AMKOR TECHNOLOGY, INC. (AMKR) FY 2021 MD&A

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section includes comparisons of certain 2021 financial information to the same information for 2020. For discussion of 2020 results in comparison with 2019 results refer to “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on February 19, 2021.

Overview

Amkor is one of the world’s leading providers of outsourced semiconductor packaging and test services. Our financial goal is profitable sales growth. To achieve this goal, we are focused on leveraging our leadership position in services for advanced technologies, optimizing utilization of existing assets, broadening our customer base and selectively growing our scale and scope through strategic investments.

We are an industry leader in developing and commercializing advanced packaging and test technologies. We believe these advanced technology solutions provide substantial value to our customers, particularly in the mobile communications market, where growth generally outpaces the overall semiconductor industry. Advanced packages are now the preferred choice in both the high-end and the mid-range segments of the smartphone market, which together account for a high portion of mobile phone semiconductor value. The demand for advanced packages is also being driven by second-wave mobile device customers, who are transitioning out of wirebond into wafer-level and flip-chip packages. Interest in advanced packages for automotive applications is growing as well, largely due to new, data-intensive applications, which require increased pin count and performance. We believe that our technology leadership and this technology transition create significant growth opportunities for us.

We typically look for opportunities in the advanced packaging and test areas where we can generate reasonably quick returns on investments made for customers seeking leading edge technologies. We also focus on developing a second wave of customers to fill the capacity that becomes available when leading edge customers transition to newer packaging and test equipment and platforms. In addition, we are seeking to add new customers and to deepen our engagement with existing customers. This includes an expanded emphasis on the automotive and industrial end market where semiconductor content continues to grow and in the analog area for our mainstream wirebond technologies.

From time to time, we identify attractive opportunities to grow our customer base and expand the markets we serve through expansion of our operations, joint ventures, acquisitions and other strategic investments. For example, we have recently announced plans to expand our operations to Vietnam through the construction of a new factory. We believe that taking advantage of these opportunities helps to diversify our revenue streams, improve our profits, broaden our portfolio of services and maintain our technological leadership.

As a supplier in the semiconductor industry, our business is cyclical and impacted by broad economic factors. Historical trends indicate there has been a strong correlation between worldwide gross domestic product levels, consumer spending and semiconductor industry cycles. The semiconductor industry has experienced significant and sometimes prolonged cyclical upturns and downturns in the past. We cannot predict the timing, strength or duration of any correction, economic slowdown or subsequent economic recovery.

The full potential effect of the ongoing Covid-19 pandemic is unknown, and there remains uncertainty related to the ultimate impact that the Covid-19 pandemic will have on the global economy, the semiconductor industry and our business, results of operations and financial condition. While our revenue increased significantly in the year ended December 31, 2021, and we were able to successfully ramp new products during the year, we are subject to industry-wide supply constraints, and these constraints had an effect of restraining growth in some of the end markets we serve. We expect these constraints to persist throughout 2022. For additional information regarding the potential impact of macroeconomic factors, the Covid-19 pandemic and other risks on our business, results of operations and financial condition, please refer to the “Risk Factors” section in Part I, Item 1A of this Form 10-K.

We operate in a capital-intensive industry. Servicing our current and future customers requires that we incur significant operating expenses and continue to make significant capital expenditures, which are generally made in advance of the related revenues and without firm customer commitments. We fund our operations, including capital expenditures and

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debt service requirements, with cash flows from operations, existing cash and cash equivalents, short-term investments, borrowings under available credit facilities and proceeds from any additional financing. Maintaining an appropriate level of liquidity is important to our business and depends on, among other considerations, the performance of our business, our capital expenditure levels, our ability to repay debt out of our operating cash flows or proceeds from debt or equity financings and our investment strategy. As of December 31, 2021, we had cash and cash equivalents and short-term investments of $826.7 million and $251.5 million, respectively.

Our net sales, gross profit, operating income, cash flows, liquidity and capital resources have historically fluctuated significantly from quarter to quarter due to many factors, including the seasonality of our business, the cyclical nature of the semiconductor industry and other factors discussed in Part 1, Item 1A of this Form 10-K.

2021 Financial Summary

Our net sales increased $1,087.7 million or 21.5% to $6,138.3 million in 2021 from $5,050.6 million in 2020. The increase was attributable to higher sales in all end markets led by the further adoption of 5G smartphones in the communications end market.

Gross margin increased to 20.0% in 2021 compared to 17.8% in 2020. The increase in gross margin was primarily due to the increase in volume across all of our end markets.

Operating income margin expanded 330 basis points to 12.4% in 2021 from 9.1% in 2020. The increase in our operating income margin was primarily due to our increase in net sales and expansion in gross margin discussed above along with disciplined cost control.

In 2021, our capital expenditures totaled $779.8 million, or 12.7% of net sales compared to $553.0 million, or 10.9% of net sales in 2020. Our spending was primarily focused on investments in advanced packaging and test equipment.

Net cash provided by operating activities was $1,121.3 million for the year ended December 31, 2021, compared to $770.0 million for the year ended December 31, 2020. This increase was primarily due to higher net sales, higher operating profit and an increase in contract liabilities due to customer advance payments. This increase was offset by changes in working capital.

In November 2021, our Board of Directors approved a quarterly dividend of $0.05 per share, a 25% increase. In 2021, we paid total quarterly cash dividends of $51.2 million.

In November 2021, we announced our plans for a new factory location in Bac Ninh, Vietnam. Construction of the first phase is expected to commence in 2022, and high volume manufacturing is expected to begin in mid-2023. Our initial investment is expected to be between $200 million and $250 million.

Results of Operations

The following table sets forth certain operating data as a percentage of net sales for the periods indicated:

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Net Sales

The $1.1 billion increase in net sales in 2021 compared to 2020 was due to higher sales across all end markets. Sales in the communications end market represented 42% of the increase, driven primarily by the further adoption of 5G smartphones. The automotive and industrial end market recovered in the current year from weakened demand relating to the Covid-19 pandemic in the prior year, representing 25% of our growth in net sales. Sales in the computing end market accounted for 20% of the increase in 2021 due to growth in all applications, primarily due to the shift in cloud computing needs and new product introductions within personal computing. The consumer end market continues to see strong sales, primarily due to demand for both home and personal electronics, and made up the remaining 13% of the increase compared to 2020.

Gross Profit and Gross Margin

Our cost of sales consists principally of materials, labor, depreciation and manufacturing overhead. Since a substantial portion of the costs at our factories is fixed, there tends to be a strong relationship between our revenue levels and gross margin. Accordingly, relatively modest increases or decreases in revenue can have a significant effect on margin and on labor and other manufacturing costs as a percentage of revenue, depending upon product mix, utilization and seasonality. Recently, we have expanded our business in advanced SiP modules, which tend to have higher material costs when compared to our other products. As we continue to increase production of these higher material cost modules, there could be an impact on our profitability, depending on overall utilization.

Gross profit and gross margin for 2021 increased compared to 2020, primarily due to the increase in net sales. The increase was partially offset by an increase in fixed costs from our expanded capacity investments and an increase in the mix of products sold with higher material costs.

Selling, General and Administrative

Selling, general and administrative expenses decreased in 2021 compared to 2020. The decrease was primarily due to a reduction of $15.1 million in costs incurred for factory consolidation efforts in Japan compared to the prior year. These decreases were partially offset by increased professional fees.

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Research and Development

Research and development activities are focused on developing new packaging and test services and improving the efficiency and capabilities of our existing production processes. The costs related to our technology and product development projects are included in research and development expense until the project moves into production. Once production begins, the costs relating to production become part of the cost of sales, including ongoing depreciation for the equipment previously held for research and development activities. Research and development expenses in 2021 increased compared to 2020 due to new development projects in advanced packaging technologies, primarily advanced SiP modules.

Other Income and Expense

Interest expense decreased in 2021 compared to 2020, primarily due to the decrease in our average outstanding debt throughout the year.

Interest income decreased in 2021 compared to 2020, primarily due to lower interest rates in the overall market.

The changes in foreign currency (gain) loss, net for 2021 compared to 2020 were due to foreign currency exchange rate movements, mainly the Korean won, and the associated impact on our net monetary exposure at our foreign subsidiaries.

Income Tax Expense

Income tax expense, which includes foreign withholding taxes and minimum taxes, reflects the applicable tax rates in effect in the various countries where our income is earned and is subject to volatility depending on the relative mix of earnings in each location.

The effective tax rate is below the U.S. statutory rate of 21% primarily due to lower tax rates applicable to our operations in some foreign jurisdictions where we earn income. The effective tax rate in 2020 includes a $20.2 million income tax benefit from the recognition of deferred tax assets we expect to utilize in future years.

During 2021, 2020 and 2019, our subsidiaries in Korea, the Philippines and Singapore operated under various tax holidays. The tax holidays granted to certain operations in the Philippines expired during 2020 and 2021. As these tax

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holidays expire, income earned in these jurisdictions will be subject to higher statutory income tax rates, which may cause our effective tax rate to increase.

See Note 4 to our Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for additional information about our income tax expense.

Liquidity

We assess our liquidity based on our current expectations regarding sales and operating expenses, capital spending, dividend payments, stock repurchases, debt service requirements and other funding needs. Based on this assessment, we believe that our cash flow from operating activities, together with existing cash and cash equivalents, short-term investments and availability under our credit facilities, will be sufficient to fund our working capital, capital expenditures, dividend payments, debt service and other financial requirements for at least the next twelve months.

Our liquidity is affected by, among other factors, volatility in the global economy and credit markets, the performance of our business, our capital expenditure levels, other uses of our cash including any dividends and purchases of stock under any stock repurchase program, any acquisitions, joint ventures or other investments and our ability to either repay debt out of operating cash flow or refinance it at or prior to maturity with the proceeds from debt or equity offerings. There can be no assurance that we will generate the necessary net income or operating cash flows, or be able to borrow sufficient funds, to meet the funding needs of our business beyond the next twelve months due to a variety of factors, including the cyclical nature of the semiconductor industry and other factors discussed in Part I, Item 1A of this Form 10-K.

Our primary source of cash and the source of funds for our operations are cash flows from operations, current cash and cash equivalents, short-term investments, borrowings under available credit facilities and proceeds from any additional debt or equity financings. Please refer to Note 6 and Note 11 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for additional information on our investments and borrowings, respectively.

As of December 31, 2021, we had cash and cash equivalents and short-term investments of $1,078.3 million. Included in our cash and short-term investments balances as of December 31, 2021, is $918.4 million held offshore by our foreign subsidiaries. We have the ability to access cash held offshore by our foreign subsidiaries primarily through the repayment of intercompany debt obligations. If we were to distribute this offshore cash to the U.S. as dividends from our foreign subsidiaries, the dividends generally would not be subject to U.S. federal income tax. For the year ended December 31, 2021, we estimate that repatriation of this foreign cash and short-term investments would generate withholding taxes and state income taxes of approximately $35 million.

As of December 31, 2021, our net liability associated with unrecognized tax benefits is $38.3 million. Due to the uncertainty regarding the amount and timing of any future cash outflows associated with our unrecognized tax benefits, we are unable to reasonably estimate the amount and period of ultimate settlement, if any, with the various taxing authorities.

For certain accounts receivable, we use non-recourse factoring arrangements with third party financial institutions to manage our working capital and cash flows. Under these arrangements, we sell receivables to a financial institution for cash at a discount to the face amount. Available capacity under these arrangements is dependent on the level of our trade accounts receivable eligible to be sold, the financial institutions’ willingness to purchase such receivables and the limits provided by the financial institutions. These factoring arrangements can be reduced or eliminated at any time due to market conditions and changes in the credit worthiness of customers. For the year ended December 31, 2021 and 2020, we sold accounts receivable totaling $464.4 million and $499.3 million, net of discounts and fees of $1.2 million and $2.9 million, respectively.

We operate in a capital-intensive industry. Servicing our current and future customers may require that we incur significant operating expenses and make significant investments in equipment and facilities, which are generally made in advance of the related revenues and without firm customer commitments.

The borrowing base under our $250.0 million first lien senior secured revolving credit facility (the “Singapore Revolver”) entered into by our subsidiary, Amkor Technology Singapore Holding Pte, Ltd. (“ATSH”), is limited to the amount of eligible accounts receivable. As of December 31, 2021, we had availability of $250.0 million and no

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outstanding standby letters of credit. As of December 31, 2021, our foreign subsidiaries had $316.0 million available for future borrowings under revolving credit facilities, including the Singapore Revolver, and $222.4 million available to be borrowed under term loan credit facilities for working capital purposes and capital expenditures. For additional information regarding the Singapore Revolver, please refer to Note 11 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

As of December 31, 2021, we had debt of $1,138.0 million, with $153.0 million payable within 12 months. As of December 31, 2021, the interest payment obligations, based on stated coupon rates for fixed rate debt and interest rates applicable at December 31, 2021 for variable rate debt, were $235.6 million during the remaining term of the debt. Interest payment obligations payable within 12 months is $44.4 million. We were in compliance with all debt covenants as of December 31, 2021, and we expect to remain in compliance with these covenants for at least the next twelve months. For additional information regarding our debt arrangements, please refer to Note 11 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Certain of our debt agreements have restrictions on dividend payments and the repurchase of stock and subordinated securities. These restrictions are determined in part by our covenant compliance and on calculations based upon cumulative net income or, in the case of our Singapore Revolver, borrowing availability, and do not currently have a material impact on our ability to make dividend payments or stock repurchases.

The debt of Amkor Technology, Inc. is structurally subordinated in right of payment to all existing and future debt and other liabilities of our subsidiaries. From time to time, Amkor Technology, Inc. and certain of our subsidiaries also guarantee certain debt of our other subsidiaries.

In order to reduce our debt and future cash interest payments, we may from time to time repurchase or redeem our outstanding notes for cash or exchange shares of our common stock for our outstanding notes. Any such transaction may be made in the open market, through privately negotiated transactions or otherwise, and would be subject to the terms of our indentures and other debt agreements, market conditions and other factors.

Our subsidiary in Korea maintains an unfunded severance plan that covers certain employees that were employed prior to August 1, 2015. As of December 31, 2021, the severance liability was $73.2 million, with $8.2 million payable within 12 months. Accrued severance benefits are estimated assuming all eligible employees were to terminate their employment at the balance sheet date. For service periods subsequent to August 1, 2015, employees participate in either a defined benefit pension plan or a defined contribution pension plan. From time to time, we may offer employees the option to convert from the severance plan to the defined contribution plan which would require us to fund the converted portion of the liability. In addition, as of December 31, 2021, we had foreign pension plan obligations of $55.2 million, for which the timing and actual amount of impact on our future cash flow is uncertain. For additional information regarding our pension and severance plans, please refer to Note 12 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

We lease certain machinery and equipment, office space, and manufacturing facilities. As of December 31, 2021, our total remaining operating lease obligations and finance lease obligations were $158.7 million and $89.6 million, respectively, with $68.7 million and $33.2 million payable within 12 months, respectively. The lease obligations represent our future minimum lease payments including interest payments. For additional information regarding our leases, please refer to Note 9 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

We had off-balance sheet purchase obligations for capital expenditures, long-term supply contracts and other contractual commitments. As of December 31, 2021, the purchase obligations were $460.1 million, with $432.8 million payable within 12 months.

In 2021, we paid total quarterly cash dividends of $51.2 million. We currently anticipate that we will continue to pay quarterly cash dividends in the future. However, the payment, amount and timing of future dividends remain within the discretion of our Board of Directors and will depend upon our results of operations, financial condition, cash requirements, debt restrictions and other factors.

Our Board of Directors previously adopted a stock repurchase program (the “Stock Repurchase Program”) authorizing the repurchase of up to $300.0 million of our common stock, exclusive of any fees, commissions or other expenses. Under the Stock Repurchase Program, the purchase of stock may be made in the open market or through privately

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negotiated transactions. The timing, manner, price and amount of any repurchases will be determined by us at our discretion and will depend upon a variety of factors including economic and market conditions, the cash needs and investment opportunities for the business, the current market price of our stock, applicable legal requirements and other factors. We have not purchased any stock under the Stock Repurchase Program since 2012. At December 31, 2021, approximately $91.6 million was available to repurchase common stock pursuant to the Stock Repurchase Program.

Capital Resources

We make significant capital expenditures in order to service the demand of our customers, which are primarily focused on investments in advanced packaging and test equipment. In 2021, our capital expenditures totaled $779.8 million or approximately 12.7% of net sales.

We expect that our 2022 capital expenditures will be approximately $950 million, approximately $100 million of which we expect to spend on the construction of our new Vietnam factory. Ultimately, the amount of our 2022 capital expenditures will depend on several factors including, among others, the timing and implementation of any capital projects under review, the performance of our business, economic and market conditions, the cash needs and investment opportunities for the business, the need for additional capacity to service anticipated customer demand, equipment lead times and the availability of cash flows from operations or financing.

In addition, we are subject to risks associated with our capital expenditures, including those discussed in Part I, Item 1A of this Form 10-K under the caption “We make substantial investments in equipment and facilities to support the demand of our customers, which may materially and adversely affect our business if the demand of our customers does not develop as we expect or is adversely affected.”

Cash Flows

Net cash provided by (used in) operating, investing and financing activities for each of the three years ended December 31, 2021 was as follows:

Operating activities:  Our cash flow provided by operating activities for the year ended December 31, 2021 increased by $351.3 million compared to the year ended December 31, 2020, primarily due to higher net sales, higher operating profit and an increase in contract liabilities due to customer advance payments. This increase was offset by changes in working capital.

Investing activities:  Our cash flow used in investing activities for the year ended December 31, 2021 increased by $305.2 million compared to the year ended December 31, 2020, primarily due to increased payments related to property, plant and equipment and increased net payments for foreign currency forward contracts. Payments for property, plant and equipment can fluctuate based on the timing of purchase, receipt and acceptance of equipment.

Financing activities:  The net cash used in financing activities for the year ended December 31, 2021 was primarily due to dividend payments, partially offset by net debt borrowing in Korea. The net cash used in financing activities for the year ended December 31, 2020 was primarily due to the net debt repayments in Korea and Taiwan.

We provide the following supplemental data to assist our investors and analysts in understanding our liquidity and capital resources. We define free cash flow as net cash provided by operating activities less payments for property, plant and equipment, plus proceeds from the sale of and insurance recovery for property, plant and equipment, if applicable. Free cash flow is not defined by U.S. GAAP. We believe free cash flow to be relevant and useful information to our investors

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because it provides them with additional information in assessing our liquidity, capital resources and financial operating results. Our management uses free cash flow in evaluating our liquidity, our ability to service debt, our ability to fund capital expenditures and our ability to pay dividends and the amount of dividends to be paid. However, free cash flow has certain limitations, including that it does not represent the residual cash flow available for discretionary expenditures since other, non-discretionary expenditures, such as mandatory debt service, are not deducted from the measure. The amount of mandatory versus discretionary expenditures can vary significantly between periods. This measure should be considered in addition to, and not as a substitute for, or superior to, other measures of liquidity or financial performance prepared in accordance with U.S. GAAP, such as net cash provided by operating activities. Furthermore, our definition of free cash flow may not be comparable to similarly titled measures reported by other companies.

Contingencies, Indemnifications and Guarantees

Please refer to Note 17 to our Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for a discussion of contingencies related to litigation and other legal matters.

Critical Accounting Policies and Use of Estimates

We have identified the policies below as critical to our business operations and the understanding of our results of operations. A summary of our significant accounting policies used in the preparation of our Consolidated Financial Statements appears in Note 1 to our Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K. Our preparation of this Form 10-K requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates, including the impact of Covid-19 and any deterioration in the global business and economic environment.

We believe the following critical accounting estimates and policies, which have been reviewed with the Audit Committee of our Board of Directors, affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.

Revenue Recognition.  We recognize revenue, net of sales, use, value-added and other similar taxes, as a performance obligation is satisfied in an amount reflecting the consideration to which we expect to be entitled. We apply a five-step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations in the contract; and (5) recognizing revenue when the performance obligation is satisfied. Substantially all of our revenue is recognized as services are rendered.

Our packaging and test services are our performance obligations to our customers. Our packaging services include wafer bump, probe and assembly. We provide packaging and test services to our customers either individually or as part of a combined offering. In a combined offering, we account for the individual services separately if they are determined to be distinct. We determine a service to be distinct if it is separately identifiable from other services in the combined offering and if a customer can benefit from the unique service on its own or with other resources that are readily available to the customer.

The consideration, including variable consideration, is allocated between the distinct services in a combined offering based upon the stand-alone selling prices of the individual services. Our services involve a high degree of specialization

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which are unique based on the design and purpose of the customer’s wafers. Accordingly, our negotiated pricing reflects the customized nature of our services and represents a customer-specific stand-alone selling price. We recognize revenue as services are rendered, which generally occurs over the course of two to three weeks. Services are generally billed at completion of each individual packaging or test service or in some instances at the completion of all services in a combined offering.

We recognize revenue over time as services are rendered because our services create or enhance the customer’s wafer. We utilize an input method (cost incurred plus estimated margin) to determine the amount of revenue to recognize for in-process, but incomplete, customer orders at a reporting date. During the period of providing our services, we generally do not control or take ownership of customers’ wafers, nor do we include the cost of the wafer in our cost calculations. We believe that a cost-based input method is the most appropriate manner to measure how we satisfy our performance obligations to customers because the effort and costs incurred to package and/or test customer wafers are not linear over the duration of these services.

Shipping and handling costs are accounted for as a cost to fulfill our performance obligations to customers. Accordingly, we record customer payments of shipping and handling costs as a component of net sales, and the costs incurred for shipping and handling are then charged to cost of sales.

Income Taxes.  We operate in and file income tax returns in various U.S. and non-U.S. jurisdictions which are subject to examination by tax authorities. The tax returns for years where the statute of limitations remains open in all jurisdictions in which we do business are subject to change upon examination. We believe that we have estimated and provided adequate accruals for potential additional taxes and related interest expense that may ultimately result from such examinations. We believe that any additional taxes or related interest over the amounts accrued will not have a material effect on our financial condition, results of operations or cash flows. However, resolution of these matters involves uncertainties, and there can be no assurance that the outcomes will be favorable. In addition, changes in the mix of income from our foreign subsidiaries, expiration of tax holidays or changes in tax laws or regulations could result in increased tax expense and effective tax rates in the future.

Additionally, we monitor on an ongoing basis our ability to utilize our deferred tax assets and whether there is a need for a related valuation allowance. In evaluating our ability to recover our deferred tax assets in the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and results of recent operations. With the exception of a certain foreign jurisdiction and select U.S. and foreign carryforwards, we consider it more likely than not that we will have sufficient taxable income to allow us to realize these deferred tax assets. However, in the event taxable income falls short of current expectations, we may need to establish a valuation allowance against such deferred tax assets. We have valuation allowances on certain U.S. federal net operating losses and U.S. foreign tax credit carryforwards expected to expire unused and on select deferred tax assets in certain foreign jurisdictions. Such valuation allowances are released as the related tax benefits are realized or when sufficient evidence exists to conclude that it is more likely than not that the deferred tax assets will be realized.

Valuation of Inventory.  We order raw materials based on customers’ forecasted demand. If our customers change their forecasted requirements and we are unable to cancel our raw materials order, or if our vendors require that we order a minimum quantity that exceeds the current forecasted demand, we will experience a build-up in raw material inventory. We will either seek to recover the cost of the materials from our customers or utilize the inventory in production. However, we may not be successful in recovering the cost from our customers or be able to use the inventory in production and, accordingly, if we believe that it is probable that we will not be able to recover such costs, we reduce the carrying value of our inventory. Additionally, we reduce the carrying value of our inventories by the cost of inventory we estimate is excess and obsolete based on the age of our inventories. When a determination is made that the inventory will not be utilized in production or is not saleable, it is written off. The forecast of demand and the evaluation of inventory recoverability require estimates and judgment. Although we make an effort to ensure forecasted demand and estimates of inventory are accurate, any unanticipated changes could have a material effect on our financial condition and result of operations.

Inventories consist of raw materials and purchased components and are stated at the lower of cost and net realizable value. Cost is principally determined by standard cost or the weighted moving average method, both of which

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approximate actual cost. For inventory valued using the standard cost method, we review and set our standard costs as needed, but at a minimum on an annual basis.

Valuation of Long-lived Assets. We review long-lived assets, which include property, plant and equipment and goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

•significant under-performance relative to expected historical or projected future operating results;

•significant changes in the manner of our use of the asset;

•significant negative industry or economic trends; and

•our market capitalization relative to net book value.

Recoverability of a long-lived asset group to be held and used in operations is measured by a comparison of the carrying amount to the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. If such asset group is considered to be impaired, the impairment loss is measured as the amount by which the carrying amount of the asset group exceeds its fair value. Long-lived assets to be disposed of are carried at the lower of cost or fair value less the costs of disposal.

We review goodwill for impairment annually during the fourth quarter of each year and whenever events or changes in circumstances indicate that an impairment may exist. Impairment losses are recorded when the carrying amount of the reporting unit exceeds its fair value.