May 8, 2020, 5:15 p.m. EDT

10-Q: ACM RESEARCH, INC.

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(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, or our Annual Report. The following discussion contains forward�looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward�looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in the section titled "Item 1A. Risk Factors" in Part II below.

Overview

We supply advanced, innovative capital equipment developed for the global semiconductor industry. Fabricators of advanced integrated circuits, or chips, can use our single-wafer wet-cleaning tools in numerous steps to improve product yield, even at increasingly advanced process nodes. We have designed these tools for use in fabricating foundry, logic and memory chips, including dynamic random-access memory (or DRAM) and 3D NAND-flash memory chips. We also develop, manufacture and sell a range of advanced packaging tools to wafer assembly and packaging customers.

Selling prices for our single-wafer wet-cleaning tools range from $2 million to more than $5 million. Our customers for single-wafer wet-cleaning and other front-end cleaning tools have included Semiconductor Manufacturing International Corporation, Shanghai Huali Microelectronics Corporation, SK Hynix Inc. and Yangtze Memory Technologies Co., Ltd. We recognized revenue from sales of single-wafer wet cleaning and other front-end processing equipment totaling $22.8 million, or 94% of total revenue, for the three months ending March 31, 2020 compared to $12.8 million, or 63% of total revenue, for the three months ending March 31, 2019.

Based on Gartner's December 2019 estimates, the market for global wafer cleaning equipment (auto wet stations, single-wafer processors, and other clean process) grew by 20% to $3.46 billion in 2018, decreased by 5% to $3.28 billion in 2019, and was expected to decrease by 6% to $3.07 billion in 2020. We estimate, based on third-party reports and on customer and other information, that our tools address more than 50% of this global wafer cleaning equipment market.

We focus our selling efforts on establishing a referenceable base of leading foundry, logic and memory chip makers, whose use of our products can influence decisions by other manufacturers. We believe this customer base will help us penetrate the mature chip manufacturing markets and build credibility with additional industry leaders. Using a "demo-to-sales" process, we have placed evaluation equipment, or "first tools," with a number of selected customers. Since 2009 we have delivered more than 95 single-wafer wet cleaning and other front-end processing tools, more than 85 of which have been accepted by customers and thereby generated revenue to us and the balance of which are awaiting customer acceptance should contractual conditions be met.

Since our formation in 1998, we have focused on building a strategic portfolio of intellectual property to support and protect our key innovations. Our tools have been developed using our key proprietary technologies:

? Timely Energized Bubble Oscillation, or TEBO, technology for patterned wafer surfaces at advanced process nodes, which provides effective, damage-free cleaning for 2D and 3D patterned wafers with fine feature sizes;

? Tahoe technology for cost and environmental savings, which delivers high cleaning performance using significantly less sulfuric acid and hydrogen peroxide than is typically consumed by conventional high-temperature single-wafer cleaning tools; and

? Electro-Chemical Plating, or ECP, technology for advanced metal plating, which includes Ultra ECP AP, or Advanced Packaging, technology for back-end assembly processes and Ultra ECP MAP, or Multi-Anode Partial Plating, technology for front-end wafer fabrication processes.

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We have been issued more than 285 patents in the United States, the People's Republic of China or PRC, Japan, Korea, Singapore and Taiwan.

Corporate Background

ACM Research was incorporated in California in 1998 and redomesticated in Delaware in 2016. We perform strategic planning, marketing, and financial activities at our global corporate headquarters in Fremont, California.

Initially we focused on developing tools for chip manufacturing process steps involving the integration of ultra�low�K materials and copper. In the early 2000s we sold tools based on stress-free copper polishing technology. In 2007 we began to focus our development efforts on single-wafer wet-cleaning solutions for the front-end chip fabrication process. Since that time, we have strategically built our technology base and expanded our product offerings:

In 2009 we introduced SAPS megasonic technology, which can be applied in wet wafer cleaning at numerous steps during the chip fabrication process.

In 2016 we introduced TEBO technology, which can be applied at numerous steps during the fabrication of small node conventional two-dimensional and three-dimensional patterned wafers.

In August 2018 we introduced the Ultra-C Tahoe wafer cleaning tool, which delivers high cleaning performance with significantly less sulfuric acid than typically consumed by conventional high temperature single-wafer cleaning tools.

In March 2019 we introduced (a) the Ultra ECP AP or Advanced Wafer Level Packaging tool, a back-end assembly tool used for bumping, or applying copper, tin and nickel to wafers at the die-level prior to packaging, and (b) the Ultra ECP MAP or Multi Anode Plating tool, a front-end process tool that utilizes our proprietary technology to deliver world-class electrochemical copper planting for copper interconnect applications.

In April 2020 we introduced the Ultra Furnace, our first system developed for multiple dry processing applications.

In May 2020 we introduced the Ultra C Family of semi-critical cleaning systems, including the UltraC b for backside clean, the Ultra C wb automated wet bench, and the Ultra C s scrubber.

To help us establish and build relationships with chip manufacturers in the PRC, in 2006 we moved our operational center to Shanghai and began to conduct our business through our subsidiary ACM Shanghai. Since that time, we have expanded our geographic presence:

In 2011 ACM Shanghai formed a wholly owned subsidiary in the PRC, ACM Research (Wuxi), Inc., to manage sales and service operations.

In June 2017 we formed a wholly owned subsidiary in Hong Kong, CleanChip Technologies Limited, to act on our behalf in Asian markets outside the PRC by, for example, serving as a trading partner between ACM Shanghai and its customers, procuring raw materials and components, performing sales and marketing activities, and making strategic investments.

In December 2017 we formed a wholly owned subsidiary in the Republic of Korea, ACM Research Korea CO., LTD., to serve our customers based in the Republic of Korea and perform sales, marketing, and research and development activities.

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Our initial factory is located in the Pudong Region of Shanghai and has a total of 36,000 square feet of available floor space.

In September 2018 we announced the opening of a second factory in the Pudong region of Shanghai. The new facility has a total of 50,000 square feet of available floor space for production capacity.

In November 2019 ACM Shanghai entered into an agreement initiating a bidding process to acquire land rights to build a center in the Lingang region of Shanghai for manufacturing as well as development.

Recent Developments

STAR Market Listing and IPO

In June 2019, we announced our intention to complete:

? a concurrent initial public offering, which we refer to as the STAR IPO, of ACM Shanghai shares in the People's Republic of China, or the PRC, at a pre-offering valuation of not less than RMB 5.15 billion ($747.1 million).

We believe the listing of ACM Shanghai shares on the STAR Market will help us scale our business in mainland PRC, as we continue to seek to broaden our markets in Europe, Japan, Korea, Taiwan and the United States. Our global headquarters will continue to be located in Fremont, California, and we are committed to maintaining the listing of ACM Research Class A common stock on the Nasdaq Global Market.

To qualify for the STAR Listing, ACM Shanghai must have multiple independent stockholders in the PRC.

? In November 2019 ACM Shanghai entered into agreements with each of the First Tranche Investors and eight PRC-based investment firms, or the Second Tranche Investors, pursuant to which the Second Tranche Investors subsequently purchased ACM Shanghai shares, or the Second Tranche Shares, for a total of RMB 228.2 million ($32.4 million as of November 29, 2019). The purchase price per Second Tranche Share was equal to the purchase price per share paid by the First Tranche Investors and was based on a pre-investment enterprise valuation of ACM Shanghai of RMB 4.84 billion ($688.9 million as of November 29, 2019).

As of March 31, 2020, 91.7% of the outstanding shares of ACM Shanghai were owned by ACM Research, 3.8% are owned by the First Tranche Investors and 4.5% are owned by the Second Tranche Investors. The board of directors of ACM Shanghai will consist of nine members, seven of whom will be nominated by ACM Research and two of whom will be nominated by two of the Second Tranche Investors.

If, within three years from the date on which ACM Shanghai shares were issued to the First Tranche Investors, the STAR Listing and the STAR IPO have not been completed and the China Securities Regulatory Commission has not otherwise approved the registration of ACM Shanghai's listing application, each First Tranche Investor will have the right to require that ACM Shanghai repurchase, and ACM Shanghai will have the right to purchase, the First Tranche Investor's ACM Shanghai shares for a price equal to the initial purchase price paid by the First Tranche Investor, without interest.

If ACM Shanghai does not officially submit application documents for the STAR Listing to the Shanghai Stock Exchange by December 31, 2022, each Second Tranche Investor will have the right to require that ACM Shanghai repurchase, and ACM Shanghai will have the right to require that each Second Tranche Investor sell to ACM Shanghai, such Second Tranche Investor's Second Tranche Shares for a price equal to the initial purchase price paid by the Second Tranche Investor, without interest.

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Transactions Relating to SMC Investment

In December 2016 Shengxin (Shanghai) Management Consulting Limited Partnership, or SMC, paid 20,123,500 RMB ($3.0 million as of the date of funding), or the SMC Investment, to ACM Shanghai for investment pursuant to terms to be subsequently negotiated. SMC is a PRC limited partnership owned by employees of ACM Shanghai, including Jian Wang, the general partner of SMC. Jian Wang is the Chief Executive Officer and President of ACM Shanghai and the brother of David H. Wang, our Chief Executive Officer, President and Chair of the Board.

In March 2017, (a) ACM Research issued to SMC a warrant, or the Warrant, exercisable to purchase 397,502 shares of Class A common stock at a price of $7.50 per share, for a total exercise price of $3.0 million and (b) ACM Shanghai agreed to repay the SMC Investment within 60 days after the exercise of the Warrant.

In March 2018 SMC exercised the Warrant in full, as a result of which (1) ACM Research issued 397,502 shares of Class A common stock to SMC, (2) SMC borrowed the funds to pay the Warrant exercise price pursuant to a senior secured promissory note, or the SMC Note, in the principal amount of $3.0 million issued to ACM Shanghai, which in turn issued to ACM Research a promissory note, or the Intercompany Note, in the principal amount of $3.0 million in payment of the Warrant exercise price. Each of the two notes bears interest at a rate of 3.01% per annum and matures on August 17, 2023. The SMC Note was secured by a pledge of the shares issued upon exercise of the Warrant.

In connection with its follow-on public offering of Class A common stock in August 2019, ACM Research agreed to purchase a total of 154,821 of the Warrant shares from SMC at a per share price of $13.195, of which (a) $1.2 million was applied to reduce SMC's obligations to ACM Shanghai under the SMC Note, and which ACM Research then withheld for its own account and applied to reduce ACM Shanghai's obligations to ACM Research under the Intercompany Note and (b) the remaining $0.9 million was paid to SMC. In a separate transaction, ACM Shanghai repaid $1.2 million of the SMC Investment in cash, which reduced the amount of the SMC Investment due to SMC to $1.8 million.

In preparation for the STAR IPO, ACM Shanghai is required to terminate its financial relationship with SMC. In order to facilitate such termination, on April 30, 2020, ACM Research entered into two agreements relating to outstanding obligations among ACM Research, ACM Shanghai and SMC. Pursuant to such agreements (i) ACM Shanghai assigned to ACM its rights under the SMC Note, including the right to receive payment of the $1.8 million payable thereunder;

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COVID-19, or the coronavirus, originated in Wuhan, China, in December 2019 and has subsequently spread rapidly across the PRC and globally. The COVID-19 outbreak affected our business and operating results for the first quarter of 2020. The COVID-19 situation continues to develop rapidly, and it is impossible for us to predict the effect and ultimate impact of the COVID-19 outbreak on our business operations and results. While the quarantine, social distancing and other regulatory measures instituted or recommended in response to COVID-19 are expected to be temporary, the duration of the business disruptions, and related financial impact, of the outbreak cannot be estimated at this time. For an explanation of some of the risks we potentially face, please read carefully the information provided under "Item 1A. Risk Factors-Risks Related to the COVID-19 Outbreak," which is incorporated by reference in "Item 1A. Risk Factors" of Part II of this report.

The following summary reflects our expectations and estimates based on information known to us as of the date of this filing:

Operations: We conduct substantially all of our product development, manufacturing, support and services in the PRC, and those activities have been directly impacted by the COVID-19 outbreak and related restrictions on transportation and public appearances. In February 2020 our ACM Shanghai headquarters were closed for an additional six days beyond the normal Lunar New Year Holiday in accordance with Shanghai government restrictions related to the outbreak. We took steps before and after the Lunar New Year to ensure no employees took unreasonable risks to rush back to work. Currently more than 95% of our staff have returned to work at both of our Shanghai facilities. To date we have not experienced absenteeism of management or other key employees, other than certain of our executive officers being delayed in traveling back to the PRC after working from our California office in February. Our corporate headquarters are located in Alameda County in the San Francisco Bay Area and are the subject of a number of state and county public health directives and orders. These actions have not negatively impacted our business to date, however, because of the limited number of employees at our headquarters and the nature of the work they generally perform.

Customers: Our customers' business operations have been, and are continuing to be, subject to business interruptions arising from the COVID-19 outbreak. Historically a majority of our revenue from sales of single-wafer wet cleaning equipment for front-end manufacturing has been derived from customers located in the PRC and surrounding areas that have been impacted by COVID-19. Three customers that accounted for 73.8% of our revenue in 2019 and 87.6% of our revenue in 2018 are based in the PRC and Korea. One of those customers, Yangtze Memory Technologies Co., Ltd. - which accounted for 27.5% of our 2019 revenue and 39.6% of our 2018 revenue - is based in Wuhan. While Yangtze Memory Technologies Co., Ltd. and other key customers continued to operate their fabrication facilities without interruption during and after the first quarter of 2020, they were forced to restrict access of service personnel and deliveries to and from their facilities. A portion of the shipments we previously had expected to deliver in the first quarter of 2020 were postponed due in part to these factors. We believe these deliveries represent deferred, not lost, shipments and revenue, which we are working to recover by increasing our manufacturing output in the second and third quarters of 2020.

Suppliers: Our global supply chain includes components sourced from the PRC, Japan, Taiwan, the United States and Europe. While the COVID-19 outbreak has resulted in significant governmental measures being implemented to control the spread of COVID-19 around the world, to date we have not experienced material issues with our supply chain. As with our customers, we continue to be in close contact with our key suppliers to help ensure we are able to identify any potential supply issues that may arise.

Projects: Our strategy includes a number of plans to support the growth of our core business, including the proposed STAR Listing and STAR IPO with respect to shares of ACM Shanghai described above as well as ACM Shanghai's proposed acquisition of land rights in the Lingang area of Shanghai where we intend to construct a new research and development center and factory. The extent to which COVID-19 impacts these projects will depend on future developments that are highly uncertain, but to date, the timing of these potential projects has not been delayed or disrupted by COVID-19 or related government measures.

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ACM Shanghai has received five special government grants from China's Ministry of Science and Technology, the Shanghai Municipal Commission of Economy and Information, and the Shanghai Science and Technology Committee. The first grant, which was awarded in 2008, relates to the development and commercialization of 65nm to 45nm stress-free polishing technology. The second grant was awarded in 2009 to fund interest expense on short-term borrowings. The third grant was made in 2014 and relates to the development of electro copper-plating technology. The fourth grant was made in June 2018 and related to development of polytetrafluoroethylene. The fifth grant was made in 2020, and relates to the development of Tahoe single bench cleaning technologies. These governmental authorities provide the majority of the funding, although ACM Shanghai is also required to invest certain amounts in the projects.

The governmental grants contain certain operating conditions, and we are required to go through a government due diligence process once the project is complete. The grants therefore are recorded as long-term liabilities upon receipt, although we are not required to return any funds we receive. Grant amounts are recognized in our statements of operations and comprehensive income as follows:

Government subsidies relating to current expenses are reflected as reductions of those expenses in the periods in which they are reported. Those reductions totaled $0.2 million in the first three months of 2020, as compared to $1.3 million in the first three months of 2019.

Government grants used to acquire depreciable assets are transferred from long-term liabilities to property, plant and equipment when the assets are acquired and then the recorded amounts of the assets are credited to other income over the useful lives of the assets. Related government subsidies recognized as other income totaled $37,000 and $35,000 in the first three months of 2020 and 2019, respectively.

How We Evaluate Our Operations

We present information below with respect to four measures of financial performance:

We define "shipments" of tools to include (a)a "repeat" delivery to a customer of a type of tool that the customer has previously accepted, for which we recognize revenue upon delivery, and (b)a "first-time" delivery of a tool to a customer on an approval basis, for which we may recognize revenue in the future if contractual conditions are met and customer acceptance is received.

We define "adjusted EBITDA" as our net income excluding interest expense (net), income tax benefit (expense), depreciation and amortization, and stock-based compensation. We define adjusted EBITDA to also exclude restructuring costs, although we have not incurred any such costs to date.

We define "free cash flow" as net cash provided by operating activities less purchases of property and equipment (net of proceeds from disposals) and of intangible assets.

We define "adjusted operating income" as our income from operations excluding stock-based compensation.

These financial measures are not based on any standardized methodologies prescribed by accounting principles generally accepted in the United States, or GAAP, and are not necessarily comparable to similarly titled measures presented by other companies.

We have presented shipments, adjusted EBITDA, free cash flow and adjusted operating income because they are key measures used by our management and board of directors to understand and evaluate our operating performance, to establish budgets and to develop operational goals for managing our business. We believe that these financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA and adjusted operating income can provide useful measures for period-to-period comparisons of our core operating performance and that the exclusion of property and equipment purchases from operating cash flow can provide a usual means to gauge our capability to generate cash. Accordingly, we believe that these financial measures provide useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making.

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Shipments

Shipments consist of two components:

a shipment to a customer of a type of tool that the customer has previously-accepted, for which we recognize revenue when the tool is delivered; and

a shipment to a customer of a type of tool that the customer is receiving and evaluating for the first time, in each case a "first tool," for which we may recognize revenue at a later date, subject to the customer's acceptance of the tool upon the tool's satisfaction of applicable contractual requirements.

"First tool" shipments can be made to either an existing customer that not previously accepted that specific type of tool in the past - for example, a delivery of SAPS V tool to a customer that previously had received only SAPS II tools - or to a new customer that has never purchased any tool from us.

Shipments in the three months ended March 31, 2020 totaled $12 million, as compared to $14 million in the three months ended March 31, 2019, and $25 million in the three months ended December 31, 2019.

The dollar amount attributed to a "first tool" shipment is equal to the consideration we expect to receive if any and all contractual requirements are satisfied and the customer accepts the tool. There are a number of limitations related to the use of shipments in evaluating our business, including that customers have significant discretion in determining whether to accept our tools . . .

May 08, 2020

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