News Column

ALPHA & OMEGA SEMICONDUCTOR LTD - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 29, 2014

You should read the following discussion of the financial condition and results of our operations in conjunction with our consolidated financial statements and the notes to those statements included elsewhere in this annual report. Our consolidated financial statements contained in this annual report are prepared in accordance with U.S. GAAP. Overview We are a designer, developer and global supplier of a broad portfolio of power semiconductors. Our portfolio of power semiconductors includes over 1,400 products, and has grown significantly with the introduction of over 150 new products during the fiscal year 2014, and over 195 and 240 new products in the fiscal years 2013 and 2012, respectively. Our teams of scientists and engineers have developed extensive intellectual properties and technical knowledge that encompass major aspects of power semiconductors, which we believe it 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 approximately 420 patents and 213 patent applications in the United States as of June 30, 2014. We differentiate ourselves by integrating our expertise in technology, design and advanced manufacturing and packaging to optimize product performance and cost. Our portfolio of products targets high-volume applications, including personal computers, flat panel TVs, LED lighting, smart phones, battery packs, consumer and industrial motor controls and power supplies for TVs, computers, servers and telecommunications equipment. During the fiscal year ended June 30, 2014, we continued our diversification program by developing new silicon and packaging platforms to expand our serviceable available market, or SAM and offer higher performance products. Our metal-oxide-semiconductor field-effect transistors, or MOSFET, portfolio expanded significantly across a full range of voltage applications. For example, for the power discrete products, in the September quarter of 2013, we released seven new products in our 600V AlphalGBT portfolio with high efficiency Insulated Gate Bipolar Transistor (IGBT) solutions ranging from 20A to 60A in the TO247 package. These new products are suitable for a wide variety of applications including household appliances, commercial HVAC systems, photovoltaic inverters, and industrial equipment. In addition, in the June quarter of 2014, we released new 1350V IGBT optimized for induction heating applications. The device prevents avalanche destruction from voltage transients. In the December quarter of 2013, we also introduced a new lower voltage dual MOSFET family in the common-drain configuration in both DFN 5x6 and Micro-DFN 3.2x2 packages. These devices are suitable for battery pack applications to enhance battery pack performance in the latest generation Ultrabooks and tablets, where low conduction loss is essential for optimizing battery life. For the power IC products, we continue to expand the product family by introducing new solutions to LED lighting and LED back lighting for LCD-TV. In the September quarter of 2013, we introduced a new generation of high efficiency DrMos power modules. The new device enables higher power density voltage regulator solutions which is ideal for servers, work stations, graphic cards and high-end desktop PC applications. In addition, in the same quarter, we launched a third-generation high efficiency power module with an EZPair package. This new device enables high power density voltage regulator solutions which is ideal for notebook PCs, servers, and graphic cards applications. Moreover, in the June quarter of 2014, we released dual-channel EZPower Smart Load Switch that delivers up to 6A per channel of continuous current. These devices offer industry leading performance and allow the ideal load switch for a variety of applications. 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 a 200mm wafer fabrication facility located in Hillsboro, Oregon, or the Oregon fab, which is critical for us to accelerate proprietary technology development, new product introduction and improve our financial performance in the long run. To meet the market demand for the more mature high volume products, we also utilize the wafer manufacturing capacity of selected third party foundries. For assembly and test, we primarily rely upon our in-house facilities in China. In addition, we utilize subcontracting partners for industry standard packages. We believe our in-house packaging and testing capability provides us with a competitive advantage in proprietary packaging technology, product quality, cost and sales cycle time. Factors affecting our performance Our performance is affected by several key factors, including the following: 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. In particular, because a significant amount of our revenue is derived from sales of products in the personal computer, or PC markets, such as notebooks, motherboards and notebook battery packs, a significant decline or downturn in the PC markets can have a material adverse effect on our revenue and results of operations. Any decline in the PC markets would 39 -------------------------------------------------------------------------------- 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 been executing and are continuing to execute strategies to diversify our product portfolio and penetrate into other market segments, such as the consumer, communication and industrial market segments, which we believe would mitigate and eventually overcome the reduced demand resulting from the declining PC markets. As we develop and sell new products that serve more diversified markets, we expect that sales based on the PC markets, as a percentage of the total revenue, will continue to decline. Our revenue from the PC markets accounted for approximately 45.2%, 50.0% and 54.4% of our total revenue for the years ended June 30, 2014, 2013 and 2012, respectively. However, if the rate of decline in the PC markets is faster than we expected, or if we cannot successfully diversify or introduce new products to keep pace with the declining PC markets, we may not be able to alleviate its negative impact, which will adversely affect our 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 that average selling prices of our existing products will continue to decline in the future. However, as a normal course of business, we seek to offset the effect of declining average selling prices by introducing new and higher value products, expanding existing products for new applications and new customers, and reducing manufacturing cost of existing products. 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 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 shares with customers. Distributor ordering patterns 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 outlooks 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. Manufacturing Costs: Our gross margin may be affected by our manufacturing costs, including utilization of our own manufacturing facilities, pricing of wafers from other 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 in-house packaging and testing facilities and our Oregon fab. If we are unable to utilize the capacity of our in-house manufacturing facilities at a desired level, our gross margin may be adversely affected. For example, we may experience lower capacity utilization at our factories as a result of declining PC markets, which could adversely affect our gross margin and profitability. Principal line items of statements of income The following describes the principal line items set forth in our consolidated statements of operations: Revenue We generate revenue primarily from the sale of power semiconductors, consisting of power discretes and power ICs. Historically, a majority of our revenue was derived from power discrete products and a smaller amount was derived from power IC products. Because our products typically have three-year to five-year life cycles, the rate of new product introduction is an important driver of revenue growth over time. We believe that expanding the breadth of our product portfolio is important to our business prospects, because it provides us with an opportunity to increase our total bill-of-materials within an electronic system and to address the power requirements of additional electronic systems. In addition, a small percentage of our total revenue is generated by providing packaging and testing services to third-parties through one of our subsidiaries. 40 -------------------------------------------------------------------------------- Our product revenue includes 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. 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 cost 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 and impairment of long-lived assets. We expect that our total operating expenses will generally increase over time due to our belief that our business will continue to grow. However, our operating expenses as a percentage of revenue may fluctuate from period to period. 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 for research and development personnel. As we continue to invest significant resources in developing new technologies and products, we expect our research and development expenses to increase. 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 increase as we expand our business. Impairment of Long-Lived Assets: Long-lived assets or asset groups are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. The recoverability of an asset or asset group is assessed by determining if the carrying value of the asset or asset group exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life. The impairment loss is measured based on the difference between the carrying amount and estimated fair value. 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 than likely to be realized upon settlement. 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. 41

-------------------------------------------------------------------------------- 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. Operating results The following tables set forth our results of operations and as a percentage of revenue for the fiscal years ended June 30, 2014, 2013 and 2012. Our historical results of operations are not necessarily indicative of the results for any future period. Year Ended June 30, 2014 2013 2012 2014 2013 2012 (in thousands) (% of revenue) Revenue $ 318,121$ 337,436$ 342,291 100.0 % 100.0 % 100.0 % Cost of goods sold (1) 259,050 272,851 259,126 81.4 % 80.9 % 75.7 % Gross profit 59,071 64,585 83,165 18.6 % 19.1 % 24.3 % Operating expenses: Research and development (1) 24,409 27,833 30,630 7.7 % 8.2 % 8.9 % Selling, general and administrative (1) 34,855 35,473 35,800 11.0 % 10.5 % 10.5 % Impairment of long-lived assets - 2,557 - - % 0.8 % - % Total operating expenses 59,264 65,863 66,430 18.7 % 19.5 % 19.4 % Operating income (loss) (193 ) (1,278 ) 16,735 (0.1 )% (0.4 )% 4.9 % Interest income 124 76 105 - % - % - % Interest expense (266 ) (372 ) (342 ) (0.1 )% (0.1 )% (0.1 )% Income (loss) before income taxes (335 ) (1,574 ) 16,498 (0.2 )% (0.5 )% 4.8 % Income tax expense 2,973 4,001 3,581 0.9 % 1.2 % 1.0 % Net income (loss) $ (3,308 )$ (5,575 )$ 12,917 (1.1 )% (1.7 )% 3.8 %



(1) Includes share-based compensation expense allocated as follows:

Year Ended June 30, 2014 2013 2012 2014 2013 2012 (in thousands) (% of revenue) Cost of goods sold $ 614$ 700$ 532 0.2 % 0.2 % 0.2 % Research and development 786 1,402 1,361 0.2 % 0.4 % 0.4 % Selling, general and administrative 1,975 2,717 3,529 0.6 % 0.8 % 1.0 % $ 3,375$ 4,819$ 5,422 1.0 % 1.4 % 1.6 % Revenue



The following is a summary of revenue by product type:

42 --------------------------------------------------------------------------------

Year Ended June 30, Change 2014 2013 2012 2014 2013 (in thousands) (in thousands) (in percentage) (in thousands) (in percentage) Power discrete $ 246,033$ 265,150$ 267,059$ (19,117 ) (7.2 )% $ (1,909 ) (0.7 )% Power IC 53,993 52,841 53,396 1,152 2.2 % (555 ) (1.0 )% Packaging and testing services 18,095 19,445 21,836 (1,350 ) (6.9 )% (2,391 ) (10.9 )% $ 318,121$ 337,436$ 342,291$ (19,315 ) (5.7 )% $ (4,855 ) (1.4 )% Fiscal 2014 vs 2013 Total revenue was $318.1 million for fiscal year 2014, a decrease of $19.3 million, or 5.7%, as compared to $337.4 million for fiscal year 2013. The decrease consisted of $19.1 million and $1.4 million decrease in sales of power discrete products and packaging and testing services, respectively, partially offset by an increase in sales of power IC products of $1.2 million. The net decrease in product revenue, including power discrete and power IC products was mainly a result of a 7.0% decrease in average selling price primarily due to selling price erosion in the computing and consumer markets as compared to fiscal year 2013, partially offset by a 1.2% increase in unit shipments and to a lesser extent, a shift in product mix as a result of reduced demand for our products related to PC applications. The decrease in revenue of packaging and testing services as compared to last year was primarily due to reduced demand as a result of the declining PC market. In response to the declining PC market, we have been executing and are continuing to execute strategies to diversify our product portfolio and penetrate into other market segments, which we believe would mitigate and eventually overcome the reduced demand resulting from the declining PC market. During fiscal year 2014, we accelerated the development of new technology platforms which allowed us to introduce 62 medium and high voltage MOSFET products, targeting the consumer, communication and industrial markets, as well as 48 low voltage MOSFET products for the computing market. In addition, we introduced 23 Power IC new products for consumer, communications and computing applications. Fiscal 2013 vs 2012 Total revenue was $337.4 million for fiscal year 2013, a decrease of $4.9 million, or 1.4%, as compared to $342.3 million for fiscal year 2012. The decrease consisted of $1.9 million, $0.6 million and $2.4 million decrease in sales of power discrete, power IC products and packaging and testing services, respectively. The decrease in sales of power discrete and power IC products was mainly a result of a 4.2% decrease in average selling price partially offset by a 3.8% increase in unit shipments as compared to last year. The 4.2% decrease in average selling price was mainly due to a shift in product mix, the reduced demand for our products related to PC applications, and to a lesser extent, selling price erosion in the computing and consumer markets. The decrease in revenue of packaging and testing services as compared to last year was primarily due to reduced demand as a result of the declining PC market. Cost of goods sold and gross profit Year Ended June 30, Change 2014 2013 2012 2014 2013 (in thousands) (in



thousands) (in percentage) (in thousands) (in percentage) Cost of goods sold $ 259,050$ 272,851$ 259,126$ (13,801 ) (5.1 )% $ 13,725

5.3 %



Percentage of revenue 81.4 % 80.9 % 75.7 %

Gross profit $ 59,071$ 64,585$ 83,165$ (5,514 ) (8.5 )% $ (18,580 ) (22.3 )% Percentage of revenue 18.6 % 19.1 % 24.3 % Fiscal 2014 vs 2013 Cost of goods sold was $259.1 million for fiscal year 2014, a decrease of $13.8 million, or 5.1%, as compared to $272.9 million for fiscal year 2013, primarily as a result of the overall manufacturing cost reduction due to continued cost control efforts and factory utilization improvement during fiscal year 2014 as well as the impact of the $7.7 million non-recurring inventory write-down during fiscal year 2013 for certain excess and obsolete inventory consisting of developed products for PC applications for a major OEM that were not compatible with its particular applications, which had subsequently been fully resolved. Gross margin decreased by 0.5 percentage points to 18.6% for fiscal year 2014, as compared to 19.1% for fiscal year 43 -------------------------------------------------------------------------------- 2013. The decrease in gross margin was primarily due to reduced average selling price mainly as a result of lower demand in the declining PC market during the current year, despite the $7.7 million non-recurring inventory write-down in fiscal year 2013, partially offset by the positive impact of improved factory utilization and continued factory cost reduction efforts during the current year. We expect our gross margin to continue to fluctuate in the future as a result of variations in our product mix, factory utilization, semiconductor wafer and raw material pricing, manufacturing labor cost and general economic and PC market conditions. Fiscal 2013 vs 2012 Cost of goods sold was $272.9 million for fiscal year 2013, an increase of $13.7 million, or 5.3%, as compared to $259.1 million for fiscal year 2012, primarily as a result of a $7.7 million non-recurring inventory write-down and increased unit shipments. The non-recurring inventory write-down was for certain excess and obsolete inventory consisting of newly developed products for desktop PC applications primarily for a major OEM that were not compatible with its particular applications, and to a lesser extent, products for power supplies. Gross margin decreased by 5.2 percentage points to 19.1% for fiscal year 2013, as compared to 24.3% for fiscal year 2012. The decrease in gross margin was primarily due to the non-recurring inventory write-down of $7.7 million, as well as reduced average selling price, partially offset by tighter factory expense control as compared to last year. Research and development expenses Year Ended June 30, Change 2014 2013 2012 2014 2013 (in thousands) (in thousands) (in percentage) (in thousands) (in percentage) Research and development $ 24,409$ 27,833$ 30,630$ (3,424 ) (12.3 )% $ (2,797 ) (9.1 )% Fiscal 2014 vs 2013 Research and development expenses were $24.4 million for fiscal year 2014, a decrease of $3.4 million, or 12.3%, as compared to $27.8 million for fiscal year 2013. The decrease was primarily attributable to a $2.6 million decrease in product prototyping engineering expenses mainly due to temporary shut downs of the Company as cost control measures, $0.6 million decrease in shared-based compensation expense primarily due to increased cancellations of stock options and rewards, $0.2 million decrease in depreciation and amortization expenses as a result of certain assets were fully amortized in fiscal year of 2013. We continue to invest significant resources in developing new technologies and new products utilizing our own fabrication and packaging facilities. However, we expect that our research and development expenses will fluctuate from time to time. Fiscal 2013 vs 2012 Research and development expenses were $27.8 million for fiscal year 2013, a decrease of $2.8 million, or 9.1%, as compared to $30.6 million for fiscal year 2012. The decrease was primarily attributable to a $3.6 million decrease in product prototyping engineering expenses, mainly related to engineering wafers expenses incurred during fiscal year 2012 under the then foundry agreement with IDT prior to the acquisition of the Oregon fab. The decrease was partially offset by a $0.7 million increase in employee compensation and benefits primarily due to increase in headcount related to the Oregon fab acquired in January 2012. Selling, general and administrative expenses Year Ended June 30, Change 2014 2013 2012 2014 2013 (in thousands) (in thousands)



(in percentage) (in thousands) (in percentage) Selling, general and administrative $ 34,855$ 35,473$ 35,800 $ (618 )

(1.7 )% $ (327 ) (0.9 )% Fiscal 2014 vs 2013 44

-------------------------------------------------------------------------------- Selling, general and administrative expenses were $34.9 million for fiscal year 2014, a decrease of $0.6 million, or 1.7%, as compared to $35.5 million for fiscal year 2013. The decrease was primarily due to a $0.7 million decrease in share-based compensation due to increased cancellations of stock options and awards during the current year, a $0.7 million decrease in depreciation and amortization expenses primarily due to certain assets that were fully amortized in fiscal year 2013 and less acquisitions of fixed assets during the current year, a $0.3 million decrease in marketing and commission expenses due to reduced sales and marketing activities, a $0.4 million in recovery of doubtful accounts as a result of continued effort in collection from a service customer in current fiscal year, as well as a $0.4 million decrease in audit and tax consulting fees due to reduced related consulting activities. These decreases were partially offset by a $0.8 million increase in unrealized foreign exchange losses related to our cash and cash equivalents denominated in Renminbi or RMB, held by our subsidiaries in China, caused by the recent appreciation of USD against RMB, and a $0.8 million increase in employee compensation and benefits due to headcount increase, as well as a $0.3 million of business tax refunds of a subsidiary in China during fiscal year 2013.



Fiscal 2013 vs 2012

Selling, general and administrative expenses were $35.5 million for fiscal year 2013, a decrease of $0.3 million, or 0.9%, as compared to $35.8 million for fiscal year 2012. The decrease was primarily due to a $0.8 million decrease in share-based compensation due to increased cancellations of stock options and other equity awards, a $0.7 million decrease in accounting, Sarbanes-Oxley compliance and consulting fees due to the decrease in related accounting and consulting activities, a $0.3 million decrease in business taxes primarily due to a business tax refund received by a subsidiary in China during fiscal year 2013, a $0.2 million decrease in sales commission primarily due to decrease in sales and a $0.6 million bad debt expenses incurred related to a service customer during fiscal year 2012, and these decreases were partially offset by a $1.4 million increase in employee compensation, benefits and business expenses mainly due to increase in headcount, a $0.3 million increase in depreciation and amortization expenses primarily due to fixed assets acquired during fiscal year 2013 and a $0.6 million increase in legal expenses due to increased legal consulting services. Impairment of long-lived assets During the third quarter of fiscal year 2013, in light of the unfavorable market conditions particularly related to the accelerated decline of the PC market, we conducted an in-depth analysis of our strategic plan. In our review, we reconsidered the key assumptions in our overall strategic business and manufacturing capacity plans in light of the continued declines in the PC market. As a result, we revised our PC related revenue and volume outlook as well as our manufacturing capacity requirements. These material changes in our outlook and plans, which we were able to determine in the third quarter of fiscal 2013, triggered an impairment review of our long-lived assets. We determined that the related estimated undiscounted cash flows were not sufficient to recover the carrying value of certain manufacturing machinery and equipment primarily for the packaging of our PC-related products due to the accelerated decline of the PC markets. The average remaining useful life of those impaired assets was approximately two years. We estimated the fair values of those long-lived assets based on net realizable values of similar machinery and equipment recently transacted by third-party used-machine brokers and recorded an asset impairment charge of approximately $2.6 million to reduce the related carrying amount to its estimated fair value as of March 31, 2013. During the fourth quarter of fiscal year 2014, we evaluated our amortizable intangible assets for impairment and determined that the related estimated undiscounted cash flows exceeded the carrying value of the intangible assets and no impairment charge was recorded. During the same period, we also evaluated our goodwill for impairment and determined that the fair value of the reporting unit, estimated based on the market capitalization approach, was more than its carrying value and no impairment charge was recorded. Interest income and expenses Interest income was primarily related to interest earned from cash and cash equivalents. The increase in interest income for fiscal year 2014 as compared to fiscal year 2013 was primarily due to increase in average cash balances. The decrease in interest income for fiscal year 2013 as compared to fiscal year 2012 was primarily due to lower average interest rate. Interest expense was primarily related to bank borrowings. The decrease in interest expenses for fiscal year 2014 was primarily due to a decrease in bank borrowings related to $20.0 million term loan obtained in May 2012 for our Oregon fab as compared to fiscal year 2013. The increase in interest expenses for fiscal year 2013 was primarily due to an increase in bank borrowings, including the $20.0 million term loan obtained in May 2012 for working capital of our Oregon fab as compared to fiscal year 2012. 45 --------------------------------------------------------------------------------



Income tax expense

Year Ended June 30, Change 2014 2013 2012 2014 2013 (in thousands) (in thousands) (in percentage) (in thousands) (in percentage) Income tax expense $ 2,973$ 4,001$ 3,581$ (1,028 ) (25.7 )% $ 420 11.7 % Fiscal 2014 vs 2013 Income tax expense for fiscal years 2014 and 2013 was $3.0 million and $4.0 million, respectively. Income tax expense decreased by $1.0 million, or 25.7%, in fiscal year 2014 as compared to fiscal year 2013 primarily due to a reduction in our uncertain tax positions offset partially by a change in the mix of earnings in various geographic jurisdictions.



Fiscal 2013 vs 2012

Income tax expense for fiscal years 2013 and 2012 was $4.0 million and $3.6 million, respectively. Income tax expense increased by $0.4 million, or 11.7%, in fiscal year 2013 as compared to fiscal year 2012 primarily due to the changes in the mix of earnings in various geographic jurisdictions, which was partially offset by the tax benefits from the January 2013 reinstatement of the U.S. federal R&D credit retroactive to January 1, 2012.



Liquidity and Capital Resources

Our principal need for liquidity and capital resources is to maintain sufficient working capital to support our operations and to invest adequate capital expenditures to fuel the growth of our business. Currently, we primarily financed our operations and capital expenditures through funds generated from operations. On May 11, 2012, we entered into a loan agreement with a financial institution that provides a term loan of $20.0 million for general purposes and a $10.0 million non-revolving credit line for the purchase of equipment. Both the term loan and equipment credit line will be fully repayable in May 2015. The borrowings may be made in the form of either Eurodollar loans or Base Rate loans. Eurodollar loans accrue interest based on an adjusted London Interbank Offer Rate ("LIBOR") as defined in the agreement, plus a margin of 1.00% to 1.75%. Base Rate loans accrue interest at the highest of (a) the lender's Prime Rate, (b) the Federal Funds Rate plus 0.5% and (c) the Eurodollar Rate (for a one-month interest period) plus 1%; plus a margin of -0.5% to 0.25%. The applicable margins for both Eurodollar loans and Base Rate loans will vary from time to time in the foregoing ranges based on the cash and cash equivalent balances maintained by us and our subsidiaries with the lender. In May 2013, the equipment credit line expired and there was no outstanding balance. As of July 31, 2014 and 2013, the outstanding balance of the term loan was $13.5 million and $16.4 million, respectively. The obligations under the loan agreement are secured by substantially all assets of two of our subsidiaries, including but not limited to, certain real property and related assets located at the Oregon fab. In addition, we and certain of our subsidiaries have agreed to guarantee full repayment and performance of the obligations under the loan agreement. The loan agreement contains customary restrictive covenants and includes certain financial covenants that require us to maintain on a consolidated basis specified financial ratios including total liabilities to tangible net worth, fixed charge coverage and current assets to current liabilities. As of July 31, 2014 and 2013, we were in compliance with these covenants. During July 2012, we entered into a loan agreement with the State of Oregon for an amount of $0.3 million. The loan is required to be used for training new and re-training existing employees of the Oregon fab. The loan bears a compound annual interest rate of 5.0% and is to be repaid in April 2014. The State may forgive the outstanding balance under the loan and any unpaid interest if we meet certain conditions primarily relating to hiring targets. Currently the State of Oregon is reviewing the loan to determine whether such conditions are satisfied. We believe that it is more likely than not that we will meet those hiring targets. As of July 31, 2014, the outstanding balance and accrued interest of the loan, included in short term debt, was $0.3 million. Our Board of Directors periodically considers various options to utilize our cash reserve to enhance the value of our shareholders. On May 8, 2014, our Board of Directors approved to reactivate our existing $25.0 million share repurchase program and authorized management to repurchase, subject to oversight by the Board, our common shares up to remaining balance of the program, or $22.7 million. The repurchases may be made from the open market or through negotiated block transactions, and to date repurchases have been made pursuant to a pre-established 10b5-1 trading plan. Such 10b5-1 trading plan was expired in Augus 46 -------------------------------------------------------------------------------- t 2014 and the Board intends to review conditions from time to time to determine whether it is appropriate to implement a new 10b5-1 trading plan or to conduct repurchases under the program outside of a 10b5-1 trading plan. The amount and timing of any purchases will depend on a number of factors, including but not limited to the price and availability of our common shares, trading volume of our common shares, applicable regulatory requirements, our business and financial conditions and general market environment, and there is no guarantee that any repurchases will be made or that such repurchases may enhance the value of our shares. During the fourth quarter of fiscal year 2014, we repurchased 119,594 shares from the open market for a total cost of $0.9 million, at an average price of $7.66 per share. As of June 30, 2014, we repurchased an aggregate of 361,364 shares from the open market for a total cost of $3.2 million, at an average price of $8.82 per share, since inception of the program. Shares repurchased are accounted for as treasury shares and the total cost of shares repurchased is recorded as a reduction of shareholders' equity. As of June 30, 2014, of the 361,364 repurchased shares, 21,650 shares with a weighted average repurchase price of $13.81 per share, were reissued at an average price of $3.00 per share for option exercises and vested restricted stock units. The Chinese government imposes certain currency exchange controls on cash transfers out of China. Regulations in China permit foreign owned entities to freely convert the Renminbi into foreign currency for transactions that fall under the "current account," which includes trade related receipts and payments, and interests. Accordingly, our Chinese subsidiaries may use Renminbi to purchase foreign exchange currency for settlement of such "current account" transactions without pre-approval. Other transactions that involve conversion of Renminbi into foreign currency are classified as "capital account" transactions. Examples of "capital account" transactions include repatriations of investments by or dividends to foreign owners. Pursuant to applicable regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In calculating accumulated profits, foreign investment enterprises in China are required to allocate at least 10% of their profits each year, if any, to fund the equity reserve account unless the reserve has reached 50% of the registered capital of the enterprises. "Capital account" transactions require prior approval from China'sState Administration of Foreign Exchange (SAFE) or its provincial branch to convert a remittance into a foreign currency, such as U.S. dollars, and transmit the foreign currency outside of China. As a result of this and other restrictions under PRC laws and regulations, our China subsidiaries are restricted in their ability to transfer a portion of their net assets to the parent. As of June 30, 2014 and 2013, such restricted portion amounted to approximately $85.6 million and $85.9 million, or 30.3% and 30.5%, of our total consolidated net assets, respectively. We believe that our current cash and cash equivalents and cash flows from operations will be sufficient to meet our anticipated cash needs, including working capital and capital expenditures, for at least the next twelve months. In the long-term, we may require additional capital due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our cash is insufficient to meet our needs, we may seek to raise capital through equity or debt financing. The sale of additional equity securities could result in dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and may include operating and financial covenants that would restrict our operations. We cannot be certain that any financing will be available in the amounts we need or on terms acceptable to us, if at all. Cash and cash equivalents As of June 30, 2014 and 2013, we had $117.8 million and $92.4 million of cash and cash equivalents, respectively. Our cash and cash equivalents primarily consist of cash on hand and short-term bank deposits with original maturities of three months or less. Of the $117.8 million and $92.4 million cash and cash equivalents, $77.0 million and $53.2 million, respectively, are deposited with financial institutions outside the United States. The following table shows our cash flows from operating, investing and financing activities for the periods indicated: Year Ended June 30, 2014 2013 2012 (in thousands)



Net cash provided by operating activities $ 37,644$ 28,007

$ 32,881 Net cash used in investing activities (9,191 ) (17,278 ) (57,931 ) Net cash provided by (used in) financing activities (3,081 ) (485 ) 20,462 Effect of exchange rate changes on cash and cash equivalents 10 (4 ) 46 Net increase (decrease) in cash and cash equivalents $ 25,382$ 10,240



$ (4,542 )

Cash flows from operating activities

47 -------------------------------------------------------------------------------- Net cash provided by operating activities of $37.6 million for fiscal year 2014 resulted primarily from net loss of $3.3 million, non-cash charges of $31.5 million and net change in assets and liabilities providing net cash of $9.4 million. The non-cash charges of $31.5 million included depreciation and amortization expenses of $27.9 million, share-based compensation expense of $3.4 million, and net deferred income taxes of $0.8 million, partially offset by allowance for doubtful account of $0.4 million and gain on disposal of property and equipment of $0.2 million during the fiscal year 2014. The net change in assets and liabilities providing net cash of $9.4 million was primarily due to $1.8 million decrease in inventories as we reduced our inventories, $2.1 million decrease in accounts receivable due to the timing of billings and collection of payments, $5.5 million increase in accounts payable primarily due to increase in inventory purchase and timing of payment, and $2.4 million increase in accrued and other liabilities primarily related to employee compensation and performance bonuses, partially offset by $0.9 million decrease in income taxes payable, and $1.5 million increase in other current and long-term assets primarily due to increase in advance payments to suppliers. Net cash provided by operating activities of $28.0 million for fiscal year 2013 resulted primarily from net loss of $5.6 million, non-cash charges of $37.8 million and net change in assets and liabilities using net cash of $4.2 million. The non-cash charges of $37.8 million included $29.4 million in depreciation and amortization expenses, $4.8 million in share-based compensation expense, $1.0 million in net deferred income taxes, and $2.6 million in impairment charges of long-lived assets during the third quarter. The net change in assets and liabilities using net cash of $4.2 million was primarily due to $0.7 million decrease in income taxes payable, $2.6 million increase in inventories as we built up our inventories for the Oregon fab ramp up, and $5.4 million decrease in accrued and other liabilities primarily related to payment of performance bonuses, partially offset by $0.6 million decrease in accounts receivable due to the timing of billings and collection of payments, $1.8 million increase in accounts payable primarily due to increase in inventory purchase and timing of payment, and $2.1 million decrease in other current and long-term assets primarily due to decrease in advance payments to suppliers. Net cash provided by operating activities of $32.9 million for fiscal year 2012 resulted primarily from net income of $12.9 million, non-cash charges of $29.8 million and net change in assets and liabilities using net cash of $9.8 million. The non-cash charges of $29.8 million included $25.3 million in depreciation and amortization, $5.4 million in share-based compensation expense and $0.6 million in allowance for doubtful accounts, partially offset by $1.5 million in net deferred income taxes. The net change in working capital using net cash of $9.8 million was primarily due to $3.1 million decrease in accounts receivable due to the timing of billings and collection of payments, $1.6 million decrease in inventories as we reduced our inventories in response to changes in market condition, $1.3 million decrease in other current and long-term assets primarily due to a decrease in advance payments to suppliers, $4.5 million increase in accrued and other liabilities primarily related to expenses of the Oregon fab and $0.4 million increase in income taxes payable, offset by a $20.8 million decrease in accounts payable primarily due to timing of payment. Cash flows from investing activities Net cash used in investing activities of $9.2 million for the fiscal year 2014 was primarily attributable to $9.4 million purchase of property and equipment to increase our in-house production capacity, partially offset by $0.2 million proceeds from sale of certain equipment. Net cash used in investing activities of $17.3 million for the fiscal year 2013 was primarily attributable to $17.6 million purchase of property and equipment to increase our in-house production capacity, partially offset by $0.3 million proceeds from sale of certain equipment. Net cash used in investing activities of $57.9 million for fiscal year 2012 was primarily attributable to $36.3 million for purchase of property and equipment to increase our in-house production capacity at the Oregon fab facility, $21.3 million of cash for acquisition of the Oregon fab in January 2012, $0.2 million increase in restricted cash, and $0.1 million related to the investment in a privately held company. Cash flows from financing activities Net cash used in financing activities of $3.1 million for the fiscal year 2014 was primarily attributable to $3.6 million of repayment to our borrowings, $1.0 million for repurchase of our common shares under the repurchase program, and $1.3 million in payment of capital lease obligations; partially offset by a $2.7 million of proceeds from exercises of share options and issuance of shares under the ESPP. 48

-------------------------------------------------------------------------------- Net cash used in financing activities of $0.5 million for the fiscal year 2013 was primarily attributable to $2.6 million of net repayment to our borrowings and $1.0 million in payment of capital lease obligations; partially offset by a $3.1 million of proceeds from exercises of share options and issuance of shares under the ESPP. Net cash provided by financing activities of $20.5 million for fiscal year 2012 was primarily attributable to $20.0 million of net proceeds from our revolving lines of credit and term loan and $2.3 million of proceeds from exercise of share options and ESPP, partially offset by $1.6 million for repurchase of our common shares under the share repurchase program and $0.3 million in payment of capital lease obligations. Contractual Obligations Our contractual obligations as of June 30, 2014 are as follows: Payments Due by Period Less than More than Total 1 year 1-3 years 3-5years 5 years (in thousands) Bank borrowings $ 13,571$ 13,571 $ - $ - $ - Oregon state loan 275 275 - - - Capital leases 2,173 1,123 1,000 50 - Operating leases 15,009 3,164 4,414 3,861 3,570 Capital commitments with respect to property and equipment 4,644 4,644 - - - Purchase commitments with respect to inventories and research and development 34,510 34,510 - - - Total contractual obligations $ 70,182$ 57,287$ 5,414$ 3,911$ 3,570 As of June 30, 2014, we had recorded liabilities of $2.0 million for uncertain tax positions and $0.3 million for potential interest and penalties, which are not included in the above table because we are unable to reliably estimate the amount of payments in individual years that would be made in connection with these uncertain tax positions. Off-Balance Sheet Arrangements



As of June 30, 2014, we had no material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Critical Accounting Policies and Estimates The preparation of our consolidated financial statements requires us 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, our consolidated financial statements will be affected. On an ongoing basis, we evaluate the estimates, judgments and assumptions including those related to revenue recognition, inventory reserves, warranty accrual, income taxes, share-based compensation, and useful lives for property and equipment and for goodwill and intangible assets. Revenue recognition We recognize revenue when there is persuasive evidence that an arrangement exists, delivery has occurred, the price to the buyer is fixed or determinable and when collectability is reasonably assured. We recognize revenue when product is shipped to the customer, net of estimated stock rotation returns and price adjustments to certain distributors. We sell our products primarily to distributors, who in turn sell our products globally to various end customers. Our revenue is net of the effect of the estimated stock rotation returns and price adjustments that we expect to provide to certain distributors. Stock rotation returns are governed by contract and are limited to a specified percentage of the monetary value of the products purchased by distributors during a specified period. We estimate provision for stock rotation returns based on historical returns and individual distributor agreements. We also provide special pricing to certain distributors primarily based on volume, to encourage resale of our products. We estimate the expected price adjustments at the time the revenue is 49 -------------------------------------------------------------------------------- recognized based on distributor inventory levels, pre-approved future distributor selling prices, distributor margins and demand for our products. If actual stock rotation returns or price adjustments differ from our estimates, adjustments may be recorded in the period when such actual information is known. Allowance for price adjustments is recorded against accounts receivable and provision for stock rotation is recorded in accrued liabilities on the consolidated balance sheets. Revenue from certain distributors is deferred until the distributor resells the products to end customers due to price protection adjustments and right of returns that cannot be reliably measured. The deferred revenue, net of the associated deferred cost of the inventory, is recorded as deferred margin on the consolidated balance sheets. Packaging and testing services revenue is recognized upon shipment of serviced products to the customer. Inventory reserves We carry inventories at the lower of cost (determined on a first-in, first-out basis) or market value. Cost primarily consists of semiconductor wafers and raw materials, labor, depreciation expenses and other manufacturing expenses and overhead, and packaging and testing fees paid to third parties if subcontractors are used. Inventory reserves are made based on our periodic review of inventory quantities on hand as compared with our sales forecasts, historical usage, aging of inventories, production yield levels and current product selling prices. If actual market conditions are less favorable than those forecasted by us, additional future inventory write-downs may be required that could adversely affect our operating results. Inventory reserves once established are not reversed until the related inventory has been sold or scrapped. If actual market conditions are more favorable than expected and the products that have previously been written down are sold, our gross margin would be favorably impacted. Product warranty We provide a standard one-year warranty for the products we sell. We accrue for estimated warranty costs at the time revenue is recognized. Our warranty obligation is affected by product failure rates, labor and material costs for replacing defective parts, related freight costs for failed parts and other quality assurance costs. We monitor our product returns for warranty claims and maintain warranty reserve based on our historical experiences and anticipated warranty claims known at the time of estimation. If actual warranty costs differ significantly from our estimates, revisions to the estimated warranty accrual would be required and any such adjustments could be material. Accounting for income taxes We are subject to income taxes in a number of jurisdictions. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits and deductions, and in the calculation of certain tax assets and liabilities which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as interest and penalties related to uncertain tax positions. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. We establish accruals for certain tax contingencies based on estimates of whether additional taxes may be due. While the final tax outcome of these matters may differ from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made. As a result, significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. Significant management judgment is also required in determining whether deferred tax assets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as net operating losses or foreign tax credit carryforwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that cannot be realized. We consider all available positive and negative evidence on a jurisdiction-by-jurisdiction basis when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of cumulative losses in recent years and our forecast of future taxable income. We intend to maintain a partial valuation allowance equal to the state research and development credit carryfowards until sufficient positive evidence exists to support reversal of the valuation allowance. We have not provided for withholding taxes on the undistributed earnings of our foreign subsidiaries because we intend to reinvest such earnings indefinitely. As of June 30, 2014, the cumulative amount of undistributed earnings of our foreign subsidiaries considered permanently reinvested is $49.8 million. The determination of the unrecognized deferred tax liability on these earnings is not practicable. Should we decide to remit this income to the Bermuda parent company in a future period, our provision for income taxes may increase materially in that period. 50 -------------------------------------------------------------------------------- The Financial Accounting Standards Board, or FASB, has issued guidance which clarifies the accounting for income taxes by prescribing a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. The minimum threshold is defined as a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely to be realized upon ultimate settlement. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. Although the guidance on the accounting for uncertainty in income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. If the ultimate resolution of tax uncertainties is different from what is currently estimated, a material impact on income tax expense could result. Our provision for income taxes is subject to volatility and could be adversely impacted by changes in earnings or tax laws and regulations in various jurisdictions. We are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of changes to reserves, as well as the related net interest and penalties. Share-based compensation expense We recognize share-based compensation expense based on the estimated fair value of the awards determined by the Black-Scholes option valuation model, using the accelerated vesting attribution method. Share-based compensation expense is significant to the consolidated financial statements and is calculated using our best estimates, which involve inherent uncertainties and the application of management's judgment. We determined the weighted average valuation assumptions as follows: Expected term. It is determined by using the historical data of industry peers as adjusted for expected changes in future exercise patterns.



Forfeiture rate. It is estimated based on the historical average period of

time that the awards were outstanding and forfeited. The estimate of

forfeitures is adjusted over the requisite service period to the extent

that actual forfeitures differ, or are expected to differ, from the prior

estimates. Changes in estimated forfeitures are recognized in the period

of change and impact the amount of stock compensation expenses to be

recognized in future periods, which could be material if actual results

differ significantly from our estimates.

Volatility. It is estimated based on that of the publicly traded shares of

industry peers over a period equivalent to the expected term of the stock

awards granted.

Risk-free interest rate. It is based on the yields of U.S. Treasury

securities with maturities similar to the expected term of the awards

granted.

Dividend yield. It is zero as the Company has never declared or paid any

dividends and currently has no intention to pay dividends in the

foreseeable future.

Estimated Useful Lives for Property, Plant and Equipment and Intangible Assets Property, plant and equipment are recorded at cost and are depreciated using the straight-line method over estimated useful lives of the assets. Patents and exclusive technology rights purchased from third parties are amortized on a straight-line basis over their estimated useful lives of three to seven years. Trade name and customer relationships acquired in a business combination are recognized at fair values at the acquisition date and amortized on a straight-line basis over their estimated economic lives of three years and four years, respectively. Goodwill 51

-------------------------------------------------------------------------------- Goodwill and intangible assets with indefinite useful lives are not amortized, but are tested for impairment at least annually, or whenever changes in circumstances indicate that the carrying amount of goodwill or intangible assets may not be recoverable. These tests are performed at the reporting unit level using a two-step, fair-value based approach. In testing for a potential impairment of goodwill, we first compare the carrying value of assets and liabilities to the estimated fair value. If estimated fair value is less than carrying value, then potential impairment exists. The amount of any impairment is then calculated by determining the implied fair value of goodwill using a hypothetical purchase price allocation, similar to that which would be applied if it were an acquisition and the purchase price was equivalent to fair value as calculated in the first step. Impairment is equivalent to any excess of goodwill carrying value over its implied fair value. The process of evaluating the potential impairment of goodwill requires significant judgment at many points during the analysis, including calculating fair value of each reporting unit based on estimated future cash flows and discount rates to be applied. Recently Issued Accounting Pronouncements See Note 1 of the Notes to the consolidated financial statements under Item 15 in this Annual Report on Form 10-K for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition. 52



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