, accounting and finance, human resources, information technology, and other administrative personnel, including stock-based compensation; • professional fees, including accounting and corporate legal and defense fees; • other corporate expenses including insurance; and • allocated overhead for rent and utilities. We expect that, for the foreseeable future, general and administrative expenses will increase in dollars, as we incur additional costs associated with growing our business, ACM Research operating a public company in the United States and ACM Shanghai operating as a public company in the PRC. Income from Operations Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Income from operations $ 31,636 $ 11,795 168.2 % $ 19,841 Income from operations increased by $19.8 million during the three months ended September 30, 2022 as compared to the prior year period, due to $36.3 million increase in gross profit, partly offset by a $16.4 million increase in operating expenses. Interest income (expense), net, Other Income (expense), net Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Interest Income $ 2,016 $ 33 6009.1 % $ 1,983 Interest Expense (419 ) (191 ) 119.4 % (228 ) Interest Income (expense), net $ 1,597 $ (158 ) -1110.8 % $ 1,755 Other income (expense), net $ 7,207 $ (255 ) -2926.3 % $ 7,462 Interest income (expense), net consists of interest earned on our cash and equivalents, restricted cash accounts, and short term and long term time deposits, offset by interest expense incurred from outstanding short-term and long-term borrowings. We realized $1.6 million of interest income (expense), net in the three months ended September 30, 2022 as compared to an expense of $158,000 of interest income (expense), net in the corresponding period in 2021. The significant change from the year-ago-period resulted from a slightly lower balance of cash and equivalents and time deposits together with higher interest rates on these balances, partly offset by a higher balance of short-term and long-term borrowings. 51 Table of Contents Other income (expense), net primarily reflects (a) gains or losses recognized from the impact of exchange rates on our foreign currency-denominated working-capital transactions and (b) depreciation of assets acquired with government subsidies, as described under “—Government Research and Development Funding” above. We realized $7.2 million of other income (expense) in the three months ended September 30, 2022, of which $6.4 million was due to gains realized from transactions that resulted from changes in the RMB-to-U.S. dollar exchange rate, as compared to a loss of ($0.3) million in the corresponding period in 2021. Realized gain and unrealized loss from trading securities, and equity income in net income of affiliates. Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Realized gain from sale of trading securities $ 1,136 $ - 100.0 % $ 1,136 Unrealized (loss) on trading securities $ (5,281 ) $ (919 ) 474.6 % $ (4,362 ) Equity income in net income of affiliates $ 1,251 $ 421 197.1 % $ 830 We recorded a realized gain from sale of trading securities of $1.1 million for the three months ended September 30, 2022 due to a sale of ACM Shanghai’s indirect investment in SMIC shares on the STAR Market as is described in note 15 to the condensed consolidated financial statements included in this report. We recorded an unrealized loss on trading securities of $5.3 million for the three months ended September 30, 2022 as compared to an unrealized loss of $0.9 million for the same period in 2021, based on a change in market value of ACM Shanghai’s indirect investment in SMIC shares on the STAR Market as is described in note 15 to the condensed consolidated financial statements included in this report. Equity income in net income of affiliates increased by $0.8 million for the three months ended September 30, 2022 due to higher net income from investments in affiliates (note 14). Income Tax Benefit (Expense) The following presents components of income tax benefit (expense) for the indicated periods: Three Months Ended September 30, 2022 2021 (in thousands) Total income tax benefit (expense) $ (10,470 ) $ 266 We recognized a tax expense of $10.5 million for the three months ended September 30, 2022 as compared to a tax benefit of $266,000 for the prior year period. The increased tax expense in 2022 primarily resulted from the tax effect of increased operating profit generated and an increase in our effective income tax rate. The increase in our effective income tax rate for the three months ended September 30, 2022 compared to the same period of the prior year was primarily due to a new requirement to capitalize and amortize previously deductible research and experimental expenses resulting from a change in Section 174 made by the Tax Cuts and Jobs Act of 2017 (the “TCJA”) which became effective on January 1, 2022, and a decrease in discrete tax benefits associated with stock-based compensation deductions. The capitalization of overseas R&D expenses resulted in a significant increase in our global intangible low-taxed income inclusion. Congress is considering legislation, but legislation has not passed, that would defer the capitalization requirement to later years. 52 Table of Contents Our effective tax rate differs from statutory rates of 21% for U.S. federal income tax purposes and 12.5% to 25% for Chinese income tax purposes due to the treatment of stock-based compensation including the impact from stock option exercises and non-US research expenses. Our two PRC subsidiaries, ACM Shanghai and ACM Research (Wuxi), Inc., are liable for PRC corporate income taxes at the rates of 12.5% and 25%, respectively. Pursuant to the Corporate Income Tax Law of the PRC, our PRC subsidiaries generally would be liable for PRC corporate income taxes at a rate of 25%. According to Guoshuihan 2009 No. 203, an entity certified as an “advanced and new technology enterprise” is entitled to a preferential income tax rate of 15%. ACM Shanghai was certified as an “advanced and new technology enterprise” in 2012 and again in 2016, 2018, and 2021 with an effective period of three years. In 2021, ACM Shanghai was certified as an eligible integrated circuit production enterprise and is entitled to a preferential income tax rate of 12.5% from January 1, 2020 to December 31, 2022. We file income tax returns in the United States and state and foreign jurisdictions. Those federal, state and foreign income tax returns are under the statute of limitations subject to tax examinations for 1999 through 2021. To the extent we have tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state or foreign tax authorities to the extent utilized in a future period. Net Income Attributable to Non-Controlling Interests Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Net income attributable to non-controlling interests $ 6,072 $ 995 510.3 % $ 5,077 In 2019 ACM Shanghai sold a total number of shares representing 8.3% of its outstanding ACM Shanghai shares, after which ACM Research held the remaining 91.7% of ACM Shanghai’s outstanding shares. In 2021 ACM Shanghai sold a total number shares representing an additional 10% of its outstanding ACM Shanghai shares in its STAR IPO, after which ACM Research held the remaining 82.5% of ACM Shanghai’s outstanding shares. As a result, we reflect, the portion of our net income allocable to the minority holders of ACM Shanghai shares as net income attributable to non-controlling interests. In the three months ended September 30, 2022, this amount totaled $6.1 million as compared to $1.0 million in the corresponding period in 2021. Foreign currency translation adjustment Three Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Foreign currency translation adjustment $ (42,416 ) $ (409 ) 10270.7 % $ (42,007 ) We recorded a foreign currency translation adjustment of ($42.4) million for the three months ended September 30, 2022, as compared to ($0.4) million for the same period in 2021, based on the net effect of RMB to dollar exchange rate fluctuations for the period on the converted value of ACM Shanghai’s RMB-denominated balances to U.S. dollar equivalents. The amount was especially large due to a significant weakening of the RMB versus the U.S. dollar during the period. 53 Table of Contents Comparison of Nine Months Ended September 30, 2022 and 2021 Revenue Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Revenue $ 280,290 $ 164,609 70.3 % $ 115,681 Single wafer cleaning, Tahoe and semi-critical cleaning equipment $ 198,336 $ 127,322 55.8 % $ 71,014 ECP (front-end and packaging), furnace and other technologies 57,269 13,750 316.5 % 43,519 Advanced packaging (excluding ECP), services & spares 24,685 23,537 4.9 % 1,148 Total Revenue By Product Category $ 280,290 $ 164,609 70.3 % $ 115,681 Wet-cleaning and other front-end processing tools $ 229,195 $ 127,322 80.0 % $ 101,873 Advanced packaging, other processing tools, services and spares 51,095 37,287 37.0 % 13,808 Total Revenue Front-end and Back-End $ 280,290 $ 164,609 70.3 % $ 115,681 Revenue increased by $115.7 million in the nine months ended September 30, 2022 as compared to the same period in 2021. The increase was driven primarily by higher sales of single wafer cleaning, Tahoe and semi-critical cleaning equipment, and increased contribution from newer ECP (front-end and packaging), furnace and other technologies. Revenue was impacted by COVID-19 related restrictions which reduced production output and logistics to and from our facilities for several months particularly during the first half of the year, with a return to more normal operations in the August timeframe. The increased demand from PRC-based customers is due in part to their longer term commitment to increase production capacity to achieve a greater share of the mainland China semiconductor market. Cost of Revenue and Gross Margin Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Cost of revenue $ 150,480 $ 95,199 58.1 % $ 55,281 Gross profit $ 129,810 $ 69,410 87.0 % $ 60,400 Gross margin 46.3 % 42.2 % 4.15 % 415 Cost of revenue increased $55.3 million and gross profit increased $60.4 million in the nine months ended September 30, 2022 as compared to the corresponding period in 2021 due to the increased sales volume, and an increase in gross margin. The increased gross margin versus the prior-year period was primarily due to a higher mix of ECP (front-end and packaging), furnace, and other technologies, and a positive impact due to a change in the RMB to US dollar currency exchange rate. Gross margin may vary from period to period, primarily related to the level of utilization and the timing and mix of purchase orders. We expect gross margin to be between 40.0% and 45.0% for the foreseeable future, with direct manufacturing costs approximating 50.0% to 55.0% of revenue and overhead costs totaling 5.0% of revenue. Operating Expenses Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Sales and marketing expense $ 27,494 $ 17,460 57.5 % $ 10,034 Research and development expense 44,391 21,293 108.5 % 23,098 General and administrative expense 15,560 11,081 40.4 % 4,479 Total operating expenses $ 87,445 $ 49,834 75.5 % $ 37,611 54 Table of Contents Sales and marketing expense increased by $10.0 million in the nine months ended September 30, 2022 as compared to the corresponding period in 2021, and reflected an increase of $5.2 million due to higher costs of tools built for promotional purposes for current or potential new customers, and an increase of $3.5 million due increased costs for personnel, commissions, outside services, travel & entertainment costs, and an increase of $1.3 million due to warranty accruals. Sales and marketing expense consists primarily of: • compensation of personnel associated with pre- and after-sale services and support and other sales and marketing activities, including stock-based compensation; • sales commissions paid to independent sales representatives; • fees paid to sales consultants; • cost of trade shows; • costs of tools built for promotional purposes for current or potential new customers; • travel and entertainment; and • allocated overhead for rent and utilities. We expect that, for the foreseeable future, sales and marketing expenses will increase in dollars, as we incur additional costs associated with growing our customer base in mainland China and regions outside of mainland China. Research and development expense increased by $23.1 million in the nine months ended September 30, 2022 as compared to the corresponding period in 2021, reflecting an increase of $9.4 million for personnel, stock-based compensation, and travel & entertainment costs to support product development, an increase of $8.4 million in costs of components, costs of tools built for product development purposes, and an increase of $5.3 million for outside services, and other R&D related expenses. Research and development expense represented 15.8% and 12.9% of our revenue in the nine months ended September 30, 2022 and 2021, respectively. Without reduction by grant amounts received from PRC governmental authorities (see “—Government Research and Development Funding”), gross research and development expense totaled $44.7 million, or 15.9% of total revenue, in the nine months ended September 30, 2022 and $28.4 million, or 17.3% of revenue, in the corresponding period in 2021. Research and development expense relates to the development of new products and processes and encompasses our research, development and customer support activities. Research and development expense consists primarily of: • compensation of personnel associated with our research and development activities, including stock based compensation; • costs of components and other research and development supplies; • costs of tools built for product development purposes; • travel expense associated with the research of technical requirements for product development purposes and testing of concepts under consideration; • amortization of costs of software used for research and development purposes; and • allocated overhead for rent and utilities. We expect that, for the foreseeable future, research and development expenses will increase in dollars, as we incur additional costs to expand our product portfolio to address additional production steps and expand our research and development team to new regions. General and administrative expense increased $4.5 million in the nine months ended September 30, 2022 as compared to the corresponding period in 2021. General and administrative expense consists primarily of: • compensation of executive, accounting and finance, human resources, information technology, and other administrative personnel, including stock-based compensation; 55 Table of Contents • professional fees, including accounting and corporate legal and defense fees; • other corporate expenses including insurance; and • allocated overhead for rent and utilities. We expect that, for the foreseeable future, general and administrative expenses will increase in dollars, as we incur additional costs associated with growing our business, ACM Research operating a public company in the United States and ACM Shanghai operating a public company in the PRC. Income from operations Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Income from operations $ 42,365 $ 19,576 116.4 % $ 22,789 Income from operations increased by $22.8 million during the nine months ended September 30, 2022 as compared to the prior year period, due to an $60.4 million increase in gross profit, partly offset by a $37.6 million increase in operating expenses. Interest income (expense), net, Other Income (expense), net Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Interest Income $ 5,965 $ 113 5178.8 % $ 5,852 Interest Expense (986 ) (574 ) 71.8 % (412 ) Interest Income (expense), net $ 4,979 $ (461 ) -1180.0 % $ 5,440 Other income (expense), net $ 9,949 $ (683 ) -1556.7 % $ 10,632 Interest income (expense), net consists of interest earned on our cash and equivalents and restricted cash accounts, offset by interest expense incurred from outstanding short-term borrowings. We realized $5.0 million of interest income (expense), net in the nine months ended September 30, 2022 as compared to ($461,000) of interest income (expense), net in the corresponding period in 2021. The significant increase from the year-ago-period resulted from a higher balance of cash and equivalents and time deposits, and higher interest rates on these balances. Other income, net primarily reflects (a) gains or losses recognized from the impact of exchange rates on our foreign currency-denominated working-capital transactions and (b) depreciation of assets acquired with government subsidies, as described under “—Government Research and Development Funding” above. We realized $9.9 million of other income (expense) in the three months ended September 30, 2022, of which $8.8 million was due to gains realized from transactions that resulted from changes in the RMB-to-U.S. dollar exchange rate, as compared to a loss of ($0.7) million in the corresponding period in 2021. The variance was due primarily to the impact to transactions that resulted from changes in the RMB-to-U.S. dollar exchange rate during the respective periods. 56 Table of Contents Unrealized loss from trading securities and equity income in net income of affiliates Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Realized gain from sale of trading securities $ 1,136 $ - 100.0 % $ 1,136 Unrealized gain (loss) on trading securities $ (9,562 ) $ 1,817 -626.3 % $ (11,379 ) Equity income in net income of affiliates $ 1,652 $ 1,036 59.5 % $ 616 We recorded a realized gain from sale of trading securities of $1.1 million for the nine months ended September 30, 2022, due to a sale of ACM Shanghai’s indirect investment in SMIC shares on the STAR Market as is described in note 15 to the condensed consolidated financial statements included in this report. We recorded an unrealized loss on trading securities of $9.6 million for the nine months ended September 30, 2022, as compared to an unrealized gain of $1.8 million for the same period in 2021, based on a change in market value of ACM Shanghai’s indirect investment in SMIC shares on the STAR Market as is described in note 15 to the condensed consolidated financial statements included in this report. Equity income in net income of affiliates increased by $0.6 million for the nine months ended September 30, 2022. Income Tax Benefit (Expense) The following presents components of income tax benefit (expense) for the indicated period: Nine Months Ended September 30, 2022 2021 (in thousands) Total income tax benefit (expense) $ (14,138 ) $ 3,021 We recognized a tax expense of $14.1 million for the nine months ended September 30, 2022 as compared to a tax benefit of $3 million for prior year period. The increased tax expense in 2022 primarily resulted from the tax effect of increased operating profit generated and an increase in our effective income tax rate. The increase in our effective income tax rate for the nine months ended September 30, 2022 compared to the same period of the prior year was primarily due to a new requirement to capitalize and amortize previously deductible research and experimental expenses resulting from a change in Section 174 made by the TCJA which became effective on January 1, 2022, and a decrease in discrete tax benefits associated with stock-based compensation deductions. The capitalization of overseas R&D expenses resulted in a significant increase in our global intangible low-taxed income inclusion. Congress is considering legislation, but legislation has not passed, that would defer the capitalization requirement to later years. Our effective tax rate differs from statutory rates of 21% for U.S. federal income tax purposes and 12.5% to 25% for Chinese income tax purposes due to the treatment of stock-based compensation including the impact from stock option exercises and non-US research expenses. Our two PRC subsidiaries, ACM Shanghai and ACM Research (Wuxi), Inc., are liable for PRC corporate income taxes at the rates of 12.5% and 25%, respectively. Pursuant to the Corporate Income Tax Law of the PRC, our PRC subsidiaries generally would be liable for PRC corporate income taxes at a rate of 25%. According to Guoshuihan 2009 No. 203, an entity certified as an “advanced and new technology enterprise” is entitled to a preferential income tax rate of 15%. ACM Shanghai was certified as an “advanced and new technology enterprise” in 2012 and again in 2016, 2018, and 2021, with an effective period of three years. In 2021, ACM Shanghai was certified as an eligible integrated circuit production enterprise and is entitled to a preferential income tax rate of 12.5% from January 1, 2020 to December 31, 2022. 57 Table of Contents We file income tax returns in the United States and state and foreign jurisdictions. Those federal, state and foreign income tax returns are under the statute of limitations subject to tax examinations for 1999 through 2021. To the extent we have tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state or foreign tax authorities to the extent utilized in a future period. Net Income Attributable to Non-Controlling Interests Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Net income attributable to non-controlling interests $ 8,927 $ 2,114 322.3 % $ 6,813 In 2019 ACM Shanghai sold shares representing 8.3% of its outstanding ACM Shanghai shares, after which ACM Research held the remaining 91.7% of ACM Shanghai’s outstanding shares. In 2021 ACM Shanghai sold a total number shares representing an additional 10% of its outstanding ACM Shanghai shares in its STAR IPO, after which ACM Research held the remaining 82.5% of ACM Shanghai’s outstanding shares. As a result, we reflect, the portion of our net income allocable to the minority holders of ACM Shanghai shares as net income attributable to non-controlling interests. In the nine months ended September 30, 2022, this amount totaled $8.9 million as compared to $2.1 million in the corresponding period in 2021. Foreign currency translation adjustment Nine Months Ended September 30, 2022 2021 % Change 2022 v 2021 Absolute Change 2022 v 2021 (in thousands) Foreign currency translation adjustment $ (80,334 ) $ 1,259 -6480.8 % $ (81,593 ) We recorded a foreign currency translation adjustment of ($80.3) million for the nine months ended September 30, 2022, as compared to $1.3 million for the same period in 2021, based on the net effect of RMB to dollar exchange rate fluctuations for the period on the converted value of ACM Shanghai’s RMB-denominated balances to U.S. dollar equivalents. The amount was especially large due to a significant weakening of the RMB versus the U.S. dollar during the period. 58 Table of Contents Liquidity and Capital Resources During the first nine months of 2022, we funded our technology development and operations principally through our beginning global cash balances, including the cash balances at ACM Shanghai, and borrowings by ACM Shanghai from local financial institutions. Cash and cash equivalents, short-term time deposits and long-term time deposits were $472.9 million at September 30, 2022, compared to $562.5 million at December 31, 2021. The $89.7 million decrease was primarily driven by $36.8 million provided by financing activities, offset by $63.9 million of cash used by operations, a $42.6 million decline from the effect of exchange rate on cash, cash equivalents and restricted cash, and $20.2 million net cash used in investing activities. September 30, 2022 December 31, 2021 (In thousands) Cash and cash equivalents and time deposits: Cash and cash equivalents 336,275 562,548 Short-term time deposits 66,176 - Long-term time deposits 70,400 - Total $ 472,851 $ 562,548 Our future working capital needs beyond the next twelve months will depend on many factors, including the rate of our business and revenue growth, the payment schedules of our customers, the timing and magnitude of our capital expenditures, and the timing of investment in our research and development as well as sales and marketing. We believe our existing cash and cash equivalents and short-term and long-term time deposits, our cash flow from operating activities, and bank borrowings by ACM Shanghai will be sufficient to meet our anticipated cash needs within our longer term planning horizon. ACM Shanghai has historically participated in certain PRC government-sponsored grant and subsidy programs, as described under “—Key Components of Results of Operations—PRC Government Research and Development Funding” and “—Contractual Obligations” and we expect that ACM Shanghai will continue to take advantage of these programs when they are available and fit with our business strategy. ACM Shanghai generally applies for these grants and subsidies through the applicable PRC government agency’s defined processes. Periodically, the public relations department researches the availability of these grants and subsidies through the PRC government agencies with whom ACM Shanghai files business surveys and taxes. Management of ACM Shanghai then assesses which grants and subsidies for which ACM Shanghai may be eligible and submits the relevant application. The decision to award the grant to ACM Shanghai is made by the relevant PRC government agencies based on suitability and the merits of the application. Neither ACM Research, nor ACM Shanghai or any of our other subsidiaries, has any direct relationship with any PRC government agency, and our anticipated cash needs for the next twelve months neither anticipate, nor require, receipt of any PRC government grants or subsidies. To the extent our cash and cash equivalents, cash flow from operating activities and short-term bank borrowings are insufficient to fund our future activities in accordance with our strategic plan, we may determine to raise additional funds through public or private debt or equity financings or additional bank credit arrangements. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies and products. If additional funding is necessary or desirable, we may not be able to obtain bank credit arrangements or to affect an equity or debt financing on terms acceptable to us or at all. 59 Table of Contents Restrictions under PRC laws and regulations as well as restrictions under ACM Shanghai’s bank loan agreements, may significantly restrict ACM Shanghai’s ability to transfer a portion of ACM Shanghai’s net assets to ACM Research, other subsidiaries of ACM Research and to holders of ACM Research Class A common stock. See “Item 1A. Risk Factors–Regulatory Risks–The PRC’s currency exchange control and government restrictions on investment repatriation may impact our ability to transfer funds outside of the PRC, which could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, otherwise fund and conduct our business, or pay dividends on our common stock” in our Annual Report. For the nine months ended September 30, 2022 and 2021, no transfers, dividends, or distributions have been made between ACM Research, and its subsidiaries, including ACM Shanghai, or to holders of ACM Research Class A common stock. Our cash and cash equivalents at September 30, 2022 were held for working capital purposes and other potential investments. ACM Shanghai, our only direct PRC subsidiary, is, however, subject to PRC restrictions on distributions to equity holders. The use of proceeds raised by the STAR Market IPO, without further approvals, are limited to specific usage. We currently intend for ACM Shanghai to retain all available funds any future earnings for use in the operation of its business and do not anticipate its paying any cash dividends. Our accounts receivable balance fluctuates from period to period, which affects our cash flow from operating activities. Fluctuations vary depending on cash collections, client mix, and the timing of shipment and acceptance of our tools. We have never declared or paid cash dividends on our capital stock. We intend to retain all available funds and any future earnings to support the operation of and to finance the growth and development of our business and do not anticipate paying any cash dividends in the foreseeable future. Cash Flow Used in Operating Activities. Net cash used by operations of $63.9 million during the nine months ended September 30, 2022 consisted of: Nine Months Ended September 30, 2022 2021 (In thousands) Net Income $ 36,381 $ 24,306 Depreciation and amortization 4,104 1,597 Realized gain on trading securities (1,136 ) - Equity income in net income of affiliates (1,652 ) (1,036 ) Unrealized loss (gain) on trading securities 9,562 (1,817 ) Deferred income taxes 5,036 (4,666 ) Stock-based compensation 5,236 3,823 Net changes in operating assets and liabilities: (121,061 ) (26,029 ) Net cash flow used in operating activities $ (63,530 ) $ (3,822 ) Significant changes in operating asset and liability accounts included the following uses of cash: increases of inventories of $132 million (Note 5), and an increase of accounts receivable of $96.8 million (Note 4). As described under “—Key Components of Results of Operations—PRC Government Research and Development Funding,” ACM Shanghai has received research and development grants from local and central PRC governmental authorities. ACM Shanghai received $48,000 payments related to such grants in the first nine months of 2022, as compared to cash receipts of $4.2 million in the same period of 2021. The uses of cash are offset by the following significant sources of cash: an increase in advances from customers of $88.9 (Note 3), an increase in other payables and accrued expenses of $10.6 million, and an increase in accounts payable of $10.2 million. 60 Table of Contents Cash Flow from Investing Activities. Net cash used for investing activities, excluding net cash used to purchase time deposits, for the nine-months ended September 30, 2022 was $20.2 million, primarily consisting of $18.4 million purchase of property and equipment, $4.2 million purchase of long term investment (Note 14), $1 million investments in affiliates (Note 14), and $1.1 million purchase of intangible assets, offset by $4.5 million in proceeds from selling trading securities (Note 15). Cash Flow from Financing Activities. Net cash provided by financing for the nine-months ended September 30, 2022 was $36.8 million, primarily consisting of $35.7 million net proceeds from short and long-term borrowings, and $1.2 million in proceeds from the exercise of stock options. ACM Shanghai, together with its subsidiaries, has short-term and long-term borrowings with five banks, as follows: Lender Agreement Date Maturity Date Annual Interest Rate Maximum Borrowing Amount(1) Amount Outstanding at September 30, 2022 (in thousands) China Everbright Bank July 2021 September 2023 3.40%~3.60% RMB150,000 RMB120,000 $ 21,120 $ 16,896 Bank of Communications August 2022 September 2023 3.50%~3.60% RMB100,000 RMB100,000 $ 14,080 $ 14,080 Bank of China August 2022 August 2023 3.15 % RMB40,000 RMB40,000 $ 5,632 $ 5,632 China Merchants Bank October 2021 October 2022 3.50 % RMB100,000 RMB100,000 $ 14,080 14,080.00 China Merchants Bank November 2020 Repayable by installments and the last installments repayable in November 2030 3.95 % RMB128,500 RMB109,149 $ 18,093 $ 15,368 Bank of China June 2021 Repayable by installments and the last installments repayable in June 2024 2.60 % RMB10,000 RMB9,000 $ 1,408 $ 1,267 Bank of China September, 2021 Repayable by installments and the last installments repayable in September 2021 2.60 % RMB35,000 RMB31,500 $ 4,928 $ 4,435 $ 79,341 $ 71,758 (1) Converted from RMB to dollars as of September 30, 2022. All of the amounts owing under the line of credit with Bank of Shanghai Pudong Branch are guaranteed by CleanChip Technologies LTD, a wholly-owned subsidiary of ACM Shanghai. The loan from China Merchants Bank is secured by a pledge of the property of ACM Shengwei and guaranteed by ACM Shanghai, as described above under “—Contractual Obligations.” Effect of exchange rate changes on cash, cash equivalents and restricted cash. The value of our cash, and cash equivalents declined $42.6 million during the first nine months of 2022. The impact of fluctuations of the RMB to U.S. dollar currency exchange rate on a significant balance of these items held in RMB-denominated accounts (Note 2) contributed to the change. 61 Table of Contents Contractual Obligations Grant Contract for State-owned Construction Land Use Right in Shanghai City In 2020 ACM Shanghai, through its wholly-owned subsidiary ACM Shengwei, entered into a Grant Contract for State-owned Construction Land Use Right in Shanghai City (Category of R&D Headquarters and Industrial Projects), or the Grant Agreement, with the China (Shanghai) Pilot Free Trade Zone Lin-gang Special Area Administration, or the Grantor. ACM Shengwei obtained rights to use approximately 43,000 square meters (10.6 acres) of land in the Lingang Heavy Equipment Industrial Zone of Lin-gang Special Area of China (Shanghai) Pilot Free Trade Zone, or the Land Use Right, for a period of fifty years, commencing on the date of delivery of the land in July 2020, which we refer to as the Delivery Date. In exchange for its land use rights, ACM Shengwei paid aggregate grant fees of RMB 61.7 million ($9.5 million), or the Grant Fees, and a performance deposit of RMB 12.3 million ($1.9 million), which is equal to 20% of the aggregate grant fees, to secure its achievement of the following performance milestones: • the start of construction within 6 months after the Delivery Date (60% of the performance deposit), or Construction Start Milestone; • the completion of construction within 30 months after the Delivery Date (20% of the performance deposit), or Construction Completion Milestone; and • the start of production within 42 months after the Delivery Date (20% of the performance deposit), or Production Start Milestone. Upon satisfaction of a milestone, the portion of the performance deposit attributable to that milestone will be repayable to ACM Shengwei within ten business days. If the achievement of any of the above milestones is delayed or abandoned, ACM Shengwei may be subject to additional penalties and may lose its rights to both the use of the granted land and any partially completed facilities on that land. The status of the performance milestones for the period ended September 30, 2022 is as follows: • ACM Shengwei achieved the Construction Start Milestone and 60% of the performance deposit was refunded to ACM Shanghai in 2020. • The Construction Completion Milestone is required to be met prior to January 9, 2023. Although this date has not yet been reached, due to COVID-19 related restrictions, ACM Shengwei has experienced delays and does not expect to meet the milestone, and plans to file a request for an extension in December 2022. We cannot guarantee the extension will be met or that ACM Shengwei will be refunded this 20% portion of the performance deposit. Contractual penalties in the case of a delay of Construction Completion Milestone : o If ACM Shengwei fails to complete the construction pursuant to the date agreed under the Grant Agreement or any extended completion date approved by the Grantor, ACM Shengwei shall pay 50% of the deposit for timely completion of construction as liquidated damages; o If the ACM Shengwei delays the completion for more than six months beyond the date agreed under the Grant Agreement, or beyond any extended completion date approved by the Grantor, it shall pay the total deposit for timely completion of construction as liquidated damages. o If the delay is more than one year, the Grantor is entitled to terminate the Grant Agreement and take back the Land Use Right. In such case, the Grantor shall refund the Grant Fees for the remaining land use term after deducting the deposit agreed under the Grant Agreement and refund the deposit for timely commencement of production and relevant bank interests in full to ACM Shengwei. • The Production Start Milestone is required to be met prior to January 9, 2024. Although this date has not yet been reached, ACM Shengwei plans to also file a request for an extension of this milestone due to COVID-related delays. We cannot guarantee the extension will be met or that ACM Shengwei will be refunded this 20% portion of the performance deposit. 62 Table of Contents Contractual penalties in the case of a delay of Production Start Milestone : o If ACM Shengwei fails to commence production pursuant to the date agreed under the Grant Agreement or any extended commencement date approved by the Grantor, ACM Shengwei shall pay the total deposit for timely commencement of production as liquidated damages; o If ACM Shengwei fails to commence production pursuant to the extended commencement of production date, the Grantor is entitled to terminate the Grant Agreement and take back the Land Use Right. In such case, the Grantor shall refund the Grant Fees for the remaining land use term after deducting the deposit agreed under the Grant Agreement to ACM Shengwei. In addition to the milestones, covenants in the Grant Agreement require that, among other things, ACM Shengwei will be required to pay liquidated damages in the event that: (a) it does not make a total investment (including the costs of construction, fixtures, equipment and grant fees) of at least RMB 450.0 million ($63.4 million). ACM Shengwei shall pay the liquidated damages equal to the same proportion of the Grant Fees as the proportion of the actual shortfall amount of investment in the total agreed investment amount or the investment intensity. (b) within six years after the Delivery Date, or prior to July 9, 2026, it does not (i) generate a minimum specified amount of annual sales of products manufactured on the granted land or (ii) pay to the PRC at least RMB 157.6 million ($22.2 million) in annual total taxes (including value-added taxes, corporate income tax, personal income taxes, urban maintenance and construction taxes, education surcharges, stamp taxes, and vehicle and shipping taxes) as a result of operations in connection with the granted land. If the total tax revenue of the project fails to reach but is no less than 80% of the standard agreed under the Grant Agreement, ACM Shengwei shall pay 20% of the actual shortfall amount of the tax revenue as liquidated damages. If the total tax revenue of the project fails to reach 80% of the standard agreed under the Grant Agreement within 1 month after the agreed date of reaching target production, the Grantor is entitled to terminate this Contract, take back the Land Use Right, and shall refund the Grant Fees for the remaining Land Use Term to ACM Shengwei. If the Grant Agreement is terminated because of breach of any terms above, the Grantor shall take back the buildings, fixtures and auxiliary facilities on the land area and provide ACM Shengwei with corresponding compensation according to the residual value of the buildings, fixtures and auxiliary facilities when they are taken back. The total cumulative investment of land, buildings and construction in progress related to ACM Shengwei amounted to $23.1 million and $13.3 million at September 30, 2022 and December 31, 2021, respectively. 63 Table of Contents Loan and Mortgage Contract for Lingang, Shanghai Housing Units In connection with its financing the purchase of housing units in Lingang, Shanghai, or the Property, in November 2020 ACM Shengwei entered into a Loan and Mortgage Contract, or the Loan Agreement, with China Merchants Bank Co., Ltd., Shanghai Pilot Free Trade Zone Lin-Gang Special Area Sub-branch, or the Lender, pursuant to which ACM Shengwei obtained a loan in the aggregate amount of $19.6 million. The loan under the Loan Agreement is secured by a pledge of the Property, which ACM Shangwei’s subsidiary received ownership of in January 2022, and is guaranteed by ACM Shanghai. Under the Loan Agreement, ACM Shengwei must deliver the right certificate of the Property within sixty days of the execution of the Loan Agreement or the Lender has the right to, among other things, declare a breach of contract and enforce its remedies under the Loan Agreement, which remedies include the ability to declare any borrowings outstanding, together with accrued and unpaid interest and fees, to be immediately due and payable. As of the date of this report, ACM Shengwei and its developer have been unable to obtain the required right certificate of the Property due to administrative difficulties related to the COVID 19 pandemic and, as a result, the procedures of the formal pledge registration by the Lender have not been completed. The Lender delivered an updated letter to ACM Shengwei on October 21, 2022 confirming that it is aware of the cause of the delay in ACM Shengwei’s delivery of the right certificate of the Property and as of the date of this report has not taken any action to date as a result of the delay. The Lender could, however, assert at any time that the delay is a breach of contract and, among other remedies, could seek to declare the amounts owing under the Loan Agreement to be due and payable. The Shanghai Lingang Industrial Zone Public Rental Housing Construction and Operation Management Co., Ltd., or the Developer, delivered a letter to ACM Shengwei on August 4, 2022, citing a force majeure delay due to the COVID-19-related restrictions in Shanghai for the delay of the initial registration of the housing ownership, and that it expected to complete the initial registration of housing ownership by the end of August 2022. ACM Shanghai has confirmed the Developer has completed the initial registration of the housing ownership with local PRC authorities, and, as of the date of this filing, expects to receive the right certificate before December 31, 2022. See “Risks Related to International Aspects of Our Business—As the result of administrative delays in the PRC related to the COVID-19 pandemic, ACM Research’s indirect subsidiary ACM Shengwei has not been able to obtain the right certificate of property in Lingang, Shanghai as required by its Loan and Mortgage Contract, and our liquidity, financial position and business would be adversely affected if the lender bank were to assert successfully that the failure to obtain the right certificate is a breach of the Loan and Mortgage Contract” in Item 1A. Risk Factors of Part II of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2022. How We Evaluate Our Operations We present information below with respect to four measures of financial performance: ● We define “shipments” of tools to include (a) a “repeat” delivery to a customer of a type of tool that the customer has previously accepted, for which we recognize revenue upon delivery, and (b) a “first-time” delivery of a “first tool” to a customer on an approval basis, for which we may recognize revenue in the future if contractual conditions are met, or if a purchase order is received. ● We define “adjusted EBITDA” as net income excluding interest expense (net), income tax benefit (expense), depreciation and amortization, unrealized (gain) loss on trading securities, and stock-based compensation. We define adjusted EBITDA to also exclude restructuring costs, although we have not incurred any such costs to date. ● We define “free cash flow” as net cash provided by operating activities less purchases of property and equipment (net of proceeds from disposals). ● We define “adjusted operating income (loss)” as our income (loss) from operations excluding stock-based compensation. These financial measures are not based on any standardized methodologies prescribed by accounting principles generally accepted in the United States, or GAAP, and are not necessarily comparable to similarly titled measures presented by other companies. We have presented shipments, adjusted EBITDA, free cash flow and adjusted operating income (loss) because they are key measures used by our management and board of directors to understand and evaluate our operating performance, to establish budgets and to develop operational goals for managing our business. We believe that these financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA and adjusted operating income (loss) can provide useful measures for period-to-period comparisons of our core operating performance and that the exclusion of property and equipment purchases from operating cash flow can provide a usual means to gauge our capability to generate cash. Accordingly, we believe that these financial measures provide useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making. 64 Table of Contents Shipments, adjusted EBITDA, free cash flow and adjusted operating income (loss) are not prepared in accordance with GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with GAAP. Shipments We consider shipments a key operating metric as it reflects the total value of products delivered to customers and prospective customers by our productive assets. Shipments consist of two components: ● a shipment to a customer of a type of tool that the customer has previously accepted, for which we recognize revenue when the tool is delivered; and ● a shipment to a customer of a type of tool that the customer is receiving and evaluating for the first time, in each case a “first tool,” for which we may recognize revenue at a later date, subject to the customer’s acceptance of the tool upon the tool’s satisfaction of applicable contractual requirements or subject to the costumer’s subsequent discretionary commitment to purchase the tool. “First tool” shipments can be made to either an existing customer that has not previously accepted that specific type of tool in the past ─ for example, a delivery of a SAPS V tool to a customer that previously had received only SAPS II tools ─ or to a new customer that has never purchased any tool from us. Shipments in the three and nine months ended September 30, 2022 totaled $163 million and $342 million, as compared to $99 million and $255 million for the same periods in 2021. Repeat tool shipments in the three and nine months ended September 30, 2022 totaled $112 million and $209 million, as compared to $58 million and $145 million for the same periods in 2021. First tool shipments in the three- and nine-months ended September 30, 2022 totaled $51 million and $133 million, as compared to $41 million and $110 million for the same periods in 2021. The dollar amount attributed to a “first tool” shipment is equal to the consideration we expect to receive if any and all contractual requirements are satisfied and the customer accepts the tool, or if the customer subsequently determines in its discretion to purchase the tool. There are a number of limitations related to the use of shipments in evaluating our business, including that customers have significant, or in some cases total, discretion in determining whether to accept or purchase our tools after evaluation and their decision not to accept or purchase delivered tools is likely to result in our inability to recognize revenue from the delivered tools. “First tool” shipments reflect the value of incremental new products under evaluation delivered to our customers or prospective customers for a given period and is used as an internal key metric to reflect future potential revenue opportunity. The cumulative cost of “first tool” shipments under evaluation at customers which have not been accepted by the customer is carried at cost and reflected in finished goods inventory (see note 5 to the condensed consolidated financial statements included in this report). “First tool” shipments exclude deliveries to customers for which ACM does not have a basis to expect future revenue. Adjusted EBITDA There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss), which is the nearest GAAP equivalent. Some of these limitations are: ● adjusted EBITDA excludes depreciation and amortization and, although these are non-cash expenses, the assets being depreciated or amortized may have to be replaced in the future; 65 Table of Contents ● we exclude stock-based compensation expense from adjusted EBITDA and adjusted operating income (loss), although (a) it has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy and (b) if we did not pay out a portion of our compensation in the form of stock-based compensation, the cash salary expense included in operating expenses would be higher, which would affect our cash position; ● the expenses and other items that we exclude in our calculation of adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from adjusted EBITDA when they report their operating results; ● adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs; ● adjusted EBITDA does not reflect interest expense, or the requirements necessary to service interest or principal payments on debt; ● adjusted EBITDA does not reflect income tax expense (benefit) or the cash requirements to pay taxes; ● adjusted EBITDA does not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments; ● although depreciation and amortization charges are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements; and ● adjusted EBITDA includes expense reductions and non-operating other income attributable to PRC governmental grants, which may mask the effect of underlying developments in net income, including trends in current expenses and interest expense, and free cash flow includes the PRC governmental grants, the amount and timing of which can be difficult to predict and are outside our control. The following table reconciles net income, the most directly comparable GAAP financial measure, to adjusted EBITDA: Nine Months Ended September 30, % Change 2022 v 2021 Absolute Change 2022 v 2021 2022 2021 (in thousands) Adjusted EBITDA Data: Net Income $ 36,381 $ 24,306 49.7 % $ 12,075 Interest expense (income), net (4,979 ) 461 -1180.0 % (5,440 ) Income tax expense (benefit) 14,138 (3,021 ) -568.0 % 17,159 Depreciation and amortization 4,104 1,597 157.0 % 2,507 Stock based compensation 5,236 3,823 37.0 % 1,413 Unrealized (gain) loss on trading securities 9,562 (1,817 ) -626.3 % 11,379 Adjusted EBITDA $ 64,442 $ 25,349 154.2 % $ 39,093 The $39.1 million increase in adjusted EBITDA for the nine months ended September 30, 2022 as compared to the same period in 2021 reflected a $17.2 million impact from a change in income tax benefit (expense), a $12.1 million increase in net income, an $11.4 million increase in unrealized (gain) loss on trading securities, a $1.4 million increase in stock based compensation, and a $2.5 million increase in depreciation and amortization, partly offset by a $5.4 million impact from an increase in interest income, net. We do not exclude from adjusted EBITDA expense reductions and non-operating other income attributable to PRC governmental grants because we consider and incorporate the expected amounts and timing of those grants in incurring expenses and capital expenditures. If we did not receive the grants, our cash expenses therefore would be lower, and our cash position would not be affected, to the extent we have accurately anticipated the amounts of the grants. For additional information regarding our PRC grants, please see “—Key Components of Results of Operations—PRC Government Research and Development Funding.” 66 Table of Contents Free Cash Flow The following table reconciles net cash provided by (used in) operating activities, the most directly comparable GAAP financial measure, to free cash flow: Nine Months Ended September 30, % Change 2022 v 2021 Absolute Change 2022 v 2021 2022 2021 (in thousands) Free Cash Flow Data: Net cash used in operating activities $ (63,530 ) $ (3,822 ) 1562.2 % $ (59,708 ) Purchase of property and equipment (18,417 ) (5,059 ) 264.0 % (13,358 ) Free cash flow $ (81,947 ) $ (8,881 ) 822.7 % $ (73,066 ) The $73.1 million decrease in free cash flow for the nine months ended September 30, 2022 as compared to the same period in 2021 reflected the factors driving net cash used in operating activities, an increase of purchases of property and equipment, and an increase of purchase of intangible assets. Consistent with our methodology for calculating adjusted EBITDA, we do not adjust free cash flow for the effects of PRC government subsidies, because we take those subsidies into account in incurring expenses and capital expenditures. We do not adjust free cash flow for the effects of time-deposits, which for our internal purposes are considered as largely similar to cash. Adjusted Operating Income Adjusted operating income excludes stock-based compensation from income from operations. Although stock-based compensation is an important aspect of the compensation of our employees and executives, determining the fair value of certain of the stock-based instruments we utilize involves a high degree of judgment and estimation and the expense recorded may bear little resemblance to the actual value realized upon the vesting or future exercise of the related stock-based awards. Furthermore, unlike cash compensation, the value of stock options, which is an element of our ongoing stock-based compensation expense, is determined using a complex formula that incorporates factors, such as market volatility, that are beyond our control. Management believes it is useful to exclude stock-based compensation in order to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies. The use of non-GAAP financial measures excluding stock-based compensation has limitations, however. If we did not pay out a portion of our compensation in the form of stock-based compensation, the cash salary expense included in operating expenses would be higher and our cash holdings would be less. The following tables reflect the exclusion of stock-based compensation, or SBC, from line items comprising income from operations: Nine Months Ended September 30, 2022 2021 Actual (GAAP) SBC Adjusted (Non- GAAP) Actual (GAAP) SBC Adjusted (Non-GAAP) (in thousands) Revenue $ 280,290 $ - $ 280,290 $ 164,609 $ - $ 164,609 Cost of revenue (150,480 ) (383 ) (150,097 ) (95,199 ) (289 ) (94,910 ) Gross profit 129,810 (383 ) 130,193 69,410 (289 ) 69,699 Operating expenses: Sales and marketing (27,494 ) (1,277 ) (26,217 ) (17,460 ) (1,400 ) (16,060 ) Research and development (44,391 ) (1,733 ) (42,658 ) (21,293 ) (801 ) (20,492 ) General and administrative (15,560 ) (1,843 ) (13,717 ) (11,081 ) (1,333 ) (9,748 ) Income (loss) from operations 42,365 (5,236 ) 47,601 19,576 (3,823 ) 23,399 Adjusted operating income for the nine months ended September 30, 2022 increased by $24.2 million, as compared with the same period in 2021, due to a $22.8 million increase in income from operations and a $1.4 million increase in stock-based compensation expense. 67 Table of Contents Three Months Ended September 30, 2022 2021 Actual (GAAP) SBC Adjusted (Non- GAAP) Actual (GAAP) SBC Adjusted (Non-GAAP) (in thousands) Revenue $ 133,709 $ - $ 133,709 $ 67,013 $ - $ 67,013 Cost of revenue (67,742 ) (130 ) (67,612 ) (37,328 ) (108 ) (37,220 ) Gross profit 65,967 (130 ) 66,097 29,685 (108 ) 29,793 Operating expenses: Sales and marketing (13,133 ) (349 ) (12,784 ) (6,363 ) (417 ) (5,946 ) Research and development (15,678 ) (666 ) (15,012 ) (7,856 ) (293 ) (7,563 ) General and administrative (5,520 ) (748 ) (4,772 ) (3,671 ) (460 ) (3,211 ) Income (loss) from operations 31,636 (1,893 ) 33,529 11,795 (1,278 ) 13,073 Adjusted operating income for the three months ended September 30, 2022 increased by $20.5 million, as compared with the same period in 2021, due to a $19.8 million increase in income from operations, offset by a $0.6 million increase in stock-based compensation expense.