(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes included in this report. In addition to historical information, the following discussion contains forward-looking statements that involves risks, uncertainties and assumptions. See "Forward-Looking Statements and Statistical Data" at page 3 of this report. Please read "Item 1A. Risk Factors" for a discussion of factors that could cause our actual results to differ materially from our expectations
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.
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.
We conduct substantially all of our product development, manufacturing, support and services in the PRC. All of our tools are built to order at our manufacturing facilities in Shanghai, which encompass 86,000 square feet of floor space for production capacity.
Follow-on Public Offering
In August 2019 we received $26.4 million in net proceeds (after underwriting discounts and related expenses), from our sale, at a purchase price of $13.195 per share, of 2,053,572 shares of Class A common stock (including 267,857 shares sold pursuant to the underwriters' exercise of an over-allotment option) to an underwriting syndicate, for which Stifel, Nicolaus & Company, Incorporated, served as representative. The offering and sale of the 2,053,572 shares to the public were registered under a registration statement on Form S-3 filed with the SEC.
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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 Listing, ACM Shanghai must have multiple independent shareholders 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 20, 2020, 91.7% of the outstanding shares of ACM Shanghai are 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 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 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.
We have determined, voluntarily and not pursuant to any contractual or legal obligation, that pending either (a) ACM Shanghai's submission of the application documents for the Listing to the Shanghai Stock Exchange or (b) application to repurchase the Second Tranche Shares, ACM Shanghai will deposit, and hold in reserve, all of the proceeds received from the sale of Additional Placement Shares in segregated cash and cash-equivalent accounts.
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.
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In March 2018 SMC exercised the Warrant in full, as a result of which (1) ACM Research issued 397,502 Shares 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.
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 did not affect our business or operating results in 2019. As of the date of filing of this report with the SEC, the outbreak has had an impact on our business and operating results in the first quarter of 2020. Given the scope of the outbreak and based on our assumption that the situation will continue to improve steadily in the PRC and will begin to stabilize in the rest of the world, we believe our business will begin to return to previously anticipated levels in the second quarter of 2020. The following summary reflects our expectations and estimates based on information known to us as of the date of this filing:
? Operating Results; 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 revenues we previously expected to recognize in the first quarter of 2020 will not be recognized, as we have, in accordance with orders received from customers, deferred delivery of some tools from the first quarter. We believe these deliveries represent deferred, not lost, revenues, 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 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 project has not been delayed or disrupted by COVID-19 or related government measures.
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."
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Key Components of Results of Operations
We develop, manufacture and sell single-wafer wet cleaning equipment and custom-made wafer assembly and packaging equipment. Because we sell tools to a small number of customers and we customize those tools to fulfill the customers' specific requirements, our revenue generation fluctuates, depending on the length of the sales, development and evaluation phases:
? Evaluation Periods. When a chip manufacturer proposes to purchase a particular type of tool from us for the first time, we offer the manufacturer an opportunity to evaluate the tool for a period that can extend for 24 months or longer. In some cases, we do not receive any payment on first-time purchases until the tool is accepted. As a result, we may spend between $1.0 and $2.0 million to produce a tool without receiving payment for more than 24 months or, if the tool is not accepted, without receiving any payment. Please see "Item 1A. Risk Factors-Risks Related to Our Business and Our Industry-We may incur significant expenses long before we can recognize revenue from new products, if at all, due to the costs and length of research, development, manufacturing and customer evaluation process cycles."
? Purchase Orders. In accordance with industry practice, sales of our tools are made pursuant to purchase orders. Each purchase order from a customer for one of our tools contains specific technical requirements intended to ensure, among other things, that the tool will be compatible with the customer's manufacturing process line. Until a purchase order is received, we do not have a binding purchase commitment. Our SAPS and TEBO customers to date have provided us with non-binding one- to two-year forecasts of their anticipated demands, and we expect future customers to furnish similar non-binding forecasts for planning purposes. Any of those forecasts would be subject to change, however, by the customer at any time, without notice to us.
? Fulfillment. We seek to obtain a purchase order for a tool from three to four months in advance of the expected delivery date. Depending upon the nature of a customer's specifications, the lead time for production of a tool generally will extend from two to four months. The lead-time can be as long as six months, however, and in some cases we may need to begin producing a tool based on a customer's non-binding forecast, rather than waiting to receive a binding purchase order.
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We expect our sales prices generally to range from $2 million to more than $5 million for our single-wafer wet cleaning tools. The sales price of a particular tool will vary depending upon the required specifications. We have designed equipment models using a modular configuration that we customize to meet customers' technical specifications. For example, our Ultra C models for SAPS, TEBO and Tahoe solutions use common modular configurations that enable us to create a wet-cleaning tool meeting a customer's specific requirements, while using pre-existing designs for chamber, electrical, chemical delivery and other modules.
Because of the relatively large purchase prices of our tools, customers generally pay in installments. For a customer's repeat purchase of a particular type of tool, the specific payment terms are negotiated in connection with acceptance milestones of a purchase order. Based on our limited experience with repeat sales of our tools, we expect that we will receive an initial payment upon delivery of a tool in connection with a repeat purchase, with the balance being paid once the tool has been tested and accepted by the customer. Our sales arrangements for repeat purchases do not include a general right of return.
Based on our market experience, we believe that implementation of our equipment by one of our selected leading companies will attract and encourage other manufacturers to evaluate our equipment, because the leading company's implementation will serve as validation of our equipment and will enable the other manufacturers to shorten their evaluation processes. We placed our first SAPS-based tool in 2009 as a prototype. We worked closely with the customer for two years in debugging and modifying the tool, and the customer then spent two more years of qualification and running pilot production before beginning volume manufacturing. We expect that the period from new product introduction to high volume manufacturing will be three years or less in the future. Please see "Item 1A. Risk Factors-Business-We depend on a small number of customers for a substantial portion of our revenue, and the loss of, or a significant reduction in orders from, one or more of our major customers could have a material adverse effect on our revenue and operating results. There are also a limited number of potential customers for our products."
All of our sales in 2019 and 2018 were to customers located in Asia, and we anticipate that a substantial majority of our revenue will continue to come from customers located in this region for the near future. We have increased our sales efforts to penetrate the markets in North America and Western Europe.
We utilize the guidance set forth in Accounting Standards Update, or ASU, No. 2014-09, Revenue from Contracts with Customers (Topic 606), of the Financial Accounting Standards Board, or FASB, regarding the recognition, presentation and disclosure of revenue in our financial statements as described below under "-Critical Accounting Policies and Significant Judgments and Estimates-Revenue Recognition."
We offer extended maintenance service contracts to provide services such as trouble-shooting or fine-tuning tools, and installing spare parts, following expiration of applicable initial standard warranty coverage periods, which for sales to date have extended from 12 to 36 months as described under "-Critical Accounting Policies and Significant Judgments and Estimates-Warranty." A limited number of the single-wafer wet cleaning tools we have sold to date are no longer covered by their initial warranties. In 2019 and 2018, we received payments for parts and labor for service activities provided from time to time, but as of December 31, 2019 we had not yet entered into extended maintenance service contracts with respect to any of the tools for which initial warranty coverage had expired. We expect to enter into extended maintenance service contracts with customers as additional initial warranties expire, but we do not expect revenue from extended maintenance service contracts to represent a material portion of our revenue in the future.
The loss or delay of one or more large sale transactions in a quarter could impact our results of operations for that quarter and any future quarters for which revenue from that transaction is lost or delayed, as described under "Item 1A. Risk Factors-Risks Related to Our Business and Our Industry-Our quarterly operating results can be difficult to predict and can fluctuate substantially, which could result in volatility in the price of Class A common stock." It is difficult to predict accurately when, or even if, we can complete a sale of a tool to a potential customer or to increase sales to any existing customer. Our tool demand forecasts are based on multiple assumptions, including non-binding forecasts received from customers years in advance, each of which may introduce error into our estimates. Difficulties in forecasting demand for our tools make it difficult for us to project future operating results and may lead to periodic inventory shortages or excess spending on inventory or on tools that may not be purchased, as further described in "Item 1A. Risk Factors-Risks Related to Our Business and Our Industry-Difficulties in forecasting demand for our tools may lead to periodic inventory shortages or excess spending on inventory items that may not be used."
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Cost of Revenue
Cost of revenue for capital equipment consists primarily of:
? compensation of personnel associated with our manufacturing operations, including stock-based compensation;
? depreciation of manufacturing equipment;
? amortization of costs of software used for manufacturing purposes;
? other expenses attributable to our manufacturing department; and
? allocated overhead for rent and utilities.
We are not party to any long-term purchasing agreements with suppliers. Please see "Item 1A. Risk Factors-Risks Related to Our Business and Our Industry-Our customers do not enter into long-term purchase commitments, and they may decrease, cancel or delay their projected purchases at any time."
As our customer base and tool installations continue to grow, we will need to hire additional manufacturing personnel. The rates at which we add customers and install tools will affect the level and time of this spending. In addition, because we often import components and spare parts from the United States, we have experienced, and expect to continue to experience, the effect of the dollar's growth on our cost of revenue.
Our gross margin was 47.1% in 2019 and 46.2% in 2018. Gross margin may vary from period to period, primarily related to the level of utilization and the timing and mix of purchase orders. We expect gross margin to range between 40% and 45% for the foreseeable future, with direct manufacturing costs approximating 50% to 55% of revenue and overhead costs totaling approximately 5% of revenue.
We seek to maintain our gross margin by continuing to develop proprietary technologies that avoid pricing pressure for our wet cleaning equipment. We actively manage our operations through principles of operational excellence designed to ensure continuing improvement in the efficiency and quality of our manufacturing operations by, for example, implementing factory constraint management and change control and inventory management systems. In addition, our purchasing department actively seeks to identify and negotiate supply contracts with improved pricing to reduce cost of revenue.
A significant portion of our raw materials are denominated in the Chinese Renminbi, while the majority of our purchase orders are denominated in U.S. dollars. As a result, currency exchange rates may have a significant effect on our gross margin.
We have experienced, and expect to continue to experience, growth in the absolute dollar amount of our operating expenses, as we invest to support the anticipated growth of our customer base and the continued development of proprietary technologies.
Sales and Marketing
Sales and marketing expense accounted for 11.1% of our revenue in 2019 and 12.9% of our revenue in 2018. Sales and marketing expense consists primarily of:
? sales commissions paid to independent sales representatives;
? fees paid to sales consultants;
? shipping and handling costs for transportation of products to customers;
? cost of trade shows;
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? travel and entertainment; and
? allocated overhead for rent and utilities.
Sales and marketing expense can be significant and may fluctuate, in part because of the resource-intensive nature of our sales efforts and the length and variability of our sales cycle. The length of our sales cycle, from initial contact with a customer to the execution of a purchase order, is generally 6 to 24 months.
During the sales cycle, we expend significant time and money on sales and marketing activities, including educating customers about our tools, participating in extended tool evaluations and configuring our tools to customer-specific needs. Sales and marketing expense in a given period can be particularly affected by the increase in travel and entertainment expenses associated with the finalization of purchase orders or the installation of tools.
We expect that, for the foreseeable future, sales and marketing expense will increase in absolute dollars, as we continue to invest in sales and marketing by . . .
Mar 24, 2020
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