ALPHA & OMEGA SEMICONDUCTOR Ltd 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the matters addressed in this Item 2 constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward looking statements include, but are not limited to, statements regarding future financial performance of the Company; the expected ramp up timeline of the 12-inch fab at the JV Company; the impact of government investigation and coronavirus on our financial performance; and other statements and information set forth under the heading “Factors Affecting Our Performance”. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below under the heading “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company’s management. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides certain “safe harbor” provisions for forward-looking statements. All forward-looking statements made in this Quarterly Report on Form 10-Q are made pursuant to the Act. The Company undertakes no obligation to publicly release the results of any revisions to its forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events. Unless the context otherwise requires, the words “AOS,” the “Company,” “we,” “us” and “our” refer to Alpha and Omega Semiconductor Limited and its subsidiaries. This management’s discussion should be read in conjunction with the management’s discussion included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2023, filed with the Securities and Exchange Commission on August 29, 2023. Overview We are a designer, developer and global supplier of a broad portfolio of power semiconductors. Our portfolio of power semiconductors includes approximately 2,600 products, and has grown significantly with the introduction of over 60 new products in the fiscal year ended June 30, 2023, and over 130 and 160 new products in the fiscal years ended June 30, 2022 and 2021, respectively. During the three months ended September 30, 2023, we introduced an additional 23 new products. Our teams of scientists and engineers have developed extensive intellectual property and technical knowledge that encompass major aspects of power semiconductors, which we believe enables us to introduce and develop innovative products to address the increasingly complex power requirements of advanced electronics. We have an extensive patent portfolio that consists of 923 patents and 53 patent applications in the United States as of September 30, 2023. We also have a total of 986 foreign patents, which were based primarily on our research and development efforts through September 30, 2023. We differentiate ourselves by integrating our expertise in technology, design and advanced manufacturing and packaging to optimize product performance and cost. Our portfolio of products targets high-volume applications, including personal computers, graphic cards, game consoles, flat panel TVs, home appliances, power tools, smart phones, battery packs, consumer and industrial motor controls and power supplies for TVs, computers, servers and telecommunications equipment. Our business model leverages global resources, including research and development and manufacturing in the United States and Asia. Our sales and technical support teams are localized in several growing markets. We operate an 8-inch wafer fabrication facility located in Hillsboro, Oregon, or the Oregon Fab, which is critical for us to accelerate proprietary technology development, new product introduction and improve our financial performance. To meet the market demand for the more mature high volume products, we also utilize the wafer manufacturing capacity of selected third party foundries. For assembly and test, we primarily rely upon our in-house facilities in China. In addition, we utilize subcontracting partners for industry standard packages. We believe our in-house packaging and testing capability provides us with a competitive advantage in proprietary packaging technology, product quality, cost and sales cycle time. During the fiscal quarter ended September 30, 2023, we continued our product diversification program by developing new silicon and packaging platforms to expand our serviceable available market, or SAM and offer higher performance products. Our metal-oxide-semiconductor field-effect transistors, or MOSFET, and power IC product portfolio also expanded. On March 29, 2016, we formed a joint venture (the “JV Company”) with two investment funds owned by the Municipality of Chongqing (the “Chongqing Funds”), for the purpose of constructing and operating a power semiconductor packaging, testing and 12-inch wafer fabrication facility (“Fab”) in the LiangJiang New Area of Chongqing, China. As of December 1, 2021, we owned 50.9%, and the Chongqing Funds owned 49.1% of the equity interest in the JV Company. The Joint Venture was accounted under the provisions of the consolidation guidance since we had controlling financial interest until December 1, 2021. On December 1, 2021 (the “Effective Date”), Alpha & Omega Semiconductor (Shanghai) Ltd. (“AOS SH”) and Agape Package Manufacturing (Shanghai) Limited (“APM SH” and, together with AOS SH, the “Sellers”), each a wholly-owned subsidiary of the Company, entered into a share transfer agreement ("STA") with a third-party investor to sell a portion of the 30 Company's equity interest in the JV Company which consists of a power semiconductor packaging, testing and 12-inch wafer fabrication facility in Chongqing, China (the “Transaction”). The Transaction closed on December 2, 2021 (the “Closing Date”), which reduced the Company’s equity interest in the JV Company from 50.9% to 48.8%. Also, the Company’s right to designate directors on the board of JV Company was reduced to three (3) out of seven (7) directors, from four (4) directors prior to the Transaction. As a result of the Transaction and other factors, the Company no longer has a controlling financial interest in the JV Company and has determined that the JV Company was deconsolidated from the Company’s Consolidated Financial Statements effective as of the Closing Date. On December 24, 2021, the Company entered into a share transfer agreement with another third-party investor, pursuant to which the Company sold to this investor 1.1% of outstanding equity interest held by the Company in the JV Company. In addition, the JV Company adopted an employee equity incentive plan and issued an equity interest equivalent to 3.99% of the JV Company in exchange for cash. As a result of these two transactions, the Company owned 45.8% of the equity interest in the JV Company as of December 31, 2021. On January 26, 2022, the JV Company completed a financing transaction pursuant to a corporate investment agreement (the “Investment Agreement”) between the JV Company and certain third-party investors (the “New Investors”). Under the Investment Agreement, the New Investors purchased newly issued equity interest of the JV Company, representing approximately 7.82% of post-transaction outstanding equity interests of the JV Company, for a total purchase price of RMB 509 million (or approximately USD 80 million based on the currency exchange rate as of January 26, 2022) (the “Investment”). Following the closing of the January 26, 2022 Investment, the percentage of outstanding JV equity interest beneficially owned by the Company was reduced to 42.2% at both June 30, 2022 and September 30, 2023. We reduced our ownership of the JV Company to below 50% to increase the flexibility of the JV Company to raise capital to fund its future expansion. The JV Company is also contemplating an eventual listing on the Science and Technology Innovation Board, or STAR Market, of the Shanghai Stock Exchange. The reduction of our ownership assists the JV Company in meeting certain regulatory listing requirements. A potential STAR Market listing may take several years to consummate and there is no guarantee that such listing by the JV Company will be successful or will be completed in a timely manner, or at all. In addition, the JV Company will continue to provide us with significant level of foundry capacity to enable us to develop and manufacture our products. On July 12, 2022, the current shareholders of the JV Company entered into a shareholders contract, pursuant to which the JV Company provided us with a monthly wafer production capacity guarantee, subject to future increase when the JV Company’s production capacity reaches certain specified level. Other Factors affecting our Performance The global, regional economic and PC market conditions : Because our products primarily serve consumer electronic applications, any significant changes in global and regional economic conditions could materially affect our revenue and results of operations. Since mid-2022, we have experienced an industry-wide decline of customer demand for semiconductor products, which resulted in inventory corrections and reduction of sales by our major customers that has negatively affected our recent financial performance. The prolonged and extended downturn in the semiconductor industry have a substantial impact on our operating results and financial conditions. A significant amount of our revenue is derived from sales of products in the PC markets, such as notebooks, motherboards and notebook battery packs. Therefore, a substantial decline in the PC market could have a material adverse effect on our revenue and results of operations. The PC markets have experienced a modest global decline in recent years due to continued growth of demand in tablets and smart phones, worldwide economic conditions and the industry inventory correction which had and may continue to have a material impact on the demand for our products. A decline of the PC market may have a negative impact on our revenue, factory utilization, gross margin, our ability to resell excess inventory, and other performance measures. We have executed and continue to execute strategies to diversify our product portfolio, penetrate other market segments, including the consumer, communications and industrial markets, and improve gross margins and profit by implementing cost control measures. While making efforts to reduce our reliance on the computing market, we continue to support our computing business and capitalize on the opportunities in this market with a more focused and competitive PC product strategy to gain market share. Manufacturing costs and capacity availability : Our gross margin is affected by a number of factors including our manufacturing costs, utilization of our manufacturing facilities, the product mixes of our sales, pricing of wafers from third party foundries and pricing of semiconductor raw materials. Capacity utilization affects our gross margin because we have certain fixed costs at our Shanghai facilities and our Oregon Fab. If we are unable to utilize our manufacturing facilities at a desired level, our gross margin may be adversely affected. In addition, from time to time, we may experience wafer capacity constraints, particularly at third party foundries, that may prevent us from meeting fully the demand of our customers. For example, the recent global shortage of semiconductor manufacturing capacity has provided us with both challenges and opportunities in the market, and highlighted the importance of maintaining sufficient and independent in-house manufacturing capabilities to meet increasing customer demands. While we can mitigate these constraints by increasing and re-allocating 31 capacity at our own fab, we may not be able to do so quickly or at sufficient level, which could adversely affect our financial conditions and results of operations. In addition, we enhanced the manufacturing capability and capacity of our Oregon Fab by investing in new equipment and expanding our factory facilities, which we expect will have a positive impact on our future new product development and revenue, particularly during the period of global shortage of capacity. We also rely substantially on the JV Company to provide foundry capacity to manufacture our products, therefore it is critical that we maintain continuous access to such capacity, which may not be available at sufficient level or at a pricing terms favorable to us because of lack of control over the JV Company’s operation. As a result of sales of our JV Company equity interests and issuance of additional equity interests by the JV Company to third-party investors in financing transactions, our equity interest in the JV Company was reduced to 42.2%, which resulted in the loss of control and reduced influence over the JV Company. We continue to maintain a business relationship with the JV Company to ensure uninterrupted supply of manufacturing capacity. On July 12, 2022, we entered into an agreement with the JV Company, pursuant to which the JV Company agrees to provide us with a monthly wafer production capacity guarantee, subject to future increase when the JV Company’s production capacity reaches certain specified level. Because we continue to rely on the JV Company to provide us with manufacturing capacity, if the JV Company take actions or make decisions that prevents us from accessing required capacity, our operations may be adversely affected. Erosion and fluctuation of average selling price: Erosion of average selling prices of established products is typical in our industry. Consistent with this historical trend, we expect our average selling prices of existing products to decline in the future. However, in the normal course of business, we seek to offset the effect of declining average selling price by introducing new and higher value products, expanding existing products for new applications and new customers and reducing the manufacturing cost of existing products. These strategies may cause the average selling price of our products to fluctuate significantly from time to time, thereby affecting our financial performance and profitability. Product introductions and customers’ product requirements: Our success depends on our ability to introduce products on a timely basis that meet or are compatible with our customers' specifications and performance requirements. Both factors, timeliness of product introductions and conformance to customers' requirements, are equally important in securing design wins with our customers. As we accelerate the development of new technology platforms, we expect to increase the pace at which we introduce new products and seek and acquire design wins. If we were to fail to introduce new products on a timely basis that meet customers’ specifications and performance requirements, particularly those products with major OEM customers, and continue to expand our serviceable markets, then we would lose market share and our financial performance would be adversely affected. Distributor ordering patterns, customer demand and seasonality : Our distributors place purchase orders with us based on their forecasts of end customer demand, and this demand may vary significantly depending on the sales outlook and market and economic conditions of end customers. Because these forecasts may not be accurate, channel inventory held at our distributors may fluctuate significantly, which in turn may prompt distributors to make significant adjustments to their purchase orders placed with us. As a result, our revenue and operating results may fluctuate significantly from quarter to quarter. In addition, because our products are used in consumer electronics products, our revenue is subject to seasonality. Our sales seasonality is affected by numerous factors, including global and regional economic conditions as well as the PC market conditions, revenue generated from new products, changes in distributor ordering patterns in response to channel inventory adjustments and end customer demand for our products and fluctuations in consumer purchase patterns prior to major holiday seasons. In recent periods, broad fluctuations in the semiconductor markets and the global and regional economic conditions, in particular the decline of the PC market conditions, have had a more significant impact on our results of operations than seasonality. Furthermore, our revenue may be impacted by the level of demand from our major customers due to factors outside of our control. If these major customers experience significant decline in the demand of their products, encounter difficulties or defects in their products, or otherwise fail to execute their sales and marketing strategies successfully, it may adversely affect our revenue and results of operations. 32 Principal line items of condensed consolidated statements of income The following describes the principal line items set forth in our Condensed Consolidated Statements of Income: Revenue We generate revenue primarily from the sale of power semiconductors, consisting of power discretes and power ICs. Historically, a majority of our revenue has been derived from power discrete products. Because our products typically have three-year to five-year life cycles, the rate of new product introduction is an important driver of revenue growth over time. We believe that expanding the breadth of our product portfolio is important to our business prospects, because it provides us with an opportunity to increase our total bill-of-materials within an electronic system and to address the power requirements of additional electronic systems. In addition, a small percentage of our total revenue is generated by providing packaging and testing services to third parties through one of our subsidiaries. Our product revenue is reported net of the effect of the estimated stock rotation returns and price adjustments that we expect to provide to our distributors. Stock rotation returns are governed by contract and are limited to a specified percentage of the monetary value of products purchased by the distributor during a specified period. At our discretion or upon our direct negotiations with the original design manufacturers (“ODMs”) or original equipment manufacturers (“OEMs”), we may elect to grant special pricing that is below the prices at which we sold our products to the distributors. In these situations, we will grant price adjustments to the distributors reflecting such special pricing. We estimate the price adjustments for inventory at the distributors based on factors such as distributor inventory levels, pre-approved future distributor selling prices, distributor margins and demand for our products. In February 2023, we entered into a license agreement with a customer to license our proprietary SiC technology and to provide 24-months of engineering and development services for a total fee of $45 million, consisting of an upfront fee of $18 million and $6.8 million paid to us in the March and July 2023, with the remaining amount to be paid upon the achievement of specified engineering services and product milestones. The license and development fee is determined to be one performance obligation and is recognized over the 24 months during which we perform the engineering and development services. We use the input method to measure progression of the transfer of services. As of September 30, 2023, the Company had recorded $15.6 million of license and development revenue. We also entered an accompanying supply agreement to provide limited wafer supply to the customer. Cost of goods sold Our cost of goods sold primarily consists of costs associated with semiconductor wafers, packaging and testing, personnel, including share-based compensation expense, overhead attributable to manufacturing, operations and procurement, and costs associated with yield improvements, capacity utilization, warranty and valuation of inventories. As the volume of sales increases, we expect cost of goods sold to increase. While our utilization rates cannot be immune to the market conditions, our goal is to make them less vulnerable to market fluctuations. We believe our market diversification strategy and product growth will drive higher volume of manufacturing which will improve our factory utilization rates and gross margin in the long run. Operating expenses Our operating expenses consist of research and development, and selling, general and administrative expenses. We expect our operating expenses as a percentage of revenue to fluctuate from period to period as we continue to exercise cost control measures in response to the declining PC market as well as align our operating expenses to the revenue level. Research and development expenses . Our research and development expenses consist primarily of salaries, bonuses, benefits, share-based compensation expense, expenses associated with new product prototypes, travel expenses, fees for engineering services provided by outside contractors and consultants, amortization of software and design tools, depreciation of equipment and overhead costs. We continue to invest in developing new technologies and products utilizing our own fabrication and packaging facilities as it is critical to our long-term success. We also evaluate appropriate investment levels and stay focused on new product introductions to improve our competitiveness. We expect that our research and development expenses will fluctuate from time to time. Selling, general and administrative expenses. Our selling, general and administrative expenses consist primarily of salaries, bonuses, benefits, share-based compensation expense, product promotion costs, occupancy costs, travel expenses, expenses related to sales and marketing activities, amortization of software, depreciation of equipment, maintenance costs and other expenses for general and administrative functions as well as costs for outside professional services, including legal, audit 33 and accounting services. We expect our selling, general and administrative expenses to fluctuate in the near future as we continue to exercise cost control measures. Income tax expense We are subject to income taxes in various jurisdictions. Significant judgment and estimates are required in determining our worldwide income tax expense. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations of different jurisdictions globally. We establish accruals for potential liabilities and contingencies based on a more likely than not threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, the applicable accounting guidance permits us to recognize a tax benefit measured at the largest amount of tax benefit that is more likely than not to be realized upon settlement with a taxing authority. If the actual tax outcome of such exposures is different from the amounts that were initially recorded, the differences will impact the income tax and deferred tax provisions in the period in which such determination is made. Changes in the location of taxable income (loss) could result in significant changes in our income tax expense. We record a valuation allowance against deferred tax assets if it is more likely than not that a portion of the deferred tax assets will not be realized, based on historical profitability and our estimate of future taxable income in a particular jurisdiction. Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws, tax planning strategies or other factors. If our assumptions and consequently our estimates change in the future, the deferred tax assets may increase or decrease, resulting in corresponding changes in income tax expense. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide profits or losses, the tax laws and regulations in each geographical region where we have operations, the availability of tax credits and carry-forwards and the effectiveness of our tax planning strategies. "U.S. Tax Cuts and Jobs Act", Enacted December 22, 2017 On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act (“the Tax Act”), which significantly changes the existing U.S. tax laws, including, but not limited to, (1) a reduction in the corporate tax rate from 35% to 21%, (2) a shift from a worldwide tax system to a territorial system, (3) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized, (4) bonus depreciation that will allow for full expensing of qualified property, (5) creating a new limitation on deductible interest expense and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. The Company is not currently subject to the Base Erosion and Anti-Abuse (BEAT) tax, which is a tax imposed on certain entities who make payments to their non U.S. affiliates, where such payments reduce the U.S. tax base. The BEAT tax is imposed at a rate of 10% on Adjusted Taxable Income, excluding certain payments to foreign related entities. It is an incremental tax over and above the corporate income tax and is recorded as a period cost. It is possible that this tax could be applicable in future periods, which would cause an increase to the effective tax rate and cash taxes. “The Chip and Science Act of 2022”, Enacted August 2, 2022 In August 2022 the U.S. enacted the Chip and Science Act of 2022 (the Chips Act). The Chips Act provides incentives to semiconductor chip manufacturers in the United States, including providing manufacturing investment credits of 25% for investments in semiconductor manufacturing property placed in service after December 31, 2022, for which construction begins before January 1, 2027. Property investments qualify for the 25% credit if, among other requirements, the property is integral to the operation of an advanced manufacturing facility, defined as having a primary purpose of manufacturing semiconductors or semiconductor manufacturing equipment. Currently, we are evaluating the impact of the Chips Act to us. “The Inflation Reduction Act”, Enacted August 16, 2022 In August 2022 the United States enacted tax legislation through the Inflation Reduction Act (IRA). The IRA introduces a 15% corporate alternative minimum tax (CAMT) for corporations whose average annual adjusted financial statement income (AFSI) for any consecutive three-tax-year period preceding the applicable tax year exceeds $1 billion. The CAMT is effective for tax years beginning after 31 December 2022. The CAMT is currently not applicable to the Company. 34 Altera Litigation On July 27, 2015, in Altera Corp. v. Commissioner, the U.S. Tax Court issued an opinion related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. In the July 2015 ruling, the Tax Court concluded that the sharing of the cost of employee stock compensation in a company’s cost-sharing arrangement was invalid under the U.S. Administrative Procedures Act. In June 2019, a panel of the Ninth Circuit of the U.S. Court of Appeals reversed this decision. In July 2019, Altera petitioned U.S. Court of Appeals for the Ninth Circuit to hold an en banc rehearing of the case. The petition was subsequently denied by the Ninth Circuit. Altera appealed the case to the U.S. Supreme Court in February 2020, but the U.S. Supreme Court declined to hear the case in June 2020, leaving intact the U.S. Court of Appeals for the Ninth Circuit’s decision. AOS has not recorded any benefit related to the Altera Corporation Tax Court decision in any period through December 2022. The Company will continue to monitor ongoing developments and potential impact to its financial statements. Equity method investment income/loss from equity investee We use the equity method of accounting when we have the ability to exercise significant influence, but we do not have control, as determined in accordance with generally accepted accounting principles, over the operating and financial policies of the company. Effective December 2, 2021, we reduced our equity interest in the JV Company below 50% of outstanding equity ownership and experienced a loss of control of the JV Company. As a result, we record our investment under equity method of accounting. Since we are unable to obtain accurate financial information from the JV Company in a timely manner, we record our share of earnings or losses of such affiliate on a one quarter lag. We record our interest in the net earnings of the equity method investee, along with adjustments for unrealized profits or losses on intra-entity transactions and amortization of basis differences, within earnings or loss from equity interests in the Consolidated Statements of Income. Profits or losses related to intra-entity sales with the equity method investee are eliminated until realized by the investor or investee. Basis differences represent differences between the cost of the investment and the underlying equity in net assets of the investment and are generally amortized over the lives of the related assets that gave rise to them. Equity method goodwill is not amortized or tested for impairment. Instead the total equity method investment balance, including equity method goodwill, is tested for impairment. We review for impairment whenever factors indicate that the carrying amount of the investment might not be recoverable. In such a case, the decrease in value is recognized in the period the impairment occurs in the Consolidated Statement of Income. 35 Results of Operations The following tables set forth statements of income, also expressed as a percentage of revenue, for the three months ended September 30, 2023 and 2022. Our historical results of operations are not necessarily indicative of the results for any future period. Three Months Ended September 30, 2023 2022 2023 2022 (in thousands) (% of revenue) Revenue $ 180,633 $ 208,476 100.0 % 100.0 % Cost of goods sold 129,708 137,348 71.8 % 65.9 % Gross profit 50,925 71,128 28.2 % 34.1 % Operating expenses Research and development 22,113 21,389 12.2 % 10.3 % Selling, general and administrative 19,431 24,205 10.8 % 11.6 % Total operating expenses 41,544 45,594 23.0 % 21.9 % Operating income 9,381 25,534 5.2 % 12.2 % Other income (loss), net 26 (16) — % — % Interest income (expense), net 229 (608) 0.1 % (0.3) % Net income before income taxes 9,636 24,910 5.3 % 11.9 % Income tax expense 1,138 1,374 0.6 % 0.6 % Net income before income (loss) from equity method investment 8,498 23,536 4.7 % 11.3 % Equity method investment income (loss) from equity investee (2,712) 2,502 (1.5) % 1.2 % Net income $ 5,786 $ 26,038 3.2 % 12.5 % Share-based compensation expense was recorded as follows: Three Months Ended September 30, 2023 2022 2023 2022 (in thousands) (% of revenue) Cost of goods sold $ 212 $ 1,788 0.1 % 0.9 % Research and development 6 2,494 — % 1.2 % Selling, general and administrative 700 6,314 0.4 % 3.0 % Total $ 918 $ 10,596 0.5 % 5.1 % 36 Three Months Ended September 30, 2023 and 2022 Revenue The following is a summary of revenue by product type: Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Power discrete $ 121,500 $ 144,573 $ (23,073) (16.0) % Power IC 52,747 62,320 (9,573) (15.4) % Packaging and testing services 745 1,583 (838) (52.9) % License and development services 5,641 — 5,641 100.0 % $ 180,633 $ 208,476 $ (27,843) (13.4) % The following is a summary of revenue by end market: Three Months Ended September 30, 2023 2022 2023 2022 (in thousands) (% of revenue) Computing $ 70,350 $ 89,265 38.9 % 42.8 % Consumer 31,090 45,280 17.2 % 21.7 % Communication 31,027 31,421 17.2 % 15.1 % Power Supply and Industrial 41,780 40,927 23.2 % 19.6 % Packaging and testing services 745 1,583 0.4 % 0.8 % License and development services 5,641 — 3.1 % — % $ 180,633 $ 208,476 100.0 % 100.0 % Total revenue was $180.6 million for the three months ended September 30, 2023, a decrease of $27.8 million, or 13.4%, as compared to $208.5 million for the same quarter last year. The decrease was primarily due to a decrease of $23.1 million and $9.6 million in sales of power discrete products and power IC products, respectively. The decrease in power discrete and power IC product sales was primarily due to a 21.7% decrease in average selling price as compared to same quarter last year due to a shift in product mix, offset by a 7.5% increase in unit shipments. The decrease in revenues was primarily driven by the significant decrease in the computing market, reflecting weaker demand for computers and inventory correction by our customers, and decreased in the consumer markets, particularly in gaming products. The decrease in revenue of packaging and testing services for the three months ended September 30, 2023, as compared to same quarter last year, was primarily due to decreased demand. The increase in license and development services for the three months ended September 30, 2023 was related to the license agreement with a customer to license our proprietary SiC technology and to provide 24-month engineering and development services. Cost of goods sold and gross profit Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Cost of goods sold $ 129,708 $ 137,348 $ (7,640) (5.6) % Percentage of revenue 71.8 % 65.9 % Gross profit $ 50,925 $ 71,128 $ (20,203) (28.4) % Percentage of revenue 28.2 % 34.1 % 37 Cost of goods sold was $129.7 million for the three months ended September 30, 2023, a decrease of $7.6 million, or 5.6%, as compared to $137.3 million for the same quarter last year. The decrease was primarily due to 13.4% decrease in revenue. Gross margin decreased by 5.9 percentage points to 28.2% for the three months ended September 30, 2023, as compared to 34.1% for the same quarter last year. The decrease in gross margin was primarily due to higher material costs and less favorable product mix during the three months ended September 30, 2023. Research and development expenses Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Research and development expenses $ 22,113 $ 21,389 $ 724 3.4 % Research and development expenses were $22.1 million for the three months ended September 30, 2023, an increase of $0.7 million, or 3.4%, as compared to $21.4 million for the same quarter last year. The increase was primarily attributable to $1.1 million increase in product prototyping engineering expense as a result of increased engineering activities, a $0.7 million increase in employee compensation and benefit expense mainly due to increased headcount and higher business and medical insurance expenses, partially offset by lower bonus accrual, a $0.2 million increase in depreciation expenses, a $0.2 million increase in consulting fees and a $1.1 million in allocation, partially offset by a $2.5 million decrease in share-based compensation expense as a result of more cancellation of performance-based restricted stock units and a modification of market-based restricted stock units. Selling, general and administrative expenses Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Selling, general and administrative $ 19,431 $ 24,205 $ (4,774) (19.7) % Selling, general and administrative expenses were $19.4 million for the three months ended September 30, 2023, a decrease of $4.8 million, or 19.7%, as compared to $24.2 million for the same quarter last year. The decrease was primarily due to a $1.2 million decrease in employee compensation and benefits expenses primarily due to lower bonus expenses accrual, partially offset by increased medical and business insurance expenses, as well as a $5.6 million decrease in share-based compensation expense as a result of more cancellation of performance-based restricted stock units and a modification of market-based restricted stock units, partially offset by a $0.5 million increase in legal expenses, a $0.6 million increase in audit fees, a $0.5 million increase in consulting fees, a $0.3 million increase in employee business expenses and a $0.3 million increase in facility expenses as a result of more rent expenses. Other income (loss), net Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Other income (loss), net $ 26 $ (16) $ 42 (262.5) % Other income (loss), net in the three months ended September 30, 2023 and 2022 was flat. 38 Interest income (expense), net Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Interest income (expense), net $ 229 $ (608) $ 837 (137.7) % Interest income (expense), net increased by $0.8 million during the three months ended September 30, 2023 as compared to the same quarter last year primarily due to a $0.9 million increase in interest income as a result of higher interest rates, partially offset by a $0.1 million increase in interest expense as a result of an increase in bank borrowings. Income tax expense Three Months Ended September 30, 2023 2022 Change (in thousands) (in thousands) (in percentage) Income tax expense $ 1,138 $ 1,374 $ (236) (17.2) % The Company recognized income tax expense of approximately $1.1 million and $1.4 million for the three months ended September 30, 2023 and 2022, respectively. The income tax expense of $1.1 million for the three months ended September 30, 2023 included a $0.05 million discrete tax expense. The income tax expense of $1.4 million for the three months ended September 30, 2022 included a $0.07 million discrete tax expense. Excluding the discrete income tax items, the income tax expense for the three months ended September 30, 2023 and 2022 was $1.1 million and $1.3 million, respectively, and the effective tax rate for the three months ended September 30, 2023 and 2022 was 15.7% and 4.8%, respectively. The changes in the tax expense and effective tax rate between the periods resulted primarily from changes in the mix of earnings in various geographic jurisdictions between the current year and the same period of last year. The Company files its income tax returns in the United States and in various foreign jurisdictions. The tax years 2004 to 2023 remain open to examination by U.S. federal and state tax authorities. The tax years 2017 to 2023 remain open to examination by foreign tax authorities. The Company's income tax returns are subject to examinations by the Internal Revenue Service and other tax authorities in various jurisdictions. In accordance with the guidance on the accounting for uncertainty in income taxes, the Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. These assessments can require considerable estimates and judgments. As of September 30, 2023, the gross amount of unrecognized tax benefits was approximately $9.4 million, of which $6.3 million, if recognized, would reduce the effective income tax rate in future periods. If the Company's estimate of income tax liabilities proves to be less than the ultimate assessment, then a further charge to expense would be required. If the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when the Company determines the liabilities are no longer necessary. The Company does not anticipate any material changes to its uncertain tax positions during the next twelve months. Liquidity and Capital Resources Our principal need for liquidity and capital resources is to maintain sufficient working capital to support our operations and to invest adequate capital expenditures to grow our business. To date, we finance our operations and capital expenditures primarily through funds generated from operations and borrowings under our term loans, financing lease and other debt agreements. On February 6, 2023, we entered into a license and engineering service agreement with a leading power semiconductor automotive supplier related to our Silicon Carbide (SiC) MOSFET and diode technology. Pursuant to the agreement, we license and provide 24-month engineering support for our proprietary SiC technology to the supplier for a total fee of $45 million, consisted of an upfront fees of $18 million and $6.8 million paid to us in the March and July 2023, respectively, and the remaining amount to be paid upon our achievements of specified business and product milestones. In addition, we entered an accompanying supply agreement with the supplier to provide it with limited wafer supply. 39 In September 2023, one of the Company's subsidiaries in China entered into a line of credit facility with China Construction Bank. The purpose of the credit facility is to provide working capital borrowings. The Company could borrow up to approximately RMB 50 million or $6.8 million based on currency exchange rate between RMB and U.S. Dollar on September 30, 2023 with a maturity date of September 8, 2025. As of September 30, 2023, there was no outstanding balance for this loan. In January 2023, one of the Company's subsidiaries in China entered into a line of credit facility with Bank of Communications Limited in China. The purpose of the credit facility is to provide working capital borrowings. The Company could borrow up to approximately RMB 140 million or $20.6 million based on currency exchange rate between RMB and U.S. Dollar on January 31, 2023 with a maturity date of December 1, 2023. As of September 30, 2023, there was no outstanding balance for this loan. In September 2022, one of the Company's subsidiaries in China entered into a line of credit facility with Industrial and Commercial Bank of China. The purpose of the credit facility was to provide working capital borrowings. The Company could borrow up to approximately RMB 72.0 million, or $10.3 million based on currency exchange rate between RMB and U.S. Dollar on September 20, 2022, with a maturity date of September 30, 2023. As of September 30, 2023, there was no outstanding balance and this loan expired. In September 2021, Jireh Semiconductor Incorporated (“Jireh”), one of the wholly-owned subsidiaries, entered into a financing arrangement agreement with a company (“Lender”) for the lease and purchase of a machinery equipment manufactured by a supplier. This agreement has a 5 years term, after which Jireh has the option to purchase the equipment for $1. The implied interest rate was 4.75% per annum which was adjustable based on every five basis point increase in 60-month U.S. Treasury Notes, until the final installation and acceptance of the equipment . The total purchase price of this equipment was euro 12.0 million. In April 2021, Jireh made a down payment of euro 6.0 million, representing 50% of the total purchase price of the equipment, to the supplier. In June 2022, the equipment was delivered to Jireh after Lender paid 40% of the total purchase price, for euro 4.8 million, to the supplier on behalf of Jireh. In September 2022, Lender paid the remaining 10% payment for the total purchase price and reimbursed Jireh for the 50% down payment, after the installation and configuration of the equipment. The title of the equipment was transferred to Lender following such payment. The agreement was amended with fixed implied interest rate of 7.51% and monthly payment of principal and interest effective in October 2022. Other terms remain the same. In addition, Jireh purchased hardware for the machine under this financing arrangement. The purchase price of this hardware was $0.2 million. The financing arrangement is secured by this equipment and other equipment which had the carrying amount of $14.8 million as of September 30, 2023. As of September 30, 2023, the outstanding balance of this debt financing was $11.0 million. On August 18, 2021, Jireh entered into a term loan agreement with a financial institution (the "Bank") in an amount up to $45.0 million for the purpose of expanding and upgrading the Company’s fabrication facility located in Oregon. The obligation under the loan agreement is secured by substantially all assets of Jireh and guaranteed by the Company. The agreement has a 5.5 year term and matures on February 16, 2027. Jireh is required to make consecutive quarterly payments of principal and interest. The loan accrues interest based on adjusted LIBOR plus the applicable margin based on the outstanding balance of the loan. This agreement contains customary restrictive covenants and includes certain financial covenants that the Company is required to maintain. Jireh drew down $45.0 million on February 16, 2022 with the first payment of principal beginning in October 2022. As of September 30, 2023, Jireh was in compliance with these covenants and the outstanding balance of this loan wa s $36.0 million. On August 9, 2019, one of the Company's wholly-owned subsidiaries (the “Borrower”) entered into a factoring agreement with the Hongkong and Shanghai Banking Corporation Limited (“HSBC”), whereby the Borrower assigns certain of its accounts receivable with recourse. This factoring agreement allows the Borrower to borrow up to 70% of the net amount of its eligible accounts receivable of the Borrower with a maximum amount of $30.0 million. The interest rate is based on one month London Interbank Offered Rate (“LIBOR”) plus 1.75% per annum. The Company is the guarantor for this agreement. The Company is accounting for this transaction as a secured borrowing under the Transfers and Servicing of Financial Assets guidance. In addition, any cash held in the restricted bank account controlled by HSBC has a legal right of offset against the borrowing. This agreement, with certain financial covenants required, has no expiration date. On August 11, 2021, the Borrower signed an agreement with HSBC to reduce the borrowing maximum amount to $8.0 million with certain financial covenants required. Other terms remain the same. As of September 30, 2023, the Borrower was in compliance with these covenants. As of September 30, 2023, there was no outstanding balance and the Company had unused credit of approximately $8.0 million. We believe that our current cash and cash equivalents and cash flows from operations will be sufficient to meet our anticipated cash needs, including working capital and capital expenditures, for at least the next twelve months. In addition, we commenced an investment plan to expand the manufacturing capacity and upgrade the operational capabilities of our Oregon Fab. We intend to fund the costs by a combination of cash reserve, bank loans and equipment leases. In the long-term, we may require additional capital due to changing business conditions or other future developments, including any investments or 40 acquisitions we may decide to pursue. If our cash is insufficient to meet our needs, we may seek to raise capital through equity or debt financing. The sale of additional equity securities could result in dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and may include operating and financial covenants that would restrict our operations. We cannot be certain that any financing will be available in the amounts we need or on terms acceptable to us, if at all. Cash, cash equivalents and restricted cash As of September 30, 2023 and June 30, 2023, we h a d $193.8 million and $195.6 million of cash, cash equivalents and restricted cash, respectively. Our cash, cash equivalents and restricted cash primarily consist of cash on hand, restricted cash, and short-term bank deposits with original maturities of three months or less. Of the $193.8 million and $195.6 million cash, cash equivalents and restricted cash, $114.6 million and $108.2 million, respectively, are deposited with financial institutions outside the United States. The following table shows our cash flows from operating, investing and financing activities for the periods indicated: Three Months Ended September 30, 2023 2022 (in thousands) Net cash provided by operating activities $ 13,823 $ 36,675 Net cash used in investing activities (12,510) (39,974) Net cash provided by (used in) financing activities (2,999) 5,462 Effect of exchange rate changes on cash, cash equivalents and restricted cash (135) (417) Net increase (decrease) in cash, cash equivalents and restricted cash $ (1,821) $ 1,746 Cash flows from operating activities Net cash provided by operating activities of $13.8 million for the three months ended September 30, 2023 resulted primarily from net income of $5.8 million and non-cash expenses of $15.4 million, partially offset by net changes in assets and liabilities using cash of $7.4 million, The non-cash expenses of $15.4 million primarily included $0.9 million of share-based compensation expense, $13.0 million of depreciation and amortization expenses, $2.7 million of loss from equity investment and $1.2 million of deferred income taxes. The net changes in assets and liabilities of $7.4 million were primarily due to a $8.2 million increase in net payable from equity investee, a $3.1 million increase in accounts payable due to timing of payments, and $1.1 million increase in deferred revenue, partially offset by a $4.5 million increase in inventories as a result of our inventories built up for preparation of uncertainty of supply chains, $1.3 million increase in other current and long-term assets due to increase in advance payments to vendors, and a $1.1 million decrease in accrued and other liabilities, a $12.0 million increase in accounts receivable as a result of timing of the shipments and payments collected, and a $0.8 million decrease in income taxes payable. Net cash provided by operating activities of $36.7 million for the three months ended September 30, 2022 resulted primarily from net income of $26.0 million and non-cash expenses of $17.7 million, partially offset by net changes in assets and liabilities using cash of $7.1 million, The non-cash expenses of $17.7 million primarily included $10.6 million of share-based compensation expense, $9.4 million of depreciation and amortization expenses, $0.4 million of loss on disposal of property and equipment, and $2.5 million of income on equity investment. The net changes in assets and liabilities of $7.1 million were primarily due to a $9.5 million decrease in other payable from equity investee, a $6.0 million decrease in accounts payable due to timing of payments, a $6.9 million increase in inventories as a result of our inventories built up for preparation of uncertainty of supply chains, and a $0.5 million increase in other current and long-term assets due to increase in advance payments to vendors, partially offset by a $9.9 million decrease in accounts receivable as a result of timing of the shipments and payments collected, a $0.5 million increase in income taxes payable, and a $5.5 million increase in accrued and other liabilities. Cash flows from investing activities Net cash used in investing activities of $12.5 million for the three months ended September 30, 2023 was primarily due to purchases of property and equipment, Net cash used in investing activities of $40.0 million for the three months ended September 30, 2022 was primarily attributable to $40.3 million purchases of property and equipment, partially offset by $0.3 million government grants related to fixed assets. 41 Cash flows from financing activities Net cash used in financing activities of $3.0 million for the three months ended September 30, 2023 was primarily attributable to $2.9 million in repayments of borrowings, $0.2 million in payment of finance lease obligations, and $0.4 million in common shares acquired to settle withholding tax related to vesting of restricted stock units, partially offset by $0.4 million of proceeds from exercise of stock options and ESPP. Net cash provided by financing activities of $5.5 million for the three months ended September 30, 2022 was primarily attributable to $8.6 million proceeds from borrowings, partially offset by $2.6 million in repayments of borrowings, $0.2 million in payment of finance lease obligations, and $0.4 million in common shares acquired to settle withholding tax related to vesting of restricted stock units. Commitments See Note 12 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for a description of commitments. Off-Balance Sheet Arrangements As of September 30, 2023, we had no off-balance sheet arrangements. Contractual Obligations There were no material changes outside of our ordinary course of business in our contractual obligations from those disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2023. Recent Accounting Pronouncements See Note 1 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference. 42 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in the market risks previously disclosed in Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the year ended June 30, 2023, filed with the SEC on August 29, 2023.