Credo Technology Group Holding Ltd 10-Q

Item 1. Financial Statements. Credo Technology Group Holding Ltd Condensed Consolidated Balance Sheets (unaudited, in thousands, except per share amounts) October 29, 2022 April 30, 2022 Assets Current Assets: Cash and cash equivalents $ 190,542 $ 259,322 Short-term investments 50,000 — Accounts receivable 51,768 29,524 Inventories 47,829 27,337 Contract assets 6,434 10,071 Prepaid expenses and other current assets 3,234 5,923 Total current assets 349,807 332,177 Property and equipment, net 40,664 21,844 Right of use assets 16,132 16,954 Other non-current assets 7,429 4,714 Total assets $ 414,032 $ 375,689 Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ 23,273 $ 8,487 Accrued compensation and benefits 5,373 4,713 Accrued expenses and other current liabilities 19,447 12,063 Deferred revenue 1,389 1,234 Total current liabilities 49,482 26,497 Non-current operating lease liabilities 14,081 14,809 Other non-current liabilities 6,365 220 Total liabilities 69,928 41,526 Commitments and contingencies (Note 7) Shareholders' equity: Ordinary shares, $ 0.00005 par value; 1,000,000 shares authorized; 146,486 shares issued and outstanding at October 29, 2022; and 1,000,000 shares authorized; 144,755 shares issued and outstanding at April 30, 2022 7 7 Additional paid in capital 438,352 424,562 Accumulated other comprehensive income (loss) ( 393 ) 23 Accumulated deficit ( 93,862 ) ( 90,429 ) Total shareholders' equity 344,104 334,163 Total liabilities and shareholders' equity $ 414,032 $ 375,689 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4 Credo Technology Group Holding Ltd Condensed Consolidated Statements of Operations (unaudited, in thousands, except per share amounts) Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Revenue: Product sales $ 44,349 $ 18,454 $ 79,612 $ 25,717 Product engineering services 3,750 1,355 4,574 2,674 IP license 2,084 6,142 12,464 7,172 IP license engineering services 1,186 476 1,186 1,588 Total revenue 51,369 26,427 97,836 37,151 Cost of revenue: Cost of product sales revenue 22,658 9,849 40,183 14,206 Cost of product engineering services revenue 418 532 518 1,397 Cost of IP license revenue — — 1,179 — Cost of IP license engineering services revenue 334 92 334 414 Total cost of revenue 23,410 10,473 42,214 16,017 Gross profit 27,959 15,954 55,622 21,134 Operating expenses: Research and development 18,158 11,800 34,841 21,493 Selling, general and administrative 11,540 7,708 22,738 14,825 Total operating expenses 29,698 19,508 57,579 36,318 Operating loss ( 1,739 ) ( 3,554 ) ( 1,957 ) ( 15,184 ) Other income (expense), net ( 692 ) 55 ( 912 ) 10 Loss before income taxes ( 2,431 ) ( 3,499 ) ( 2,869 ) ( 15,174 ) Provision for income taxes 929 601 564 1,503 Net loss $ ( 3,360 ) $ ( 4,100 ) $ ( 3,433 ) $ ( 16,677 ) Net loss per share: Basic and diluted $ ( 0.02 ) $ ( 0.06 ) $ ( 0.02 ) $ ( 0.24 ) Weighted-average shares: Basic and diluted 146,012 69,094 145,545 68,751 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 Credo Technology Group Holding Ltd Condensed Consolidated Statements of Comprehensive Loss (unaudited, in thousands) Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Net loss $ ( 3,360 ) $ ( 4,100 ) $ ( 3,433 ) $ ( 16,677 ) Other comprehensive gain (loss): Foreign currency translation gain (loss) ( 320 ) 32 ( 416 ) 27 Total comprehensive loss $ ( 3,680 ) $ ( 4,068 ) $ ( 3,849 ) $ ( 16,650 ) The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 6 Credo Technology Group Holding Ltd Condensed Consolidated Statements of Convertible Preferred Shares and Shareholders’ Equity (Deficit) (unaudited, in thousands) Convertible Preferred Shares Ordinary Shares Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Total Shareholders’ Equity (Deficit) Number of Shares Amount Number of Shares Amount Balances at April 30, 2022 — — 144,755 $ 7 $ 424,562 $ 23 $ ( 90,429 ) $ 334,163 Ordinary shares issued under equity incentive plans — — 589 — 1,977 — — 1,977 Share-based compensation — — — — 5,546 — — 5,546 Warrant contra revenue — — — — 388 — — 388 Total comprehensive loss — — — — — ( 96 ) ( 73 ) ( 169 ) Balances at July 30, 2022 — $ — 145,344 $ 7 $ 432,473 $ ( 73 ) $ ( 90,502 ) $ 341,905 Ordinary shares issued under equity incentive plans — — 1,142 — 741 — — 741 Share-based compensation — — — — 4,891 — — 4,891 Warrant contra revenue — — — — 247 — — 247 Total comprehensive loss — — — — — ( 320 ) ( 3,360 ) ( 3,680 ) Balances at October 29, 2022 — $ — 146,486 $ 7 $ 438,352 $ ( 393 ) $ ( 93,862 ) $ 344,104 Balances at April 30, 2021 50,809 $ 197,965 68,282 $ 3 $ 12,592 $ 227 $ ( 68,253 ) $ ( 55,431 ) Issuance of Series D+ convertible preferred shares, net of issuance costs 1,251 7,245 — — — — — — Ordinary shares issued under equity incentive plans — — 554 — 461 — — 461 Share-based compensation — — — — 1,075 — — 1,075 Total comprehensive loss — — — — — ( 5 ) ( 12,577 ) ( 12,582 ) Balances at July 31, 2021 52,060 $ 205,210 68,836 $ 3 $ 14,128 $ 222 $ ( 80,830 ) $ ( 66,477 ) Ordinary shares issued under equity incentive plans — — 667 — 587 — — 587 Share-based compensation — — — — 1,307 — — 1,307 Total comprehensive loss — — — — — 32 ( 4,100 ) ( 4,068 ) Balances at October 31, 2021 52,060 205,210 69,503 $ 3 $ 16,022 $ 254 $ ( 84,930 ) $ ( 68,651 ) The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 7 Credo Technology Group Holding Ltd Condensed Consolidated Statements of Cash Flows (unaudited, in thousands) Six Months Ended October 29, 2022 October 31, 2021 Cash flows from operating activities: Net loss $ ( 3,433 ) $ ( 16,677 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 4,260 2,000 Share-based compensation 10,437 2,382 Warrant contra revenue 635 — Write-downs for excess and obsolete inventory 1,102 696 Changes in operating assets and liabilities: Accounts receivable ( 22,244 ) ( 15,335 ) Inventories ( 21,594 ) ( 14,879 ) Contract assets 3,629 ( 900 ) Prepaid and other current assets 2,689 ( 124 ) Other non-current assets ( 998 ) ( 1,691 ) Accounts payable 10,073 3,135 Accrued expenses, compensation and other liabilities 4,827 5,015 Deferred revenue 155 1,459 Net cash used in operating activities ( 10,462 ) ( 34,919 ) Cash flows from investing activities: Purchases of property and equipment ( 10,925 ) ( 4,985 ) Purchases of short-term investments ( 50,000 ) — Net cash used in investing activities ( 60,925 ) ( 4,985 ) Cash flows from financing activities: Payments for IPO offering costs — ( 948 ) Proceeds from employee share incentive plans 2,723 869 Proceeds from issuance of convertible preferred shares, net of issuance costs — 7,245 Net cash provided by financing activities 2,723 7,166 Effect of exchange rate changes on cash ( 116 ) 28 Net decrease in cash and cash equivalents ( 68,780 ) ( 32,710 ) Cash and cash equivalents at beginning of the period 259,322 103,757 Cash and cash equivalents at end of the period $ 190,542 $ 71,047 Supplemental cash flow information: Purchase of property and equipment included in accounts payable, accrued expenses and other liabilities $ 14,513 $ 183 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 8 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements 1. Description of Business and Basis of Presentation Credo Technology Group Holding Ltd was formed under the laws of the Cayman Islands in September 2014. Credo Technology Group Holding Ltd directly owns Credo Technology Group Ltd., which owns, directly and indirectly, all of the shares of its subsidiaries in mainland China, Hong Kong, and the United States (“U.S.”). References to the “Company” in these notes refer to Credo Technology Group Holding Ltd and its subsidiaries on a consolidated basis, unless otherwise specified. The Company is an innovator in providing secure, high-speed connectivity solutions that deliver improved power and cost efficiency. The Company’s connectivity solutions are optimized for optical and electrical Ethernet applications, including the emerging 100G, 200G, 400G and 800G markets. The Company’s products are based on its Serializer/Deserializer (“SerDes”) and Digital Signal Processor (“DSP”) technologies. The Company’s product families include integrated circuits (“ICs”), Active Electrical Cables (“AECs”) and SerDes Chiplets. The Company’s intellectual property (“IP”) solutions consist primarily of SerDes IP licensing. Basis of Presentation The accompanying unaudited condensed consolidated financial statements are presented in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted as permitted by the SEC. These unaudited condensed consolidated financial statements and related notes should be read in conjunction with the Company’s fiscal year 2022 audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2022. The unaudited condensed consolidated financial statements include all adjustments, including normal recurring adjustments and other adjustments, that are considered necessary for fair presentation of the Company’s financial position and results of operations. All inter-company accounts and transactions have been eliminated. Operating results for the periods presented herein are not necessarily indicative of the results that may be expected for the entire year. Effective May 1, 2022, the Company changed its fiscal year to a 52- or 53-week period ending on the Saturday closest to April 30. Our fiscal year ending April 29, 2023 (“fiscal year 2023”) is a 52-week fiscal year. The first quarter of our fiscal year 2023 ended on July 30, 2022, the second quarter ended on October 29, 2022 and the third quarter ends on January 28, 2023. 2. Significant Accounting Policies The Company believes that other than the adoption of new accounting pronouncements and the accounting policies as described below, there have been no significant changes during the three and six months ended October 29, 2022 to the items disclosed in Note 2, “Significant Accounting Policies,” included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2022. Use of Estimates The preparation of these condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. The Company bases its estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future, given the available information. Estimates are used for, but not limited to, write-down for excess and obsolete inventories, the standalone selling price for each distinct performance obligation included in customer contracts with multiple performance obligations, variable consideration from revenue contracts, determination of the fair value of share-based awards, ordinary shares and a customer warrant, realization of tax assets and estimates of tax reserves, and incremental borrowing rate used in the Company’s operating lease calculations. Actual results may differ from those estimates and such differences may be material to the financial statements. In the current macroeconomic environment affected by COVID-19, these estimates require increased judgment and carry a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, these estimates may change materially in future periods. Reclassifications 9 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements Certain prior period balances were reclassified to conform to the current period’s presentation. None of these reclassifications had an impact on reported net income or cash flows for any of the periods presented. Cash, Cash Equivalents and Short-term Investments Cash and cash equivalents are highly liquid investments with insignificant interest rate risk and maturities of three months or less at the time of acquisition. Cash and cash equivalents consist primarily of cash balances in the Company’s bank checking and savings accounts, and government and institutional money market funds. Investments not considered cash equivalents, and with maturities of one year or less from the consolidated balance sheet date, are classified as short-term investments. Short-term investments consist of a certificate of deposit with original maturity date between three and twelve months. The classification of our investments in marketable debt securities is determined at the time of purchase, and such determination is reevaluated at each balance sheet date. Marketable debt securities are classified as available-for-sale. These investments are considered impaired when a decline in fair value is judged to be other-than-temporary. We consult with our investment managers and consider available quantitative and qualitative evidence in evaluating potential impairment of our investments on a quarterly basis. If the cost of an individual investment exceeds its fair value, we evaluate, among other factors, general market conditions, the duration and extent to which the fair value is less than cost, and our intent and ability to hold the investment. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is established. Accounting Pronouncement Recently Adopted In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes , which simplifies the accounting for income taxes by eliminating some exceptions to the general approach in Topic 740 in order to reduce cost and complexity of its application. This new guidance is effective for the Company for its fiscal year beginning May 1, 2022. The Company adopted this guidance on May 1, 2022 prospectively, and the impact on its consolidated financial statements was not material. Recent Accounting Pronouncements Not Yet Adopted In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected, with further clarifications made more recently. For trade receivables, loans and other financial instruments, the Company will be required to use a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable. Credit losses relating to available-for-sale debt securities are required to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. This guidance is effective for the Company for its fiscal year beginning April 30, 2023 and interim periods within its fiscal year beginning April 28, 2024. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements. 3. Concentrations Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short term investments and accounts receivable. Cash is placed in major financial institutions around the world. The Company’s cash deposits exceed insured limits. Short-term investments are subject to counterparty risk up to the amount presented on the balance sheet. Historically, a relatively small number of customers have accounted for a significant portion of the Company’s revenue. The particular customers which account for revenue concentration have varied from period-to-period as a result of the addition of new contracts, completion of existing contracts, and the volumes and prices at which the customers have recently bought the Company’s products. These variations are expected to continue in the foreseeable future. 10 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements The following table summarizes the significant customers’ accounts receivable and revenue as a percentage of total accounts receivable and total revenue, respectively: Accounts Receivable October 29, 2022 April 30, 2022 Customer A 44 % * Customer B 21 % * Customer C 14 % 52 % Customer D 11 % 14 % Three months ended Six months ended Revenue October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Customer A 44 % * 43 % * Customer B * 22 % * 15 % Customer C 16 % 33 % 11 % 24 % Customer D 19 % * 13 % 15 % Customer E * 19 % * 19 % * Less than 10% of total accounts receivable or total revenue. 4. Revenue Recognition The following table summarizes revenue disaggregated by primary geographical market based on destination of shipment and location of contracting entity, which may differ from the customer’s principal offices (in thousands): Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Mainland China $ 31,423 $ 9,255 $ 54,179 $ 9,336 United States 6,422 8,782 18,488 13,075 Hong Kong 2,281 1,658 7,053 2,980 Mexico 2,611 1,329 4,135 3,881 Taiwan 2,934 94 3,001 1,725 Singapore 1,079 4,941 4,150 4,962 Rest of World 4,619 368 6,830 1,192 $ 51,369 $ 26,427 $ 97,836 $ 37,151 Contract Balances The contract assets are primarily related to the Company’s fixed fee IP licensing arrangements and rights to consideration for performance obligations delivered but not billed as of October 29, 2022 and April 30, 2022. During the three months ended October 29, 2022, the Company recognized $ 1.8 million of revenue that was included in the deferred revenue balance as of July 30, 2022. During the three months ended October 31, 2021, the Company recognized $ 2.1 million of revenue that was included in the deferred revenue balance as of July 31, 2021. During the six months ended October 29, 2022, the Company recognized $ 1.0 million of revenue that was included in the deferred revenue balance as of April 30, 2022. During the six months ended October 31, 2021, the Company recognized $ 3.9 million of revenue that was included in the deferred revenue balance as of April 30, 2021. During six months ended October 29, 2022, the decrease in contract assets of $ 3.6 million was primarily due to IP licensing and engineering services arrangements where certain billing milestones had been reached. During six months ended October 29, 2022, the change to deferred revenue balance was not material. Remaining Performance Obligations 11 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements Revenue allocated to remaining performance obligations represents the transaction price allocated to the performance obligations that are unsatisfied, or partially unsatisfied, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. The contracted but unsatisfied performance obligation was approximately $ 11.4 million and the satisfied but unrecognized performance obligations was approximately $ 20.2 million as of October 29, 2022, which the Company expects to recognize over the next year. The amounts stated above include amounts relating to an IP licensing and development contract we entered into with a customer in September 2021, for total cash consideration of $ 43.5 million, which is receivable over an estimated period of three years upon meeting certain contractual milestones. As of October 29, 2022, we had billed $ 22.2 million and recognized revenue amounting to $ 21.8 million upon delivery of certain milestones of the contract. We have applied constraints on certain remaining milestones due to significant uncertainty relating to the delivery of those milestones as of October 29, 2022 associated with dependency on actions by the customer. The constraints will be re-evaluated at each future reporting period. Customer Warrant On December 28, 2021, the Company issued a warrant to Amazon.com NV Investment Holdings LLC (“Holder”) to purchase an aggregate of up to 4,080,000 of our ordinary shares at an exercise price of $ 10.74 per share (the Warrant). The exercise period of the Warrant is through the seventh anniversary of the issue date. Upon issuance of the Warrant, 40,000 of the shares issuable upon exercise of the Warrant vested immediately and the remainder of the shares issuable will vest in tranches over the contract term based on the amount of global payments by Holder and its affiliates to us, up to $ 201 million in aggregate payments. No other tranches were vested as of October 29, 2022. The grant date fair value of the Warrant share was determined at $ 4.65 per share using the Black-Scholes option pricing model. The grant date fair value of the Warrant share was estimated using the following assumptions: At Grant Date Expected volatility 40.00 % Weighted-average expected term (in years) 7.00 Risk-free interest rate 1.41 % Dividend yield — % Fair value per ordinary share $ 10.74 During the three and six months ended October 29, 2022, the Company recognized $ 0.2 million and $ 0.6 million, respectively, as contra revenue within the product sales revenue on the condensed consolidated statements of operations. 5. Fair Value Measurements Fair value is an exit price representing the amount that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value: Level 1 - Observable inputs that reflect quoted prices for identical assets or liabilities in active markets. Level 2 - Other inputs that are directly or indirectly observable in the marketplace. Level 3 - Unobservable inputs that are supported by little or no market activity. The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company measures the fair value of money market funds using Level 1 inputs. The Company’s certificates of deposit are classified as a held-to-maturity security as the Company intends to hold until their maturity dates. The certificates of deposit are valued using Level 2 inputs. Pricing sources may include industry standard data providers, security master files from large financial institutions, and other third -party sources used to determine a daily market value. 12 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements The following table present the fair value of the financial instruments measured on a recurring basis as of October 29, 2022 (in thousands). October 29, 2022 Level 1 Level 2 Level 3 Total Cash equivalents: Certificates of deposit $ — $ 9,226 $ — $ 9,226 Money market funds 150,000 — — 150,000 Short-term investments: Certificate of deposit — 50,000 — 50,000 Total cash equivalents and short-term investments $ 150,000 $ 59,226 $ — $ 209,226 The carrying amount of the Company’s financial instruments, including cash equivalents, short-term investments, accounts receivable, and accounts payable, approximate their respective fair values because of their short maturities. As of October 29, 2022, there were no unrealized loss or gains associated with the Company’s financial instruments. 6. Supplemental Financial Information Inventories Inventories consisted of the following (in thousands): October 29, 2022 April 30, 2022 Raw materials $ 20,739 $ 11,610 Work in process 11,913 10,352 Finished goods 15,177 5,375 $ 47,829 $ 27,337 Property and Equipment, Net Property and equipment consisted of the following (in thousands): October 29, 2022 April 30, 2022 Computer equipment and software $ 13,832 $ 1,736 Laboratory equipment 11,123 9,521 Production equipment 17,314 15,502 Leasehold improvements 1,559 1,465 Others 512 524 Construction in progress 9,313 2,932 53,653 31,680 Less: accumulated depreciation and amortization ( 12,989 ) ( 9,836 ) $ 40,664 $ 21,844 Depreciation and amortization expense for the three months ended October 29, 2022 and October 31, 2021 was $ 2.6 million and $ 1.1 million, respectively. Depreciation and amortization expense for the six months ended October 29, 2022 and October 31, 2021 was $ 4.3 million and $ 2.0 million, respectively. Computer equipment and software primarily includes electronic design automation software relating to the Company’s R&D design of future products and intellectual properties. Construction in progress and production equipment primarily includes mask set costs capitalized relating to the Company’s new products already introduced or to be introduced. 13 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following (in thousands): October 29, 2022 April 30, 2022 Accrued expenses $ 12,098 $ 8,372 Current payables relating to purchases of property and equipment 3,615 — Current portion of operating lease liabilities 2,542 2,379 Income tax payable 1,192 1,312 $ 19,447 $ 12,063 Other non-current Liabilities Other non-current liabilities consisted of the following (in thousands): October 29, 2022 April 30, 2022 Non-current payables relating to purchases of property and equipment $ 6,017 $ — Deferred tax liabilities 348 220 $ 6,365 $ 220 7. Commitments and Contingencies Non-cancelable Purchase Obligations Total future non-cancelable purchase obligations as of October 29, 2022 are as follows (in thousands): Fiscal Year Purchase Commitments to Manufacturing Vendors Technology License Fees Remainder of 2023 $ 6,200 $ 2,202 2024 4,039 5,177 2025 6,763 5,432 2026 8,131 350 2027 9,282 350 Thereafter 7,319 700 Total unconditional purchase commitments $ 41,734 $ 14,211 Technology license fees include the liabilities under agreements for technology licenses between the Company and various vendors. Under the Company’s manufacturing relationships with its foundry partners, cancellation of outstanding purchase orders is allowed but requires payment of all costs and expenses incurred through the date of cancellation. As of October 29, 2022, the total value of non-cancelable purchase orders payable within the next one year, that were committed with the Company’s third party subcontractors was approximately $ 6.2 million. Such purchase commitments are included in the preceding table. The Company entered into a manufacturing supply capacity reservation agreement with an assembly subcontractor during the current fiscal year due to the current global supply shortage environment. Under this arrangement, the Company agreed to pay refundable deposits to the supplier in exchange for reserved manufacturing production capacity over the term of the agreement, which approximates five years. In addition, the Company committed to certain purchase levels that were in line with the capacity reserved. If the Company does not meet the purchase level commitment, the agreement requires the Company to pay a fee equal to the difference between the actual purchase and the purchase commitment, up to the value of refundable deposits made. The Company currently estimates that it has made purchase level commitments of at least $ 35.5 million for the remainder of fiscal 2023 through fiscal 2028 under the capacity reservation agreement. Such purchase commitments are included in the preceding table. In addition, refundable deposits payable under this arrangement are $ 5.4 million during the remainder of fiscal 2023 and $ 3.4 million in fiscal 2024. 14 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements Warranty Obligations The Company’s products generally carry a standard one year warranty. The Company’s warranty expense has not been material in the periods presented. Indemnifications In the ordinary course of business, the Company has made certain indemnifications of varying scope and terms to customers, vendors, lessors, investors, directors, officers, employees and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements, services to be provided by the Company or from intellectual property infringement claims made by third parties. These indemnifications may survive termination of the underlying agreement and the maximum potential amount of future payments the Company could be required to make under these indemnification provisions may not be subject to maximum loss clauses. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnifications. Accordingly, the Company has no liabilities recorded for these agreements as of October 29, 2022 and April 30, 2022. Legal Proceedings From time to time, the Company may be a party to various litigation claims in the normal course of business. Legal fees and other costs associated with such actions are expensed as incurred. The Company assesses, in conjunction with legal counsel, the need to record a liability for litigation and contingencies. Accrual estimates are recorded when and if it is determined that such a liability for litigation and contingencies are both probable and reasonably estimable. As of the date of issuance of the unaudited condensed consolidated financial statements, the Company was not subject to any litigation. No accruals for loss contingencies or recognition of actual losses have been recorded in any of the periods presented. 8. Convertible Preferred Shares The Company had previously issued Series A convertible preferred shares, Series B convertible preferred shares, Series C convertible preferred shares, Series D convertible preferred shares and Series D+ convertible preferred shares (collectively, the “Preferred Shares”). Immediately prior to the completion of the IPO during fiscal 2022, all of the then outstanding 52,059,826 shares of the Company’s convertible Preferred Shares were automatically converted into an aggregate 52,059,826 shares of ordinary share on a one -for-one basis, and such Preferred Shares were cancelled, retired and eliminated from the shares that the Company is authorized to issue and shall not be reissued by the Company. A summary of the preferred shares prior to the conversion into ordinary shares consisted of the following: Series Shares Authorized Shares Issued and Outstanding Per Share Liquidation Preference Aggregate Liquidation Preference (in thousands) Series A 8,313 8,313 $ 1.00 $ 8,313 Series B 8,593 8,593 2.10 18,000 Series C 5,245 5,245 4.29 22,500 Series D 20,028 20,028 4.99 100,000 Series D+ 9,881 9,881 5.81 57,361 52,060 52,060 $ 206,174 The rights, privileges, and preferences of the Series A, Series B, Series C, Series D, and Series D+ convertible preferred shares were as follows: Conversion Rights - Each preferred share was convertible, at the option of the holder, at any time, and without the payment of any additional consideration, into such number of fully paid ordinary share as was determined by dividing the applicable original issue price for each such series of preferred shares by the applicable conversion price in effect at the time of the conversion. The conversion price per share for each series of preferred share shall initially be equal to the original issue price of such series, which means $ 1.00 per share for Series A, $ 2.10 per share for Series B, $ 4.29 per share for Series C, $ 4.99 per share for Series D and $ 5.81 per share for Series D+. The 15 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements conversion price shall be subject to adjustment in order to adjust the number of ordinary shares into which the preferred shares are convertible. Each share of Series A, B, C, D and D+ convertible preferred share automatically converted into the number of ordinary shares at the conversion rate at the time in effect upon the closing of a public offering of ordinary shares which results in at least $ 25.0 million of proceeds to the Company at a per share price not less than $ 9.99 or with the vote or written consent of the holders of a majority of the then outstanding preferred shares, voting as a separate class, to convert their preferred shares at the then effective Conversion Price. Dividends - The holders of preferred shares were entitled to receive noncumulative dividends when and if declared by the Company’s board of directors. The holders of preferred shares were entitled to receive dividends prior and in preference to any payment of any dividend on ordinary shares in an amount equal to 8 % of the original issue price per share of such preferred share. After payment of such dividends, any additional dividends shall be distributed among all holders of ordinary shares and preferred shares in proportion to the number of ordinary shares that would be held by each such holder if all preferred shares were converted to ordinary shares at the then effective conversion rate. no dividends had been declared by the board of directors from inception through the date of conversion into ordinary shares. Liquidation Rights - In the event of any sale, lease, conveyance or other disposition of all or substantially all of the assets of the Company or the exclusive license of all or substantially all of the Company’s intellectual property used in generating all or substantially all of the Company’s revenues, reorganization, consolidation, acquisition, merger, liquidation, dissolution or winding up of the Company, either voluntary or involuntary, the holders of preferred shares shall be entitled to receive in preference to the holders of ordinary shares, an amount per share equal to the liquidation preference, plus any declared but unpaid dividends. After payment of the liquidation preference to holders of preferred shares, the remaining assets of the Company were available for distribution on a pro rata basis to the holders of ordinary shares. Voting Rights - The holders of the convertible preferred shares were entitled to the number of votes equal to the number of ordinary shares into which such convertible preferred shares could be converted on the record date. 9. Leases The Company leases office space, domestically and internationally, under operating leases. The Company’s leases have remaining lease terms generally between one year and nine years . Operating leases are included in right of use assets, accrued expenses and other current liabilities, and non-current operating lease liabilities on the Company’s unaudited condensed consolidated balance sheets. The Company does not have any finance leases. Lease expense and supplemental cash flow information are as follows (in thousands): Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Operating lease expenses $ 891 $ 676 $ 1,780 $ 1,355 Cash paid for amounts included in the measurement of operating lease liabilities $ 779 $ 724 $ 1,545 $ 1,371 Right-of-use assets obtained in exchange for lease obligation $ 649 $ — $ 649 $ 259 16 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements The aggregate future lease payments for operating leases as of October 29, 2022 are as follows (in thousands): Fiscal Year Operating leases Remainder of 2023 $ 1,606 2024 3,298 2025 2,862 2026 2,344 2027 2,216 Thereafter 7,796 Total lease payments 20,122 Less: Interest 3,499 Present value of lease liabilities $ 16,623 As of October 29, 2022, the weighted average remaining lease term for the Company's operating leases is 7.15 years and the weighted average discount rate used to determine the present value of the Company's operating leases is 5.81 %. 10. Share Incentive Plan Share Issuances Subject to Repurchase The Company has issued ordinary shares to certain employees that are subject to vesting periods pursuant to the respective share purchase agreements (“Restricted Share Awards” or “RSAs”). In addition, the Company allows early exercise for unvested ordinary share options granted under its 2015 Stock Plan. In regard to the ordinary shares purchased, but not vested, the Company has the right to repurchase shares at the original issue price in the event of termination of services. As of October 29, 2022, 168,390 shares from share option early exercises remained subject to the Company’s repurchase rights. As of April 30, 2022, 442,787 such ordinary shares, consisting of 16,667 shares from RSAs and 426,120 from share option early exercises, remained subject to the Company’s repurchase rights. These shares are excluded from ordinary shares outstanding. Restricted Stock Unit (“RSU”) Awards A summary of information related to RSU activity during the six months ended October 29, 2022 is as follows: RSUs Outstanding Number of shares Weighted-Average Grant Date Fair Value Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in thousands) Balances as of April 30, 2022 4,133,751 $ 10.26 Granted 716,600 $ 13.69 Vested ( 716,375 ) $ 10.01 Canceled/ forfeited ( 260,938 ) $ 10.47 Balances and expected to vest as of October 29, 2022 3,873,038 $ 10.92 1.53 $ 53,138 Share Option Awards A summary of information related to share option activity during the six months ended October 29, 2022 is as follows: 17 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements Options Outstanding Outstanding Share Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in thousands) Balance as of April 30, 2022 11,360,745 $ 1.94 Options exercised and vested ( 843,921 ) $ 1.68 Options canceled/ forfeited ( 168,586 ) $ 3.03 Balance and expected to vest as of October 29, 2022 10,348,238 $ 1.95 6.66 $ 121,814 Exercisable as of October 29, 2022 10,179,848 $ 1.95 6.66 $ 119,833 Employee Stock Purchase Plan (“ESPP”) During the six months ended October 29, 2022, 154,053 shares were issued under the ESPP. No shares were issued during the three months ended October 29, 2022 under the ESPP. Summary of Share-Based Compensation Expense The following table summarizes share-based compensation expense included in the unaudited condensed consolidated statements of operations (in thousands): Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Cost of revenue $ 149 $ 47 $ 452 $ 134 Research and development 2,756 678 5,619 1,160 Selling, general and administrative 1,986 582 4,366 1,088 $ 4,891 $ 1,307 $ 10,437 $ 2,382 11. Income Taxes The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, the Company makes a cumulative adjustment in such period. The Company’s quarterly tax provision, and estimate of its annual effective tax rate, is subject to variation due to several factors, including variability in accurately predicting our pre-tax income or loss and the mix of jurisdictions to which they relate, intercompany transactions, changes in tax laws, the applicability of special tax regimes, changes in how we do business, and discrete items. Provisions for income taxes for the three and six months ended October 29, 2022 and October 31, 2021 were as follows (in thousands except percentages): Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change Provision for income taxes $ 929 $ 601 54.6 % $ 564 $ 1,503 ( 62.5 ) % Effective tax rate ( 38 ) % ( 17 ) % ( 20 ) % ( 10 ) % Our effective tax rate for the three months ended October 29, 2022 differs from the same period in the prior year primarily due to an increase in estimated annual tax provision based on the estimated annual effective tax rate, offset by an increase in stock based compensation deductions. Our effective tax rate for the six months ended October 29, 2022 differs from the same period in the prior year primarily due to an increase in stock based compensation deductions. During the three and six months ended October 29, 2022, there were no material changes to the total amount of unrecognized tax benefits and we do not expect any significant changes in the next 12 months. 18 Credo Technology Group Holding Ltd Notes to Unaudited Condensed Consolidated Financial Statements 12. Net Loss Per Share The Company reports both basic net loss per share, which is based on the weighted-average number of common stock outstanding during the period, and diluted net loss per share, which is based on the weighted-average number of common stock outstanding and potentially dilutive shares outstanding during the period. Net loss per share was determined as follows (in thousands, except per share amounts): Three months ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Numerator: Net loss $ ( 3,360 ) $ ( 4,100 ) $ ( 3,433 ) $ ( 16,677 ) Denominator: Weighted-average shares outstanding used in basic and diluted calculation 146,012 69,094 145,545 68,751 Basic and diluted net loss per share $ ( 0.02 ) $ ( 0.06 ) $ ( 0.02 ) $ ( 0.24 ) The following potentially dilutive securities outstanding (in thousands) have been excluded from the computations of diluted weighted average shares outstanding for the three and six months ended October 29, 2022 and October 31, 2021 because such securities have an anti-dilutive impact due to losses reported: Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Options and RSAs 10,492 9,828 10,675 8,696 RSUs 3,753 — 3,981 — ESPP 76 — 76 — Customer warrants 4,080 — 4,080 — Convertible preferred shares — 52,026 — 52,026 18,401 61,854 18,812 60,722 19 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended April 30, 2022 included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2022. Some of the information contained in this discussion and analysis includes forward-looking statements that involve risks and uncertainties as described under the heading “Special Note Regarding Forward-Looking Statements” of this Quarterly Report on Form 10-Q. Overview Credo is an innovator in providing secure, high-speed connectivity solutions that deliver improved power and cost efficiency as data rates and corresponding bandwidth requirements increase exponentially throughout the data infrastructure market. Our connectivity solutions are optimized for optical and electrical Ethernet applications, including the emerging 100G, 200G, 400G and 800G port markets. Our products are based on our proprietary Serializer/Deserializer (SerDes) and Digital Signal Processor (DSP) technology. Our product families include integrated circuits (ICs), Active Electrical Cables (AECs) and SerDes Chiplets. Our IP solutions primarily are comprised of SerDes IP development and licensing. Data generation has increased dramatically over the past ten years, creating new and complicated challenges in both circuit and system design. Our proprietary SerDes and DSP technologies enable us to disrupt competition in existing markets, lead the way into emerging markets, and innovate to create new market opportunities. While many others in the data infrastructure industry struggle to meet customers’ increasing performance and energy efficiency requirements, we continue to innovate to deliver groundbreaking solutions. A recent example is the announcement of our HiWire Switch cable and open-source implementation with Microsoft that helps realize Microsoft’s vision for a network-managed dual-Top-of-Rack (ToR) architecture, overcoming complex and slow legacy enterprise approaches, simplifying deployment, and improving connection reliability in the data center. The multi-billion dollar data infrastructure market that we serve is driven largely by hyperscale data centers (hyperscalers), high performance computing (HPC) and 5G infrastructure. The demands for increased bandwidth, improved power and cost efficiency, and heightened security have simultaneously and dramatically expanded as work, education, and entertainment have rapidly digitized across billions of end-point users. Since our founding in 2008, we have achieved several significant milestones: • From 2008 to 2012, we developed our proprietary, low-power, mixed-signal SerDes architecture which could scale from 25Gbps/lane to 50Gbps/lane and ultimately to 100Gbps/lane. • In 2013, we began commercializing our core SerDes technology by providing connectivity solutions for the electrical and optical links in data centers. • In 2014, we signed our first product contract with Non-Recurring Engineering (NRE) services as well as our first IP licensing contract. • In 2016, we commenced production shipments of our Line Card PHY products. • In 2017, we developed a 3.2Tbps chiplet for high bandwidth 12.8Tbps switches. This chiplet included 64 lanes of 50Gbps SerDes and was built in 28nm using Chip-on-Wafer-on-Substrate (CoWoS) packaging technology from TSMC. • In 2018, we created AECs, a new category of data center system products, beginning with developing 400G DDC solutions up to seven meters in length. • In 2019, we developed new DSP SerDes architectures optimizing the performance and power trade-offs for 400G and 800G solutions targeting Line Card PHYs, Optical PAM4 DSPs, and AECs. • In 2020, we demonstrated the industry’s first 40Gbs PAM3 SerDes in silicon. In addition, we engineered breakthrough Line Card PHYs and Optical PAM4 DSPs with leading performance and power for 50G/lane and 100G/lane solutions. 20 • In 2021, we launched new AEC solutions targeting ToR-to-NIC connections. Our solutions enabled dual-ToR server racks to seamlessly “switch” data traffic to the redundant ToR if a ToR port failed. We design, market and sell both product and IP solutions. We help define industry conventions and standards within the markets we target by collaborating with technology leaders and standards bodies. We contract with a variety of manufacturing partners to build our products based on our proprietary SerDes and DSP technologies. We develop standard solutions we can sell broadly to our end markets and also develop tailored solutions designed to address specific customer needs. Once developed, these tailored solutions can generally be broadly leveraged across our portfolio and we are able to sell the product or license the IP into the broader market. During the three months ended October 29, 2022 and October 31, 2021, we generated $51.4 million and $26.4 million in total revenue, respectively. Product sales and product engineering services revenue comprised 94% and 75% of our total revenue in the three months ended October 29, 2022 and October 31, 2021, respectively, and IP license and IP license engineering services revenue represented 6% and 25% of our total revenue in the three months ended October 29, 2022 and October 31, 2021, respectively. During the three months ended October 29, 2022 and October 31, 2021, we generated $3.4 million and $4.1 million in net loss, respectively. We derive the substantial majority of our revenue from a limited number of customers, and we anticipate we will continue to derive a significant portion of our revenue from a limited number of customers for the foreseeable future. We expect that as our products are more widely adopted and as our number of customers increase, customer concentration will decrease. Our Business Model We are a product-focused business with a strong foundation in IP, pioneering comprehensive connectivity solutions that deliver bandwidth, scalability, and end-to-end signal integrity for next-generation platforms. We also develop IP solutions to address the specific and complex needs of our customers. We earn revenue from these IP solutions primarily through licensing fees and royalties. In addition to product sales and IP license revenue, we also generate revenue from providing engineering services as part of our product and license arrangements with certain customers. Over time, we expect to generate an increased proportion of our revenue from sales of our products. We expect to see a long-term benefit from improvements in our operating leverage as our business continues to gain scale. We utilize a fabless business model, working with a network of third parties to manufacture, assemble and test our connectivity products. This approach allows us to focus our engineering and design resources on our core competencies and to control our fixed costs and capital expenditures. We employ a two-pronged sales strategy targeting both the end users of our products, as well as the suppliers of our end users. By engaging directly with the end user, we are able to better understand the needs of our customers and cater our solutions to their most pressing connectivity requirements. This strategy has enabled us to become the preferred vendor to a number of our customers who, in turn, in some cases, require their suppliers, original equipment manufacturers (OEMs), original design manufacturers (ODMs) and optical module manufacturers to utilize our solutions. 21 Revenue Mix and Associated Gross Margins We are a product-focused business with a strong foundation in IP and, as such, our customers engage with us through the purchase of our products or the licensing of our IP. In some instances, customers will engage us to develop tailored products or IP licenses to meet their specific application requirements. We charge these customers incremental fees for this tailored development which are in addition to product sales or IP license revenue, and we recognize these additional fees as product engineering or IP license engineering services revenue. By providing tailored engineering services to our customers, we believe we strengthen our customer relationships, enable additional sales and establish ourselves for potential long-term revenue opportunities from associated product sales or IP license revenue. A summary of our revenue and associated gross margin by these revenue sources for the three and six months ended October 29, 2022 and October 31, 2021, respectively, is presented below (in thousands, except percentages): Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Revenue: Product sales $ 44,349 $ 18,454 $ 79,612 $ 25,717 Product engineering services 3,750 1,355 4,574 2,674 Total product sales and product engineering services 48,099 19,809 84,186 28,391 IP license 2,084 6,142 12,464 7,172 IP license engineering services 1,186 476 1,186 1,588 Total IP license and IP license engineering services 3,270 6,618 13,650 8,760 Total revenue $ 51,369 $ 26,427 $ 97,836 $ 37,151 Gross margin: Product sales 48.9 % 46.6 % 49.5 % 44.8 % Product engineering services 88.9 % 60.7 % 88.7 % 47.8 % Total product sales and product engineering services 52.0 % 47.6 % 51.7 % 45.0 % IP license 100.0 % 100.0 % 90.5 % 100.0 % IP license engineering services 71.8 % 80.7 % 71.8 % 73.9 % Total IP license and IP license engineering services 89.8 % 98.6 % 88.9 % 95.3 % Total gross margin 54.4 % 60.4 % 56.9 % 56.9 % Over time, we anticipate that our revenues from product sales and IP license will become a larger proportion of total revenue relative to engineering services. 22 Factors Affecting Our Performance Our results of operations and financial condition have been, and will continue to be, affected by a number of factors including the following: Design Wins With New and Existing Customers Our solutions enable our end customers to differentiate their product offerings and position themselves to meet the demands of increasingly advanced networks. We work closely with our end customers to understand their product roadmaps and strategies and help them develop new products. Our goal is to develop solutions that support their product roadmap and development. If an end customer has tested our product, verified that it meets their requirements and the customer has informed us that the end customer intends to have our customer build it into their product, we consider it a design win. We consider design wins important to our future success. The selection process is typically lengthy and may require us to incur significant design and development expenditures in pursuit of a design win with no assurance that our solutions will be selected. In addition, some design wins result in significant revenue and some do not, and the timing of such revenue is difficult to predict as it depends on the success of the end customer’s product that uses our solutions. Thus, some design wins result in orders and significant revenue shortly after the design win is awarded and other design wins do not result in significant orders and revenue for several months or longer after the initial design win (if at all). As a result, the degree to which we are successful in achieving design wins and the speed and level at which end customers ramp volume production of the products into which our product is designed will impact our success and financial results in future periods. Customer Demand and Pipeline Demand for our products is dependent on conditions in the markets in which our customers operate, which are subject to cyclicality and competitive conditions. We believe our relationships with the end customers of our products and the long-term implications of decisions to adopt our solutions, provide us with valuable visibility into customer demand. Furthermore, our customers generally provide us with periodic forecasts of their requirements. This provides an opportunity for us to monitor and refine our business operations and plans. The majority of our product sales are made pursuant to standard purchase orders. Changes in customer forecasts or the timing of orders from customers expose us to the risks of inventory shortages or excess inventory. Cancellations of orders could result in the loss of anticipated sales without allowing us sufficient time to reduce and manage our operating expenses. Pricing and Product Gross Margins Our revenue is also impacted by changes in the number and average selling prices of our products. Our products are typically characterized by a life cycle that begins with higher average selling prices and lower volumes, followed by broader market adoption, leading to higher volumes, and average selling prices lower than initial levels. Our product gross margins will be affected by the extent to which these declines are paired with improvements in manufacturing yields and lower wafer, assembly and test costs that offset some of the margin reduction that results from lower average selling prices as well as the extent to which we introduce new products with higher initial average selling prices and achieve market acceptance. Our gross margins may also be affected by changes in the price of silicon wafers, copper cables, printed circuit boards (PCBs), testing costs and commodities, and the extent to which we are able to offset any increases in our costs through increases prices to our customers, productivity actions or other means. In August 2021, TSMC, on which we rely as the foundry for all our semiconductor products, began informing its customers that it plans to increase the prices of its most advanced chips by roughly 10% and its less advanced chips by up to 20%, effective in late 2021 or early 2022 as a result of a global supply shortage that began in 2020. If we are unable to offset the increased costs associated with this price increase through pricing increases on our products, our gross margins may decrease. Our product gross margins may also fluctuate from period to period as a result of changes in average selling prices 23 due to new product introductions or existing product transitions into larger scale commercial volumes and manufacturing costs as well as our product and customer mix. Product Adoption We develop and sell leading-edge connectivity solutions for digital infrastructure which are intended to replace existing legacy solutions and support our customers’ future applications and needs. Our success is dependent on customers adopting our new technology and preferring our solutions over competing offerings or other current or future technologies. Technology Development We operate in industries characterized by rapidly changing technologies, industry standards and technological obsolescence. We work closely with our customers to understand their product roadmaps and strategies to forecast their future needs. This helps inform our technology roadmap and development priorities. We also monitor forecasts by industry analysts and the adoption curve of technology as well as potential competing forces which could hinder adoption of our solutions. Our revenue growth is dependent on our ability to continually develop and introduce new products to meet the changing technology and performance requirements of our customers, diversify our revenue base and generate new revenue to replace, or build upon, the success of previously introduced products which may be rapidly maturing. As a result, our revenue is impacted, to a more significant extent, by product life cycles for a variety of products and to a much lesser extent, if any, by any single product. In order to remain competitive, we have made, and expect to continue to make, significant expenses in research and development, and our research and development expenses in a particular period may be significantly impacted by specific product or engineering initiatives that we undertake to maintain our competitiveness and expand our product portfolio. If we fail to anticipate or respond appropriately to new developments in technology, or to timely develop competitive new or enhanced products or technologies, our revenue could decrease and we could lose design wins to our competitors. Industry Trends and Cyclicality We continue to evaluate trends within the industry that affect our business performance. We design and develop high-speed connectivity solutions that deliver improved power and cost efficiency for the data infrastructure market. This market is driven by hyperscalers, HPC and 5G infrastructure. Accordingly, our revenue and business performance are influenced by the deployment and timing of broader market adoption of next generation technologies in data centers, particularly by hyperscalers, and in the HPC and 5G markets. The semiconductor industry is cyclical and is characterized by rapid technological change, evolving standards, product obsolescence, price erosion, and fluctuations in product supply and demand. Any prolonged or significant downturn in our industry generally could adversely affect our business and reduce demand for our products and otherwise harm our financial condition and results of operations. COVID-19 We continue to monitor the impact of COVID-19 on our business. The extent and nature of the impact of the COVID-19 pandemic on our business and financial performance will be influenced by a variety of factors, including the duration and spread of the pandemic, as well as future spikes of COVID-19 infections or the emergence of additional COVID-19 variants that may result in additional preventative and mitigative measures. These factors may affect the timing and magnitude of demand from customers and the availability of portions of the supply chain, logistical services and component supply and may have a material net negative impact on our business and financial results. For additional information regarding the potential impact of the COVID-19 pandemic on our business, see “ Risk Factors—Risks Related to Our Business—The ongoing COVID-19 pandemic has disrupted and will likely continue to disrupt normal business activity and may adversely impact our operations and financial results. ” in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022. 24 Results of Operations Three and Six Months Ended October 29, 2022 and October 31, 2021 The following table sets forth information derived from our unaudited consolidated statements of operations expressed as a percentage of total revenue: Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 October 29, 2022 October 31, 2021 Revenue: Product sales 86.3 % 69.8 % 81.4 % 69.2 % Product engineering services 7.3 % 5.1 % 4.7 % 7.2 % IP license 4.1 % 23.2 % 12.7 % 19.3 % IP license engineering services 2.3 % 1.8 % 1.2 % 4.3 % Total revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue: Cost of product sales revenue 44.1 % 37.3 % 41.1 % 38.2 % Cost of product engineering services revenue 0.8 % 2.0 % 0.5 % 3.8 % Cost of IP license revenue — % — % 1.2 % — % Cost of IP license engineering services revenue 0.7 % 0.3 % 0.3 % 1.1 % Total cost of revenue 45.6 % 39.6 % 43.1 % 43.1 % Gross margin 54.4 % 60.4 % 56.9 % 56.9 % Operating expenses: Research and development 35.3 % 44.6 % 35.6 % 57.9 % Selling, General and Administrative 22.5 % 29.2 % 23.2 % 39.9 % Total operating expenses 57.8 % 73.8 % 58.8 % 97.8 % Operating loss (3.4) % (13.4) % (2.0) % (40.9) % Other income (expense), net (1.3) % 0.2 % (0.9) % — % Loss before income taxes (4.7) % (13.2) % (2.9) % (40.8) % Provision for income taxes 1.8 % 2.3 % 0.6 % 4.0 % Net loss (6.5) % (15.5) % (3.5) % (44.9) % Comparison of Three and Six Months Ended October 29, 2022 and October 31, 2021 Revenue Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Product sales $ 44,349 $ 18,454 140.3 % $ 79,612 $ 25,717 209.6 % Product engineering services 3,750 1,355 176.8 % 4,574 2,674 71.1 % IP license 2,084 6,142 (66.1) % 12,464 7,172 73.8 % IP license engineering services 1,186 476 149.2 % 1,186 1,588 (25.3) % Total revenue $ 51,369 $ 26,427 94.4 % $ 97,836 $ 37,151 163.3 % Total revenue for the three months ended October 29, 2022 increased by $24.9 million, compared to the same period in fiscal 2022, primarily due to an increase in product sales revenue of $25.9 million. Total revenue for the six months ended October 29, 2022 increased by $60.7 million, compared to the same period in fiscal 2022, primarily due to increases in product sales revenue of $53.9 million and IP license revenue of $5.3 million. The increase in product sales was primarily due to an increase in the unit shipments of AEC cables that were introduced in fiscal 2021. The increase in six months ended October 29, 2022 IP license revenue was driven by a high- 25 dollar IP license delivered to a customer that resulted in revenue recognition of $9.0 million during the six months ended October 29, 2022. Cost of Revenue Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Cost of product sales revenue $ 22,658 $ 9,849 130.1 % $ 40,183 $ 14,206 182.9 % Cost of product engineering services revenue 418 532 (21.4) % 518 1,397 (62.9) % Cost of IP license revenue — — N/A 1,179 — N/A Cost of IP license engineering services revenue 334 92 263.0 % 334 414 (19.3) % Total cost of revenue $ 23,410 $ 10,473 123.5 % $ 42,214 $ 16,017 163.6 % Cost of product sales revenue increased by $12.8 million in the three months ended October 29, 2022 and $26.0 million in the six months ended October 29, 2022, compared to the same periods in fiscal 2022, primarily due to increased product sales during the same period as discussed above. Cost of IP license revenue in the six months ended October 29, 2022 related to costs incurred for delivery of a milestone during the quarter on an IP licensing and development contract entered into with a customer in September 2021 (refer to note 4 of our unaudited condensed consolidated financial statements for details). Gross Profit and Gross Margin Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Gross profit $ 27,959 $ 15,954 75.2 % $ 55,622 $ 21,134 163.2 % Gross margin 54.4 % 60.4 % 56.9 % 56.9 % Gross margin decreased by 6 percentage points in the three months ended October 29, 2022, compared to the same period in fiscal 2022, primarily driven by the increase of our product sales revenue in the product mix as our product sales business has lower gross margin compared to our IP business. Gross margin for the six months ended October 29, 2022 was consistent with the same period in fiscal 2022. Research and Development Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Research and development $ 18,158 $ 11,800 53.9 % $ 34,841 $ 21,493 62.1 % % of total revenue 35.3 % 44.6 % 35.6 % 57.9 % Research and development expense for the three months ended October 29, 2022 increased by $6.4 million compared to the same period in fiscal 2022. The increase was due primarily to a $2.8 million increase in personnel costs as a result of new hires for product development, a $2.1 million increase in share-based compensation expense driven by increased amortization expense from new equity awards granted to employees, and a $1.1 million increase in depreciation expense driven by increased computer equipment and software, and laboratory equipment utilized in R&D activities. Research and development expense for the six months ended October 29, 2022 increased by $13.3 million compared to the same period in fiscal 2022. The increase was due primarily to a $5.9 million increase in personnel costs as a result of new hires for product development, a $4.5 million increase in share-based compensation expense 26 driven by increased amortization expense from new equity awards granted to employees, a $1.3 million increase in depreciation expense driven by increased computer equipment and software, and laboratory equipment utilized in R&D activities, a $0.9 million increase in IT and facilities costs, and a $0.7 million decrease in allocation of R&D expense to costs of engineering services due to less engineering hours incurred that was associated to non-recurring engineering service revenue arrangements. Selling, General and Administrative Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Selling, General and Administrative $ 11,540 $ 7,708 49.7 % $ 22,738 $ 14,825 53.4 % % of total revenue 22.5 % 29.2 % 23.2 % 39.9 % Selling, general and administrative expense for the three months ended October 29, 2022 increased by $3.8 million compared to the same period in fiscal 2022. The increase was due primarily to a $0.9 million increase in personnel costs as a result of higher selling, general and administrative headcount, a $0.5 million increase in professional services spending, a $0.7 million increase in director and officer insurance cost as a result of being a public company, and a $1.4 million increase in share-based compensation expense driven by increased amortization expense from new equity awards granted to employees. Selling, general and administrative expense for the six months ended October 29, 2022 increased by $7.9 million compared to the same period in fiscal 2022. The increase was due primarily to a $1.8 million increase in personnel costs as a result of higher selling, general and administrative headcount, a $1.2 million increase in professional services spending, a $1.3 million increase in director and officer insurance cost as a result of being a public company, and a $3.3 million increase in share-based compensation expense driven by increased amortization expense from new equity awards granted to employees. Provision for Income Taxes Three Months Ended Six Months Ended October 29, 2022 October 31, 2021 % Change October 29, 2022 October 31, 2021 % Change (in thousands, except percentages) Provision for income taxes $ 929 $ 601 54.6 % $ 564 $ 1,503 (62.5) % % of total revenue 1.8 % 2.3 % 0.6 % 4.0 % Provision for income taxes for the three months ended October 29, 2022 increased by $0.3 million compared to the same period in fiscal 2022. The fluctuation was primarily due to an increase in the estimated annual tax expense based on the estimated annual effective tax rate, offset by an increase in stock based compensation deductions. Provision for income taxes for the six months ended October 29, 2022 decreased by $0.9 million compared to the same period in fiscal 2022. The fluctuation was primarily due to an increase in stock based compensation deductions. Liquidity and Capital Resources Our activities consist primarily of selling our products, licensing our IP, providing IP customization services and conducting research and development of our products and technology. Since our inception through October 29, 2022, our operations have been financed primarily by net proceeds from our initial public offering, the sale of convertible preferred shares and ordinary shares prior to our initial public offering, and cash generated from our customers. As of October 29, 2022 and April 30, 2022, we had $190.5 million and $259.3 million in cash and cash equivalents, respectively, and working capital of $300.3 million and $305.7 million, respectively. Our principal use of cash is to fund our operations and invest in research and development to support our growth. We believe our existing cash and cash equivalents and other components of working capital will be sufficient to meet our needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of our sales and marketing and research and development expenditures, and the continuing market acceptance of our solutions. In the event that we need to borrow funds or issue additional equity, we cannot assure you that any such additional financing will be available on terms acceptable to us, if at all. If we are 27 unable to raise additional capital when we need it, our business, results of operations and financial condition would be adversely affected. The following table summarizes our cash flows for the periods indicated. Six Months Ended October 29, 2022 October 31, 2021 (in thousands) Net cash used in operating activities $ (10,462) $ (34,919) Net cash used in investing activities $ (60,925) $ (4,985) Net cash provided by financing activities $ 2,723 $ 7,166 Cash Flows Used in Operating Activities Net cash used in operating activities was $10.5 million for the six months ended October 29, 2022. The cash outflows from operating activities for the six months ended October 29, 2022 were primarily due to $3.4 million of net loss and $23.5 million of cash outflows for working capital purposes, partially offset by $16.4 million of non-cash items. The cash outflows from working capital for the six months ended October 29, 2022 were primarily driven by an increase in accounts receivable and inventories, partially offset by an increase in accounts payable, and accrued expenses and other liabilities. Net cash used in operating activities was $34.9 million for the six months ended October 31, 2021. The cash outflows from operating activities for the six months ended October 31, 2021 were primarily due to $16.7 million of net loss and $23.3 million of cash outflows for working capital purposes, partially offset by $5.1 million of non-cash items. The cash outflows from working capital for the six months ended October 31, 2021 were primarily driven by an increase in accounts receivable and inventories, partially offset by an increase in accounts payable, and accrued expenses and other liabilities. Cash Flows Used in Investing Activities Net cash used in investing activities of $60.9 million in the six months ended October 29, 2022 was attributable to purchases of property and equipment of $10.9 million and investment in a certificate of deposit of $50.0 million. Purchases of property and equipment primarily related to mask sets purchases for new products introduced or in process of being introduced, and computer equipment and software used for research and development purposes. Net cash used in investing activities of $5.0 million in the six months ended October 31, 2021 was attributable to purchases of property and equipment, including third-party licenses. Cash Flows from Financing Activities Net cash provided by financing activities of $2.7 million for the six months ended October 29, 2022 was solely attributable to $2.7 million in proceeds from exercises of employee share options and the issuance of shares under the ESPP. Net cash provided by financing activities of $7.2 million for the six months ended October 31, 2021 was primarily attributable to $0.9 million in proceeds from exercises of employee share options and $7.2 million in proceeds from the issuance of convertible preferred shares, net of issuance costs. This cash inflow was partially offset by $0.9 million in payments for IPO offering cost. Critical Accounting Estimates There have been no material changes to our critical accounting estimates during the three and six months ended October 29, 2022, as compared to those disclosed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022. In the current macroeconomic environment affected by COVID-19, our estimates could require increased judgment and carry a higher degree of variability and volatility. We continue to monitor and assess our estimates in light of developments, and as events continue to evolve and additional information becomes available, our estimates may change materially in future periods. 28 Recent Accounting Pronouncements For more information, see Note 2 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. JOBS Act Accounting Election We are an “emerging growth company,” as defined in the JOBS Act. The JOBS Act provides that an “emerging growth company” can take advantage of an extended transition period for complying with new or revised accounting standards. This provision allows an “emerging growth company” to delay the adoption of some accounting standards until those standards would otherwise apply to private companies. We have elected to use the extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an “emerging growth company” or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.