Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________
FORM 10-Q
_________________________________
(MARK ONE)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2018

OR
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM              TO             
Commission file number 001-34717
__________________________
Alpha and Omega Semiconductor Limited
(Exact name of Registrant as Specified in its Charter)
Bermuda
77-0553536
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification Number)
Clarendon House, 2 Church Street
Hamilton HM 11, Bermuda
(Address of Principal Registered
Offices including Zip Code)
(408) 830-9742
(Registrant's Telephone Number, Including Area Code)
__________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x     No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o
Accelerated filer  x
Non-accelerated filer  o
 
 
(Do not check if a smaller reporting company)
Smaller reporting company    x

Emerging growth company o
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Number of common shares outstanding as of January 31, 2019: 23,940,455



Alpha and Omega Semiconductor Limited
Form 10-Q
Fiscal Second Quarter Ended December 31, 2018
TABLE OF CONTENTS
 
 
 
Page
Part I.
 
    Item 1.
 
 
 
 
 
    Item 2.
    Item 3.
    Item 4.
Part II.
 
    Item 1.
    Item 1A.
    Item 2.
    Item 3.
    Item 4.
    Item 5.
    Item 6.
 






PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands except par value per share)
 
December 31,
2018
 
June 30,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
146,632

 
$
131,535

Restricted cash
255

 
189

Accounts receivable, net
33,858

 
33,755

Inventories
102,962

 
90,182

Other current assets
34,271

 
29,551

Total current assets
317,978

 
285,212

Property, plant and equipment, net
380,783

 
331,656

Intangible assets, net
16,939

 
16,591

Deferred income tax assets
4,944

 
4,892

Other long-term assets
13,544

 
28,698

Total assets
$
734,188

 
$
667,049

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
102,617

 
$
92,661

Accrued liabilities
59,013

 
49,841

Income taxes payable
1,769

 
2,211

Short-term debt
22,797

 
3,811

Deferred margin

 
1,665

Capital leases
7,429

 
4,491

Total current liabilities
193,625

 
154,680

Long-term debt
36,729

 
26,786

Income taxes payable - long-term
951

 
924

Deferred income tax liabilities
1,134

 
713

Capital leases - long-term
51,185

 
56,791

Other long-term liabilities
6,036

 
993

Total liabilities
289,660

 
240,887

Commitments and contingencies (Note 11)

 

Equity:
 
 
 
Preferred shares, par value $0.002 per share:
 
 
 
Authorized: 10,000 shares, issued and outstanding: none at December 31, 2018 and June 30, 2018

 

Common shares, par value $0.002 per share:
 
 
 
Authorized: 100,000 shares, issued and outstanding: 30,590 shares and 23,939 shares, respectively at December 31, 2018 and 30,400 shares and 23,860 shares, respectively at June 30, 2018
61

 
61

Treasury shares at cost, 6,651 shares at December 31, 2018 and 6,540 shares at June 30, 2018
(66,283
)
 
(64,790
)
Additional paid-in capital
227,818

 
220,244

Accumulated other comprehensive income (loss)
(2,842
)
 
440

Retained earnings
124,538

 
122,639

Total Alpha and Omega Semiconductor Limited shareholder's equity
283,292

 
278,594

Noncontrolling interest
161,236

 
147,568

Total equity
444,528

 
426,162

Total liabilities and equity
$
734,188

 
$
667,049

See accompanying notes to these condensed consolidated financial statements.

1

Table of Contents

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share data)

 

 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
Revenue
$
114,925

 
$
103,896

 
$
229,997

 
$
208,754

Cost of goods sold
85,423

 
75,814

 
167,884

 
153,142

Gross profit
29,502

 
28,082

 
62,113

 
55,612

Operating expenses
 
 
 
 
 
 
 
Research and development
12,600

 
9,102

 
23,984

 
17,427

Selling, general and administrative
20,104

 
15,756

 
40,456

 
30,371

Total operating expenses
32,704

 
24,858

 
64,440

 
47,798

Operating income (loss)
(3,202
)
 
3,224

 
(2,327
)
 
7,814

Interest income and other income (loss), net
74

 
(160
)
 
336

 
(120
)
Interest expense
(1,706
)
 
(14
)
 
(3,196
)
 
(31
)
Net income (loss) before income taxes
(4,834
)
 
3,050

 
(5,187
)
 
7,663

Income tax expense (benefit)
701

 
(2,072
)
 
1,261

 
(798
)
Net income (loss) including noncontrolling interest
(5,535
)
 
5,122

 
(6,448
)
 
8,461

Net loss attributable to noncontrolling interest
(3,990
)
 
(1,669
)
 
(7,319
)
 
(3,130
)
Net income (loss) attributable to Alpha and Omega Semiconductor Limited
$
(1,545
)
 
$
6,791

 
$
871

 
$
11,591

Net income (loss) per common share attributable to Alpha and Omega Semiconductor Limited
 
 
 
 
 
 
 
Basic
$
(0.06
)
 
$
0.28

 
$
0.04

 
$
0.48

Diluted
$
(0.06
)
 
$
0.27

 
$
0.04

 
$
0.46

Weighted average number of common shares attributable to Alpha and Omega Semiconductor Limited used to compute net income (loss) per share
 
 
 
 
 
 
 
Basic
23,887

 
23,925

 
23,865

 
23,973

Diluted
23,887

 
25,033

 
24,513

 
24,997

















See accompanying notes to these condensed consolidated financial statements.


2

Table of Contents

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands)


 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
Net income (loss) including noncontrolling interest
$
(5,535
)
 
$
5,122

 
$
(6,448
)
 
$
8,461

Other comprehensive income, net of tax
 
 
 
 
 
 
 
Foreign currency translation adjustment
(58
)
 
3,347

 
(6,295
)
 
4,048

Comprehensive income (loss)
(5,593
)
 
8,469

 
(12,743
)
 
12,509

Noncontrolling interest
(4,014
)
 
(104
)
 
(10,332
)
 
(1,231
)
Comprehensive income (loss) attributable to Alpha and Omega Semiconductor Limited
$
(1,579
)
 
$
8,573

 
$
(2,411
)
 
$
13,740






























See accompanying notes to these condensed consolidated financial statements.


3

Table of Contents
ALPHA AND OMEGA SEMICONDUCTOR LIMITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)



 
Six Months Ended December 31,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net income (loss) including noncontrolling interest
$
(6,448
)
 
$
8,461

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
16,149

 
14,386

Share-based compensation expense
7,547

 
6,017

Deferred income taxes, net
94

 
(2,224
)
Loss (gain) on disposal of property and equipment
(6
)
 
55

Changes in assets and liabilities:
 
 
 
Accounts receivable, net
(326
)
 
4,127

Inventories
(12,780
)
 
(9,418
)
Other current and long-term assets
(696
)
 
(9,081
)
Accounts payable
9,927

 
1,877

Income taxes payable
(415
)
 
(448
)
Accrued and other liabilities
18,035

 
8,102

Net cash provided by operating activities
31,081

 
21,854

Cash flows from investing activities
 
 
 
Purchases of property and equipment excluding JV Company
(23,218
)
 
(23,192
)
Purchases of property and equipment in JV Company
(42,723
)
 
(41,576
)
Purchase of intangible assets
(405
)
 
(10,384
)
Proceeds from sale of property and equipment
19

 

Net cash used in investing activities
(66,327
)
 
(75,152
)
Cash flows from financing activities
 
 
 
Proceeds from investment by noncontrolling interest
24,000

 
86,994

Withholding tax on restricted stock units
(203
)
 
(249
)
Proceeds from exercise of stock options and ESPP
1,278

 
2,205

Payment for repurchases of common shares
(1,501
)
 
(6,022
)
Proceeds from borrowings
36,191

 

Repayments of borrowings
(7,308
)
 

Principal payments on capital leases
(417
)
 
(399
)
Net cash provided by financing activities
52,040

 
82,529

Effect of exchange rate changes on cash, cash equivalents and restricted cash
(1,631
)
 
1,241

Net increase in cash, cash equivalents and restricted cash
15,163

 
30,472

Cash, cash equivalents and restricted cash at beginning of period
131,724

 
115,929

Cash, cash equivalents and restricted cash at end of period
$
146,887

 
$
146,401

 
 
 
 
Supplemental disclosures of non-cash investing and financing information:
 
 
 
Property and equipment purchased but not yet paid
$
61,573

 
$
43,235

Re-issuance of treasury stock
$
8

 
$
3



See accompanying notes to these condensed consolidated financial statements.

4

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. The Company and Significant Accounting Policies
The Company

Alpha and Omega Semiconductor Limited and its subsidiaries (the “Company”, "AOS", "we" or "us") design, develop and supply a broad range of power semiconductors. The Company's portfolio of products targets high-volume applications, including personal computers, flat panel TVs, LED lighting, smart phones, battery packs, quick chargers, home appliances, consumer and industrial motor controls and power supplies for TVs, computers, servers and telecommunications equipment. The Company conducts its operations primarily in the United States of America (“USA”), Hong Kong, China, and South Korea.
Basis of Preparation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Article 10 of Securities and Exchange Commission Regulation S-X, as amended. They do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with U.S. GAAP for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair presentation of the results of operations for the periods presented have been included in the interim periods. Operating results for the six months ended December 31, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2019. The condensed consolidated balance sheet at June 30, 2018 is derived from the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

Joint Venture

In March 2016, the Company executed an agreement with two strategic investment funds owned by the Municipality of Chongqing, China (the "Chongqing Funds") to form a joint venture, (the "JV Company"), for a new state-of-the-art power semiconductor packaging, testing and wafer fabrication facility in Liangjiang New Area of Chongqing (the "Joint Venture"). The initial capitalization of the Joint Venture under the agreement was $330.0 million, which includes cash contributions from the Chongqing Funds and contributions of cash, equipment and intangible assets from the Company. In August 2018, the Company invested an additional $25.0 million of cash contribution to the JV Company, which resulted in the Company owned 54.4%, and the Chongqing Funds owned 45.6%, of the equity interest in the JV Company. At the end of December 2018, the Chongqing Funds invested additional $24.0 million of cash contribution to the JV Company, which resulted in the Company owning 50.9%, and the Chongqing Funds owning 49.1%, of the equity interest in the JV Company. The Joint Venture is accounted for under the provisions of the consolidation guidance since the Company has a controlling financial interest.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires the Company to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. To the extent there are material differences between these estimates and actual results, the Company's condensed consolidated financial statements will be affected. On an ongoing basis, the Company evaluates the estimates, judgments and assumptions including those related to stock rotation returns, price adjustments, allowance for doubtful accounts, inventory reserves, warranty accrual, income taxes, share-based compensation, and useful lives for property, plant and equipment and intangible assets.
Share-based Compensation Expense
The Company recognizes expense related to share-based compensation awards that are ultimately expected to vest based on estimated fair values on the date of grant. The fair value of restricted share units is based on the market value of the Company's common share on the date of grant. For restricted stock awards subject to market conditions, the fair value of each

5

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

restricted stock award is estimated at the date of grant using the Monte-Carlo pricing model. The fair value of stock options is estimated on the date of grant using the Black-Scholes option valuation model. Share-based compensation expense is recognized on the accelerated attribution basis, net of estimated forfeitures, over the requisite service period of the award, which generally equals the vesting period.
Fair Value of Financial Instruments

The fair value of cash equivalents is based on observable market prices and have been categorized in Level 1 in the fair value hierarchy. Cash equivalents consist primarily of short term bank deposits. The carrying values of financial instruments such as cash and cash equivalents, accounts receivable and accounts payable approximate their carrying values due to their short-term maturities. The carrying value of the company's debt is considered a reasonable estimate of fair value which is estimated by considering the current rates available to the Company for debt of the same remaining maturities, structure and terms of the debts.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The Company's accumulated other comprehensive income (loss) consists of cumulative foreign currency translation adjustments. Total comprehensive income (loss) is presented in the condensed consolidated statements of comprehensive income (loss).

Recent Accounting Pronouncements
    
Recently Issued Accounting Standards not yet adopted

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should be presented in the form of a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed with the SEC. The Company's first presentation of changes in stockholders' equity will be included in its Form 10-Q for the quarter ending March 31, 2019.

In August 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-15 “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15”). These amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contact with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. ASU 2018-15 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements.

In August 2018, the FASB issued Accounting Standard Updates ("ASU") ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13”). ASU 2018-13 amends existing fair value measurement disclosure requirements by adding, changing, or removing certain disclosures. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. ASU No. 2018-13 is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. The Company does not expect the adoption of this guidance will have a material impact on its consolidated financial position, results of operations or cash flows.

In June 2018, the FASB issued ASU 2018-07, "Compensation -Stock Compensation: Improvement to Nonemployees Share-Based Payment Accounting ("ASU 2018-07"), which expands the scope of Topic 718 to include all share-based payment

6

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

transactions for acquiring goods and services from nonemployees. ASU 2018-07 specifies that Topic 718 applies to all share-based payment transactions in which the grantor acquires goods and services to be used or consumed in its own operations by issuing share-based payment awards. ASU 2018-07 also clarifies that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under ASC 606. ASU 2018-07 is effective fiscal years beginning after December 15, 2018, including interim periods within that fiscal year, with early adoption permitted, but no earlier than our adoption of ASC 606. The Company does not expect the adoption of this guidance will have a material impact on its consolidated financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases. This guidance requires a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding liability on its balance sheet, with differing methodology for income statement recognition. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements.”, which permits an entity to elect an additional transition method to the existing modified retrospective transition requirements. Under the new transition method, an entity could adopt the provisions of ASU No. 2016-02 by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without adjustment to the financial statements for periods prior to adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with the previous lease guidance in ASC Topic 840. ASU 2018-11 also allows a practical expedient that permits lessors to not separate non-lease components from the associated lease component if certain conditions are present. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous Generally Accepted Accounting Principles.  Although the Company is currently evaluating the impact the pronouncement will have on its consolidated financial statements and related disclosures, the Company expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption.

Recently Adopted Accounting Standards

In May 2017, the FASB issued ASU 2017-09, "Compensation -Stock Compensation: Scope of Modification Accounting ("ASU 2017-09"). ASU 2017-09 is an update to the existing guidance to clarify when modification accounting would be applied for a change to the terms or conditions of a share-based award. Under this new guidance, modification accounting is required only if the fair value, a vesting condition, or the classification of the award changes as a result of the change in terms or conditions. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted. The Company does not regularly modify the terms and conditions of its share-based awards and the adoption of this guidance has no impact on its financial statements.

In November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows: Restricted Cash ("ASU 2016-18"). ASU 2016-18 requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted and requires retrospective adoption.  The Company adopted this standard effective July 1, 2018. The reclassified restricted cash balances from investing activities to changes in cash, cash equivalents and restricted cash on the condensed consolidated statements of cash flows were not material for all periods presented.

In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-15 identifies how certain cash receipts and cash payments are presented and classified in the Statement of Cash Flows under Topic 230. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted.  Upon adoption, entities must apply the guidance retrospectively to all periods presented. There was no impact on the Company's consolidated financial statements upon the adoption of this standard.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASC 606). The standard provides companies with a single model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry-specific revenue guidance. The core principle of the model is to recognize

7

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

revenue when control of the goods or services transfers to the customer, as opposed to recognizing revenue when the risks and rewards transfer to the customer under the existing revenue guidance.
The change for the Company under ASC 606 relates to the timing of revenue recognition with two U.S.-based distributors. Sales to these distributors are governed under the terms of agreements providing extended price protection and other return rights, and were historically deferred under the previous accounting guidance until the related product was sold to the end customer. Under ASC 606, the transaction price takes into consideration the effect of variable consideration such as price adjustments and returns rights, which are estimated and recorded at the time the goods are delivered. Accordingly, the Company recognizes revenue under ASC 606 at the time of shipment or delivery to these two distributors, adjusted for estimates of the price adjustments and product returns based on historical data and other available information. Revenue from other non-U.S. distributors and direct customers, which consists of the majority of the Company's total revenue, is recognized at the time of shipment or delivery to the distributors and direct customers. Accordingly, revenue recognition with these distributors and direct customers remains unchanged upon adoption of ASC 606. See "Note 2 - Revenue" for additional information on the impact of the adoption of the new standard on the Company’s consolidated financial statements.

2. Revenue

Impact from the Adoption of the New Revenue Standard:

On July 1, 2018, the Company adopted ASC 606 using the modified retrospective method applied to all contracts. Results for reporting periods beginning after July 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 605.

The change for the Company under ASC 606 relates to the timing of revenue recognition with two U.S.-based distributors. Sales to these distributors are governed under the terms of agreements providing extended price protection and other return rights. The Company recorded a net increase to opening retained earnings of $1.0 million as of July 1, 2018 due to the cumulative impact of adopting ASC 606, with a corresponding $1.6 million decrease in deferred margin, a $0.2 million decrease in accounts receivables, a $0.1 million increase in current accrued liabilities, and a $0.3 million increase in deferred tax liabilities. Effective July 1, 2018, the Company recognized revenue at the time of shipment or delivery to these two distributors, adjusted for estimates of the price adjustments and return rights based on historical data and other available information. Based on the Company's assessment, only minimal changes were required to the Company's existing policies, processes, and controls to support the standard's measurement and disclosure requirements.

The following tables compare the amounts reported in the condensed consolidated statements of income and condensed consolidated balance sheet to the amounts had the previous revenue recognition guidance been in effect:

 
As of December 31, 2018
 
As Reported
 
Adjustment
 
Balances Without Adoption
 
(in thousands)
Accounts receivable, net
$
33,858

 
$
193

 
$
34,051

Accrued liabilities
$
59,013

 
$
(84
)
 
$
58,929

Deferred margin
$

 
$
1,782

 
$
1,782

Income taxes payable
$
1,769

 
$
(45
)
 
$
1,724

Deferred income tax liabilities
$
1,134

 
$
(313
)
 
$
821

Retained earnings
$
124,538

 
$
(1,183
)
 
$
123,355



8

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Three Months Ended December 31, 2018
 
Six Months Ended December 31, 2018
 
As Reported
 
Adjustment
 
Balances Without Adoption
 
As Reported
 
Adjustment
 
Balances Without Adoption
 
(in thousands)
 
(in thousands)
Revenue
$
114,925

 
$
(349
)
 
$
114,576

 
$
229,997

 
$
(308
)
 
$
229,689

Cost of goods sold
$
85,423

 
$
(134
)
 
$
85,289

 
$
167,884

 
$
(114
)
 
$
167,770

Gross profit
$
29,502

 
$
(215
)
 
$
29,287

 
$
62,113

 
$
(194
)
 
$
61,919

Income tax expense (benefit)
$
701

 
$
(37
)
 
$
664

 
$
1,261

 
$
(45
)
 
$
1,216

Net loss including noncontrolling interest
$
(5,535
)
 
$
(178
)
 
$
(5,713
)
 
(6,448
)
 
$
(149
)
 
$
(6,597
)

New Revenue Recognition Policy Including Significant Judgments and Estimates

As a result of the adoption of the new revenue standard on July 1, 2018, at the beginning of the first quarter of fiscal year 2019, the Company determines revenue recognition through the following steps: (1) identification of the contract with a customer; (2) identification of the performance obligations in the contract; (3) determination of the transaction price; (4) allocation of the transaction price to the performance obligations in the contract; and (5) recognition of revenue when, or as, a performance obligation is satisfied.

The Company has written contracts with combination of agreements and purchase orders with all customers including certain general terms and conditions. Often purchase orders entail merchandises, quantities and prices, which define the performance obligations of each party and are approved or accepted by the Company. The Company’s contracts with customers do not typically include extended payment terms. Payment terms vary by contract type and type of customer and generally range from 30 to 60 days.

The Company’s performance obligations are to deliver the requested goods or services to customers according to the agreed shipping terms. As such, there is no material difference in regards to performance obligations vs. “deliverables” under ASC 606 vs. the legacy revenue guidance. The Company recognizes revenue when the performance obligation is satisfied.

The majority of the Company’s total revenue is from non-U.S. distributors and direct customers, which is recognized at the time of shipment or delivery to distributors and direct customers. Accordingly, revenue recognition with these distributors and direct customers remains unchanged upon adoption of ASC 606. As noted above, the change for the Company under ASC 606 relates to the timing of revenue recognition with two U.S.-based distributors. Sales to these distributors are governed under the terms of agreements providing extended price protection and other return rights, and were historically deferred under the previous accounting guidance until the related product was sold to end customers. Under ASC 606, the transaction price takes into consideration the effect of variable consideration such as price adjustments and return rights, which are estimated and recorded at the time the goods are delivered.

Because all of the Company’s performance obligations relate to contracts with a duration of less than one year, the Company elected to apply the optional exemption practical expedient provided in ASC 606 and, therefore, is not required to disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period.

The Company adjusts the transaction price for variable consideration. Variable consideration primarily are adjustments related to stock rotation rights and price adjustments provided to our distributors. As a practical expedient, the Company recognizes the incremental costs of obtaining a contract, specifically commission expenses that have a period of benefit of less than twelve months, as an expense when incurred. Additionally, the Company has adopted an accounting policy to recognize shipping costs that occur after control transfers to the customer as a fulfillment activity.

The Company warrants its products to be free of defects generally for a period of one year. The Company estimates its warranty costs based on historical warranty claim experience and includes such costs in cost of goods sold. Warranty expenses and the accrued warranty liability were not material as of December 31, 2018.


9

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table presents the Company's revenue information by geographical location based on the country or region to which the products were shipped. The Company sells its products primarily to distributors in the Asia Pacific region, who in turn sell these products to end customers. Because the Company's distributors sell their products to end customers which may have a global presence, revenue by geographical location is not necessarily representative of the geographical distribution of sales to end user markets.
 
Three Months Ended December 31,
 
 
Six Months Ended December 31,
 
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(in thousands)
Hong Kong
$
87,180

 
$
82,440

 
$
178,771

 
$
167,670

China
24,760

 
19,153

 
45,157

 
36,273

South Korea
139

 
301

 
308

 
588

United States
1,967

 
1,314

 
3,940

 
2,692

Other countries
879

 
688

 
1,821

 
1,531

 
$
114,925

 
$
103,896

 
$
229,997

 
$
208,754


The following is a summary of revenue by product type:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(in thousands)
Power discrete
$
93,294

 
$
85,094

 
$
185,549

 
$
168,772

Power IC
19,384

 
15,758

 
38,799

 
33,855

Packaging and testing services
2,247

 
3,044

 
5,649

 
6,127

 
$
114,925

 
$
103,896

 
$
229,997

 
$
208,754


10

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Net Income (Loss) Per Common Share Attributable to Alpha and Omega Semiconductor Limited
The following table presents the calculation of basic and diluted net income (loss) per share attributable to common shareholders:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
 
(in thousands, except per share data)
Numerator:
 
 
 
 
 
 
 
Net income (loss) attributable to Alpha and Omega Semiconductor Limited
$
(1,545
)
 
$
6,791

 
$
871

 
$
11,591

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Weighted average number of common shares used to compute basic net income (loss) per share
23,887

 
23,925

 
23,865

 
23,973

Diluted:
 
 
 
 
 
 
 
Weighted average number of common shares used to compute basic net income per share
23,887

 
23,925

 
23,865

 
23,973

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Stock options, RSUs and ESPP shares

 
1,108

 
648

 
1,024

Weighted average number of common shares used to compute diluted net income per share
23,887

 
25,033

 
24,513

 
24,997

Net income (loss) per share attributable to Alpha and Omega Semiconductor Limited:
 
 
 
 
 
 
 
Basic
$
(0.06
)
 
$
0.28

 
$
0.04

 
$
0.48

Diluted
$
(0.06
)
 
$
0.27

 
$
0.04

 
$
0.46

The following potential dilutive securities were excluded from the computation of diluted net income per share as their effect would have been anti-dilutive:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(in thousands)
Employee stock options and RSUs
2,225

 
165

 
646

 
169

ESPP
1,240

 

 
508

 
45

Total potential dilutive securities
3,465

 
165

 
1,154

 
214



11

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4. Concentration of Credit Risk and Significant Customers
The Company manages its credit risk associated with exposure to distributors and direct customers on outstanding accounts receivable through the application and review of credit approvals, credit ratings and other monitoring procedures. In some instances, the Company also obtains letters of credit from certain customers.
Credit sales, which are mainly on credit terms of 30 to 60 days, are only made to customers who meet the Company's credit requirements, while sales to new customers or customers with low credit ratings are usually made on an advance payment basis. The Company considers its trade accounts receivable to be of good credit quality because its key distributors and direct customers have long-standing business relationships with the Company and the Company has not experienced any significant write-offs of accounts receivable in the past. The Company closely monitors the aging of accounts receivable from its distributors and direct customers, and regularly reviews their financial positions, when available.
Summarized below are individual customers whose revenue or accounts receivable balances were more than 10% of the respective total consolidated amounts:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
Percentage of revenue
2018
 
2017
 
2018
 
2017
Customer A
30.6
%
 
30.8
%
 
29.1
%
 
29.2
%
Customer B
37.6
%
 
33.7
%
 
37.8
%
 
33.8
%


 
December 31,
2018
 
June 30,
2018
Percentage of accounts receivable
 
Customer A
25.0
%
 
17.1
%
Customer B
35.1
%
 
35.5
%
Customer C
*

 
10.6
%

* Less than 10%

12

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
5. Balance Sheet Components
Accounts receivable, net:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Accounts receivable
$
52,465

 
$
52,687

Less: Allowance for price adjustments
(18,577
)
 
(18,902
)
Less: Allowance for doubtful accounts
(30
)
 
(30
)
Accounts receivable, net
$
33,858

 
$
33,755


Inventories:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Raw materials
$
54,188

 
$
47,097

Work in-process
39,307

 
35,243

Finished goods
9,467

 
7,842

 
$
102,962

 
$
90,182


Other current assets:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
VAT receivable
$
28,305

 
$
17,601

Other prepaid expenses
2,603

 
2,121

Prepaid insurance
538

 
906

Prepaid maintenance
693

 
556

Prepayment to supplier
535

 
227

Prepaid income tax
747

 
761

Custom deposit
55

 
5,749

Lease financing cost
655

 
960

Other receivable
140

 
670

 
$
34,271

 
$
29,551



13

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Property, plant and equipment, net:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Land
$
4,877

 
$
4,877

Building
33,884

 
4,325

Manufacturing machinery and equipment
285,078

 
265,192

Equipment and tooling
19,334

 
16,605

Computer equipment and software
28,062

 
25,686

Office furniture and equipment
2,794

 
2,314

Leasehold improvements
30,920

 
29,900

Land use rights
8,751

 
9,089

 
413,700

 
357,988

Less: accumulated depreciation
(237,620
)
 
(225,184
)
 
176,080

 
132,804

Equipment and construction in progress
204,703

 
198,852

Property, plant and equipment, net
$
380,783

 
$
331,656


Intangible assets, net:

 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Patents and technology rights
$
18,037

 
$
17,633

Trade name
268

 
268

Customer relationships
1,150

 
1,150

 
19,455

 
19,051

Less: accumulated amortization
(2,785
)
 
(2,729
)
 
16,670

 
16,322

Goodwill
269

 
269

Intangible assets, net
$
16,939

 
$
16,591


Intangible assets of patents and technology rights are primarily related to a license agreement that the Company entered into with STMicroelectronics International N.V. (“STMicro”) on September 5, 2017, pursuant to which STMicro granted the Company a world-wide, royalty-free and fully-paid license to use its technologies to develop, market and distribute certain digital multi-phase controller products, which have been offered by STMicro.  This agreement allows the Company to develop and market products in a new market for digital power products, primarily in the computer server segment. As of December 31, 2018, the Company recorded $16.2 million of intangible assets related to STMicro. The Company begins amortizing such license fees when the technology has met the Company's qualification and is ready for its intended use in production.





14

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Other long-term assets:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Prepayments for property and equipment
$
6,222

 
$
17,599

Investment in a privately held company
700

 
700

Lease financing costs
1,650

 
1,922

VAT long-term receivable
4

 
3,396

Custom deposit
1,701

 
1,589

Other long-term deposits
1,812

 
2,252

Office leases deposits
989

 
853

Other
466

 
387

 
$
13,544

 
$
28,698

Accrued liabilities:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
Accrued compensation and benefits
$
29,694

 
$
18,484

Warranty accrual
655

 
535

Stock rotation accrual
1,847

 
1,750

Accrued professional fees
1,738

 
1,922

Accrued inventory
1,340

 
667

Accrued facilities related expenses
1,879

 
2,163

Accrued financing lease costs
727

 
1,510

Accrued property, plant and equipment
13,090

 
18,145

Other accrued expenses
8,043

 
4,665

 
$
59,013

 
$
49,841

The activities in the warranty accrual, included in accrued liabilities, are as follows:
 
Six Months Ended December 31,
 
 
2018
 
2017
 
 
(in thousands)
 
Beginning balance
$
535

 
$
1,866

 
Additions (reductions)
189

 
(1,063
)
*
Utilization
(69
)
 
(36
)
 
Ending balance
$
655

 
$
767

 
* Released a specific warranty reserve of approximately $1.0 million due to expired warranty period.



15

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The activities in the stock rotation accrual, included in accrued liabilities, are as follows:
 
Six Months Ended December 31,
 
2018
 
2017
 
(in thousands)
Beginning balance
$
1,750

 
$
1,871

Additions
2,229

 
992

Utilization
(2,132
)
 
(1,252
)
Ending balance
$
1,847

 
$
1,611



16

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6. Bank Borrowings

Short-term borrowing

On November 29 and December 4, 2018, the JV Company entered into two one-year loan agreements with China Merchant Bank in China to provide loans for Chinese Renminbi (RMB) 80 million and 20 million, respectively, or $14.5 million in total based on currency exchange rate between RMB and U.S. Dollars on December 31, 2018 at varying interest rates. Interest payments are due monthly and quarterly with the entire principal due not later than December 18 and December 5, 2019, respectively. As of December 31, 2018, the outstanding balance under the loans were 80 million RMB and 20 million (equivalent of $14.5 million in total based on the currency exchange rate as of December 31, 2018).

On November 16, 2018, the Company's subsidiary in China entered into a line of credit facility with Industrial and Commercial Bank of China, which expires on September 30, 2019. The purpose the credit facility is to provide short-term borrowings. The Company can borrow up to approximately RMB 72.0 million or $10.3 million based on currency exchange rate between RMB and U.S. Dollars on November 16, 2018. In November 2018, the Company borrowed $5.0 million under this line with an interest rate of 3.64% per annum. The amount of $5.0 million was repaid in December 2018.

Credit Facilities

On May 9, 2018 (the “Effective Date”), the JV Company entered into a lease finance agreement and a security agreement (the “Agreements”) with YinHai Leasing Company and China Import/Export Bank (the “Lenders”).  Pursuant to the Agreements, the Lenders agree to provide an aggregate of RMB 400.0 million, or $62.8 million based on the currency exchange rate between RMB and U.S. Dollars on the Effective Date, of financing to the JV Company (the “Lease Financing”). In exchange for the Lease Financing, the JV Company agrees to transfer title of its assembly and testing equipment to the Lenders, and the Lenders lease such equipment to the JV Company under a five-year lease arrangement, pursuant to which the JV Company makes quarterly lease payments to the Lenders consisting of principal and interest based on a repayment schedule mutually agreed by the parties.  The interest under the Lease Financing is accrued based on the China Base Rate multiplied by 1.15, or 5.4625% on the Effective Date.  Under the Agreements, at the end of the five-year lease term, the Lenders agree to sell such equipment back to the JV Company for a nominal amount (RMB 1).  The JV Company’s obligations under the Lease Financing are secured by the land and building owned by the JV Company (the “Collateral”).  The proceeds from the Lease Financing will be used primarily for the acquisition and installation of the 12-inch fabrication equipment and other expenses of the JV Company relating to the completion of the fabrication facility located in Chongqing. The Agreements contain customary representation, warranties and covenants, including restrictions on the transfer of the Collateral. The Agreements also contain customary events of default, including but are not limited to, failure to make payments and breach of material terms under the Agreements. The Agreements include certain customary closing conditions, including the payment of deposit by the JV Company. As of December 31, 2018, the outstanding balance under the Agreement was 400 million RMB (equivalent of $58.2 million based on the currency exchange rate as of December 31, 2018), which was recorded under short-term and long-term capital lease liabilities.

Capital lease liabilities include financing leases, computer software and exclusive technology rights. Future minimum lease payments are as follows (in thousands):

Year ending June 30,
 
 
 
2019 (Remaining)
 
 
$
5,530

2020
 
 
14,203

2021
 
 
17,778

2022
 
 
16,909

2023
 
 
12,255

Total minimum lease payments
 
 
66,675

Less amount representing interest
 
 
(8,061
)
Total capital lease liabilities
 
 
$
58,614



17

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

On May 1, 2018, Jireh Semiconductor Incorporated ("Jireh"), a wholly-owned subsidiary of the Company, entered into a loan agreement with a financial institution (the "Bank") that provided a term loan in an amount of $17.8 million. The obligation under the loan agreement is secured by certain real estate assets of Jireh and guaranteed by the Company.  The loan has a five-year term and matures on June 1, 2023. Beginning June 1, 2018, Jireh made consecutive monthly payments of principal and interest to the Bank. The outstanding principal shall accrue interest at a fixed rate of 5.04% per annum on the basis of a 360-day year. The loan agreement contains customary restrictive covenants and includes certain financial covenants that require the Company to maintain, on a consolidated basis, specified financial ratios. The Company is in compliance with these covenants. As of December 31, 2018, the outstanding balance of the term loan was $17.3 million.

On August 15, 2017, Jireh entered into a credit agreement with the Bank that provided a term loan in an amount up to $30.0 million for the purpose of purchasing certain equipment for the Company's fabrication facility located in Oregon.  The obligation under the credit agreement is secured by substantially all assets of Jireh and guaranteed by the Company.  The credit agreement has a five-year term and matures on August 15, 2022. In January 2018 and July 2018, Jireh drew down the loan in the amount of $13.2 million and $16.7 million, respectively. Beginning in October 2018, Jireh was required to pay to the Bank on each payment date, the outstanding principal amount of the loan in monthly installments.  The loan accrues interest based on an adjusted London Interbank Offered Rate ("LIBOR") as defined in the credit agreement, plus specified applicable margin in the range of 1.75% to 2.25%, based on the outstanding balance of the loan.  The credit agreement contains customary restrictive covenants and includes certain financial covenants that require the Company to maintain, on a consolidated basis, specified financial ratios and fixed charge coverage ratio. The Company is in compliance with these covenants. As of December 31, 2018, the outstanding balances of the term loan were $27.9 million.

Maturities of Jireh debt were as follows (in thousands):

Year ending June 30,
 
 
 
2019 (Remaining)
 
 
$
4,170

2020
 
 
8,340

2021
 
 
8,340

2022
 
 
8,340

2023
 
 
16,028

Total principal of debt
 
 
45,218

Less: debt issuance costs
 
 
(233
)
Total principal of debt, less debt issuance costs
 
 
$
44,985


7. Joint Venture

On March 29, 2016, the Company entered into a joint venture contract (the “JV Agreement”) with two investment funds owned by the Municipality of Chongqing (the “Chongqing Funds”), pursuant to which the Company and the Chongqing Funds formed a joint venture, (the “JV Company”), for the purpose of constructing and operating a power semiconductor packaging, testing and 12-inch wafer fabrication facility in the Liangjiang New Area of Chongqing, China (the “JV Transaction”). As of September 30, 2018, the Company owned 54.4%, and the Chongqing Funds owned 45.6%, of the equity interest in the JV Company. At the end of December 2018, the Chongqing Funds invested additional $24.0 million of cash contribution to the JV Company, which resulted in the Company owning 50.9%, and the Chongqing Funds owning 49.1%, of the equity interest in the JV Company. The JV Company commenced small mass production for assembly and testing started the quarter ended September 30, 2018. During the quarter ended December 31, 2018, the JV Company continued the production ramp and commenced trial production at the 12-inch wafer fabrication facility.

As part of the JV Transaction, the JV Company entered into an Engineering, Procurement and Construction Contract (the “EPC Contract”) with The IT Electronics Eleventh Design & Research Institute Scientific and Technological Engineering Corporation Limited (the “Contractor”), effective as of January 10, 2017 (the "Effective Date"), pursuant which the Contractor was engaged to construct the manufacturing facility contemplated under the JV Agreement. The total price payable under the EPC Contract is Chinese Renminbi (RMB) 540.0 million, or approximately $78.0 million based on the currency exchange rate between RMB and U.S. Dollars on the Effective Date, which consists of $2.8 million (RMB 19.5 million) of design fees and $75.2 million (RMB 520.5 million) of construction and procurement fees (including compliance with safety and aesthetic

18

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

requirements). As of December 31, 2018, the JV Company paid approximately $68.3 million (RMB 470.0 million), and expects to pay the remaining of $10.2 million (RMB 70.0 million) in fiscal year 2019.

The changes in total AOS shareholders' equity, noncontrolling interest and total equity were as follows (in thousands):

 
 
Total AOS Shareholders' Equity
 
Noncontrolling Interest
 
Total Equity
Balance, June 30, 2018
 
$
278,594

 
$
147,568

 
$
426,162

Exercise of common stock options and release of RSUs
 
110

 

 
110

Withholding tax on restricted stock units
 
(203
)
 

 
(203
)
Issuance of shares under ESPP
 
1,168

 

 
1,168

Repurchase of common shares under shares repurchase program
 
(1,501
)
 

 
(1,501
)
     Share-based compensation expense
 
6,499

 

 
6,499

     Net income (loss)
 
871

 
(7,319
)
 
(6,448
)
Impact on retained earnings related to ASC 606 adoption
 
1,036

 

 
1,036

     Cumulative translation adjustment
 
(3,282
)
 
(3,013
)
 
(6,295
)
     Contributions from noncontrolling interest
 

 
24,000

 
24,000

Balance, December 31, 2018
 
$
283,292

 
$
161,236

 
$
444,528



8. Shareholders' Equity and Share-based Compensation
Share Repurchase

In September 2017, the Board of Directors terminated the repurchase program that was previously approved in 2015 and approved a new repurchase program (the “Repurchase Program”), which allows the Company to repurchase its common shares from the open market pursuant to a pre-established Rule 10b5-1 trading plan or through privately negotiated transactions up to an aggregate of $30.0 million. The amount and timing of any repurchases under the Repurchase Program depend on a number of factors, including but not limited to, the trading price, volume, availability of the Company's common shares and the amount of available cash reserve. Shares repurchased under this program are accounted for as treasury shares and the total cost of shares repurchased is recorded as a reduction of shareholders' equity.

During the six months ended December 31, 2018, the Company repurchased an aggregate of 111,509 shares from the open market, for a total cost of $1.5 million, excluding fees and related expenses, at an average price of $13.43 per share. Since the inception of the prior repurchase program in 2010, the Company repurchased an aggregate of 6,784,648 shares from the open market including shares purchased in a dutch tender offer for a total cost of $67.3 million, at an average price of $9.92 per share, excluding fees and related expenses.  No repurchased shares have been retired. Of the 6,784,648 repurchased shares, 133,728 shares with a weighted average repurchase price of $10.48 per share, were reissued at an average price of $5.77 per share pursuant to option exercises and vested restricted share units. As of December 31, 2018, approximately $13.4 million remained available under the Repurchase Program.
Time-based Restricted Stock Units ("TRSU")
The following table summarizes the Company's TRSU activities for the six months ended December 31, 2018:

19

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Number of Restricted Stock
Units
 
Weighted Average
Grant Date Fair
Value Per Share
 
Weighted Average
Remaining
Recognition
Period (Years)
 
Aggregate Intrinsic Value
Nonvested at June 30, 2018
919,023

 
$
15.14

 
1.62
 
$
13,086,888

Granted
103,222

 
$
11.96

 
 
 
 
Vested
(68,182
)
 
$
14.97

 
 
 
 
Forfeited
(11,250
)
 
$
13.63

 
 
 
 
Nonvested at December 31, 2018
942,813

 
$
14.82

 
1.24
 
$
9,607,264

TRSUs vested and expected to vest
874,061

 
 
 
1.18
 
$
8,906,681


The Board approved the incentive bonus plan (the “Plan”) for the calendar year commencing January 1, 2018 pursuant to which each executive officer of the Company who continues in service through the end of the calendar year will be eligible to receive an incentive award, based on the level of attainment of certain specified Company performance goals. The Company recorded $1.0 million of such RSUs expenses during the three and six months ended December 31, 2018. The expenses are reported in the accrued liabilities line in the condensed consolidated balance sheet as the total amount of bonus is to be settled in variable number of shares. Such non-cash compensation expenses are recorded as part of stock-based compensation expense in the condensed consolidated statements of operations.
Market-based Restricted Stock Units ("MSUs")

During the quarter ended September 30, 2018, the Company granted 1.3 million market-based restricted stock units ("MSUs") to certain personnel. The number of shares to be earned at the end of performance period is determined based on the Company’s achievement of specified stock prices and revenue thresholds during the performance period from January 1, 2019 to December 31, 2021 as well as the recipients remaining in continuous service with the Company through such period. The MSUs vests in four equal annual installments after the end of each performance period. The Company estimated the grant date fair values of its MSUs with derived service periods of 4.5 to 7.5 years using a Monte-Carlo simulation model with the following assumptions: Risk-free interest rate of 2.7%, expected term of 3.5 years, expected volatility of 38.8% and dividend yield of 0%. The Company recorded approximately $0.2 million and $0.4 million of expenses for these MSUs during the three and six months ended December 31, 2018.
The following table summarizes the Company's MSUs activities for the six months ended December 31, 2018:

 
Number of Performance-based Restricted Stock
Units
 
Weighted Average
Grant Date Fair
Value Per Share
 
Weighted Average
Remaining
Recognition
Period (Years)
Nonvested at June 30, 2018

 
$

 

Granted
1,310,000

 
$
5.17

 
 
Vested

 
$

 
 
Forfeited
(20,000
)
 
$
5.17

 
 
Nonvested at December 31, 2018
1,290,000

 
$
5.17

 
5.46

MSUs vested and expected to vest
920,290

 
 
 
5.38

Performance-based Restricted Stock Units ("PRSUs")

In March 2017 and 2018, the Company granted 170,000 and 298,000 performance-based RSUs (“PRSUs”) to certain personnel. The number shares to be earned under the PRSUs is determined based on the level of attainment of predetermined financial goals. The PRSUs vests in four equal annual installments from the first anniversary date after the grant date if certain predetermined financial goals were met. The Company recorded approximately $0.8 million and $1.4 million of expenses for these PRSUs during the three and six months ended December 31, 2018, respectively, and approximately $0.5 million and $0.7 million during the three and six months ended December 31, 2017, respectively.

20

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table summarizes the Company's PRSUs activities for the six months ended December 31, 2018:

 
Number of Performance-based Restricted Stock
Units
 
Weighted Average
Grant Date Fair
Value Per Share
 
Weighted Average
Remaining
Recognition
Period (Years)
 
Aggregate Intrinsic Value
Nonvested at June 30, 2018
422,300

 
$
16.63

 
2.06
 
$
6,013,552

Granted

 

 
 
 
 
Vested

 

 
 
 
 
Forfeited
(1,000
)
 
$
16.22

 
 
 
 
Nonvested at December 31, 2018
421,300

 
$
16.63

 
1.55
 
$
4,293,047

PRSUs vested and expected to vest
383,347

 
 
 
1.48
 
$
3,906,307

Stock Options
The Company did not grant any stock options during the three and six months ended December 31, 2018. The number of options expected to vest is the result of applying the pre-vesting forfeiture rate assumption to total outstanding options.

The following table summarizes the Company's stock option activities for the six months ended December 31, 2018:

 
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
Average
 
 
 
 
 
Average
 
Remaining
 
 
 
Number of
 
Exercise Price
 
Contractual
 
Aggregate
 
Shares
 
Per Share
 
Term (in years)
 
Intrinsic Value
Outstanding at June 30, 2018
886,978

 
$
10.97

 
4.03
 
$
3,557,248

Exercised
(10,500
)
 
$
10.50

 
 
 
$
43,415

Outstanding at December 31, 2018
876,478

 
$
10.98

 
3.56
 
$
1,176,781

Options vested and expected to vest
876,478

 
$
10.98

 
3.56
 
$
1,176,781

Exercisable at December 31, 2018
876,478

 
$
10.98

 
3.56
 
$
1,176,781


Employee Share Purchase Plan ("ESPP")
The assumptions used to estimate the fair values of common shares issued under the ESPP were as follows:
 
 
 
Six Months Ended December 31,
 
2018
Volatility rate
40.1%
Risk-free interest rate
2.5% - 2.9%
Expected term
1.3 years
Dividend yield
0%
Share-based Compensation Expense
The total share-based compensation expense recognized in the condensed consolidated statements of operations for the periods presented was as follows:

21

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(in thousands)
Cost of goods sold
$
541

 
$
415

 
$
1,038

 
$
731

Research and development
742

 
617

 
1,374

 
979

Selling, general and administrative
3,135

 
2,977

 
5,135

 
4,307

 
$
4,418

 
$
4,009

 
$
7,547

 
$
6,017


As of December 31, 2018, total unrecognized compensation cost under the Company's equity plans was $15.8 million, which is expected to be recognized over a weighted-average period of 2.4 years.

9. Income Taxes

For the three months ended December 31, 2018, the Company recognized income tax expense of approximately $0.7 million. For the three months ended December 31, 2017, the Company recognized income tax benefit of approximately $2.1 million, which included a discrete tax benefit of $2.7 million related to re-measuring the Company’s U.S. deferred tax assets and liabilities following enactment of the 2017 U.S. Tax Cut and Jobs Act in December 2017. Excluding the discrete income tax items, the estimated effective tax rate for the three months ended December 31, 2018 was (13.8)% compared to 31.4% for the three months ended December 31, 2017. The changes in the effective tax rate and tax expense between the periods resulted primarily from changes in the mix of earnings in various geographic jurisdictions between the current year and the same period of last year somewhat offset by the reduction in the U.S. corporate tax rate following the enactment of the 2017 U.S. Tax Cut and Jobs Act.

For the six months ended December 31, 2018, the Company recognized income tax expense of approximately $1.3 million, which included a discrete tax expense of $0.03 million. For the six months ended December 31, 2017, the Company recognized an income tax benefit of approximately $0.8 million, which included a discrete tax benefit of $2.7 million related to remeasuring the Company’s U.S. deferred tax assets and liabilities following enactment of the 2017 U.S. Tax Cut and Jobs Act in December 2017. Excluding the discrete income tax items, the estimated effective tax rate for the six months ended December 31, 2018 was (23.7)% compared to 24.0% for the six months ended December 31, 2017. The changes in the effective tax rate and tax expense between the periods resulted primarily from the reduction in the U.S. corporate tax rate following the enactment of the 2017 U.S. Tax Cut and Jobs Act along with changes in the mix of earnings in various geographic jurisdictions between the current year and the same period of last year.

The Company adopted ASC 606 using the modified retrospective method applied to those contracts which were not completed as of July 1, 2018. Results for reporting periods beginning after July 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 605. The adoption resulted in a derecognition of a deferred tax asset of $0.3 million related to previously unrecognized gross profit for U.S. GAAP purposes that was previously recognized for income tax purposes, with an offsetting reduction to retained earnings.

The Company files its income tax returns in the United States and in various foreign jurisdictions. The tax years 2001 to 2018 remain open to examination by U.S. federal and state tax authorities. The tax years 2011 to 2018 remain open to examination by foreign tax authorities.

The Company's income tax returns are subject to examinations by the Internal Revenue Service and other tax authorities in various jurisdictions. In accordance with the guidance on the accounting for uncertainty in income taxes, the Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. These assessments can require considerable estimates and judgments. As of December 31, 2018, the gross amount of unrecognized tax benefits was approximately $7.4 million, of which $4.5 million, if recognized, would reduce the effective income tax rate in future periods. If the Company's estimate of income tax liabilities proves to be less than the ultimate assessment, then a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period

22

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

when the Company determines the liabilities are no longer necessary. The Company does not anticipate any material changes to its uncertain tax positions during the next twelve months.

On July 27, 2015, in Altera Corp. v. Commissioner, the U.S. Tax Court issued an opinion related to the treatment of share-based compensation expense in an intercompany cost-sharing arrangement. A final decision has yet to be issued by the Tax Court due to other outstanding issues related to the case. At this time, the U.S. Department of the Treasury has not withdrawn the requirement to include share-based compensation from its regulations. Due to the uncertainty surrounding the status of the current regulations, questions related to the scope of potential benefits, and the risk of the Tax Court’s decision being overturned upon appeal, the Company has not recorded any benefit as of December 31, 2018. The Company will continue to monitor ongoing developments and potential impacts to its financial statements.

10. Segment and Geographic Information
The Company is organized as, and operates in, one operating segment: the design, development and supply of power semiconductor products for computing, consumer electronics, communication and industrial applications. The chief operating decision-maker is the Chief Executive Officer. The financial information presented to the Company's Chief Executive Officer is on a consolidated basis, accompanied by information about revenue by customer and geographic region, for purposes of evaluating financial performance and allocating resources. The Company has one business segment, and there are no segment managers who are held accountable for operations, operating results and plans for products or components below the consolidated unit level. Accordingly, the Company reports as a single operating segment.
 
Long-lived assets, net consisting of property, plant and equipment and land use rights, by geographical area are as follows:
 
December 31,
2018
 
June 30,
2018
 
(in thousands)
China
$
294,437

 
$
248,003

United States
85,678

 
83,040

Other Countries
668

 
613

 
$
380,783

 
$
331,656


For our revenues by geography, please refer to Note 2.

23

ALPHA AND OMEGA SEMICONDUCTOR LIMITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11. Commitments and Contingencies
Purchase Commitments
As of December 31, 2018 and June 30, 2018, the Company had approximately $48.9 million and $38.0 million, respectively, of outstanding purchase commitments primarily for purchases of semiconductor raw materials, wafers, spare parts and packaging and testing services, and approximately $78.9 million and $58.3 million, respectively, of capital commitments for the purchase of property and equipment and EPC construction.
Other Commitments
See Note 6 and Note 7 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for descriptions of commitments including bank borrowings and Joint Venture.
Contingencies and Indemnities
The Company is currently not a party to any pending material legal proceedings. The Company has in the past, and may from time to time in the future, become involved in legal proceedings arising from the normal course of business activities.  The semiconductor industry is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. Irrespective of the validity of such claims, the Company could incur significant costs in the defense of such claims and suffer adverse effects on its operations.
The Company is a party to a variety of agreements that it has contracted with various third parties. Pursuant to these agreements, the Company may be obligated to indemnify another party to such an agreement with respect to certain matters. Typically, these obligations arise in the context of contracts entered into by the Company, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of representations and covenants related to such matters as title to assets sold, certain intellectual property rights, specified environmental matters and certain income taxes. In these circumstances, payment by the Company is customarily conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, which procedures typically allow the Company to challenge the other party's claim. Further, the Company's obligations under these agreements may be limited in time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments made by it under these agreements. The Company has not historically paid or recorded any material indemnifications, and no accrual has been made at December 31, 2018 and June 30, 2018.
The Company has agreed to indemnify its directors and certain employees as permitted by law and pursuant to its Bye-laws, and has entered into indemnification agreements with its directors and executive officers. The Company has not recorded a liability associated with these indemnification arrangements, as it historically has not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that the Company maintains. However, such insurance may not cover any, or may cover only a portion of, the amounts the Company may be required to pay. In addition, the Company may not be able to maintain such insurance coverage in the future.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, the matters addressed in this Item 2 constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below under the heading “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company’s management. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides certain “safe harbor” provisions for forward-looking statements. All forward-looking statements made in this Quarterly Report on Form 10-Q are made pursuant to the Act. The Company undertakes no obligation to publicly release the results of any revisions to its forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events. Unless the context otherwise requires, the words “AOS,” the “Company,” “we,” “us” and “our” refer to Alpha and Omega Semiconductor Limited and its subsidiaries.

24


This management’s discussion should be read in conjunction with the management’s discussion included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the Securities and Exchange Commission on August 23, 2018.

Overview

We are a designer, developer and global supplier of a broad portfolio of power semiconductors. Our portfolio of power semiconductors includes approximately 1,900 products, and has grown with the introduction of 200 new products during the fiscal year ended June 30, 2018, and over 80 and 90 new products in each of the fiscal years ended June 30, 2017 and 2016, respectively. During the six months ended December 31, 2018, we introduced an additional 46 new products. Our teams of scientists and engineers have developed extensive intellectual properties and technical knowledge that encompass major aspects of power semiconductors, which we believe enables us to introduce and develop innovative products to address the increasingly complex power requirements of advanced electronics. We have an extensive patent portfolio that consists of 753 patents and 95 patent applications in the United States as of December 31, 2018. We also had a total of 791 foreign patents, which primarily were based on our research and development efforts through December 31, 2018. We differentiate ourselves by integrating our expertise in technology, design and advanced packaging to optimize product performance and cost. Our portfolio of products targets high-volume applications, including personal computers, flat panel TVs, LED lighting, smart phones, battery packs, consumer and industrial motor controls and power supplies for TVs, computers, servers and telecommunications equipment.
Our business model leverages global resources, including research and development and manufacturing in the United States and Asia. Our sales and technical support teams are localized in several growing markets. We operate an 8-inch wafer fabrication facility in Hillsboro, Oregon, or the Oregon fab, which is critical for us to accelerate proprietary technology development and new product introduction as well as to improve our financial performance in the long run. To meet the market demand for more mature high volume products, we also utilize the wafer manufacturing capacity of selected third party foundries. For assembly and test, we primarily rely upon our in-house facilities in China. In addition, we utilize subcontracting partners for industry standard packages. We believe our in-house packaging and testing capability provides us with a competitive advantage in proprietary packaging technology, product quality, cost and sales cycle time.

On March 29, 2016, we entered into a joint venture contract (the “JV Agreement”) with two investment funds owned by the Municipality of Chongqing (the “Chongqing Funds”), pursuant to which we and the Chongqing Funds formed a joint venture, (the “JV Company”), for the purpose of constructing a power semiconductor packaging, testing and wafer fabrication facility in the Liangjiang New Area of Chongqing, China (the “JV Transaction”). As of September 30, 2018, we owned 54.4%, and the Chongqing Funds owned 45.6%, of the equity interest in the JV Company. At the end of December 2018, the Chongqing Funds invested additional $24.0 million of cash contribution to the JV Company, which resulted us owning 50.9%, and the Chongqing Funds owning 49.1%, of the equity interest in the JV Company. The JV Company commenced small mass production for assembly and testing started the quarter ended September 30, 2018. During the quarter ended December 31, 2018, the JV Company continued the production ramp and commenced trial production at the 12-inch wafer fabrication facility. We expect to ramp up assembly and testing within the next two quarters, and start to produce customer samples from the 12-inch fab in the quarter ending March 31, 2019. During the three and six months ended December 31, 2018, we recorded $4.0 million and $7.3 million, respectively, in net loss attributable to noncontrolling interest in the JV Company. In the long-term, we expect the joint venture to deliver significant cost savings, enhance our market positions in China, and drive meaningful improvements in working capital and capital expenditures.

In January 2017, the JV Company entered into an Engineering, Procurement and Construction Contract (the “EPC Contract”) with The IT Electronics Eleventh Design & Research Institute Scientific and Technological Engineering Corporation Limited (the “Contractor”) for the construction of the manufacturing facility contemplated under the JV Agreement. The total price payable under the EPC Contract is Chinese Renminbi (RMB) 540.0 million, or approximately $78.0 million, based on the currency exchange rate between RMB and U.S. Dollars on the effective date of the EPC Contract. The payment is subject to volatility as a result of exposure to fluctuations in RMB foreign exchange rates. As of December 31, 2018, the JV Company paid approximately $68.3 million (RMB 470.0 million), and expects to pay the remaining of $10.2 million (RMB 70.0 million) in fiscal year 2019. The payment is subject to volatility as a result of exposure to fluctuations in RMB foreign exchange rates.

On September 5, 2017, we entered into a license agreement with STMicroelectronics International N.V. (“STMicro”), pursuant to which STMicro granted us a world-wide, royalty-free and fully-paid license to use its technologies to develop, market and distribute certain digital multi-phase controller products, which have been previously offered by STMicro.  Under the license agreement, we agreed to pay a total price in cash of $17.0 million based on the payment schedule as set forth in the agreement of

25




approximately $10.1 million, $6.7 million and $0.2 million in calendar year 2017, 2018 and 2019, respectively. As of December 31, 2018, we recorded $16.2 million of such intangible assets.

During the six months ended December 31, 2018, we announced a new Type-C Power Delivery compliant input protection switch with up to 28V over-voltage protection. This new device offers low RDS(ON) (20mohm) in a thermally enhanced 3x3mm DFN package, made possible by our advanced co-packaging technology, combining a high performance IC with protection features and our latest high SOA MOSFET. We also announced new TO-Leadless (TOLL) packaging technology for high current 400A applications. The TOLL packaging technology offers very low package resistance and inductance due to the clip technology in comparison to other TO-Leadless packages using standard wire-bonding technology which enables improved EMI performance.
Factors affecting our performance
Our performance is affected by several key factors, including the following:

Costs of JV Company and digital power business: We are incurring an increase in operating expenses due to the additional costs associated with ramping up pre-production activities of the JV Company, as well as the initial startup work to develop and establish our new digital power business will have the significant impact on our financial performance. The JV Company commenced small mass production for assembly and testing started the quarter ended September 30, 2018. During the quarter ended December 31, 2018, the JV Company continued the production ramp and commenced trial production at the 12-inch wafer fabrication facility. The pre-production costs include costs relating to the installation of equipment; performance of the qualification process; increased demand for electrical power and other utilities; increased headcount as a result of hiring of additional personnel, staff and operators; and establishment of administrative and management functions and systems. In addition, a portion of these pre-production expenses and production ramp-up costs cannot be capitalized under U.S. GAAP accounting, therefore such costs impact our profitability. Furthermore, we are developing our digital power business based on the STMicro license agreement in September 2017, which will allow us to design and distribute a full suite of advanced low-voltage power IC products. We have incurred and expect to continue to incur additional costs, including costs relating to hiring and compensation of qualified engineers and technical staff and other research and development and management activities, as we continue to build this new business. In the short term, we will not be able to generate sufficient amount of revenue from either of these two business initiatives to offset the increase costs, which will likely negatively impact our results of operations.

Manufacturing costs:  Our gross margin may be affected by our manufacturing costs, including utilization of our manufacturing facilities, pricing of wafers from third party foundries and semiconductor raw materials, which may fluctuate from time to time largely due to the market demand and supply.  Capacity utilization affects our gross margin because we have certain fixed costs associated with our packaging and testing facilities and our Oregon fab and our Chongqing fabrication facility operated by the JV Company.  We expect that in the long term our joint venture agreement with Chongqing Funds will reduce our cost of manufacturing. If we are unable to utilize our manufacturing facilities at a desired level, our gross margin may be adversely affected.  In addition, from time to time, we may experience wafer capacity constraints, particularly at third party foundries, that may prevent us from fully meeting the demand of our customers. While we can mitigate such constraints by increasing and re-allocating capacity at our own fab, we may not be able to do so quickly or at sufficient level, which could adversely affect our financial conditions and results of operations.

Erosion of average selling price: Erosion of average selling prices of established products is typical in our industry. Consistent with this historical trend, we expect our average selling prices of existing products to decline in the future. However, in the normal course of business, we seek to offset the effect of declining average selling price by introducing new and higher value products, expanding existing products for new applications and new customers and reducing the manufacturing cost of existing products.

The global, regional economic and PC market conditions: Because our products primarily serve consumer electronic applications, a deterioration of the global and regional economic conditions could materially affect our revenue and results of operations. For example, because a significant amount of our revenue is derived from sales of products in the personal computing ("PC") markets, such as notebooks, motherboards and notebook battery packs, a significant decline or downturn in the PC market can have a material adverse effect on our revenue and results of operations.  Our revenue from the PC market accounted for approximately 48.5% and 42.6% of our total revenue for the three months ended December 31, 2018 and 2017, respectively and 46.1% and 40.7% of our total revenue for the six months ended December 31, 2018 and 2017, respectively. In the past, we have experienced a significant global decline in the PC markets due to continued growth of demand in tablets and smart phones, worldwide economic conditions and the industry inventory correction which had and may continue to have a material negative impact on the demand for our products, revenue, factory utilization, gross margin, our ability to resell excess inventory, and other performance measures. We have executed and continue to execute strategies to diversify our product portfolio, penetrate into

26




other market segments, including the consumer, communications and industrial markets, and improve gross margins and profit by implementing cost control measures. While making progress in reducing our reliance on the computing market, we continue to support our computing business and capitalize on the opportunities in this market with a more focused and competitive PC product strategy.
  
Product introductions and customers' product requirements: Our success depends on our ability to introduce products on a timely basis that meet or are compatible with our customers' specifications and performance requirements. Both factors, timeliness of product introductions and conformance to customers' requirements, are equally important in securing design wins with our customers. As we accelerate the development of new technology platforms, we expect to increase the pace at which we introduce new products and obtain design wins. Our failure to introduce new products on a timely basis that meet customers' specifications and performance requirements, particularly those products with major OEM customers, and our inability to continue to expand our serviceable markets, could adversely affect our financial performance, including loss of market share. We believe that the JV Transaction will increase and diversify our customer base, particularly in China, in the long term. The JV Company commenced small mass production for assembly and testing during the quarter ended September 30, 2018. During the quarter ended December 31, 2018, the JV Company continued the production ramp and commenced trial production at the 12-inch wafer fabrication facility. However, we may experience delays in the commencement or ramp up of the production at the JV Company. Even if we are able to ramp up the JV operation timely, we may not be successful in acquiring a sufficient number of new customers to offset the additional costs due to various factors, including but are not limited to, competition from other semiconductor companies in the region, our lack of history and prior relationships with customers as a new entrant, difficulties in executing our joint venture strategies, lack of control over our operations and the general economic conditions in Chongqing and China.
Distributor ordering patterns, customer demand and seasonality: Our distributors place purchase orders with us based on their forecasts of end customer demand, and this demand may vary significantly depending on the sales outlook and market and economic conditions of end customers. Because these forecasts may not be accurate, channel inventory held at our distributors may fluctuate significantly, which in turn may prompt distributors to make significant adjustments to their purchase orders placed with us. As a result, our revenue and operating results may fluctuate significantly from quarter to quarter. In addition, because our products are used in consumer electronics products, our revenue is subject to seasonality. Our sales seasonality is affected by numerous factors, including global and regional economic conditions as well as the PC market conditions, revenue generated from new products, changes in distributor ordering patterns in response to channel inventory adjustments and end customer demand for our products and fluctuations in consumer purchase patterns prior to major holiday seasons. In recent periods, broad fluctuations in the semiconductor markets and the global and regional economic conditions, in particular the decline of the PC market conditions, have had a more significant impact on our results of operations than seasonality. Furthermore, our revenue may be impacted by the level of demand from our major customers due to factors outside of our control. If these major customers experience significant decline in the demand of their products, encounter difficulties or defects in their products, or otherwise fail to execute their sales and marketing strategies successfully, it may adversely affect our revenue and results of operations.
Principal line items of statements of operations
The following describes the principal line items set forth in our condensed consolidated statements of operations:
Revenue
We generate revenue primarily from the sale of power semiconductors, consisting of power discretes and power ICs. Because our products typically have three to five year life cycles, the rate of new product introduction is an important driver of revenue growth over time. We believe that expanding the breadth of our product portfolio is important to our business prospects, because it provides us with an opportunity to increase our total bill-of-materials within an electronic system and to address the power requirements of additional electronic systems. In addition, a small percentage of our total revenue is generated by providing packaging and testing services to third-parties through one of our subsidiaries.

Our product revenue is reported net of the effect of the estimated stock rotation returns and price adjustments that we expect to provide to our distributors. Stock rotation returns are governed by contract and are limited to a specified percentage of the monetary value of products purchased by the distributor during a specified period. At our discretion or upon our direct negotiations with the original design manufacturers ("ODMs") or original equipment manufacturers ("OEMs"), we may elect to grant special pricing that is below the prices at which we sold our products to the distributors. In these situations, we will grant price adjustments to the distributors reflecting such special pricing. We estimate the price adjustments for inventory at the distributors based on factors such as distributor inventory levels, pre-approved future distributor selling prices, distributor margins and demand for our products.

27




Cost of goods sold

Our cost of goods sold primarily consists of costs associated with semiconductor wafers, packaging and testing, personnel, including share-based compensation expense, overhead attributable to manufacturing, operations and procurement, and costs associated with yield improvements, capacity utilization, warranty and inventory reserves. As the volume of sales increases, we expect cost of goods sold to increase. We implemented a process to improve our factory capacity utilization rates by transferring more wafer production to our Oregon fab and reducing our reliance on outside foundries. While our utilization rates cannot be immune to the market conditions, our goal is to make them less vulnerable to market fluctuations. We believe our market diversification strategy and product growth will drive higher volume of manufacturing which will improve our factory utilization rates and gross margin in the long run.
Operating expenses
Our operating expenses consist of research and development, selling, general and administrative expenses. We expect our operating expenses as a percentage of revenue to fluctuate from period to period as we continue to exercise cost control measures in response to the declining PC market as well as align our operating expenses to the revenue level.

Research and development expenses.  Our research and development expenses consist primarily of salaries, bonuses, benefits, share-based compensation expense, expenses associated with new product prototypes, travel expenses, fees for engineering services provided by outside contractors and consultants, amortization of software and design tools, depreciation of equipment and overhead costs. We continue to invest in developing new technologies and products utilizing our own fabrication and packaging facilities as it is critical to our long-term success. We also evaluate appropriate investment levels and stay focused on new product introductions to improve our competitiveness. We expect that our research and development expenses will fluctuate from time to time.
Selling, general and administrative expenses.  Our selling, general and administrative expenses consist primarily of salaries, bonuses, benefits, share-based compensation expense, product promotion costs, occupancy costs, travel expenses, expenses related to sales and marketing activities, amortization of software, depreciation of equipment, maintenance costs and other expenses for general and administrative functions as well as costs for outside professional services, including legal, audit and accounting services. We expect our selling, general and administrative expenses to fluctuate in the near future as we continue to exercise cost control measures.
Income tax expense

We are subject to income taxes in various jurisdictions. Significant judgment and estimates are required in determining our worldwide income tax expense. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations of different jurisdictions globally. We establish accruals for potential liabilities and contingencies based on a more likely than not threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, the applicable accounting guidance permits us to recognize a tax benefit measured at the largest amount of tax benefit that is more likely than not to be realized upon settlement with a taxing authority. If the actual tax outcome of such exposures is different from the amounts that were initially recorded, the differences will impact the income tax and deferred tax provisions in the period in which such determination is made. Changes in the location of taxable income (loss) could result in significant changes in our income tax expense.

We record a valuation allowance against deferred tax assets if it is more likely than not that a portion of the deferred tax assets will not be realized, based on historical profitability and our estimate of future taxable income in a particular jurisdiction. Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws, tax planning strategies or other factors. If our assumptions and consequently our estimates change in the future, the deferred tax assets may increase or decrease, resulting in corresponding changes in income tax expense. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide profits or losses, the tax laws and regulations in each geographical region where we have operations, the availability of tax credits and carry-forwards and the effectiveness of our tax planning strategies.

Results of Operations
The following tables set forth statements of operations, also expressed as a percentage of revenue, for the three and six months ended December 31, 2018 and 2017. Our historical results of operations are not necessarily indicative of the results for any future period.

28




 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(% of revenue)
 
(in thousands)
 
(% of revenue)
Revenue
$
114,925

 
$
103,896

 
100.0
 %
 
100.0
 %
 
$
229,997

 
$
208,754

 
100.0
 %
 
100.0
 %
Cost of goods sold
85,423

 
75,814

 
74.3
 %
 
73.0
 %
 
167,884

 
153,142

 
73.0
 %
 
73.4
 %
Gross profit
29,502

 
28,082

 
25.7
 %
 
27.0
 %
 
62,113

 
55,612

 
27.0
 %
 
26.6
 %
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
12,600

 
9,102

 
11.0
 %
 
8.8
 %
 
23,984

 
17,427

 
10.4
 %
 
8.3
 %
Selling, general and administrative
20,104

 
15,756

 
17.5
 %
 
15.2
 %
 
40,456

 
30,371

 
17.6
 %
 
14.5
 %
Total operating expenses
32,704

 
24,858

 
28.5
 %
 
24.0
 %
 
64,440

 
47,798

 
28.0
 %
 
22.8
 %
Operating income (loss)
(3,202
)
 
3,224

 
(2.8
)%
 
3.0
 %
 
(2,327
)
 
7,814

 
(1.0
)%
 
3.8
 %
Interest income and other income (loss), net
74

 
(160
)
 
0.1
 %
 
(0.2
)%
 
336

 
(120
)
 
0.1
 %
 
(0.1
)%
Interest expense
(1,706
)
 
(14
)
 
(1.5
)%
 
 %
 
(3,196
)
 
(31
)
 
(1.4
)%
 
 %
Net income (loss) before income taxes
(4,834
)
 
3,050

 
(4.2
)%
 
2.8
 %
 
(5,187
)
 
7,663

 
(2.3
)%
 
3.7
 %
Income tax expense (benefit)
701

 
(2,072
)
 
0.6
 %
 
(2.0
)%
 
1,261

 
(798
)
 
0.5
 %
 
(0.4
)%
Net income (loss) including noncontrolling interest
(5,535
)
 
5,122

 
(4.8
)%
 
4.8
 %
 
(6,448
)
 
8,461

 
(2.8
)%
 
4.1
 %
Net loss attributable to noncontrolling interest
(3,990
)
 
(1,669
)
 
(3.5
)%
 
(1.6
)%
 
(7,319
)
 
(3,130
)
 
(3.2
)%
 
(1.5
)%
Net income (loss) attributable to Alpha and Omega Semiconductor Limited
$
(1,545
)
 
$
6,791

 
(1.3
)%
 
6.4
 %
 
$
871

 
$
11,591

 
0.4
 %
 
5.6
 %
Share-based compensation expense was allocated as follows:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(% of revenue)
 
(in thousands)
 
(% of revenue)
Cost of goods sold
$
541

 
$
415

 
0.5
%
 
0.4
%
 
$
1,038

 
$
731

 
0.5
%
 
0.4
%
Research and development
742

 
617

 
0.6
%
 
0.6
%
 
1,374

 
979

 
0.6
%
 
0.5
%
Selling, general and administrative
3,135

 
2,977

 
2.7
%
 
2.9
%
 
5,135

 
4,307

 
2.2
%
 
2.1
%
Total
$
4,418

 
$
4,009

 
3.8
%
 
3.9
%
 
$
7,547

 
$
6,017

 
3.3
%
 
3.0
%

Three and Six Months Ended December 31, 2018 and 2017
Revenue
The following is a summary of revenue by product type:
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
 
(in thousands)
 
(in thousands)
 
(in percentage)
 
(in thousands)
 
(in thousands)
 
(in percentage)
Power discrete
$
93,294

 
$
85,094

 
$
8,200

 
9.6
 %
 
$
185,549

 
$
168,772

 
$
16,777

 
9.9
 %
Power IC
19,384

 
15,758

 
3,626

 
23.0
 %
 
38,799

 
33,855

 
4,944

 
14.6
 %
Packaging and testing services
2,247

 
$
3,044

 
(797
)
 
(26.2
)%
 
5,649

 
6,127

 
(478
)
 
(7.8
)%
 
$
114,925

 
$
103,896

 
$
11,029

 
10.6
 %
 
$
229,997

 
$
208,754

 
$
21,243

 
10.2
 %

29





Total revenue was $114.9 million for the three months ended December 31, 2018, an increase of $11.0 million, or 10.6%, as compared to $103.9 million for the same quarter last year. The increase was primarily due to an increase of $8.2 million and $3.6 million in sales of power discrete products and in sales of power IC products, respectively. The increase in power discrete and power IC product sales was primarily due to a 17.8% increase in average selling price as compared to the same quarter last year due to a shift in product mix, partially offset by a 5.3% decrease in unit shipments. The decrease in revenue of packaging and testing services for the three months ended December 31, 2018 as compared to the same quarter last year was primarily due to decreased demand.

Total revenue was $230.0 million for the six months ended December 31, 2018, an increase of $21.2 million, or 10.2%, as compared to $208.8 million for the same period last year. The increase was primarily due to an increase of $16.8 million and $4.9 million in sales of power discrete and in sales of power IC sales products, respectively. The net increase in product revenue, including power discrete and power IC product was primarily due to a 17.0% increase in average selling price as compared to the same period of last year mainly due to a shift in product mix, partially offset by a 5.4% decrease in unit shipments. The decrease in revenue of packaging and testing services for the six months ended December 31, 2018 as compared to the same period last year was primarily due to decreased demand.

Cost of goods sold and gross profit
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
 
(in thousands)
 
(in thousands)
 
(in percentage)
 
(in thousands)
 
(in thousands)
 
(in percentage)
Cost of goods sold
$
85,423

 
$
75,814

 
$
9,609

 
12.7
%
 
$
167,884

 
$
153,142

 
$
14,742

 
9.6
%
  Percentage of revenue
74.3
%
 
73.0
%
 


 
 
 
73.0
%
 
73.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
$
29,502

 
$
28,082

 
$
1,420

 
5.1
%
 
$
62,113

 
$
55,612

 
$
6,501

 
11.7
%
  Percentage of revenue
25.7
%
 
27.0
%
 


 
 
 
27.0
%
 
26.6
%
 
 
 
 

Cost of goods sold was $85.4 million for the three months ended December 31, 2018, an increase of $9.6 million, or 12.7%, as compared to $75.8 million for the same quarter last year. The increase was primarily due to the 10.6% increase of revenue. Cost of goods sold for the three months ended December 31, 2018 also included production ramp up costs related to our Chongqing joint venture. Gross margin decreased by 1.3 percentage points to 25.7% for the three months ended December 31, 2018 as compared to 27.0% for the same quarter last year. The decrease in gross margin was primarily due to decreased unit shipments and approximately $1.0 million of specific reserve was released due to expired warranty period during the same quarter last year, partially offset by increased average selling prices as a result of shift in product mix.

Cost of goods sold was $167.9 million for the six months ended December 31, 2018, an increase of $14.7 million, or 9.6%, as compared to $153.1 million for the same period last year, primarily due to the 10.2% increase of revenue. Cost of goods sold for the six months ended December 31, 2018 also included production ramp up costs related to our Chongqing joint venture. Gross margin increased by 0.4 percentage points to 27.0% for the six months ended December 31, 2018 as compared to 26.6% for the same period last year. The increase in gross margin was primarily due to increased average selling prices as a result of improved product mix, partially offset by decreased unit shipments and approximately $1.0 million of specific reserve was released due to expired warranty period during the same period last year.
Research and development expenses
 
Three Months Ended December 31,
 
Six Months Ended December 31,
 
2018
 
2017
 
Change
 
2018
 
2017
 
Change
 
(in thousands)
 
(in thousands)
 
(in percentage)
 
(in thousands)
 
(in thousands)
 
(in percentage)
Research and development
$
12,600

 
$
9,102