SITIME Corp (SITM) FY 2022 MD&A

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

The Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. The MD&A contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act that involve risks and uncertainties, which are discussed under Item 1A.

Overview

We are a leading provider of precision timing solutions to the global electronics industry. Our precision timing solutions are the heartbeat of our customers’ electronic systems, providing the timing functionality that is needed for electronics to operate reliably and correctly. We provide solutions that are differentiated by high performance, high resilience, and high reliability, along with programmability, small size, and low power consumption. Our products have been designed into over 300 applications across our target markets, including communications and enterprise, automotive, industrial, aerospace, mobile, IoT and consumer.

In 2022, we advanced our technology, expanded our product portfolio, increased our worldwide workforce, and generated a significant increase in revenue and profit. We saw continued strong revenue growth, increased gross margins and positive operating cash flow, but decreased operating margins. Our revenue has historically been subject to some seasonal variation. Based on the production schedules of key customers, our products typically see stronger revenue in the second half of our fiscal year. However, this was not the case in 2022 and there can be no assurance that this trend will occur in future years. Revenue grew 30% from $218.8 million in 2021 to $283.6 million in 2022. Gross margins increased from 64% in 2021 to 65% in 2022, while operating margins decreased from a 15% income in 2021 to a 6% income in 2022.

Commercial shipments of SiTime's first oscillator products began in 2006. Historically, our revenue has been substantially delivered from sales of oscillator systems across our target end markets. In addition to oscillator systems, we have expanded our products to include clock IC and timing sync solutions. We seek to expand our presence in our end markets across all product categories.

We sell our products primarily through distributors, who in turn sell to our end customers. We also sell products directly to some of our end customers. Based on sell-through information provided by our distributors, we believe the majority of our end customers are based in the U.S. We leverage our global network of distributors to address the broad set of end markets we serve. For our largest accounts, dedicated sales personnel work with the end customer to ensure that our solutions fully address the end customer’s timing needs. Our smaller customers can select the optimum timing solution for their needs by working directly with our distributors or by shopping on our online store, SiTimeDirect™.

We operate a fabless business model, allowing us to focus on the design, sales, and marketing of our products, quickly scale production, and significantly reduce our capital expenditures. This model also allows us to operate with lower capital expenditure investment than other semiconductor companies who own fabs. A fabless infrastructure gives us production flexibility and the ability to scale capacity up and down quickly to meet demand. Our programmable architecture also plays a key role in ensuring optimal production flexibility, as it allows us to offer shorter lead times and the ability to meet custom requirements more easily.

We were acquired by MegaChips in 2014 and were a wholly-owned subsidiary of MegaChips, a fabless semiconductor company based in Japan and traded on the Tokyo Stock Exchange, until November 25, 2019. On November 25, 2019, we completed the initial public offering of shares of our common stock. In June 2020, we completed a follow-on public offering, in which we issued and sold 1,525,000 shares of our common stock and MegaChips sold 2,500,000 shares of our common stock held by it. In February 2021, we completed an additional follow-on public offering, in which we issued and sold 1,500,000 shares of our common stock and MegaChips sold 1,500,000 shares of our common stock held by it. In November 2021 we completed a follow-on public offering, in which we issued and sold 1,300,000 shares of our common stock and MegaChips sold 1,000,000 shares of our common stock held by it. In May 2022, the Company entered into a Sales Agreement ("Sales Agreement") with Stifel, Nicolaus & Company, Incorporated ("Stifel"), under which we may offer and sell from time to time at our sole discretion, up to an aggregate of 800,000 shares of our common stock, par value $0.0001 per share, through Stifel as our sales agent. During the year ended December 31, 2022, we sold 225,334 shares of our common stock under the Sales Agreement. MegaChips continues to be our largest stockholder and held approximately 23.0% of our common stock as of December 31, 2022.

There have been a number of industry-wide supply constraints affecting the supply of analog circuits manufactured by certain foundries, including Taiwan Semiconductor Manufacturing Company, and affecting outsourced semiconductor assembly and test providers. We believe that the effects of the industry-wide supply constraints on other timing device suppliers contributed in part to our revenue and gross margin growth in 2021 and the first half of 2022, however, we do not expect be able to sustain these revenue and gross margin increases in 2023. In addition, macroeconomic events such as rising inflation, fear of recession, equity market volatility, geopolitical tensions, war, decreased consumer spending, lower demand for electronic products following a period of strong demand during the COVID-19 pandemic, supply chain disruptions, and the COVID-19 pandemic measures implemented in China,

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harmed sales of our products and results of operations in 2022 and we expect will continue to do so in 2023. We believe that some of our customers built up inventory in our products in 2022 to overcome the industry-wide supply constraints that occurred in the previous periods and that the macroeconomic events in 2022 have led to reduced demand for our customers' products, which led to an inventory buildup at some of our customers and their affiliates, partners and contract manufacturers, which has adversely affected sales of our products. We believe that this inventory buildup will negatively impact the sales of our products until such inventory buildup is reduced. The inventory buildup at some of our customers and their affiliates, partners, and contract manufacturers could result in significant decreases in our sales, margins, and could materially harm our results of operations. The future effects of macroeconomic events on our business and results of operations, including inventory levels at our customer and their affiliates, partners, and contract manufacturers as well as demand for our products, are uncertain and difficult to predict. For additional discussion please see Part I, Item 1A Risk Factors of this report, especially the risk factor titled “Global macroeconomic conditions have harmed and may continue to harm our business” and “Our revenue and operating results may fluctuate from period to period, which could cause our stock price to fluctuate.”

Impact of COVID-19 on our Business

The COVID-19 pandemic continued to impact our workforce and the operations of our customers and suppliers during 2022. In response to the COVID-19 pandemic and related government measures, we implemented safety measures to protect our employees and contractors at our locations around the world.

The effects of the ongoing COVID-19 pandemic on our business are evolving and difficult to predict. The ultimate impact of the COVID-19 pandemic on our business, results of operations, and financial condition continues to depend on future developments which are not within our control and cannot be accurately predicted and are uncertain, including the duration, scope and severity of the pandemic, any additional resurgences, variants and the severity of variants, and the ability to effectively and widely manufacture and distribute vaccines.

Key Factors Affecting Our Performance

Customer Orders and Forecasts

Because our sales are made pursuant to standard purchase orders, orders may be cancelled, reduced, or rescheduled with little or no notice and without penalty. Cancellations of orders could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses. In addition, changes in forecasts or the timing of orders from customers exposes us to the risks of inventory shortages or excess inventory. We may not be able to fulfill increased demand, at least in the short term, as we do not intend to acquire excess inventory to pre-build custom products.

Design Wins with New and Existing Customers

Our solutions enable our customers to differentiate their product offerings and position themselves to gain market share. We work closely with our customers to understand their product roadmaps and strategies. Our end customers continuously develop new products in existing and new application areas. We also consider design wins critical to our future success and anticipate being increasingly dependent on revenue from new design wins for our new higher-end products with higher average selling prices (“ASPs”). The selection process is typically lengthy and may require us to incur significant design and development expenditures in pursuit of a design win with no assurance that our solutions will be selected. As a result, the loss of any key design win or any significant delay in the ramp of volume production of the customer’s products into which our product is designed could adversely affect our business.

Customer Demand and Product Life Cycles

Once customers design our precision timing solutions into their products, we closely monitor all aspects of their demand cycle, including the initial design phase, prototype production, volume production, and inventories, as well as end-market demand, including seasonality, cyclicality, and the competitive landscape. Given our customer relationships and the long-term aspects of our solutions, we benefit from visibility into customer demand. This in turn provides an opportunity for us to monitor and refine our business fundamentals.

Product Adoption within New Markets and Applications

As we evaluate new market opportunities and bring new products to market, we pay particular attention to forecasts by industry analysts and the adoption curve of technology. We also analyze in detail potential competing forces that could hinder such adoption. If

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we fail to anticipate or respond to technological shifts or market demands, or to timely develop new or enhanced products or technologies in response to the same, it could result in decreased revenue and the loss of our design wins to our competitors.

Pricing, Product Cost, and Product Mix

The ASPs of our products vary significantly. While the ASP of any individual product generally decreases over time, our average ASPs have historically remained relatively flat as we continue to introduce new higher-end products with higher ASPs. Our pricing and margins depend on customer demand as well as the volumes and the features of the timing devices we provide to our customers. We continually monitor and work to reduce the cost of our products and improve the potential value our solutions provide to our customers as we target new design win opportunities and manage the product life cycles of our existing customer designs. Since we rely on third-party wafer foundries and assembly and test contractors to manufacture, assemble, and test our products, we maintain a close relationship with our suppliers to improve quality and increase yields.

Gross margin, or gross profit as a percentage of revenue, has been, and will continue to be, affected by a variety of factors, including ASPs, and product mix in a given period, material costs, yields, inventory write-downs and manufacturing operations costs. We believe the primary driver of gross margin is the ASPs negotiated between us and our customers relative to material costs and yield improvement. As our products mature and unit volumes increase, we expect their ASPs to decline. These declines often coincide with improvements in manufacturing yields and lower wafer, assembly, and testing costs, which offset some or all of the margin reduction that results from lower ASPs. However, we expect our gross margin to fluctuate on a quarterly basis as a result of changes in ASPs due to new product introductions, existing product transitions into high-volume manufacturing, manufacturing costs, and our product mix.

Cyclical Nature of the Semiconductor Industry

The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. The industry experienced a significant downturn during past adverse macroeconomic events such as global recessions, and we are currently experiencing a decrease in demand for our products. Downturns in the semiconductor industry have been characterized by diminished product demand, production overcapacity, high inventory levels, and accelerated erosion of average selling prices. Any prolonged or significant downturn in the semiconductor industry generally could adversely affect our business and reduce demand for our products and otherwise harm our business, financial condition and results of operations. In the last few years, the semiconductor industry experienced an upturn. However, this was not the case in second half of 2022 and as a result sales of our products declined in the second half of 2022. Any significant upturn in the semiconductor industry could result in increased competition for access to third-party foundry and assembly capacity. We are dependent on the availability of this capacity to manufacture and assemble our products and we can provide no assurance that adequate capacity will be available to us in the future. We cannot predict the duration or timing of any downturn or upturn in the semiconductor industry.

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Results of Operations

The following table summarizes our results of operations for the periods presented.

A discussion of changes in our results of operations from fiscal 2020 to fiscal 2021 has been omitted from this Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for fiscal 2021 filed with the Securities and Exchange Commission on February 25, 2022.

Revenue

We derive revenue primarily from sales of precision timing solutions to distributors who in turn sell to our end customers. We also sell products directly to some of our end customers. Our sales are made pursuant to standard purchase orders which may be cancelled, reduced, or rescheduled, with little or no notice. We recognize product revenue upon shipment when we satisfy our performance obligations as evidenced by the transfer of control of our products to customers. We measure revenue based on the amount of consideration we expect to be entitled to in exchange for products.

Revenue increased by $64.8 million, or 30%, for 2022 compared to 2021. The increase was primarily related to an increase in ASPs of our products, a 2% increase in volume of shipments year over year and $2.7 million in revenue recorded from the waiver of accrued customer rebate. The ASP increase was related to change in mix of the higher ASP products we shipped. The increase in sales volume was driven by higher demand for our products from new and existing customers. We do not expect to be able to sustain our revenue growth or ASP increases in 2023 as we face lower demand due to macroeconomic conditions and more pricing pressure.

Our top ten direct customers, including distributors, accounted for approximately 74%, 76% and 80% of net revenues in 2022, 2021, and 2020, respectively. In 2022, 2021, and 2020, three customers, which are distributors of our products, each accounted for more than 10% of our net revenues. International sales represented approximately 88%, 94%, and 93% of net revenues in 2022, 2021, and 2020, respectively.

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Cost of Revenue, Gross Profit, and Gross Margin

Cost of revenue consists of wafers acquired from third-party foundries, assembly, packaging, and test cost of our products paid to third-party contract manufacturers, and personnel and other costs associated with our manufacturing operations. Cost of revenue also includes depreciation of production equipment, inventory write-downs, amortization of internally developed software, shipping and handling costs, and allocation of overhead and facility costs. We also include credits for rebates received from foundries to cost of revenue.

Gross profit increased by $43.5 million in the year ended December 31, 2022 compared to the same period in 2021. Gross profit increased $49.9 million mainly from an increase in ASPs of our products and $2.7 million from the reversal of a customer rebate. This increase was offset by higher other manufacturing and overhead costs of $6.1 million.

Gross margin was higher by 1% in the year ended December 31, 2022 compared to the same period in 2021. The gross margin increased by 2% from higher sales volume and an increase in ASPs and was offset by 1% increase in our other manufacturing costs.

We expect to continue to see increases in our manufacturing costs in fiscal year 2023 due to an industry wide increase in costs. We believe that the effects of the industry-wide supply constraints on other timing device suppliers contributed in part to our gross margin growth in 2021 and the first half of 2022, however we do not expect to be able to sustain these gross margin increases in 2023. Gross margin may fluctuate from time to time due to a variety of factors. For additional discussion please see Part I, Item 1A Risk Factors of this report, especially the risk factor titled “Our gross margins may fluctuate due to a variety of factors, which could negatively impact our results of operations and our financial condition.”

Operating Expenses

Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of our operating expenses and consist of salaries, benefits, bonuses, stock-based compensation, and commissions. Our operating expenses also include consulting costs, allocated costs of facilities, information technology, and depreciation.

Research and Development

Our research and development efforts are focused on the design and development of precision timing solutions. Our research and development expense consists primarily of personnel costs, which include stock-based compensation, pre-production engineering mask costs, software license and intellectual property expenses, design tools and prototype-related expenses, facility costs, supplies, professional and consulting fees, and allocated overhead costs, which may be offset by non-recurring engineering contra-expenses recorded in certain periods. There is no assurance that we will have non-recurring engineering contra-expense from period to period. We expense research and development costs as incurred. We believe that continued investment in our products and services is important for our future growth and acquisition of new customers and, as a result, we expect our research and development expenses to continue to increase in absolute dollars. However, we expect our research and development expense to fluctuate as a percentage of revenue from period to period depending on the timing of these expenses.

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Research and development expense increased by $38.2 million, or 73%, for the year ended December 31, 2022 compared to the same period in 2021, primarily due to ongoing new product related expenses of $14.2 million, an increase in stock-based compensation expense of $13.5 million, higher personnel costs of $13.0 million due to increased headcount, and an increase in depreciation and amortization of lab equipment and licenses of $2.6 million, offset by an increase of non-recurring engineering contra-expense recognized of $6.6 million.

There is no guarantee we will enter into a non-recurring engineering arrangement or recognize such contra-expense in any future period. Based on our current contracts, we expect the non-recurring engineering contra-expense to decline in future periods.

Sales, General and Administrative

Sales, general and administrative expense consists of personnel costs, including stock-based compensation, professional and consulting fees, accounting and audit fees, legal costs, field application engineering support, travel costs, advertising expenses, and allocated overhead costs. We expect sales, general and administrative expense to continue to increase in absolute dollars as we increase our personnel and grow our operations, although it may fluctuate as a percentage of revenue from period to period depending on the timing of these expenses.

Selling, general and administrative expense increased by $22.0 million, or 40%, for the year ended December 31, 2022 compared to the same period in 2021, primarily due to higher stock-based compensation expense of $13.4 million, higher consulting fees of $5.1 million, higher personnel costs of $1.9 million related to increased headcount, and higher advertising spend of $0.8 million.

Interest Income and Other Expense

Interest income and other expense consists primarily of interest expense on our outstanding debt, interest income on our cash balances, and foreign exchange gains and losses. See Note 7 to our consolidated financial statements under Item 8 for more information about our debt.

Interest income and other expense increased $7.7 million for the year ended December 31, 2022 compared to the same period in 2021, primarily related to higher interest income earned on short term investments and net unrealized gain on foreign exchange rates due to increased activities in our foreign subsidiaries and favorable exchange rate fluctuations.

Income Tax Expense

Income tax expense consists primarily of state income taxes and income taxes in certain foreign jurisdictions in which we conduct business. We have a full valuation allowance for deferred tax assets as the realization of the full amount of our deferred tax asset is uncertain, including net operation losses (NOL), carryforwards, and tax credits related primarily to research and development. We expect to maintain this full valuation allowance until realization of the deferred tax assets becomes more likely than not. At December 31, 2022 and 2021, we had federal NOL carry-forwards of approximately $213.3 million and $259.6 million, respectively, state NOL carry-forwards of approximately $65.3 million and $64.5 million, respectively, and foreign NOL carry-forwards of approximately $1.7 million and $2.3 million, respectively. These federal, state, and foreign net operating loss carry-forwards will expire beginning in 2025, 2028, and 2028, respectively. At December 31, 2022 and 2021, we had research and development tax credit carryforwards of approximately $3.9 million and $3.9 million, respectively for U.S. federal income tax purposes and $3.6 million and

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$3.6 million, respectively for state income tax purposes. The research and development credit carryforwards for federal tax purposes will begin to expire in 2025, and state tax credits carry forward indefinitely.

Liquidity and Capital Resources

As of December 31, 2022 and 2021, we had cash and cash equivalents of $34.6 million and $559.5 million, respectively. As of December 31, 2022 we also held $529.5 million of short-term investments in held-to-maturity securities which consisted of treasury bills. Our principal use of cash is to fund our operations and to support growth.

In February 2021, we completed a follow-on public offering, in which we issued and sold 1,500,000 shares of our common stock, resulting in net proceeds to us of $181.6 million after deducting underwriting discounts and commissions and deferred offering costs.

In November 2021, we completed a follow-on public offering, in which we issued and sold 1,300,000 shares of our common stock, resulting in net proceeds to us of $279.0 million after deducting underwriting discounts and commissions and deferred offering costs.

In May 2022, we entered into a Sales Agreement with Stifel, under which we may offer and sell from time to time at our sole discretion, up to an aggregate of 800,000 shares of our common stock, par value $0.0001 per share, through Stifel as our sales agent. The Company intends to use the net proceeds from the shares of common stock offered and sold to primarily replenish funds expended to satisfy anticipated tax withholding and remittance obligations related to the net settlement upon vesting of restricted stock unit awards (“RSU”) granted to employees under the equity incentive plans. During the year ended December 31, 2022, we sold 225,334 shares of our common stock under the Sales Agreement at a weighted average price of $150.78 per share resulting in net proceeds to us of $33.0 million, after deducting underwriting discounts and commissions and deferred offering costs.

Our purchase obligations primarily include design and simulation licenses. For information about our contractual obligations refer to "Note 5 - Lease" and “Note 9 – Commitments and Contingencies” of the Notes to Consolidated Financial Statements.

We expect to continue our investing activities, primarily in the purchase of property and equipment and capitalized software, to support research and development, sales and marketing, product support, and administrative staff.

We believe that our existing cash and cash equivalents and our short-term investments will be sufficient to meet our cash needs for at least the next 12 months. Over the longer term, our future capital requirements will depend on many factors, including our growth rate, the timing and extent of our sales and marketing and research and development expenditures, and the continuing market acceptance of our solutions. In the event that we need to borrow funds or issue additional equity, we cannot provide any assurance that any such additional financing will be available on terms acceptable to us, if at all. If we are unable to raise additional capital when we need it, it would harm our business, results of operations and financial condition.

The following table summarizes our cash flows for the periods indicated:

Operating Activities

In 2022, net cash provided by operating activities of $39.8 million was primarily due to net income of $23.3 million and non-cash expenses of $67.5 million, partially offset by a change in operating assets and liabilities of $51.0 million. Non-cash expenses were mainly related to depreciation and amortization, stock-based compensation expense and unrealized interest on held to maturity investments. The changes in operating assets and liabilities resulted in cash provided primarily due to higher accounts receivable due

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to timing of shipments, an increase in inventories as we managed our inventory levels, higher prepaid expenses and other assets related to advance payments to suppliers for inventory and royalties, higher accrued expenses and other liabilities due to timing of payments, offset by an increase in accounts payable.

In 2021, net cash provided by operating activities of $59.1 million was primarily due to net income of $32.3 million and non-cash expenses of $39.9 million, partially offset by a change in operating assets and liabilities of $13.1 million, non-cash expenses were mainly related to depreciation and amortization and stock-based compensation expense. The changes in operating assets and liabilities resulted in cash provided primarily due to higher accounts receivables due to timing of shipments and an increase in inventories as we managed our inventory levels, partially offset by lower prepaid expenses and other current assets related to advance payments to suppliers for inventory and higher accounts payable and accrued expenses and other liabilities due to timing of payments.

Investing Activities

Our investing activities consist primarily of purchase of short-term investments, capital expenditures for property and equipment purchases. Our capital expenditures for property and equipment have primarily been for general business purposes, including machinery and equipment, leasehold improvements, acquired software, internally developed software used in production and support of our products, computer equipment used internally, and production masks to manufacture our products.

In 2022, cash used in investing activities was $560.1 million. We paid $673.4 million to purchase short-term investments in held-to-maturity securities. We paid $31.8 million largely to purchase test and other manufacturing equipment to support the increase in demand of our products and other property and equipment for general business purposes. We paid $3.9 million to purchase intangible assets in software licenses. All such payments were offset by $149.0 million proceeds from the maturity of held to maturity investments.

In 2021, cash used in investing activities was $33.8 million. We paid $30.9 million largely to purchase test and other manufacturing equipment to support the increase in demand of our products and other property and equipment for general business purposes. We paid $2.9 million to purchase intangible assets.

Financing Activities

Our financing activities have primarily consisted of proceeds from issuance of shares and withholding of taxes on restricted stock units.

During the year ended December 31, 2022, we sold 225,334 shares of our common stock under the Sales Agreement resulting in net proceeds to us of $33.0 million, after deducting underwriting discounts and commissions of $0.7 million and deferred offering costs of $0.2 million. The net proceeds from the Sales Agreement were offset by tax withholdings paid on behalf of employees for net share settlement of $37.6 million.

During the year ended December 31, 2021 we completed follow-on public offerings, in which we issued and sold 2,800,000 shares of common stock resulting in net proceeds of $460.6 million, consisting of proceeds from issuance of shares of $461.3 million net of underwriting commissions and discounts of $21.7 million and deferred offering costs of $0.6 million.

Critical Accounting Estimates

Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.

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Revenue Recognition

We derive our revenue from product sales to distributors, who in turn sell to original equipment manufacturers or other end customers. We recognize product revenue, at a point in time, upon shipment when we satisfy our performance obligations as evidenced by the transfer of control of our products to customers. We measure revenue based on the amount of consideration we expect to be entitled to in exchange for products. Variable consideration is estimated and reflected as an adjustment to the transaction price. Depending on the terms of the contract, variable consideration is estimated using either the expected value approach or the most likely value approach. We determine variable consideration at the end of each reporting period, which consists primarily of price adjustments and product returns by estimating the amount of consideration we expect to receive from our customers based on historical experience. Our distributors have limited return rights under our contracts with them. If variable considerations are anticipated to exceed historical experience, we may adjust our sales returns allowance accordingly to properly reflect our net revenue. Since our performance obligations relate to contracts with a duration of less than one year, we do not disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period.

Inventories

Inventories consist of raw materials, work-in-process, and finished goods and are stated at the lower of standard cost, determined using first-in first out method or market net realizable value. We review and set standard costs to approximate actual manufacturing costs. We perform detailed reviews of the net realizable value of inventories, both on hand as well as for inventories that we are committed to purchase at the end of each reporting period. We write-down the inventory value for estimated deterioration, excess, obsolete and other factors based on management’s assessment of future demand and market conditions of our inventory. These estimates may include uncertain elements such as our demand forecast. These forecasts are developed based on current backlogs, inputs from our customers, and internal analyses which may consist of customer historical purchasing trends and level of inventory in the distributor channel, actual and anticipated design wins, market and economic conditions, technology changes, new product introductions, changes in strategic direction and other factors. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to write down additional inventory, which would have a negative impact on our gross margin. Once written-down, inventory write-downs are not reversed until the inventory is sold or scrapped. In the second half of 2022, we acquired inventory in excess of consumption mainly to increase our buffer inventory levels.

Stock-Based Compensation

Stock-based compensation expense is measured at the grant date based on the fair value of the equity award and is recognized as expense over the requisite service period, which is generally the vesting period. We have elected to recognize forfeitures as they occur.

The fair value of each restricted stock unit is estimated based on the market price of our common shares on the date of grant.

We amortize stock-based compensation expense for time-based awards under the straight-line attribution method over the vesting period. Stock-based compensation expense for performance-based awards is recognized when it becomes probable that the performance conditions will be met. We amortize stock-based compensation expense for performance-based awards using the accelerated method. The Company recognizes the expense related to the multi-year performance based restricted stock unit awards on a graded-vesting method over the requisite service period.

Income Taxes

Deferred tax liabilities and assets are recognized for the expected future tax consequences of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities and net operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to a level which, more likely than not, will be realized.

A tax position can be recognized only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date and then only in an amount more likely than not to be sustained upon review by the tax authorities. We consider many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.

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Recent Accounting Pronouncements

See Note 2 to our consolidated financial statements under Item 8 for information regarding recently issued accounting pronouncements.