S-1/A 1 d502332ds1a.htm S-1/A S-1/A
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As filed with the Securities and Exchange Commission on September 11, 2013

Registration No. 333-190761

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

Amendment No. 1

to

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

MONTAGE TECHNOLOGY GROUP LIMITED

(Exact name of registrant as specified in its charter)

 

 

 

Cayman Islands   3674   Not applicable

(State or other jurisdiction of

Incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

Room A1601, Technology Building, 900 Yi Shan Road

Xuhui District, Shanghai, 200233

People’s Republic of China

Tel: (86 21) 6128-5678

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Mark Voll

Chief Financial Officer

2025 Gateway Place, Suite 262

San Jose CA 95110

Tel: 408-982-2788

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies of Communications to:

Portia Ku

Eric C. Sibbitt

O’Melveny & Myers LLP

2765 Sand Hill Road

Menlo Park, CA 94025

Tel: (650) 473-2600

 

James J. Masetti

Heidi E. Mayon

Pillsbury Winthrop Shaw Pittman LLP

2550 Hanover Street

Palo Alto, California 94304

Tel: (650) 233-4500

 

 

Approximate date of commencement of proposed sale to public: As soon as practicable after the effective date of this Registration Statement.

If any securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of
securities to be registered
 

Amount to be

registered (1)

 

Proposed

maximum

offering price

per share

 

Proposed

maximum

aggregate

offering price (2)

  Amount of
registration fee

Ordinary shares, par value $0.0125 per share

  8,165,000   $14.00   $114,310,000        $15,592(3)

 

 

(1) Includes 1,065,000 ordinary shares that the underwriters have the option to purchase to cover over-allotments.
(2) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933, as amended.
(3) All amounts have been paid previously.

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. Neither we nor the selling shareholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and neither we nor the selling shareholders are soliciting offers to buy these securities, in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, dated September 11, 2013

7,100,000 shares

 

LOGO

Montage Technology Group Limited

Ordinary shares

 

 

This is an initial public offering of ordinary shares of Montage Technology Group Limited. We are offering 5,325,000 ordinary shares. The selling shareholders are offering 1,775,000 ordinary shares and we will not receive any of the proceeds in connection with the shares to be sold by the selling shareholders from this offering. We will bear all of the offering expenses other than the underwriting discount.

Prior to this offering, there has been no public market for our ordinary shares. We have applied to list our ordinary shares on the NASDAQ Global Market under the symbol “MONT.”

It is currently estimated that the initial public offering price per share will be between $12.00 and $14.00.

 

 

Investing in our ordinary shares involves a high degree of risk. See “Risk factors” beginning on page 11.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                $            

Underwriting discounts and commissions

   $         $    

Proceeds, before expenses, to us

   $         $     

Proceeds, before expenses, to the selling shareholders

   $         $     

The selling shareholders have granted the underwriters an option for a period of 30 days to purchase up to 1,065,000 additional ordinary shares.

Four of our executive officers, including Howard C. Yang, Stephen Tai, Mark Voll and Zhongyuan Chang, and an affiliate of an existing shareholder, UMC Capital Corporation, have indicated an interest in purchasing up to an aggregate of 950,000 ordinary shares of our company in this offering based on the midpoint of the price range set forth on the cover page of this prospectus. Because these indications of interest are not binding agreements or commitments to purchase, these persons and entities may elect not to purchase shares in this offering or the underwriters may elect not to sell any shares in this offering to such persons. The underwriters will receive the same discount and commissions from any ordinary shares purchased by such persons and entities as they will from any other ordinary shares sold to the public in this offering.

At our request, the underwriters have reserved for sale, at the public offering price, up to five percent of the shares offered by us to certain of our directors, officers, employees, business associates and related persons through a directed share program. In addition, we have requested that the underwriters offer $5.0 million of the ordinary shares offered hereby for sale at the initial public offering price to China Electronics Corporation Hua Hong International Ltd., an existing shareholder of our company that has indicated an interest in purchasing and holding such shares on behalf of China Electronics Corporation. We do not know if these persons will choose to purchase all or any portion of these reserved shares, but any purchases they make will reduce the number of shares available to the general public.

 

 

The underwriters expect to deliver the shares to purchasers on             , 2013.

 

Deutsche Bank Securities                                Barclays

Stifel

 

 

Wells Fargo Securities   Needham & Company

Prospectus dated             , 2013.


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LOGO


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TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     11   

Special Note Regarding Forward-Looking Statements

     36   

Market and Industry Data

     37   

Use of Proceeds

     38   

Dividend Policy

     39   

Capitalization

     40   

Dilution

     41   

Selected Consolidated Financial Data

     43   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     45   

Business

     74   

Management

     91   

Executive Compensation

     99   

Related Party Transactions

     104   

Principal and Selling Shareholders

     105   

Description of Share Capital

     110   

Shares Eligible for Future Sale

     118   

Taxation

     120   

Underwriters

     126   

Enforceability of Civil Liabilities

     132   

Legal Matters

     134   

Experts

     134   

Where You Can Find More Information

     134   

Index to Consolidated Financial Statements

     F-1   

 

 

Through and including             , 2013 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

Neither we, nor the selling shareholders nor the underwriters have authorized anyone to provide any information or to make any representations other than those contained or incorporated by reference in this prospectus or in any free writing prospectuses we have prepared. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained or incorporated by reference in this prospectus is current only as of its date.

For investors outside the United States: Neither we, nor the selling shareholders, nor the underwriters have done anything that would permit our initial public offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of our ordinary shares and the distribution of this prospectus outside of the United States.


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Conventions That Apply to This Prospectus

In this prospectus,

 

   

“CPU” refers to central processing unit;

 

   

“DDR” refers to DDR DRAM, or double data rate dynamic random-access memory, a class of memory integrated circuits used in servers;

 

   

“DDR2” refers to the second generation of DDR;

 

   

“DDR3” refers to the third generation of DDR;

 

   

“DDR4” refers to the fourth generation of DDR;

 

   

“DIMM” refers to dual in-line memory module;

 

   

“HDTV” refers to high-definition television;

 

   

“HKD” refers to the legal currency of the Hong Kong Special Administrative Region of the People’s Republic of China;

 

   

“JEDEC” refers to Joint Electron Devices Engineering Council, an independent semiconductor engineering trade organization to develop standards for semiconductor devices;

 

   

“LRDIMM” refers to load-reduced dual in-line memory module;

 

   

“MPEG” refers to Moving Picture Experts Group;

 

   

“preferred shares” refers to our Series A preferred shares, Series A-2 preferred shares, Series B preferred shares, Series B-1 preferred shares and Series B-2 preferred shares, each having par value of US$0.0125 per share;

 

   

“RDIMM” refers to registered dual in-line memory module;

 

   

“RF” refers to radio frequency;

 

   

“RMB” or “Renminbi” refers to the legal currency of China;

 

   

“SDTV” refers to standard-definition television;

 

   

“shares” or “ordinary shares” refers to our ordinary shares, par value of US$0.0125 per share;

 

   

“SoC” refers to system-on-chip, an integrated circuit that generally contains digital, analog, mixed-signal and radio-frequency functions on a single chip substrate; and

 

   

“we,” “us,” “our company” and “our” refer to Montage Technology Group Limited and its subsidiaries, as the context requires.

On September 6, 2013, our shareholders approved and effected a reverse share split such that every 2.5 issued and unissued ordinary and preferred shares of par value $0.005 were consolidated into one share of par value $0.0125 each. All share-related information in this prospectus is presented as if the reverse share split had occurred from our inception.


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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our ordinary shares. You should read this entire prospectus carefully, especially the “Risk Factors” section of this prospectus and our consolidated financial statements and related notes appearing at the end of this prospectus, before making an investment decision. Some of the statements in this prospectus constitute forward-looking statements. See “Special Note Regarding Forward-Looking Statements” for more information.

Our Company

We are a global fabless provider of analog and mixed-signal semiconductor solutions currently addressing the home entertainment and cloud computing markets. Our expertise in analog and radio frequency solutions, digital signal processors and high speed interfaces serves as the foundation for our technology platform. These technical capabilities enable us to design high performance, low power semiconductors. In the home entertainment market, our technology platform enables us to design highly integrated solutions with customized software and support for set-top boxes. Our solutions are designed to optimize signal processing performance under the challenging operating conditions typically found in emerging market environments, where often broadcast signals received by the set-top box may be weak, distorted or off-specification. Our solutions contain a number of different technologies that allow for enhanced signal processing, resulting in improved overall video quality under the typically limited existing broadband network infrastructure in emerging markets. In the cloud computing market, we offer high performance, low power memory interface solutions that enable memory-intensive server applications. Our technology platform approach allows us to provide integrated solutions that meet the expanding needs of our customers through our continuous innovation, cost- and power-efficient design and rapid product development. Since our inception in 2004, we have sold over 230 million integrated circuits, which have been shipped to over 150 end customers worldwide.

While analog and mixed-signal technology is applicable to a broad array of end markets, we have been highly selective in identifying our initial target end markets. We focus on markets which we believe have compelling long-term growth prospects and are also characterized by complex product design, long life cycles and stringent qualification requirements. We believe that these market characteristics coupled with our significant investment in our technology platform have created high barriers to entry for set-top box solutions in emerging markets. Initially, we developed commercial solutions for the home entertainment market to address the rapidly growing demand for television in China, Southeast Asia and other emerging markets. According to iSuppli Corporation, or iSuppli, in 2012, 154 million set-top boxes were sold by Chinese manufacturers. We believe that set-top boxes sold by Chinese manufacturers primarily target China and other emerging markets. The number of set-top boxes sold by Chinese manufacturers is expected to grow to over 243 million units in 2016 according to iSuppli. This would represent a compound annual growth rate of 12% from 2012 to 2016. A key to our success in addressing the characteristics of the home entertainment market in emerging markets is our ability to provide integrated solutions with customized software and support, which we develop through close collaboration with our end customers. Our collaborative approach allows us to develop extensive localized knowledge of a large, fragmented market with diverse technical and service requirements, deepening our customer relationships and yielding design wins across multiple product generations. Our end customers in the home entertainment market include nine of the ten largest set-top box manufacturers in China as measured by units sold in 2012.

More recently, we released our memory interface solutions to pursue opportunities arising from the rapid growth in the cloud computing market. Our close collaboration with key industry participants, including CPU manufacturers, memory module manufacturers and server original equipment manufacturers, or OEMs, has enabled us to successfully develop high performance, low power memory interface solutions for cloud computing

 

 

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environments. We sell our memory interface solutions to memory module manufacturers, which incorporate our memory interfaces into dual in-line memory modules, or DIMMs, which are devices used to add memory capacity to a CPU. The most advanced cloud computing data servers operating today currently use DDR3 memory technology and load-reduced DIMMs, or LRDIMMs, which require memory interfaces that buffer data signals in addition to command and address signals. Memory interface vendors like us are unable to sell their solutions to memory module manufacturers without those solutions first being validated by manufacturers of CPUs. We are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers. Our customers in the cloud computing market include the world’s four largest DRAM manufacturers and the world’s largest third-party DRAM module supplier as measured by 2012 revenues.

We offer ten solutions for use in the home entertainment market and two memory interface solutions for use in the cloud computing market. In 2012 and the six months ended June 30, 2013, 94% and 91%, respectively, of our revenue was generated from sales of set-top box solutions targeting the home entertainment market in emerging markets, while the remaining 6% and 9%, respectively, of our revenue was generated from sales of memory interface solutions targeting the cloud computing market. Our solutions are built upon our foundation of 37 issued patents and an additional 46 pending patent applications as of June 30, 2013. As of June 30, 2013, we had 290 engineers in our research and development organization, of which 141 hold post-graduate engineering degrees. Our revenue has grown from $29.1 million in 2010 to $78.2 million in 2012, representing a compound annual growth rate of 64%, and from $33.9 million in the six months ended June 30, 2012 to $45.4 million in the six months ended June 30, 2013, representing an annual growth rate of 34%. We had a net loss of $8.5 million in 2010 and net income of $5.0 million in 2011, $18.3 million in 2012 and $8.8 million in the six months ended June 30, 2013.

Our Target Markets

Our solutions primarily serve two large target markets, (i) the home entertainment market, in particular set-top boxes for emerging markets; and (ii) the cloud computing market, in particular memory interface solutions for data center servers.

Home Entertainment Market

In emerging markets, such as China, India, the Middle East, Latin and South America, Africa and Southeast Asia, television content is broadcast and accessed through satellite transmissions, cable network connections or terrestrial over-the-air transmissions. Viewers often access content from these three signal transmission systems using set-top boxes that are connected to televisions within the home. According to iSuppli, in 2012, 154 million set-top boxes were sold by Chinese manufacturers, primarily targeting emerging markets. Of the 154 million units sold, 66% were exported outside of China. The total number of set-top boxes sold by Chinese manufacturers is expected to grow to over 243 million units in 2016 according to iSuppli, with 58% of those units expected to be exported. This would represent a compound annual growth rate of 12% from 2012 to 2016. In addition, in some emerging markets, such as China, the broadcasting signal of television content is transitioning from analog to digital due to government- sponsored programs requiring the replacement or addition of television access equipment. For example, China has a goal of shutting down analog TV signals by 2015 and transitioning to digital TV in most regions. With improvements in content quality and increasing disposable income, we believe that viewers in China and other emerging markets are expected to increasingly purchase set-top boxes that can receive and display high-definition video content. While currently the satellite set-top box market is the largest market for China-manufactured set-top boxes in terms of total number of set-top boxes sold, the cable set-top box market is expected to represent an increasing proportion of China-manufactured set-top boxes from 2012 to 2016, according to iSuppli.

 

 

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In order to optimize for superior and robust system performance and deliver cost-efficient solutions to set-top box manufacturers, semiconductor providers are integrating multiple functions into a single silicon package. These integrated solutions also require customized embedded software and field application support to ensure proper functionality and system level performance. The demands for cost-effective yet high-performance solutions are particularly strong in emerging markets. According to iSuppli, the market for semiconductors addressing set-top boxes manufactured in China totaled $995 million in 2012 and is expected to grow to $1,316 million in 2016, with sales of integrated semiconductor solutions outpacing the growth of the overall market from 2012 to 2016. This would represent a compound annual growth rate of 7% from 2012 to 2016.

Cloud Computing Market

Global data center IP traffic is expected to increase from 1.8 zettabytes, or 1.8 billion terabytes, in 2011 to 6.6 zettabytes in 2016, according to the Cisco Global Cloud Index published by Cisco System, Inc., or Cisco. This would represent a compound annual growth rate of 30% from 2011 to 2016. The proliferation of mobile devices, cloud-based software applications and streaming video pose significant challenges for network data centers. In addition, the rate at which data is being consumed is growing much faster than the rate of mobile device growth. The limited memory and processing speed of mobile devices has led to a majority of content viewed on mobile devices being accessed using cloud computing technology.

To meet the rising demands being placed on networks, data center operators have increased the number of servers within their facilities. In cloud computing environments where a significant number of memory-intensive applications are simultaneously being run on a server, the processing performance of CPUs is limited by the amount of memory available to the CPU. Additional memory capacity is required to ensure servers perform at optimal levels, which is critical for on-demand applications like cloud computing and virtualization. As a result, memory capacity is added to a server through the use of dual in-line memory modules, or DIMMs, which house dynamic random access memory, or DRAM. Memory performance is enhanced through the use of interface devices called memory buffers that efficiently facilitate the rapid flow of data between the CPU and memory. As the number of cores in the CPU increases, the number of DIMMs required to achieve higher performance also increases. The need for greater amounts of DRAM to support high performance computing is expected to drive the development of higher capacity DIMMs, where a greater amount of gigabit storage is placed on a single DIMM. The memory content within the overall server market is expected to grow to $3,129 million in 2016, according to Gartner Inc., or Gartner. This would represent a compound annual growth rate of 22% from 2012 to 2016. In addition, memory is expected to become a larger percentage of the server semiconductor total addressable market, increasing from 13.8% in 2012 to 21.2% in 2016, according to Gartner. Based on our knowledge gained through qualification processes with CPU and memory module manufacturers, we believe higher capacity DIMMs with memory densities equal to or above 32 gigabits will require the use of LRDIMM technology to ensure the highest server performance. Furthermore, we expect that new server platforms will need to expand the capacity for the number of DIMMs to address the increasing amount of data being transmitted over public and private networks. The number of machines using LRDIMM is expected to grow from 2.3 million in 2014 to 3.1 million in 2016, while the average number of LRDIMMs used on a single machine is expected to grow from 4.8 in 2014 to 18.3 in 2016, according to Jon Peddie Research. The increase in number of machines using LRDIMMs and average number of LRDIMMs per machine is expected to drive rapid growth in the potential available market for LRDIMM chipsets, which Jon Peddie Research estimates will increase from up to $312 million in 2014 to as much as $1,958 million in 2016. This would represent a compound annual growth rate of 151% from 2014 to 2016. In terms of unit volume, Jon Peddie Research estimates the potential available market for LRDIMM chipsets will increase from up to 18.4 million units in 2014 to as much as 93.2 million units in 2016. This would represent a compound annual growth rate of 125% from 2014 to 2016.

The rise of computing power in a server also drives a significant increase in the energy costs required to operate the server. Therefore, data center operators are increasingly focused on the power efficiency of each

 

 

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component within a server system and ascribe significant value to low power solutions that can drive energy savings without compromising performance. Moreover, CPU manufacturers create technology platforms that server OEMs use as the basis for their server design. A CPU manufacturer sets the specifications for many of the key components to be used in each generation of its server platforms. In the case of memory interface solutions for DIMMs, CPU manufacturers impose strict guidelines and generally qualify only a few vendors to provide memory interface solutions for their server platforms. With each new server platform released by CPU manufacturers, providers of memory interface solutions must be validated for use on the new platform. As such, the increased technical requirements for memory interface solutions not only create higher degrees of complexity and greater requirements for performance, signal integrity and low power on the newer generation memory buffers, but also limit the number of participants in the market for memory interface solutions.

Key Requirements of Our Target Markets

Within the home entertainment market, set-top box manufacturers in emerging markets have the following critical needs which must be addressed when identifying semiconductor solutions for their products:

 

   

integration;

 

   

high level of field support;

 

   

exceptional performance and signal processing in challenging environments;

 

   

embedded software and comprehensive system-level solutions;

 

   

cost effectiveness; and

 

   

ease of manufacture.

Within the cloud computing market, server OEMs have the following critical needs which must be addressed when identifying memory interface solutions for their products:

 

   

high performance and low power;

 

   

signal integrity; and

 

   

built-in self-test capability.

To successfully compete in the home entertainment and cloud computing markets, semiconductor providers must possess strong design capabilities in both analog and mixed-signal technologies as well as system level design expertise. In addition, design solutions must effectively meet the foregoing requirements and offer an attractive value proposition for set-top box manufacturers, memory module manufacturers and server OEMs alike.

Our Solutions

We design, develop and market a range of analog and mixed-signal semiconductor solutions for set-top boxes targeting emerging markets as well as memory interface solutions for the cloud computing markets. Our solutions comprise one or more analog and mixed-signal semiconductors combined with field application and other support services.

We market a range of high performance and multi-standard compliant HDTV and SDTV semiconductor solutions for set-top boxes, including tuners, demodulators and decoders as well as integrated solutions with customized software and support. We provide an integrated solution by combining our RF and analog hardware design with customized software. Our integrated solutions can combine tuner, demodulator and decoding technology in a single semiconductor solution. We believe our set-top box solutions deliver high performance

 

 

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because we offer strong signal processing capabilities which address the challenges that are commonly found in emerging markets, where the limited and often substandard broadcast network infrastructure requires more robust signal processing and performance capabilities than required in developed markets. We support our solutions with our extensive team of field application engineers who are geographically close to our customers and work extensively to deepen our customer relationships. We offer set-top box solutions for satellite, cable and terrestrial broadcasts, with a particular strength in satellite and cable set-top boxes aimed at emerging markets.

By combining our expertise in high performance, low power mixed-signal semiconductor design technologies and other support services, we have designed and developed advanced memory interface solutions that provide high performance and low power consumption for use in data center servers for the cloud computing market. We design our memory interface solutions in close collaboration with our memory module manufacturer end customers as well as server OEMs and CPU manufacturers to meet required design specifications. We believe our memory interface solutions are high performance, because they can achieve better signal integrity than the competitors in our market, which allow our solutions to efficiently operate at higher speeds thereby increasing memory capacity and improving server performance. Additionally, our built-in self-test capabilities help our memory module manufacturer customers and server OEMs to rapidly validate memory performance.

Competitive Strengths

We believe the following strengths differentiate us from our competitors and are key drivers of our success:

 

   

High performance, low power analog and mixed-signal technology platform. Our technology platform is built upon our foundation of high performance, low power expertise and consists of a versatile and comprehensive set of hardware and software building blocks that serve both our home entertainment and cloud computing markets. For example, in the cloud computing market, we are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers.

 

   

Deep technology expertise. Our research and development team of 290 professionals, of which 141 have advanced degrees, has extensive digital signal processing, radio frequency and analog and mixed-signal design experience and includes engineers who have participated in the development of key industry standards such as JEDEC and MPEG. Our core system-level expertise and understanding of system requirements enables us to optimize our product roadmap and identify attractive opportunities.

 

   

High levels of integration. We believe our integrated solutions result in superior performance and lower material and manufacturing costs for our customers, enhancing our attractive value proposition. Our integrated solutions have significant advantages over competing discrete products such as improving signal integrity, reducing size and ultimately driving superior system performance. We believe that the enhanced performance and cost-effectiveness created by the high level of integration in our solutions allows us to deliver increased value to our end customers, which increases customer loyalty and positions us to benefit from demand for future product upgrades from end customers.

 

   

Close collaboration and relationships with customers and industry participants. Our extensive customer interaction, in particular through support provided by our field application engineers, combined with our deep understanding of our customers’ needs, fosters customer loyalty and increases visibility of evolving customer requirements and market opportunities within our business. Our close proximity to our customers, which are primarily located in Asia, also provides us with a better understanding of local system requirements and allows us to achieve faster time to market with our solutions.

 

   

Broad customer base and attractive market opportunities in home entertainment. We have sold our solutions principally through distributors to over 150 set-top box manufacturers worldwide. Our key customers include nine of the ten largest set-top box manufacturers in China, who manufacture products optimized for end users in emerging markets.

 

 

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Well positioned to capitalize on opportunities in cloud computing. We believe we offer the highest performance and lowest-power memory interface solutions for memory-intensive cloud computing applications. We are currently one of two LRDIMM suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers, and have sold our memory interface solutions to the world’s four largest DRAM manufacturers and the world’s largest third-party DRAM module supplier as measured by 2012 revenues.

Growth Strategy

We believe we can continue to grow our revenue by executing on the following strategies:

 

   

Invest to maintain technology leadership position across product lines. We intend to continue our focus on retaining and attracting high quality engineering staff and investing in our intellectual property portfolio to further extend our leading high performance, low power technologies in our markets.

 

   

Strengthen our relationships with customers and industry participants. We intend to continue to build upon and strengthen our collaborative relationships to increase our customers’ dependence on us and drive greater demand for our solutions, as well as to continue participating in the development of key industry standards to better align our future roadmap.

 

   

Expand product offering and market share in home entertainment for emerging markets. We will continue to leverage our engineering expertise to grow our market share in the globally fragmented home entertainment market. We also intend to continue to introduce solutions with higher levels of product functionality and integration, as we seek to increase our average selling price per set-top box by providing more integrated solutions.

 

   

Continue to position ourselves for growth in the cloud computing market. We intend to further penetrate our existing customer base and collaborate with new memory module partners to increase our revenue. We also intend to further develop our partnership with leading CPU manufacturers and remain aligned with their server and next generation technology roadmaps.

Risk Factors

We are subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows and prospects. You should carefully consider these risks, including all of the risks discussed in the section entitled “Risk Factors,” beginning on page 11 of this prospectus, before investing in our ordinary shares. Risks relating to our business relate to, among other things:

 

   

Our ability to sustain our recent revenue growth rates;

 

   

Our ability to sustain or increase our profitability in the future;

 

   

Our ability to develop and maintain relationships with key industry and technology leaders to enhance our solution offerings and market position;

 

   

Changes to industry standards and technical requirements relevant to our solutions and markets;

 

   

The rapidly evolving and intensely competitive nature of our markets;

 

   

Our ability to continuously develop new and enhanced solutions to meet changing market conditions;

 

   

Our reliance on third parties to manufacture, package, assemble and test the semiconductor products comprising our solutions;

 

   

Our lengthy sales cycles, which could result in uncertainty and delays in generating revenue;

 

 

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Our ability to adequately protect our intellectual property rights; and

 

   

Government policies that could have a material adverse effect on our results of operations.

Corporate Information

We are a Cayman Islands company and conduct our business primarily through our wholly owned operating subsidiaries in China, Hong Kong and the United States. Our principal executive office is located at Room A1601, Technology Building, 900 Yi Shan Road, Xuhui District, Shanghai 200233, China and our telephone number is +86 (21) 6128-5678. Our website address is www.montage-tech.com. We do not incorporate the information contained on, or accessible through, our website into this prospectus, and you should not consider it part of this prospectus.

“Montage Technology” and our logo are our trademarks. All other trademarks and trade names appearing in this prospectus are the property of their respective owners. We do not intend our use or display of other parties’ trademarks, trade names or service marks to imply, and such use or display should not be construed to imply, a relationship with, or endorsement or sponsorship of us by, these other parties.

 

 

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THE OFFERING

 

Ordinary shares offered by us

   5,325,000 shares

Ordinary shares offered by the selling shareholders

   1,775,000 shares

Ordinary shares outstanding

immediately after this offering

   26,479,343 shares

Over-allotment option

   The selling shareholders have granted to the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of 1,065,000 additional ordinary shares at the initial public offering price, less underwriting discounts and commissions, solely to cover over-allotments of ordinary shares, if any.

Use of proceeds

   We intend to use the net proceeds from this offering for general corporate purposes, including working capital and capital expenditures. See “Use of Proceeds.”

Directed Share Program

   At our request, the underwriters have reserved for sale, at the public offering price, up to five percent of the shares offered by us to certain of our directors, officers, employees, business associates and related persons through a directed share program. In addition, we have requested that the underwriters offer $5.0 million of the ordinary shares offered hereby for sale at the initial public offering price to China Electronics Computing Hua Hong International Ltd., an existing shareholder of our company that has indicated an interest in purchasing and holding such shares on behalf of China Electronics Corporation. We do not know if these persons will choose to purchase all or any portion of these reserved shares, but any purchases they make will reduce the number of shares available to the general public.

Risk factors

   Investing in our ordinary shares involves a high degree of risk. You should carefully read the information set forth under “Risk Factors” beginning on page 11 of this prospectus, together with all of the other information set forth or incorporated by reference in this prospectus, before deciding to invest in our ordinary shares.

Proposed NASDAQ Global

Market Symbol

   “MONT”

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

is based upon 4,990,745 ordinary shares outstanding as of August 31, 2013;

 

   

assumes the conversion of all outstanding preferred shares as of the date of this prospectus into an aggregate of 16,163,598 ordinary shares immediately upon the completion of this offering; and

 

   

excludes 3,771,093 ordinary shares issuable upon the exercise of options granted under our 2006 Share Incentive Plan outstanding as of August 31, 2013.

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following table sets forth our summary consolidated financial data for the periods and as of the dates indicated. Our summary consolidated financial data for each of the years ended December 31, 2010, 2011 and 2012 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our summary consolidated financial data for the six months ended June 30, 2012 and 2013 and summary consolidated balance sheet data as of June 30, 2013 have been derived from our unaudited consolidated financial statements, which are included elsewhere in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in the opinion of management, reflect all adjustments, which consist only of normal recurring adjustments, necessary for the fair statement of those unaudited consolidated financial statements.

The historical results presented below are not necessarily indicative of the results to be expected for any future period. The following summaries of our consolidated financial data for the periods presented should be read in conjunction with “Risk Factors,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, which are included elsewhere in this prospectus.

 

     Year Ended December 31,     Six Months Ended June 30,  
     2010     2011     2012     2012      2013  
     (in thousands, except share and per share
data)
    (unaudited)  

Summary Statement of Operations Data:

           

Revenue

   $ 29,078      $ 50,338      $ 78,245      $ 33,937       $ 45,392   

Cost of revenue(1)

     (21,248     (22,840     (31,736     (13,691)         (16,589
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     7,830        27,498        46,509        20,246         28,803   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating expense:

           

Research and development(1)

     (11,078     (13,651     (17,568     (8,469)         (12,473

Sales, general and administrative(1)

     (5,046     (5,895     (9,792     (3,232)         (6,801
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expense

     (16,124     (19,546     (27,360     (11,701)         (19,274
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     (8,294     7,952        19,149        8,545         9,529   

Interest income (expense), net

     (44     (36     207        4         302   

Fair value change in warrant liability

     (37     —          —          —           —     

Other income (expense), net

     (114     (307     153        233         (87
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     (8,489     7,609        19,509        8,782         9,744   

Provision for income tax

     (54     (2,637     (1,228     (553)         (972
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (8,543   $ 4,972      $ 18,281      $ 8,229       $ 8,772   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) attributable to ordinary shareholders—Basic

   $ (11,056   $ 77      $ 3,114      $ 1,357       $ 1,558   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) per share:

           

Basic

   $ (2.66   $ 0.02      $ 0.72      $ 0.32       $ 0.34   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

   $ (2.66   $ 0.02      $ 0.66      $ 0.29       $ 0.31   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Weighted-average shares used in computing net income (loss) per share:

           

Basic

     4,157,498        4,260,192        4,319,243        4,294,131         4,598,436   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

     4,157,498        5,924,390        6,366,682        6,246,974         6,572,366   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

 

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(1) Includes share-based compensation as follows:

 

     Year Ended December 31,      Six Months Ended June 30,  
       2010          2011          2012          2012          2013    
     (in thousands)     

(unaudited)

 

Cost of revenue

   $ 31       $ 13       $ 19       $ 10       $ 28   

Research and development

     358         356         497         210         578   

Sales, general and administrative

     389         262         473         169         688   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 778       $ 631       $ 989       $ 389       $ 1,294   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2) On September 6, 2013, our shareholders approved and effected a reverse share split such that every 2.5 issued and unissued ordinary and preferred shares of par value US$0.005 were consolidated into one share with a par value of US$0.0125 each. All share-related disclosures, including number of shares and net income (loss) per share, have been recast to reflect the 2.5-for-1 reverse share split for all periods presented.

The following summary consolidated balance sheet data table shows a summary of our balance sheet data as of June 30, 2013:

 

   

on an actual basis;

 

   

on a pro forma basis, giving effect to the automatic conversion of all outstanding convertible preferred shares into 16,163,598 ordinary shares; and

 

   

on a pro forma as adjusted basis to reflect, in addition, the sale by us of ordinary shares in this offering at an assumed initial public offering price of $13.00 per share, the midpoint of the price range listed on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

     As of June 30, 2013  
     Actual     Pro Forma      Pro Forma
as Adjusted
 
     (unaudited)     (unaudited)      (unaudited)  
     (in thousands)  

Summary Balance Sheet Data:

       

Cash and cash equivalents

   $ 13,921      $ 13,921       $ 75,480   

Working capital

     42,124        42,124         103,683   

Total assets

     64,592        64,592         126,151   

Total liabilities

     20,660        20,660         20,660   

Convertible preferred shares

     54,400        —           —     

Total shareholders’ equity/(deficit)

     (10,468     43,932         105,491   

 

 

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RISK FACTORS

An investment in our ordinary shares involves significant risks. You should carefully consider all of the information in this prospectus, including the risk factors described below, before making an investment in our ordinary shares. The following risk factors describe conditions, circumstances or uncertainties that create or enhance risks to our business, financial condition and results of operations or otherwise to the value of your investment in our ordinary shares. Any of these risks could result in a decline in the market price of our ordinary shares, in which case you could lose all or part of your investment.

Risk Factors Related to Our Business and Our Industry

We may be unable to sustain our recent revenue growth rates.

We experienced significant growth in revenue and profits in 2011 and 2012. Our revenue increased from $29.1 million in 2010 to $78.2 million in 2012, while our net income (loss) improved from a net loss of $8.5 million in 2010 to net income of $5.0 million in 2011 and to $18.3 million in 2012. In the six months ended June 30, 2013, we recorded $45.4 million in revenue and $8.8 million in net income, which increased from $33.9 million in revenue and $8.2 million in net income in the six months ended June 30, 2012. We may not achieve similar rates of growth in future periods. You should not rely on our results of operations for any prior quarterly or annual periods as an indication of our future performance. Our future revenue growth rate will depend in particular on the success of our memory interface solutions. In 2012 and the six months ended June 30, 2013, our memory interface solutions generated $4.6 million and $4.3 million in revenue and we may not be successful in growing our revenue from our memory interface solutions. If our revenue growth slows significantly or decreases, the market price of our ordinary shares may decline.

We have a history of losses, have only recently become profitable and may not sustain or increase profitability in the future which may cause the market price of our ordinary shares to decline.

We first became profitable on an annual basis in 2011. We incurred significant net losses prior to that year. As of June 30, 2013, we had an accumulated deficit of $15.6 million. We currently expect to increase our expense levels to support our business growth. Therefore, to sustain or increase profitability, we will need to grow our revenue. If our expenditures do not result in increased revenue growth or there is a significant time lag between these expenses and our revenue growth, we may experience net losses in the future. Because many of our expenses are fixed in the short term, or are incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall of revenue. Any incurrence of net losses in the future could cause the market price of our ordinary shares to decline.

We rely on our relationships with industry and technology leaders to enhance our solution offerings and market position, and our inability to continue to develop or maintain such relationships in the future would harm our ability to remain competitive.

We develop our semiconductor solutions for applications in systems that are driven by industry and technology leaders, in particular for our memory interface solutions. In the cloud computing market, CPU manufacturers create technology platforms that memory module manufacturers and server OEMs use as the basis for their products and solutions. A CPU manufacturer sets the specifications for many of the key components to be used on each generation of its server platforms. In the case of our memory interface solutions, CPU manufacturers impose strict guidelines and generally qualify only a few vendors to provide memory interface solutions for their server platforms. With each new server platform released by CPU manufacturers, providers of memory interface solutions must be validated for use on the new platform. In addition, we must work closely with memory module manufacturers to ensure our memory interface solutions become qualified for use with their memory modules. As a result, maintaining close relationships with leading CPU manufacturers and memory module manufacturers is crucial to the long-term success of our memory interface solutions business. If our relationships with key industry participants were to deteriorate or if our solutions were not qualified by CPU manufacturers, our market position and sales could be materially adversely affected.

 

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Changes to industry standards and technical requirements relevant to our solutions and markets could adversely affect our business, results of operations and prospects.

Our solutions comprise only a part of larger electronic systems. All solutions incorporated into these systems must comply with various industry standards and technical requirements created by regulatory bodies or industry participants in order to operate efficiently together. Industry standards and technical requirements in our markets are evolving and may change significantly over time. For our set-top box solutions, the industry standards are typically set by government regulators and vary by country. Such standards can sometimes change or additional standards may be added with limited advance notice. For memory interface solutions, the industry standards are developed by JEDEC, an industry trade organization. In addition, large industry-leading semiconductor and electronics companies play a significant role in developing standards and technical requirements for the product ecosystems within which our memory interface solutions can be used. Our end customers also may design certain specifications and other technical requirements specific to their products and solutions. These technical requirements may change as the end customer introduces new or enhanced products and solutions.

Our ability to compete in the future will depend on our ability to identify and ensure compliance with evolving industry standards and technical requirements. The emergence of new industry standards and technical requirements could render our solutions incompatible with solutions developed by other suppliers or make it difficult for our solutions to meet the requirements of certain of our end customers in both the home entertainment and cloud computing markets. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our solutions to ensure compliance with relevant standards and requirements. If our solutions are not in compliance with prevailing industry standards and technical requirements for a significant period of time, we could miss opportunities to achieve crucial design wins, our revenue may decline and we may incur significant expenses to redesign our solutions to meet the relevant standards, which could adversely affect our business, results of operations and prospects.

Our business would be adversely affected by the departure of existing members of our senior management team and other key personnel.

Our success depends, in large part, on the continued contributions of our senior management team, in particular, the services of Dr. Howard C. Yang, our Chairman of the Board and Chief Executive Officer, and Stephen Tai, our President and director, as well as other senior management. The loss of any member of our senior management team or key personnel could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

Our results of operations can fluctuate from period to period, which could cause our share price to fluctuate.

Our results of operations have fluctuated in the past and may fluctuate from period to period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere in this prospectus:

 

   

the receipt, reduction, delay or cancellation of orders by customers;

 

   

the gain or loss of significant customers;

 

   

the timing and success of our launch of new solutions and launches of new solutions by our competitors;

 

   

market acceptance of our solutions and our customers’ products;

 

   

the timing and extent of research and development costs, and in particular tape-out costs;

 

   

fluctuations in sales by and inventory levels of module manufacturers who incorporate our semiconductor solutions in their products, such as memory modules;

 

   

cyclical and seasonal fluctuations in our markets;

 

   

the timing of receiving government subsidies;

 

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fluctuations in our manufacturing yields;

 

   

significant warranty claims, including those not covered by our contract manufacturer;

 

   

changes in our revenue mix; and

 

   

loss of key personnel or the inability to attract qualified engineers.

The semiconductor industry has been highly cyclical in the past and our markets may experience significant cyclical fluctuations in demand as a result of changing economic conditions, budgeting and buying patterns of customers and others factors. As a result of the various potential factors affecting demand for our products and our results of operations in any given period, the results of any prior quarterly or annual periods should not be relied upon as indicative of our future revenue or operating performance. Fluctuations in our revenue and operating results could cause our share price to decline.

The markets for our semiconductor solutions are evolving, and changing market conditions, such as the introduction of new technologies or changes in customer preferences, may negatively affect demand for our solutions. If we fail to properly anticipate or respond to changing market conditions, our business prospects and results of operations will suffer.

Our solutions are used in the technologically advanced and rapidly evolving home entertainment and cloud computing markets. The technologies used in these markets are constantly being improved and new technologies that compete with existing technologies may be developed. Furthermore, the home entertainment market, and in particular the market for our set-top box solutions, is highly fragmented and subject to changes in viewer preferences, customer requirements and technical standards. In the cloud computing market, and in particular the market for our memory interface solutions, technology advancements are continuously underway, such as the advancements in memory technology from DDR2 to DDR3 and DDR4. Industry analysts have different opinions on how fast and how large these markets will grow. New technologies may be introduced that make the current technologies that our solutions utilize less competitive or obsolete. Due to the evolving nature of our markets, our future success depends on our ability to accurately anticipate and respond to changes in technologies, consumer preferences and other market conditions. Any decrease in demand for our set-top box and memory interface solutions, or set-top box and memory interface solutions in general, due to the emergence of competing technologies, changes in customer preferences and requirements or other factors, could adversely affect our business, results of operations and prospects.

We must continuously develop new and enhanced solutions, and if we are unable to successfully market our new and enhanced solutions that we have incurred significant expenses developing, our results of operations and financial condition will be materially adversely affected.

In order to compete effectively in our markets, we must continually design, develop and introduce new and improved solutions with improved features in a cost-effective manner in response to changing technologies and market demand. This requires us to devote substantial financial and other resources to research and development. In the home entertainment market, in response to market trends, we have focused on providing more integrated and customized solutions and are enhancing our offerings of HDTV solutions. In the memory interface market, we are developing next-generation DDR4 memory interface solutions, which we expect to be one of the drivers of our revenue growth in the future. However, we may not be successful developing and marketing these new and enhanced solutions. In particular in the memory interface market, we have generated limited revenue from sales of our memory interface solutions through 2012. While we expect revenue from our memory interface solutions to grow, we may not be able to increase our market share in this globally competitive market. Moreover, achieving and maintaining Intel validation for our advanced memory buffers, in particular our LRDIMM memory buffer for DDR4, is extremely important to our future market position and the prospects of our memory interface solutions business as the server OEMs who adopt Intel’s server platforms will only purchase components of their servers from Intel validated vendors. There is no assurance we will achieve or maintain such validations. If we are unable to successfully develop and market our new and enhanced solutions that we have incurred significant expenses developing, our results of operations and financial condition will be materially and adversely affected.

 

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Average selling prices of our solutions have historically decreased over time and will likely continue to do so, which could negatively affect our revenue and margins.

Historically, the semiconductor solutions that we sell have experienced declining average selling prices over their life cycle. The rate at which the average selling price declines may be affected by a number of factors, including relative supply and demand, the level of competition, production costs and technological changes. As a result of the general trend of decreasing average selling prices of our semiconductor solutions following their launch, our ability to grow or maintain our margins depends on our ability to introduce new or enhanced solutions with higher average selling prices and to reduce our per-unit cost of sales and operating costs. However, our new or enhanced solutions may not be as successful or enjoy as high margins as we expect. If we are unable to offset any reductions in the average selling prices by introducing new solutions with higher average selling prices or reducing our costs, our revenue and margins will be negatively affected and may decrease.

We face intense competition and expect competition to increase in the future. If we fail to compete effectively, our revenue growth and results of operations will be materially adversely affected.

The markets in which we operate are highly competitive. We compete with numerous domestic and international semiconductor companies, many of which have greater financial and other resources with which to pursue technology development, product design, manufacturing, marketing and sales and distribution of their products. Currently, our competitors range from large, international companies offering a wide range of semiconductor solutions to smaller companies specializing in set-top box or memory interface solutions. Our primary competitors in the set-top box market include semiconductor companies that sell to emerging markets such as HiSilicon Technologies Co., Ltd., ALi Corporation, RDA Microelectronics, Inc., Airoha Technology Corporation and STMicroelectronics NV, as well as smaller semiconductor design companies based in China. Our competitors in the memory interface market include Inphi Corporation, Integrated Device Technology, Inc. and Texas Instruments Inc. We expect that as the markets for our solutions grow, new entrants will enter these markets and existing competitors may make significant investments to compete more effectively against us. As the emerging markets to which we sell our set-top box solutions become developed markets, leading semiconductor companies focusing on developed markets may increasingly enter our target markets.

Our ability to compete successfully depends on factors both within and outside of our control, including:

 

   

the functionality and performance of our solutions and those of our competitors;

 

   

our relationship with our end customers and other industry participants;

 

   

prices of our solutions and prices of our competitors’ products;

 

   

our reputation and ability to provide satisfactory customer support;

 

   

our research and development capabilities to provide innovative solutions;

 

   

our ability to retain high-level talent, including our management team and engineers; and

 

   

the actions of our competitors, including merger and acquisition activity, launches of new products and other actions that could change the competitive landscape.

Intense competition could result in pricing pressure, reduced revenue and profitability and loss of market share, any of which could materially and adversely affect our business, results of operations and prospects. In the event of a market downturn, competition in the markets in which we operate may intensify as our customers reduce their purchase orders. During market downturns, our competitors that are significantly larger and have greater financial, technical, marketing, distribution, customer support and other resources or more established market recognition than us may be better positioned to accept lower prices and withstand adverse economic or market conditions.

 

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We rely on third parties to manufacture, package, assemble and test the semiconductor products comprising our solutions, which exposes us to a number of risks, including reduced control over manufacturing and delivery timing and potential exposure to price fluctuations, which could result in a loss of revenue or reduced profitability.

As a fabless semiconductor company, we outsource the manufacturing, packaging, assembly and certain testing of our semiconductor solutions to third-party foundries and assembly and testing service providers. We generally use a single foundry for the production of each semiconductor product comprising our set-top box and memory interface solutions. In 2012 and the six months ended June 30, 2013, we outsourced the manufacturing to three different foundries, Semiconductor Manufacturing International Corporation in China, Fujitsu Semiconductor Limited in Japan and United Microelectronics Corporation in Taiwan. Our assembly and testing contractors in 2012 and the six months ended June 30, 2013 were Siliconware Precision Industries Co., Ltd. in Taiwan and Suzhou, China and STATS ChipPAC Ltd. in Singapore and Korea.

Relying on third-party manufacturing, assembly and testing presents a number of risks, including but not limited to:

 

   

capacity shortages during periods of high demand;

 

   

reduced control over delivery schedules, inventories and quality;

 

   

the unavailability of, or potential delays in obtaining access to, key process technologies;

 

   

the inability to achieve required production or test capacity and acceptable yields on a timely basis;

 

   

misappropriation of our intellectual property;

 

   

limited warranties on wafers or products supplied to us; and

 

   

potential increases in prices.

We currently do not have long-term supply contracts with any of our third-party contract manufacturers, and we typically negotiate pricing on a per-purchase order basis. Therefore, they are not obligated to perform services or supply product to us for any specific period, in any specific quantities, or at any specific price, except as may be provided in a particular purchase order. During periods of high demand and tight inventories, our third-party foundries and assembly and testing contractors may allocate capacity to the production of other companies’ products while reducing deliveries to us, or significantly raise their prices. In particular, they may allocate capacity to other customers that are larger and better financed than us or that have long-term agreements, decreasing the capacity available to us. Shortages of capacity available to us may be caused by the actions of their other large customers that may be difficult to predict, such as major product launches. If we need another foundry or assembly and test contractor because of increased demand, or if we are unable to obtain timely and adequate deliveries from our providers, we might not be able to cost effectively and quickly retain other vendors to satisfy our requirements. In the event that we need to shift the production of a solution to a different contract manufacturer, it may take approximately nine to 12 months to allow a smooth transition from our current foundry or assembly services provider to the new provider. Such a transition might require a qualification process by our end customers.

We purchase from our manufacturing contractors based on our estimates of end customers’ demand, and if our estimates are incorrect our results of operations could be materially adversely impacted.

Our sales are made on the basis of purchase orders rather than long-term purchase contracts. We place orders with our third party foundries and service providers for manufacturing, assembling and testing our semiconductor products according to our estimates of customer demand several months prior to the anticipated delivery date to our distributor or end customer. This process requires us to make multiple demand forecast assumptions with respect to our end customers’ demands in advance of actual purchase orders. We might misestimate demand due to unforeseen changes in market conditions, incomplete or inaccurate customer and market information or other factors within and outside of our control. If we overestimate customer demand, we may purchase products from our third-party contractors that we may not be able to sell and may over-budget company operations, which could result in decreases in our prices or write-downs of unsold inventory.

 

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Conversely, if we underestimate customer demand or if sufficient manufacturing capacity were unavailable, we would lose out on sales opportunities and could lose market share or damage our customer relationships.

Our costs may increase substantially if our third-party manufacturing contractors do not achieve satisfactory product yields or quality.

The wafer fabrication process is an extremely complicated process where small changes in design, specifications or materials can result in material decreases in product yields or even the suspension of production. From time to time, the third-party wafer foundries that we contract to manufacture the semiconductor products comprising our solutions may experience manufacturing defects and reduced manufacturing yields related to errors or problems in their manufacturing processes or the interrelationship of their processes with our designs. In some cases, our third-party wafer foundries may not be able to detect these defects early in the fabrication process or determine the cause of such defects in a timely manner.

Generally, in pricing our solutions, we assume that manufacturing yields will continue to improve, even as the complexity of our solutions increases. Once our solutions are initially qualified with our third-party wafer foundries, minimum acceptable yields are established. We are responsible for the costs of the wafers if the actual yield is above the minimum. If actual yields are below the minimum we are not required to purchase the wafers. Typically, minimum acceptable yields for our new solutions are generally lower at first and gradually improve as we achieve full production. Unacceptably low product yields or other product manufacturing problems could substantially increase the overall production time and costs and adversely impact our operating results on sales of our solutions. Product yield losses will increase our costs and reduce our gross margin. In addition to significantly harming our operating results and cash flow, poor yields may delay shipment of our solutions and harm our relationships with existing and potential customers.

Our sales cycle can be lengthy, which could result in uncertainty and delays in generating revenue.

As we sell highly integrated solutions with customized software and support, our sales cycle for our set-top box solutions from initial engagement to volume production may take a prolonged period of time, typically several months to one year. For our memory interface solutions, our sales cycle can include working with our customers and other industry participants for up to two years or more on product development before we achieve design wins. Any delays in these lengthy sales cycles increase the risk that a customer will decide to cancel, curtail, reduce or delay its product plans or adopt a competing design or solution from one of our competitors, causing us to lose anticipated revenue. In addition, any delay or cancellation of an end customer’s plans could materially and adversely affect our financial results, as we may have incurred significant expense without generating any revenue. Finally, our end customers’ failure to successfully market and sell their products could reduce demand for our solutions and materially and adversely affect our business, results of operations and prospects. If we were unable to generate revenue after incurring substantial expenses during our sales efforts, our results of operations would suffer.

If we fail to achieve initial design wins for our solutions, we may lose the opportunity for sales to customers for a significant period of time and be unable to recoup our investments in our solutions.

We expend considerable resources in order to achieve design wins for our solutions, especially our new solutions and solution enhancements. Once a customer designs a semiconductor solution into its product, it is likely to continue to use the same semiconductor solution or enhanced versions of that solution from the same supplier across a number of similar and successor products for a lengthy period of time due to the significant costs associated with qualifying a new supplier and potentially redesigning the product to incorporate a different semiconductor solution. If we fail to achieve an initial design win in a customer’s qualification process, we may lose the opportunity for significant sales to that customer for a number of its products and for a lengthy period of time. This may cause us to be unable to recoup our investments in our solutions, which would harm our business.

 

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Our customers require our solutions and our third-party contractors to undergo a lengthy and expensive qualification process. If we are unsuccessful or delayed in qualifying any of our solutions with a customer, our business and operating results would suffer.

Prior to selecting and purchasing our solutions, our end customers typically require that our solutions undergo extensive qualification processes, which involve testing of our solutions in the customers’ systems, as well as testing for reliability. This qualification process may continue for several months for our set-top box solutions. Our memory interface solutions must obtain qualification with our memory module manufacturer customers as well as CPU manufacturers. The qualification process for our memory interface solutions can take multiple years. However, obtaining the requisite qualifications for a solution does not assure any sales of the solution. Even after successful qualification and sales of a solution to an end customer, a subsequent revision in our third party contractors’ manufacturing process or our selection of a new contract manufacturer may require a new qualification process, which may result in delays and in our holding excess or obsolete inventory. After our solutions are qualified and selected, it can take several months or more before the customer commences volume production of systems that incorporate our solutions. Despite these uncertainties, we devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualifying our solutions with customers in anticipation of sales. If we are unsuccessful or delayed in qualifying any of our solutions with a customer, sales of those solutions to the customer may be precluded or delayed, which may impede our growth and cause our business to suffer.

We have generated a substantial majority of our revenue from sales through three independent distributors, which subjects us to a number of risks.

We have sold a substantial majority of our set-top box solutions to end customers through three independent distributors, LQW Technology Company Limited, Qinuo International Co., Ltd. and China Electronic Appliance Shenzhen Co., Ltd. Sales through these three distributors accounted for 50%, 18% and 9%, respectively, of our total revenue in 2012 and 67%, 11% and 8%, respectively, of our total revenue in the six months ended June 30, 2013. As of June 30, 2013, we had $8.3 million of accounts receivable, 78% of which was due from LQW Technology Company Limited. We typically collect the accounts receivable from each distributor within one month following billing. We typically enter into distribution agreements with our distributors, with each distributor covering a defined customer base and/or geographic area. In addition, our distribution agreements are typically negotiated and entered into on an annual basis and prohibit the distributor from selling products or solutions competing with ours. If any of our distributors were to default on its obligations and fail to pay our invoices or ship our products in a timely fashion, we may be unable to collect our accounts receivable, recover our inventory, or complete sales to the customers who had placed orders through that distributor, and we may find it difficult to replace that distributor. In addition, our operating results and financial condition could be significantly disrupted by the loss of one or more of these distributors, or various factors outside of our control such as order cancellations or delays in shipment by one or more of these distributors or the failure of any of these distributors to successfully sell our solutions.

The complexity of our solutions could result in undetected defects and we may be subject to warranty and product liability claims, which could result in a decrease in customers and revenue, unexpected expenses and loss of market share.

Our solutions are incorporated into larger electronic equipment sold by our end customers. A solution usually goes through an intense qualification and testing period performed by our customers before being used in production. We primarily outsource our solution testing to third parties and also perform some testing in our laboratories in Shanghai, Suzhou and Taiwan. We inspect and test parts, or have them inspected and tested in order to screen out parts that may be weak or potentially suffer a defect incurred through the manufacturing process. From time to time, we are may be subject to warranty or product liability claims that may require us to make significant expenditures to defend these claims or pay damage awards.

 

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Generally, our agreements seek to limit our liability to the replacement of the part or to the revenue received for the solution, but these limitations on liability may not be effective or sufficient in scope in all cases. In addition, we do not maintain any product liability insurance. If an end customer’s equipment fails in use, the end customer may incur significant monetary damages including an equipment recall or associated replacement expenses, as well as lost revenue. The end customer may claim that a defect in our solution caused the equipment failure and assert a claim against us to recover monetary damages. The process of identifying a defective or potentially defective solution in systems that have been widely distributed may be lengthy and require significant resources, and we may incur significant replacement costs and contract damage claims from our end customers as well as harm to our reputation. Defects in our solutions could harm our relationships with our customers and damage our reputation. Customers may be reluctant to buy our solutions, which could harm our ability to retain existing customers and attract new customers and our financial results. In addition, the cost of defending these claims and satisfying any arbitration award or judicial judgment with respect to these claims could harm our business prospects and financial condition.

We may not be able to adequately protect our intellectual property rights.

Our success depends in part upon our ability to protect our intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, copyrights, trademarks and trade secrets in the United States, China and other jurisdictions. Effective protection of our intellectual property rights may be unavailable, limited or not applied for in some countries. Some of our solutions and technologies are not covered by any patent or patent application, as we do not believe patent protection of these solutions and technologies is critical to our business strategy at this time. A failure to timely seek patent protection on solutions or technologies generally precludes us from seeking future patent protection on these solutions or technologies. We cannot guarantee that:

 

   

any of our present or future patents or patent claims will not lapse or be invalidated, circumvented, challenged or abandoned;

 

   

our intellectual property rights will provide competitive advantages to us;

 

   

our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;

 

   

any of our pending or future patent applications will be issued or have the coverage originally sought;

 

   

our intellectual property rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;

 

   

any of the trademarks, copyrights, trade secrets or other intellectual property rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned; or

 

   

we will not lose the ability to assert our intellectual property rights against or to license our technology to others and collect royalties or other payments.

In addition, our competitors or others may design around our protected patents or technologies. In addition to registered patents, we also rely on contractual protections with our customers, suppliers, distributors, employees and consultants, and we implement security measures designed to protect our trade secrets. However, we cannot assure you that these contractual protections and security measures will not be breached, that we will have adequate remedies for any such breach or that our suppliers, employees or consultants will not assert rights to intellectual property arising out of such contracts.

Monitoring unauthorized use of our intellectual property is difficult and costly. In addition, intellectual property rights and confidentiality protection in China is generally considered less effective than in the United States or other developed countries. Unauthorized use of our intellectual property may have occurred or may occur in the future. Although we have taken steps to minimize the risk of this occurring, any such failure to identify unauthorized use and otherwise adequately protect our intellectual property would adversely affect our business.

 

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Moreover, if we are required to commence litigation, whether as a plaintiff or defendant, not only would this be time-consuming, but we would also be forced to incur significant costs and divert our attention and efforts of our employees, which could, in turn, result in lower revenue and higher expenses. If we pursue litigation to assert our intellectual property rights, an adverse decision in any of these legal actions could limit our ability to assert our intellectual property rights, limit the value of our technology or otherwise negatively impact our business, financial condition and results of operations.

We may face claims of intellectual property infringement, which could be time-consuming, costly to defend or settle, result in the loss of significant rights, harm our relationships with our customers and distributors, or otherwise materially adversely affect our business, financial condition and results of operations.

The semiconductor industry is characterized by companies that hold patents and other intellectual property rights and that vigorously pursue, protect and enforce intellectual property rights. From time to time, third parties may assert against us and our customers and distributors patent and other intellectual property rights to technologies that are important to our business.

Claims that our solutions, processes or technology infringe third-party intellectual property rights, regardless of their merit or resolution, could be costly to defend or settle and could divert the efforts and attention of our management and technical personnel. Infringement claims also could harm our relationships with our customers or distributors and might deter future customers from doing business with us. If any pending or future proceedings result in an adverse outcome, we could be required to:

 

   

cease the manufacture, use or sale of the infringing solutions, processes or technology;

 

   

pay substantial damages for infringement;

 

   

expend significant resources to develop non-infringing solutions, processes or technology, which may not be successful;

 

   

license technology from the third-party claiming infringement, which license may not be available on commercially reasonable terms, or at all;

 

   

cross-license our technology to a competitor to resolve an infringement claim, which could weaken our ability to compete with that competitor; or

 

   

pay substantial damages to our customers or end users to discontinue their use of or to replace infringing technology sold to them with non-infringing technology, if available.

Any of the foregoing results could have a material adverse effect on our business, financial condition and results of operations.

If we are unable to attract, train and retain qualified design and technical personnel, we may not be able to execute our business strategy effectively.

Our future success depends on our ability to attract and retain qualified design and technical personnel. As the source of our technological and solution innovations, our design and technical personnel represent a significant asset. Historically, we have not encountered any difficulty in hiring qualified engineers. We do not know whether we will be able to retain all of these personnel as we continue to pursue our business strategy. The loss of the services of one or more of our key employees, especially our key design and technical personnel, or our inability to attract and retain qualified design and technical personnel, could harm our business, financial condition and results of operations.

Competition for personnel in the semiconductor technology field is intense, and the availability of suitable and qualified candidates is limited. We compete to attract and retain qualified research and development personnel with other semiconductor companies, universities and research institutions. Competition for these

 

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individuals could cause us to offer higher compensation and other benefits to attract and retain them, which could materially and adversely affect our financial condition and results of operations. We previously awarded share options and restricted shares to our employees, some of which has not yet vested. Such retention awards may cease to be effective to retain our current employees once the share options or restricted shares vest. We may need to increase our total compensation costs to attract and retain experienced personnel required to achieve our business objectives and failure to do so could severely disrupt our operations and growth. If we lose the services of any key senior management member or employee, we may not be able to locate suitable or qualified replacements, and may incur additional expenses to recruit and train new personnel, which could severely impact our business and prospects.

We may not be able to effectively manage our growth, and we may need to incur significant expenditures to address the additional operational and control requirements of our growth, either of which could harm our business and operating results.

As we continue to expand our business, we expect to grow our headcount and overall size of our operations significantly. To effectively manage our growth, we must continue to expand our operational, engineering and financial systems, procedures and controls and to improve our accounting and other internal management systems. This may require substantial managerial and financial resources, and our efforts in this regard may not be successful. Our current systems, procedures and controls may not be adequate to support our future operations. If we fail to adequately manage our growth, or to improve our operational, financial and management information systems, or fail to effectively motivate or manage our new and future employees, the quality of our products and the management of our operations could suffer, which could adversely affect our operating results. In addition, we intend to implement a new enterprise resource planning system for many aspects of our business. This implementation is a technically intensive process, requiring testing, modifications and project coordination. We may experience disruptions in our business operations related to this implementation effort.

Potential future acquisitions could be difficult to integrate, divert attention of key personnel, disrupt our business, dilute shareholder value and impair our operating results.

We have completed and may continue to pursue acquisitions in the future that we believe may complement our business, semiconductor solutions or technologies. For example, we acquired a team of 29 engineers, certain intellectual property and equipment from Hengfa Electronics Co., Ltd. in August 2012. Any acquisition involves a number of risks, many of which could harm our business, including:

 

   

difficulties in integrating the operations, technologies, products, existing contracts, accounting and personnel of the target company;

 

   

realizing the anticipated benefits of any acquisition;

 

   

difficulties in transitioning and supporting customers, if any, of the target company;

 

   

diversion of financial and management resources from existing operations;

 

   

the price we pay or other resources that we devote may exceed the value we realize, or the value we could have realized if we had allocated the purchase price or other resources to another opportunity;

 

   

potential loss of key employees, customers and strategic alliances from either our current business or the target company’s business;

 

   

assumption of unanticipated problems or latent liabilities, such as problems with the quality of the target company’s products;

 

   

inability to generate sufficient revenue to offset acquisition costs;

 

   

dilutive effect on our shares as a result of any equity-based acquisitions;

 

   

inability to successfully complete transactions with a suitable acquisition candidate; and

 

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in the event of international acquisitions, risks associated with accounting and business practices that are different from applicable U.S. practices and requirements.

Acquisitions also frequently result in the recording of goodwill and other intangible assets that are subject to potential impairments, which could harm our financial results. As a result, if we fail to properly evaluate acquisitions or investments, we may not achieve the anticipated benefits of any such acquisitions, and we may incur costs in excess of what we anticipate. The failure to successfully evaluate and execute acquisitions or investments or otherwise adequately address these risks could materially harm our business and financial results.

Our business, financial condition and results of operations could be adversely affected by political and economic conditions in the countries in which we conduct business and our solutions are sold.

Our business and operating results may be adversely impacted by political and economic conditions in various countries and markets in which we operate or in which our solutions are sold. Uncertainty about current global economic conditions may cause businesses to continue to postpone spending in response to tighter credit, unemployment or negative financial news. This in turn could have a material negative effect on the demand for our semiconductor solutions or the products into which our solutions are incorporated. The demand for our set-top box solutions is driven by consumer demand for television, which is often viewed as a discretionary item in the emerging markets that we compete. A downturn in general economic conditions in the emerging markets that we target could result in a decline in demand for our set-top box solutions. In addition, our memory interface solutions are typically sold into data centers when these data centers are upgrading capital equipment such as servers. A downturn in general economic conditions can lead to delays in decisions to upgrade data center equipment or a reduction in the scope of upgrades, which could reduce demand for our memory interface solutions.

Multiple factors relating to our international operations and to particular countries in which we operate could negatively impact our business, financial condition and results of operations. These factors include:

 

   

changes in political, regulatory, legal or economic conditions;

 

   

restrictive governmental actions, such as restrictions on the transfer or repatriation of funds and foreign investments and trade protection measures, including export duties and quotas and customs duties and tariffs;

 

   

disruptions of capital and trading markets;

 

   

changes in import or export requirements;

 

   

transportation delays;

 

   

civil disturbances or political instability;

 

   

geopolitical turmoil, including terrorism, war or political or military coups;

 

   

public health emergencies;

 

   

differing employment practices and labor standards;

 

   

limitations on our ability under local laws to protect our intellectual property;

 

   

local business and cultural factors that differ from our customary standards and practices;

 

   

nationalization and expropriation;

 

   

changes in tax laws;

 

   

currency fluctuations relating to our international operating activities; and

 

   

difficulty in obtaining distribution and support.

 

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We conduct our operations primarily in China, our products are manufactured in Asia, and our solutions are sold primarily in Asia. Political and economic conditions in these markets may be less stable or predictable than in the United States. Any conflict or uncertainty in Asia, and China in particular, including due to natural disasters, public health concerns, political unrest or safety concerns, could harm our business, financial condition and results of operations.

The facilities of our third-party contractors and distributors are located in regions that are subject to earthquakes and other natural disasters.

The facilities of our third-party foundries and contract manufacturers are subject to risk of catastrophic loss due to fire, flood or other natural or man-made disasters. A number of those foundries and service providers are located in areas with above average seismic activity and also subject to typhoons and other Pacific storms. Several foundries that manufacture our wafers are located in Taiwan and Japan, and all of the third-party service providers who assemble and test our solutions are located in Asia. The risk of an earthquake in the Pacific Rim region is significant due to the proximity of major earthquake fault lines. Both Japan and Taiwan have had major earthquakes within the last 15 years that significantly disrupted their economies. Any catastrophic loss to any of these facilities would likely disrupt our operations, delay production, shipments and revenue and result in significant expenses to repair or replace the facility.

Our sales in the set-top box market experience seasonality, which is likely to cause our revenue to fluctuate.

Revenue for our set-top box solutions experiences seasonality. We typically realize a large portion of our sales of set-top-box solutions during the fourth quarter prior to the Lunar New Year holiday. We typically experience our slowest quarter in the first quarter of each year. Accordingly, our results of operations may vary significantly from quarter to quarter and our yearly results of operations may be disproportionately affected by our results during the fourth quarter.

We are subject to risks related to exchange rate fluctuations.

Our revenue is primarily denominated in U.S. dollars, while a significant portion of our assets and expenses are denominated in Renminbi. As a result, our results of operations and financial condition are subject to risks associated with exchange rate fluctuations, in particular in relation to the exchange rates between the Renminbi and the U.S. dollar. Moreover, appreciation or depreciation in the value of the Renminbi, the functional currency for our operating subsidiaries in China, relative to the U.S. dollar would affect our financial results as reported in U.S. dollars without giving effect to any underlying change in our business or results of operations. Depreciation of the Renminbi against the U.S. dollar would have a negative effect on the U.S. dollar amount available to us if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes.

The value of the Renminbi against the U.S. dollar is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. The People’s Bank of China regularly intervenes in the foreign exchange market to limit fluctuations in Renminbi exchange rates and achieve policy goals. For example, from mid-2008 to mid-2010 the Renminbi traded within a narrow range against the U.S. dollar at approximately RMB6.83 per U.S. dollar. In June 2010, the People’s Bank of China announced the removal of the de facto peg. Following this announcement, the Renminbi has appreciated modestly. It is difficult to predict when and how Renminbi-U.S. dollar exchange rate may change going forward.

 

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Risk Factors Related to Regulations Applicable to Us

Our business has benefited from certain preferential tax treatment and government subsidies. Discontinuation or revocation of the preferential tax treatment and government subsidies available to us could decrease our net income and materially and adversely affect our financial condition and results of operations.

Under the PRC Enterprise Income Tax Law, or the PRC EIT Law, and its implementation rules, both effective on January 1, 2008, the PRC has a uniform enterprise income tax rate of 25% for all enterprises incorporated in China. The PRC EIT Law and its implementation rules also permit qualified high and new technology enterprises, or HNTEs, to enjoy a reduced 15% enterprise income tax rate. Our principal operating subsidiary in China, Montage Technology (Shanghai) Co., Ltd., or Montage Shanghai, had obtained the qualification certificate of HNTE status in October 2011 with a valid period of three years. Therefore it is eligible to enjoy a preferential tax rate of 15% as long as it maintains its qualification as an HNTE. Separately, pursuant to the Notice on Several Preferential Enterprise Income Tax Policies jointly issued by the Ministry of Finance, or the MOF, and the State Administration of Taxation, or the SAT, on February 22, 2008, and the Notice on Enterprise Income Tax Policies to Further Stimulate the Development of Software and Integrate Circuit Industries jointly issued by the MOF and the SAT on April 20, 2012, qualified integrated circuit design enterprises are entitled to a two-year income tax exemption followed by a three-year 50% enterprise income tax rate reduction commencing from the first profit-making year. Montage Shanghai was recognized as an integrated circuit design enterprise in January 2007 and has passed the annual inspections from 2007 through 2012. Therefore Montage Shanghai is eligible to enjoy the tax holiday from its first profit-making year as well. However, since this tax holiday for qualified integrated circuit design enterprises and the reduced 15% enterprise income tax rate for HNTEs are mutually exclusive, Montage Shanghai elected to enjoy the tax holiday from its first profit-making year, which was 2010. Accordingly, it is exempted from enterprise income tax for 2010 and 2011 and subject to enterprise income tax at a rate of 12.5% for 2012, 2013 and 2014 as long as it maintains its qualification as a qualified integrated circuit design enterprise. Similarly, Suzhou Montage Microelectronic Technology Co., Ltd. was recognized as an integrated circuit design enterprise in December 2012 and will enjoy this tax holiday when it starts to make profit after certain procedures are completed in competent tax authorities. Furthermore, according to the Notice on the Pilot Program in Shanghai Replacing Business Tax with Value-added Tax in Transportation and Some Modern Service Sectors jointly issued by the MOF and the SAT on November 16, 2011 which is effective in the areas where such pilot program is implemented, Montage Shanghai and Suzhou Montage Microelectronic Technology Co., Ltd. are currently exempted from value-added tax for their income generated from technical development.

In addition, Montage Shanghai has received subsidies from PRC local government authorities. The aggregate amounts of the subsidies we received were $1.1 million, $0.5 million and $0.8 million in 2010, 2011, and 2012, respectively, and $0.1 million and $0.9 million in the six months ended June 30, 2012 and 2013, respectively.

Preferential tax treatments and government subsidies are subject to review and may be adjusted or revoked at any time in the future. The discontinuation of any preferential tax treatments or government subsidies available to us will cause our effective tax rate to increase, which will decrease our net income and materially and adversely affect our financial condition and results of operations. In addition, the timing of receiving government subsidies can be difficult to predict and may be subject to change, which could lead to unexpected fluctuations in our results of operations.

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes under the PRC EIT Law. Such classification could result in unfavorable tax consequences to us and our non-PRC shareholders.

Under the PRC EIT Law, an enterprise established outside the PRC with “de facto management bodies” within the PRC should be considered a PRC “resident enterprise” and is generally subject to a uniform 25% enterprise income tax rate on its worldwide income. Under the implementing rules to the PRC EIT Law, a “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and properties of an enterprise. In addition, a circular issued by the SAT on April 22, 2009, or Circular 82 sets out the standards and procedures

 

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for recognizing the location of the “de facto management bodies” of an enterprise registered outside of the PRC and controlled by any PRC enterprise or enterprise group. Circular 82 specifies that certain PRC-controlled offshore enterprises will be classified as PRC resident enterprises if the following are located or resident in the PRC: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, the company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the senior management or directors having voting rights. On July 27, 2011, the SAT issued Administrative Measures of Enterprise Income Tax of Chinese-controlled Offshore Incorporated Resident Enterprises (Trial), or Bulletin 45, which became effective on September 1, 2011, to provide further guidance on the implementation of Circular 82. Bulletin 45 clarifies certain issues related to determining PRC resident enterprise status of PRC controlled enterprises, post-determination administration and which competent tax authorities are responsible for determining offshore incorporated PRC resident enterprise status. Bulletin 45 specifies that when provided with a copy of a Chinese tax resident determination certificate issued by the competent tax authorities from an offshore incorporated PRC resident enterprise, the payer should not withhold 10% income tax when paying Chinese-sourced dividends, interest and royalties to the offshore incorporated PRC resident enterprise.

Currently, a substantial majority of the members of our management team are located in China. However, Circular 82 applies only to offshore enterprises controlled by PRC enterprises or PRC corporate groups, not those controlled by PRC or foreign individuals or foreign enterprises like us. In the absence of detailed implementing regulations or other guidance determining that offshore companies controlled by PRC or foreign individuals or foreign enterprises like us are PRC resident enterprises, we do not currently consider our company or any of our overseas subsidiaries to be a PRC resident enterprise.

However, the SAT may take the view that the determining criteria set forth in Circular 82 reflects a general position on how the “de facto management body” test should be applied in determining the tax resident status of all offshore enterprises. Additional implementing regulations or guidance may also be issued determining that our Cayman Islands holding company or other non-PRC entity is a “resident enterprise” for PRC enterprise income tax purposes. If the PRC tax authorities determine that our company or any of our non-PRC subsidiaries is a PRC resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, our company or our subsidiaries outside of China will be subject to the uniform enterprise income tax rate of 25% as to our global income as well as tax reporting obligations. Second, although dividends paid by one PRC tax resident to another PRC tax resident should qualify as “tax-exempt income” under the PRC EIT Law, there is no assurance that we would enjoy such tax exempt treatment on dividends paid to us from Montage Shanghai. As a result, such dividend may continue to be subject to a 10% withholding tax. Finally, a 10% withholding tax will be imposed on dividends we pay to our non-PRC enterprise shareholders and gains derived by our non-PRC shareholders from transferring our ordinary shares. Similar results would follow if Montage Technology Holdings Company Limited or Montage Technology Hong Kong Limited is considered a PRC “resident enterprise.” In addition to the uncertainty in how the new “resident enterprise” classification could apply, it is also possible that the rules may change in the future, possibly with retroactive effect.

We may not be able to obtain certain treaty benefits on dividends paid by our PRC subsidiary, Montage Shanghai, to us through our Hong Kong Subsidiary.

Under the PRC EIT Law, dividends generated from retained earnings after January 1, 2008 from a PRC company to a foreign parent company are subject to a withholding tax rate of 10% unless the foreign parent’s jurisdiction of incorporation has a tax treaty with China that provides for a preferential withholding arrangement. Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income, or the Hong Kong Tax Treaty, which became effective on December 8, 2006, as amended, a company incorporated in Hong Kong, such as Montage Technology Hong Kong Limited, will be subject to withholding income tax at a rate of 5% on dividends it receives from its PRC subsidiary if it holds a 25% or more interest in that particular PRC subsidiary, or 10% if it holds less than a 25% interest in that subsidiary. On October 27, 2009, the SAT

 

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promulgated a tax notice or Circular 601, which provides that tax treaty benefits will be denied to “conduit” or shell companies without business substance, and a beneficial ownership analysis will be used based on a “substance-over-the-form” principle to determine whether or not to grant tax treaty benefits. On June 29, 2012, the SAT further issued the Announcement of the State Administration of Taxation regarding Recognition of “Beneficial Owner” under Tax Treaties, or Announcement 30, which provides that a comprehensive analysis should be made when determining the beneficial owner status based on various factors that are supported by various types of documents including the articles of association, financial statements, records of cash movements, board meeting minutes, board resolutions, staffing and materials, relevant expenditures, functions and risk assumption as well as relevant contracts, patent and copyright certificates and other information. As a result, although one of our PRC subsidiaries, Montage Shanghai, is currently wholly owned by our Hong Kong subsidiary Montage Technology Hong Kong Limited, we cannot assure you that we would be entitled to the tax treaty benefits and enjoy the favorable 5% rate applicable under the Hong Kong Tax Treaty on dividends payable by Montage Shanghai. If Montage Technology Hong Kong Limited cannot be recognized as the beneficial owner of the dividends to be paid by our PRC subsidiaries to us, such dividends will be subject to a normal withholding tax of 10% as provided by the PRC EIT Law.

We may be required by the PRC tax authorities to pay withholding tax on capital gains arising out of our restructuring in November 2010 and to pay fines or penalties for the failure to pay such withholding tax.

The Notice on Various Issues Concerning Enterprise Income Tax Treatment of Enterprise Restructuring Transactions, or Circular 59, which was jointly issued by the MOF and the SAT on April 30, 2009 and became effective retroactively on January 1, 2008, as well as subsequent rules issued by the SAT, provide for scrutiny by PRC tax authorities over the transfer of equity interests in a PRC resident enterprise by a non-resident enterprise. In November 2010, Montage Technology Group Limited transferred its 100% equity interest in Montage Shanghai to Montage Technology Hong Kong Limited at a price equal to the registered capital of Montage Shanghai without recognizing any gains. As a result of the par value consideration paid in this transaction, the PRC tax authorities may adjust the purchase price for PRC tax purposes, leading to a recognition of capital gains by Montage Technology Group Limited, unless the restructuring can be certified by the PRC tax authorities as a tax-free reorganization under Circular 59. We submitted the agreement relating to the November 2010 transaction to the PRC tax authorities as part of the process to register the shareholding change with the PRC tax authorities. Such registration was completed in 2010 and we have not received any further inquiry from the PRC tax authorities regarding the transaction. However, we have not sought, and do not plan to seek, certification of the transaction as a tax-free reorganization under Circular 59. As a result, there remains the possibility the PRC tax authorities will challenge the purchase price and subject the transaction to a pricing adjustment. The PRC tax authorities have dedicated teams that review tax filings to identify avoidance of tax liabilities. These reviews do not necessarily take place according to a regular schedule and may happen at any time. During the course of the reviews of our filings PRC tax authorities can and may raise questions regarding the November 2010 transaction, in which case we may be subject to further tax investigation and a special tax adjustment if they conclude that the price of the transaction was not determined based on arm’s-length principles. In such case, we may be required to pay PRC withholding tax on the capital gains at a tax rate of 10% and fines or penalties for the failure to pay such withholding tax.

Restrictions on currency exchange and cross-border capital flows into and outside of China may limit our ability to receive and use our revenue and the proceeds from this offering effectively.

Because a significant portion of our assets are held in China in Renminbi, any restrictions on currency exchange may limit our ability to convert our revenue generated in foreign currency into Renminbi to fund any business activities we may have in China or to make dividend payments in U.S. dollars. Renminbi is generally convertible for “current account transactions,” which include among other things dividend payments and payments for the import of goods and services. Although the Renminbi has been generally convertible for current account transactions since 1996, we cannot assure you that the relevant PRC government authorities will not limit or eliminate our ability to purchase and retain foreign currencies for current account transactions in the

 

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future. Conversion of Renminbi into foreign currency, and of foreign currencies into Renminbi, for payments relating to “capital account transactions,” which principally include capital injection and loans, remain subject to significant foreign exchange controls and restrictions. As a result, we may be unable to utilize our Renminbi assets for making any investments or other capital account transactions outside of China.

Current PRC regulations permit our subsidiaries in China to pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds until such reserves have reached at least 50% of their respective registered capital. These reserves are not distributable as cash dividends. Further, if our subsidiaries in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.

Any capital contributions or loans that our non-China entities make to our PRC subsidiaries, including from the proceeds of this offering, are subject to PRC regulations and approval requirements. Capital contributions and loans to our PRC subsidiaries must be approved by or registered with relevant PRC regulatory bodies. Although we currently do not intend to use any of the proceeds from this offering to fund our operations or capital expenditures in China or otherwise transfer our proceeds from this offering into China, we cannot assure you that we will be able to complete the necessary registration or obtain the necessary approval on a timely basis, if at all, if we make capital contributions or loans to our PRC subsidiaries in the future. If we fail to complete the necessary registration or obtain the necessary approval, our ability to make loans or capital contributions to our PRC subsidiaries may be negatively affected, which could adversely affect our PRC subsidiaries’ liquidity and their ability to fund their working capital and expansion projects and meet their obligations and commitments.

Furthermore, under the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-invested Enterprises, or Circular 142, promulgated by the PRC State Administration of Foreign Exchange, or SAFE, in August 2008, Renminbi converted from foreign exchange capital contributions can only be used for activities within the approved business scope of such foreign-invested enterprise and cannot be used for domestic equity investment unless otherwise approved by SAFE or its local branch. As a result, our PRC subsidiary, Montage Shanghai, (which is a foreign-invested enterprise) may not be able to use the proceeds of this offering or other capital contributed by us for equity investment or acquisitions in China or for other purposes outside of its approved scope of business, which may adversely affect our ability to expand our business in China. Violations of Circular 142 or related regulations could result in severe penalties, such as heavy fines.

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering; any requirement to obtain prior CSRC approval could delay this offering and failure to obtain this approval, if required, could have a material adverse effect on our business, operating results and reputation as well as the trading price of our ordinary shares, and could also create uncertainties for this offering.

On August 8, 2006, six PRC regulatory agencies, namely the PRC Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006 and was amended on June 22, 2009. This M&A Rule purports, among other things, to require offshore special purpose vehicles, or SPVs, formed for overseas listing purposes through acquisitions of PRC domestic companies and directly or indirectly controlled by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice on its official website specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. While the implementation of the M&A Rule remains unclear, we believe, based on the advice of our PRC counsel, Commerce & Finance Law Offices, that CSRC approval will not be applicable to us in the context of this offering because we established our PRC

 

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subsidiaries by means of direct investment to newly established entities rather than by merger or acquisition of PRC domestic companies or assets. However, as it is uncertain how the M&A Rule will be interpreted or implemented, we cannot assure you that the relevant PRC government agency, including the CSRC, or PRC courts would reach the same conclusion as our PRC counsel. If the CSRC or other PRC regulatory agencies subsequently determine that we need to obtain the CSRC’s approval for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies. In such event, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ordinary shares. The CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ordinary shares offered by this prospectus.

The M&A Rules establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

The M&A Rules establish procedures and requirements that could make some acquisitions of Chinese companies by foreign investors more time-consuming and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a Chinese domestic enterprise. We may expand our business in part by acquiring complementary businesses. Complying with the requirements of the M&A Rules to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

We could be subject to penalties under PRC law if our PRC shareholders do not comply with PRC regulations relating to offshore investment activities by PRC residents.

SAFE promulgated in October 2005 the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Round-trip Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Circular 75, which requires PRC residents to register with local branches of SAFE if they use assets or equity interests in PRC entities as capital contributions to establish offshore companies, or if they inject assets or equity interests of their PRC entities into offshore companies to raise capital overseas (defined in Circular 75 as “round trip investment”). In addition, any PRC resident who makes, or has previously made, direct or indirect investments in such an offshore company (defined in Circular 75 as an “offshore special purpose company”) is required to further update that registration for such things as increases or decreases in the offshore special purpose company’s share capital, transfers or swaps of its shares, mergers, long-term equity or debt investments, and the creation of any security interest. Moreover, the PRC subsidiaries of that offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore special purpose company’s shareholders who are PRC residents, and do so in a timely manner. However, pursuant to the Operating Rules for Foreign Exchange Issues with Regard to Direct Investment under Capital Account, or the Operating Rules, an appendix to the Notice on Further Improving and Adjusting Foreign Exchange Administration Policies on Direct Investment promulgated by SAFE on November 19, 2012, if a PRC resident individual makes direct investments into China through an overseas enterprise that is not an offshore special purpose company as defined in Circular 75, the PRC resident is not required to carry out registration procedures for offshore special purpose companies.

Although we believe the registration for offshore special purpose companies under Circular 75 does not apply to our beneficial owners who are PRC resident individuals because it was a direct investment into China through an overseas enterprise that is not an offshore special purpose company as defined in Circular 75, these individuals are generally required under the general PRC foreign exchange regulations, such as Administrative Measures for Personal Foreign Exchange and its Implementing Rules promulgated by SAFE in 2006 and 2007 respectively, to conduct registration with the competent SAFE authority for any offshore direct investment,

 

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including by subscribing for shares in our offshore holding companies. Due to a lack of detailed implementation rules of such registration requirements and uncertainty in implementation and interpretation of the above general SAFE regulations, our beneficial owners who are PRC resident individuals have not yet conducted foreign exchange registration for offshore direct investment. In addition, the Operating Rules require that, in the case of direct investment into China through an overseas enterprise that is not an offshore special purpose company as defined in Circular 75, the PRC foreign-invested subsidiaries of such overseas enterprise should complete procedures with SAFE or its local branch to be marked as non-round trip investment by individuals. Due to the lack of detailed implementation rules with respect to such procedures, we have not submitted such request to the local SAFE authority yet. If SAFE takes a view that our beneficial owners who are PRC residents or our PRC subsidiaries have not complied with SAFE rules, we could be subject to legal sanctions, such as being prohibited from making distributions of profits or proceeds from any reduction in capital, share transfer or liquidation to our offshore entities or injecting additional capital into our PRC subsidiaries.

All employee participants in our option plan who are PRC citizens may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional option plans for our directors and employees under PRC law.

PRC regulations require that individuals in China (including PRC citizens and foreign individuals who have lived in China over one year) who intend to participate in the share incentive plan of an overseas listed company shall appoint a qualified PRC domestic agent or a PRC subsidiary of such overseas listed company (defined as a “PRC agency”) to conduct foreign exchange registration, opening of accounts and transfer and exchange of funds, and an overseas agency shall be appointed to conduct any exercise of options, buying and selling of relevant shares or equities and transfer of relevant funds. After such individuals’ foreign exchange income received from participation in the share incentive plan is remitted to PRC, relevant banks shall distribute the above funds from the account opened and managed by the PRC agency to such individuals’ foreign exchange accounts. We and our PRC employees who have been granted share options or restricted shares will be subject to these regulations upon the completion of this offering. We intend to comply with these regulations upon completion of this offering.

Failure to comply with such registration requirements may subject us and the participants of share incentive plan who are in the PRC to fines and legal sanctions, prevent us from further granting or exercising of options by our employees in China, or limit our ability to contribute additional capital into our PRC subsidiaries, limiting our PRC subsidiaries’ ability to distribute dividends to us, which could adversely affect our business operations. In addition, several of our employees in China have exercised their share options or received restricted shares under our 2006 Share Incentive Plan prior to our becoming a publicly listed company. Since there is not yet a clear regulation on how and whether individuals in China can exercise their share options or hold restricted shares granted by overseas private companies, we cannot assure you that SAFE will not take a view that we or our employees who are PRC individuals and have exercised the option or received the restricted shares violated SAFE regulations.

The enforcement of the PRC Labor Contract Law and other labor-related regulations in the PRC may adversely affect our business and our results of operations.

The PRC Labor Contract Law, which became effective on January 1, 2008, and its implementing rules impose requirements concerning contracts entered into between a PRC employer and its employees and establishes time limits for probationary periods and for how long an employee can be placed in a fixed-term labor contract. Because the Labor Contract Law and its implementing rules have not been in effect very long and because there is lack of clarity with respect to their implementation and potential penalties and fines, there may be a risk that certain of our employment policies and practices could be determined by relevant PRC authorities as being in violation the Labor Contract Law or its implementing rules, which could result in penalties, fines or other sanctions. If we are subject to large penalties or fees related to the Labor Contract Law or its implementing rules, our business, financial condition and results of operations may be materially and adversely affected. Furthermore, the PRC Labor Contract Law and subsequently passed rules and regulations have tended to provide greater rights to employees and impose more onerous requirements on employers in China. As a result of regulations designed to enhance labor protection, our labor costs in China may increase in the future.

 

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We will be subject to additional regulatory compliance requirements, including Section 404 of the Sarbanes-Oxley Act of 2002, as a result of becoming a public company.

We have never operated as a public company and will incur significant legal, accounting and other expenses that we did not incur as a private company. The individuals who constitute our management team have limited experience managing a publicly traded company, and limited experience complying with the increasingly complex and changing laws pertaining to public companies. Our management team and other personnel will need to devote a substantial amount of time to new compliance initiatives and we may not successfully or efficiently manage our transition into a public company. We expect rules and regulations such as the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, to increase our legal and finance compliance costs and to make some activities more time-consuming and costly. We will need to hire a number of additional employees with public accounting and disclosure experience in order to meet our ongoing obligations as a public company. For example, Section 404 of the Sarbanes-Oxley Act requires that our management report on the effectiveness of our internal control over financial reporting in our Annual Report on Form 10-K for the fiscal year ending December 31, 2014. Moreover, when we are no longer an emerging growth company under the federal securities laws, our independent registered public accounting firm will be required to issue an attestation report on the effectiveness of our internal control over financial reporting. Section 404 compliance may divert internal resources and will take a significant amount of time and effort to complete. We may not be able to successfully complete the procedures and certification and attestation requirements of Section 404 by the time we will be required to do so. If we fail to do so, or if in the future our Chief Executive Officer, Chief Financial Officer or independent registered public accounting firm determines that our internal control over financial reporting is not effective as defined under Section 404, this could result in material misstatements of our financial statements and we could be subject to sanctions or investigations by the NASDAQ Global Market, the Securities and Exchange Commission, or the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our shares. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors.

We are an “emerging growth company” and may elect to comply with reduced public company reporting requirements applicable to emerging growth companies, which could make our ordinary shares less attractive to investors.

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act enacted in April 2012, and, for as long as we continue to be an “emerging growth company” we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We could be an “emerging growth company” for up to five years, although, if the market value of our ordinary shares that is held by non-affiliates exceeds $700 million as of any June 30 before the end of that five-year period, we would cease to be an “emerging growth company” as of the following December 31. We cannot predict if investors will find our ordinary shares less attractive if we choose to rely on these exemptions. If some investors find our ordinary shares less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our ordinary shares and our share price may be more volatile.

Under the Jumpstart Our Business Startups Act, “emerging growth companies” can delay adopting new or revised accounting standards until such time as those standards apply to private companies. However, we have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not “emerging growth companies.”

 

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Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by Public Company Accounting Oversight Board, and as such, investors may be deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit reports included in this prospectus filed with the SEC, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditor is located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the PRC authorities, our auditor, like other independent registered public accounting firms operating in China, is currently not inspected by the PCAOB. On May 24, 2013, the PCAOB announced that it had entered into a memorandum of understanding on enforcement cooperation with the CSRC, and the MOF that establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China. However, direct PCAOB inspections of independent registered accounting firms in China are still not permitted by Chinese authorities.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The inability of the PCAOB to conduct inspections of independent registered public accounting firms operating in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

Proceedings instituted recently by the SEC against five PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Securities Exchange Act of 1934.

In December 2012, the SEC instituted proceedings under Rule 102(e)(1)(iii) of the SEC’s Rules of Practice against five PRC-based accounting firms, including our independent registered public accounting firm, alleging that these firms had violated U.S. securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ work papers related to their audits of certain PRC-based companies that are publicly traded in the United States. The order instituting these proceedings requires the administrative law judge presiding over the proceedings to issue an initial decision no later than 300 days from the date of service of the order. Rule 102(e)(1)(iii) grants to the SEC the authority to deny to any person, temporarily or permanently, the ability to practice before the SEC who is found by the SEC, after notice and opportunity for a hearing, to have willfully violated any such laws or rules and regulations. While we cannot predict the outcome of the SEC’s proceedings, if our independent registered public accounting firm were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to find timely another registered public accounting firm which can audit and issue a report on our financial statements, our financial statements could be determined to not be in compliance with the requirements for financial statements of public companies with a class of securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such a determination could ultimately lead to the delisting of our ordinary shares from the NASDAQ Global Market, which event would effectively terminate the trading market for our ordinary shares in the United States, and/or to the SEC’s revoking the registration of our ordinary shares under the Exchange Act pursuant to Section 12(j) thereof, in which event broker-dealers thereafter would be prohibited from effecting transactions in, or inducing the purchase or sale of, our ordinary shares in the United States.

Risk Factors Related to This Offering and Ownership of Our Ordinary Shares

There has been no prior market for our ordinary shares and the offering may not result in an active or liquid market for our ordinary shares, which could adversely affect the market price of our ordinary shares.

Prior to this offering, there has not been a public market for our ordinary shares. We have applied to list our ordinary shares on the NASDAQ Global Market. However, an active public market may not develop or be

 

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sustained after the offering. If an active market for our ordinary shares does not develop after the offering, the market price and liquidity of our ordinary shares may be adversely affected.

If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our shares adversely, our share price and trading volume could decline.

The trading market for our ordinary shares will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us downgrade our shares, our share price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our share price or trading volume to decline.

Substantial future sales of our ordinary shares in the public market could cause our share price to fall.

Additional sales of our ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ordinary shares to decline. Upon the completion of this offering, we will have approximately 26,479,343 ordinary shares outstanding. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, or the Securities Act, except for any shares held by our affiliates as defined in Rule 144 under the Securities Act. The remaining shares outstanding after this offering will be eligible for sale at various times beginning 180 days after the date of this prospectus upon the expiration of lock-up agreements as described below and subject to vesting requirements and the requirements of Rule 144 or Rule 701.

Our directors, executive officers and substantially all of our shareholders have agreed with limited exceptions that they will not sell any of our shares owned by them without the prior written consent of Deutsche Bank Securities Inc. and Barclays Capital Inc., on behalf of the underwriters, for a period of 180 days from the date of this prospectus. At any time and without public notice, Deutsche Bank Securities Inc. and Barclays Capital Inc. may in their sole discretion release some or all of the securities from these lock-up agreements prior to the expiration of the lock-up period. As resale restrictions end, the market price of our ordinary shares could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. In addition, after this offering, the holders of approximately 18,539,242 of our ordinary shares, including ordinary shares to be issued upon the conversion of the preferred shares, assuming the underwriters do not exercise their over-allotment option, will be entitled to contractual rights to cause us to register the sale of those shares under the Securities Act. All of these shares are subject to the 180-day lock-up period. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration statement. We also intend to file a registration statement on Form S-8 under the Securities Act to register approximately ordinary shares underlying options or other share awards which have been granted or may be granted in the future under our 2006 Share Incentive Plan or our 2013 Performance Incentive Plan.

You may face difficulties in protecting your interests as a shareholder, as Cayman Islands law provides substantially less protection when compared to the laws of the United States.

Our corporate affairs are governed by our amended and restated memorandum and articles of association and by the Companies Law (Revised) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands have a less developed body of securities laws as compared to

 

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the United States, and provide significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the United States federal courts.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against us or our officers, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

Certain judgments obtained against us by our shareholders may not be enforceable.

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. A significant portion of our assets and operations are conducted in the China and substantially all of our revenue has been generated outside the United States, particularly through sales in Hong Kong. In addition, some of our current directors and officers are nationals and residents of countries other than the United States and may have a substantial portion or all of their assets outside of the United States. Substantially all of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the United States federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. Moreover, the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities” section in this prospectus.

We have no specific business plan for the net proceeds from this offering. Our management will therefore have significant flexibility in using the net proceeds of this offering, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately.

We intend to use the net proceeds from this offering for general corporate purposes, including working capital for our operating subsidiaries outside China, as well as funding our research and development activities and making payments to our suppliers overseas. We may also use a portion of the net proceeds to acquire or invest in businesses, products and technologies that we believe will complement our business. However, depending on future developments and circumstances, we may use some of the proceeds for other purposes. We do not have more specific plans for the net proceeds from this offering. Therefore, our management will have significant flexibility in applying the net proceeds we receive from this offering. The net proceeds could be applied in ways that do not improve our operating results. The actual amounts and timing of these expenditures will vary significantly depending on a number of factors, including the amount of cash used in or generated by our operations and the market response to the introduction of any new product offerings.

Our articles of association contain anti-takeover provisions that could adversely affect the rights of our shareholders.

Our amended and restated articles of association that will take effect upon completion of this offering contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions, including, among other things:

 

   

provisions that authorize our board of directors, without action by our shareholders, to issue additional ordinary shares and preferred shares with preferential rights determined by the board;

 

   

provisions that permit only a majority of our board or the chairman of the board to call shareholder meetings and therefore do not permit shareholders to call shareholder meetings;

 

   

provisions that impose advance notice requirements, minimum shareholding periods and ownership thresholds, and other requirements and limitations on the ability of shareholders to propose matters for consideration at shareholder meetings; and

 

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establishment of a staggered board whereby our directors are divided into three classes, with each class subject to retirement and re-election once every three years on a rotating basis, while any director that simultaneously serves as our chief executive officer is not subject to retirement or re-election.

These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. With our staggered board, at least two annual shareholder meetings are generally required in order to effect a change in a majority of our directors. Our staggered board can discourage proxy contests for the election of our directors and purchases of substantial blocks of our shares by making it more difficult for a potential acquirer to gain control of our board in a relatively short period of time.

We are a foreign private issuer within the meaning of the rules under the Securities Exchange Act of 1934, as amended, and as such we are exempt from certain provisions applicable to United States domestic public companies.

We are a foreign private issuer within the meaning of the rules under the Securities Exchange Act of 1934, as amended, or the Exchange Act. As such, we are exempt from certain provisions applicable to United States domestic public companies. For example:

 

   

we are not required to provide as many Exchange Act reports, or as frequently, as a domestic public company;

 

   

we are not required to provide the same level of disclosure on certain issues, such as executive compensation;

 

   

for interim reporting, we are permitted to comply solely with our home country requirements, which are less rigorous than the rules that apply to domestic public companies;

 

   

we are not required to comply with the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; and

 

   

we are not required to comply with Section 16 of the Exchange Act requiring insiders to file public reports of their share ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction.

We currently intend to file annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K similar to U.S. domestic reporting companies and disclose the information required to be disclosed in those reports. However, we may elect in the future to file annual reports on Form 20-F and reports on Form 6-K as a foreign private issuer. If we elected to file reports as a foreign private issuer, our shareholders may not have access to certain information they may deem important.

Being a public company will increase our costs, which could adversely affect our business.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company, which could be a few million dollars or more. In addition, the Sarbanes-Oxley Act of 2002, as well as rules implemented by the SEC, require certain corporate governance practices for public companies. In addition to these rules, the NASDAQ Global Market has certain corporate governance requirements for companies that are listed on NASDAQ. Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, may also cause us to incur additional costs and subject us to risks if we are unable to fully comply. For instance, the SEC adopted new disclosure requirements in 2012 as part of implementation of the Dodd-Frank Act regarding the use of conflict minerals mined from the Democratic Republic of Congo and adjoining countries and procedures regarding a manufacturer’s efforts to prevent the sourcing of such conflict minerals. The implementation of these requirements, which will require reporting starting in 2014, could adversely affect our costs and our relationships with customers and suppliers as we must obtain additional information from them to ensure our compliance with the disclosure requirement.

 

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We expect these rules and regulations to increase our legal and financial compliance costs, and to make some operating and administrative activities more time consuming and costly, though we are not currently able to estimate these additional costs. In anticipation of becoming a public company, we have created several board committees, adopted additional internal controls and disclosure controls and procedures and will have to bear all of the internal and external costs of preparing and distributing periodic public reports. We also expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers.

We do not currently intend to pay dividends on our ordinary shares and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our ordinary shares.

We have never declared or paid any cash dividends on our ordinary shares and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your ordinary shares for the foreseeable future and the success of an investment in our ordinary shares will depend upon any future appreciation in their value. There is no guarantee that our ordinary shares will appreciate in value or even maintain the price at which our shareholders have purchased their shares.

Investors in this offering will pay a much higher price than the book value of our ordinary shares, and therefore, they will experience immediate dilution.

The initial public offering price of our ordinary shares will be $9.01 higher than our pro forma net tangible book value per share, based on an assumed initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus. As a result, investors purchasing our ordinary shares in this offering will incur immediate and substantial dilution. In the past, we issued preferred shares that are convertible into our ordinary shares and issued share options to acquire our ordinary shares at prices significantly below the initial public offering price. To the extent these outstanding options are ultimately exercised, there will be further dilution to investors.

We may be classified as a passive foreign investment company, or PFIC, which could result in adverse United States federal income tax consequence to U.S. holders of ordinary shares.

Depending upon the value of our ordinary shares and the nature and composition of our income and assets over time, we could be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for any taxable year. Based on assumptions as to our projections of the value of our outstanding ordinary shares and our expected use of the proceeds from the initial public offering and of the other cash that we will hold and generate in the ordinary course of our business, we do not expect to be a PFIC for the taxable year 2013 or in the foreseeable future. However, there can be no assurance that we will not be a PFIC for the taxable year 2013 or any future taxable year as PFIC status is tested each taxable year and depends on the composition of our income and the value of our assets in such taxable year. Our PFIC status for the current taxable year 2013 will not be determinable until the close of the taxable year ending December 31, 2013.

We will be classified as a PFIC for any taxable year if either (i) at least 75% of our gross income for the taxable year is passive income or (ii) at least 50% of the value of our assets (based on a quarterly value of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. In determining the average percentage value of our gross assets, the aggregate value of our assets will generally be deemed to be equal to our market capitalization (determined by the sum of the aggregate value of our outstanding equity) plus our liabilities. Therefore, a drop in the market price of our ordinary shares would cause a reduction in the value of our non-passive assets for purposes of the asset test. Accordingly, we would likely become a PFIC if our market capitalization were to decrease significantly while we hold substantial cash. As we have not designated specific uses for all of the net proceeds we receive from this offering, we may retain a

 

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significant portion of those net proceeds in the form of short-term investments or bank deposits for a prolonged period, which could affect our PFIC status in future years. For further details on our intended use of the net proceeds we receive from this offering, see “Use of Proceeds.”

If we are classified as a PFIC in any taxable year in which you hold our ordinary shares, and you are a U.S. taxpayer, you would generally be subject to additional taxes and interest charges on certain “excess” distributions we make and on any gain recognized on the disposition or deemed disposition of your ordinary shares in a later year, even if we are not a PFIC in the year of disposition or distribution. Moreover, if we are classified as a PFIC in any taxable year in which you hold our ordinary shares, certain non-corporate U.S. shareholders would not be able to benefit from any preferential tax rate with respect to any dividend distribution received from us in that year or in the following year. Finally, you would also be subject to special U.S. tax reporting requirements. For more information on the U.S. tax consequences to you that would result from our classification as a PFIC, see “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. The statements are found, among other places, in the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Industry,” “Business,” “Regulation” and “Management.” In some cases, these forward-looking statements can be identified by words and phrases such as “may,” “should,” “intend,” “predict,” “potential,” “continue,” “will,” “expect,” “anticipate,” “estimate,” “plan,” “believe,” “is/are likely to” or the negative form of these words and phrases or other comparable expressions. The forward-looking statements included in this prospectus relate to, among other things:

 

   

our goals and strategies;

 

   

our future business development;

 

   

the expected growth of, and trends in, our business and the markets in which we operate;

 

   

our expectations regarding competition as more semiconductor companies enter our markets and as existing competitors improve or expand their product offerings;

 

   

our plans for future products and solutions, such as DDR4 memory interface solutions, and enhancements of existing products;

 

   

future trends and challenges and our expectations regarding our results of operations and financial condition;

 

   

our expectations regarding our expenses and revenue, including our expectations that our research and development, sales and marketing and general and administrative expenses may increase in absolute dollars; and

 

   

relevant government policies and regulations relating to our industry and business.

These forward-looking statements are based on our current expectations, assumptions, estimates and projections about us and our industry and involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, we cannot assure you that our expectations will turn out to be correct. Our actual results could be materially different from our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in the “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this prospectus.

This prospectus also contains third-party data relating to the markets in which we operate that includes projections based on a number of assumptions. We have not independently verified such data. Our markets may not grow at the rates projected by market data, or at all. The failure of our markets to grow at the projected rates may have a material adverse effect on our business and the market price of our ordinary shares. Furthermore, if any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements. In addition, the relatively new and rapidly changing nature of these markets subjects any projections or estimates relating to the growth prospects or future condition of these markets to significant uncertainties.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this prospectus.

 

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MARKET AND INDUSTRY DATA

This prospectus contains information and industry data from China Digital STB Market Forecast and Detail Analysis of Chipset Market Share, an industry report commissioned by us and prepared by iSuppli Corporation, a third-party market research firm, in March 2013. All references to data from iSuppli in this prospectus are to data derived from these commissioned reports. In addition, this prospectus contains information and industry data from LR-DIMM: Market Forecast, an industry report commissioned by us and prepared by Jon Peddie Research, a third-party market research firm, in July 2013. This prospectus also contains statistical data and estimates, including those relating to market size, future performance and growth rates of the markets in which we participate, that we obtained from industry publications and reports generated by Cisco Systems, Inc., Gartner, Inc. and International Data Corporation. Although we have assessed the third-party information and found it to be reasonable and believe the publications are reliable, we have not independently verified their data.

All references to data from Gartner in this prospectus are to data derived from “Forecast: Electronic Equipment Production and Semiconductor Consumption by Application, Worldwide, 2010-2016, 4Q12 Update”, or the Gartner Report, published by Gartner on December 21, 2012. The Gartner Report represents data, research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, and are not representations of fact. The Gartner Report speaks as of its original publication date and not as of the date of this prospectus, and the opinions expressed in the Gartner Report are subject to change without notice.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately $61.6 million, after deducting underwriting discounts and commissions and estimated offering expenses payable by us and assuming an initial public offering price of $13.00 per ordinary share, the midpoint of the price range set forth on the cover page of this prospectus. Assuming the number of ordinary shares offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and estimated offering expenses payable by us, a $1.00 increase (decrease) in the assumed initial public offering price of $13.00 per ordinary share would increase (decrease) the net proceeds to us of this offering by approximately $5.0 million. We may also increase or decrease the number of ordinary shares we are offering. An increase (decrease) of 1.0 million ordinary shares in the number of ordinary shares offered by us would increase (decrease) the net proceeds to us by $12.1 million, assuming an initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of ordinary shares by the selling shareholders, although we will bear the costs, other than the underwriting discounts and commissions, associated with the sale of these shares.

The primary purposes of this offering are to obtain additional equity capital, create a public market for our ordinary shares, and facilitate future access to capital via public markets. We expect to use the net proceeds from this offering, together with available funds, for general corporate purposes, including working capital for our operating subsidiaries outside China and making payments to our suppliers overseas, capital expenditures relating to the expansion of our operations, and funding possible future acquisitions. We have not determined any particular capital expenditures for which we will use the net proceeds, and the timing and size of our particular capital expenditure needs may change rapidly in response to perceived market opportunities, technological changes and actions by our competitors. We do not currently have any agreements or understandings for material acquisitions for which we intend to allocate a portion of the net proceeds. Therefore, our management is currently unable to allocate any specific portions of the net proceeds for particular uses. We currently do not intend to use any proceeds from the offering to fund our operations or capital expenditures in China or otherwise transfer the proceeds into China.

Pending our use of the net proceeds we receive from this offering, we intend to invest our net proceeds in short-term investment grade debt securities or to deposit the proceeds into interest-bearing bank accounts.

In utilizing the proceeds of this offering, we, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries only through loans or capital contributions and to our consolidated affiliated entities only through loans, in each case subject to satisfaction of applicable government registration and approval requirements. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. Currently, the working capital requirements of our PRC subsidiaries are primarily funded by their operating income generated from providing services to our non-PRC operating entities, including research and development and marketing services. We expect our PRC operating subsidiaries to continue to fund their working capital requirements in this manner for the foreseeable future.

Our plans for the proceeds of this offering are subject to change due to unforeseen events and opportunities, and the amounts and timing of our actual expenditures depend on several factors, including our expansion plans and the amount of cash generated or used by our operations. Other than as described above, we cannot specify with certainty the particular uses for the net proceeds to be received upon the completion of this offering. Accordingly, our management will have broad discretion in the application of the net proceeds we receive from our public offering, and investors will be relying on the judgment of our management regarding the application of the net proceeds.

 

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DIVIDEND POLICY

We have never declared or paid any dividends in the past and we do not have any plan to declare or pay any dividends in the near future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

 

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CAPITALIZATION

The following table describes our capitalization as of June 30, 2013:

 

   

on an actual basis;

 

   

on a pro forma basis, giving effect to the automatic conversion of all outstanding convertible preferred shares into 16,163,598 ordinary shares; and

 

   

on a pro forma as adjusted basis to reflect, in addition, the sale by us of 5,325,000 ordinary shares in this offering at an assumed initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

You should read the following table together with our consolidated financial statements and the related notes appearing elsewhere in this prospectus and the sections of this prospectus titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Selected Consolidated Financial and Operating Data.”

     As of June 30, 2013  
     Actual     Pro
Forma
    Pro Forma as
Adjusted (1)
 
     (unaudited)     (unaudited)     (unaudited)  
     (in thousands, except per share data)  

Convertible preferred shares, par value $0.0125 per share: 17,604,639 shares authorized, 15,944,528 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma (unaudited) and pro forma as adjusted (unaudited)

   $ 54,400      $ —        $ —     

Shareholders’ equity:

      

Ordinary shares, par value $0.0125 per share: 26,804,639 shares authorized, 4,641,525 shares issued and outstanding, actual; 44,409,278 shares authorized, 20,805,123 shares issued and outstanding, pro forma (unaudited); 26,130,123 shares issued and outstanding, pro forma as adjusted (unaudited) 

     58        260        327   

Additional paid-in capital

     2,343        56,541        118,033   

Accumulated comprehensive income

     2,018        2,018        2,018   

Statutory reserve

     740        740        740   

Accumulated deficit

     (15,627     (15,627     (15,627
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity (deficit)

     (10,468     43,932        105,491   
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ 43,932      $ 43,932      $ 105,491   
  

 

 

   

 

 

   

 

 

 

 

(1) A $1.00 increase (decrease) in the assumed initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by $5.0 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions. Each increase (decrease) of 1.0 million shares in the number of shares offered by us would increase (decrease) cash and cash equivalents, additional paid-in capital, total shareholders’ equity and total capitalization by approximately $12.1 million assuming a price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and terms of this offering determined at pricing.

On September 6, 2013, our shareholders approved and effected a reverse share split such that every 2.5 issued and unissued ordinary and preferred shares of par value $0.005 were consolidated into one share of $0.0125 par value each, and the number of our authorized ordinary shares and preferred shares were reduced from 67,011,599 and 44,011,599 to 26,804,639 and 17,604,639. All data in the above table are presented as if the reverse share split had occurred from our inception.

 

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DILUTION

If you invest in our ordinary shares in this offering, your ownership interest will be diluted to the extent of the difference between the initial public offering price per share of our ordinary shares and the pro forma as adjusted net tangible book value per share of our ordinary shares immediately after this offering. Net tangible book value dilution per ordinary share to new investors represents the difference between the amount per share paid by purchasers of ordinary shares in this offering and the pro forma as adjusted net tangible book value per ordinary share immediately after completion of this offering.

Net tangible book value per share is determined by dividing our total tangible assets less our total liabilities by the number of ordinary shares outstanding. Our historical net tangible book value as of June 30, 2013 was a deficit of $11.8 million, or $2.53 per share. Our pro forma net tangible book value as of June 30, 2013 was $42.6 million, or $2.05 per share, based on the total number of shares of our ordinary shares outstanding as of June 30, 2013, after giving effect to the conversion of all outstanding shares of our preferred shares into ordinary shares assuming the conversion immediately upon to the completion of this offering.

After giving effect to our sale of ordinary shares in this offering at an assumed initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2013 would have been $104.3 million, or $3.99 per share. This represents an immediate increase in net tangible book value of $1.94 per share to existing shareholders and an immediate dilution in net tangible book value of $9.01 per share to purchasers of ordinary shares in this offering, as illustrated in the following table:

 

Assumed initial public offering price per share

      $ 13.00   

Pro forma net tangible book value per share as of June 30, 2013

   $ 2.05      

Increase in pro forma net tangible book value per share attributable to new investors

     1.94      
  

 

 

    

Pro forma as adjusted net tangible book value per share after this offering

        3.99   
     

 

 

 

Dilution per share to investors in this offering

      $ 9.01   
     

 

 

 

Each $1.00 increase (decrease) in the assumed public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by approximately $5.0 million, or approximately $0.19 per share, and the pro forma dilution per share to investors in this offering by approximately $0.81 per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of 1.0 million shares in the number of shares offered by us would result in a pro forma as adjusted net tangible book value of approximately $116.4 million, or $4.29 per share, and the pro forma dilution per share to investors in this offering would be $8.71 per share. Similarly, a decrease of 1.0 million shares in the number of shares offered by us would result in a pro forma as adjusted net tangible book value of approximately $92.2 million, or $3.67 per share, and the pro forma dilution per share to investors in this offering would be $9.33 per share.

The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ordinary shares and other terms of this offering determined at pricing.

The following table summarizes on a pro forma basis the differences as of June 30, 2013 between the shareholders at June 30, 2013 and the new investors with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per ordinary share paid. The information in the

 

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following table is illustrative only and the total consideration paid and the average price per ordinary share is subject to adjustment based on the actual initial public offering price of our ordinary shares and other terms of this offering determined at pricing.

 

     Ordinary Shares Purchased     Total
Consideration(1)
    Average
Price Per
Ordinary
Share
 
         Number              Percent         Amount      Percent    

Existing shareholders

     20,805,123         80     43,677,948         39     2.10   

New investors

     5,325,000         20     69,225,000         61     13.00   
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

     26,130,123         100     112,902,948         100     4.32   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

(1) Each $1.00 increase (decrease) in the assumed initial public offering price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the total consideration paid by new investors and total consideration paid by all shareholders by $5.3 million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. An increase (decrease) of 1.0 million shares in the number of shares offered by us would increase (decrease) the total consideration paid by new investors and total consideration paid by all shareholders by $13.00 million assuming a price of $13.00 per share, the midpoint of the price range set forth on the cover page of this prospectus.

The discussion and tables above also do not take into consideration any of our outstanding share options or unvested restricted shares. As of June 30, 2013, there were 3,763,760 ordinary shares issuable upon the exercise of outstanding share options and 315,400 unvested restricted shares. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth our selected consolidated financial data for the periods and as of the dates indicated. Our selected consolidated financial data for each of the years ended December 31, 2010, 2011 and 2012 and selected consolidated balance sheet data as of December 31, 2011 and 2012 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. Our selected consolidated financial data for the six months ended June 30, 2012 and 2013 and selected consolidated balance sheet data as of June 30, 2013 have been derived from our unaudited consolidated financial statements, which are included elsewhere in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in the opinion of management, reflect all adjustments, which consist only of normal recurring adjustments, necessary for the fair statement of those unaudited consolidated financial statements.

The historical results presented below are not necessarily indicative of the results to be expected for any future period. The following summaries of our consolidated financial data for the periods presented should be read in conjunction with “Risk Factors,” “Selected Consolidated Financial and Operating Data,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes, which are included elsewhere in this prospectus.

 

     Year Ended December 31,     Six Months Ended June 30,  
     2010     2011     2012             2012                      2013          
    

(in thousands, except share and per share data) (unaudited)

 

Selected Statement of Operations Data:

           

Revenue

   $ 29,078      $ 50,338      $ 78,245      $ 33,937       $ 45,392   

Cost of revenue(1)

     (21,248     (22,840     (31,736     (13,691)         (16,589
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross profit

     7,830        27,498        46,509        20,246         28,803   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating expense:

           

Research and development(1)

     (11,078     (13,651     (17,568     (8,469)         (12,473

Sales, general and administrative(1)

     (5,046     (5,895     (9,792     (3,232)         (6,801
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expense

     (16,124     (19,546     (27,360     (11,701)         (19,274
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) from operations

     (8,294     7,952        19,149        8,545         9,529   

Interest income (expense), net

     (44     (36     207        4         302   

Fair value change in warrant liability

     (37     —          —          —           —     

Other income (expense), net

     (114     (307     153        233         (87
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     (8,489     7,609        19,509        8,782         9,744   

Provision for income tax

     (54     (2,637     (1,228     (553)         (972
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (8,543   $ 4,972      $ 18,281      $ 8,229       $ 8,772   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) attributable to ordinary shareholders—Basic

   $ (11,056   $ 77      $ 3,114      $ 1,357       $ 1,558   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) per share:

           

Basic

   $ (2.66   $ 0.02      $ 0.72      $ 0.32       $ 0.34   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

   $ (2.66   $ 0.02      $ 0.66      $ 0.29       $ 0.31   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Weighted-average shares used in computing net income (loss) per share:

           

Basic

     4,157,498        4,260,192        4,319,243        4,294,131         4,598,436   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

     4,157,498        5,924,390        6,366,682        6,246,974         6,572,366   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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(1) Includes share-based compensation as follows:

 

     Year Ended December 31,      Six Months Ended June 30,  
     2010      2011      2012      2012      2013  
     (in thousands)      (unaudited)  

Cost of revenue

   $ 31       $ 13       $ 19       $ 10       $ 28   

Research and development

     358         356         497         210         578   

Sales, general and administrative

     389         262         473         169         688   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 778       $ 631       $ 989       $ 389       $ 1,294   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2) On September 6, 2013, our shareholders approved and effected a reverse share split such that every 2.5 issued and unissued ordinary and preferred shares of par value US$0.005 were consolidated into one share with a par value of US$0.0125 each. All share-related disclosures, including number of shares and net income (loss) per share, have been recast to reflect the 2.5-for-1 reverse share split for all periods presented.

 

     As of December 31,     As of June 30,  
     2011     2012     2013  
     (in thousands)     (unaudited)  

Selected Balance Sheet Data:

    

Cash and cash equivalents

   $ 23,343      $ 21,580      $ 13,921   

Working capital

     16,268        33,496        42,124   

Total assets

     39,866        53,802        64,592   

Total liabilities

     25,620        20,208        20,660   

Convertible preferred shares

     54,322        54,377        54,400   

Total shareholders’ deficit

     (40,076     (20,783     (10,468

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” included elsewhere in this prospectus.

Overview

We are a global fabless provider of analog and mixed-signal semiconductor solutions currently addressing the home entertainment and cloud computing markets. In the home entertainment market, we offer a range of set-top box solutions including tuners, demodulators and decoders as well as integrated solutions with customized software and support. In the cloud computing market, we offer high performance, low power memory interface solutions that enable memory intensive server applications.

Since our inception, we have been focused on developing a technology platform consisting of proprietary hardware building blocks and customized software to enable the design of high performance, low power analog and mixed-signal semiconductor solutions. We have developed expertise in analog and radio frequency solutions, digital signal processors and high speed interfaces, which serve as the foundation for our technology platform. While analog and mixed-signal technology is applicable to a broad array of end markets, in order to best leverage our technology platform, we have been highly selective in identifying our initial target end markets. We have focused on target markets which we believe have compelling long-term growth prospects and are also characterized by complex product design, long life cycles and stringent qualification requirements. We believe that our extensive customer interaction, combined with our deep understanding of our customers’ needs, fosters customer loyalty and increases visibility of evolving customer requirements and market opportunities.

Initially, we focused on the home entertainment market by designing solutions for set-top boxes used in emerging markets. We believed this end market allowed us to best leverage our technology platform and take advantage of our presence in China, where almost all of our engineering development takes place and we have extensive field application engineers to help serve our target end customers. We began addressing this market by developing stand-alone tuners, demodulators and decoders and introduced our first set-top box solution in 2005. In 2010, we began selling integrated set-top box solutions, which combine a demodulator, decoder and sometimes tuner into a single semiconductor solution and have higher average selling prices and gross margins than our stand-alone tuner, demodulator and decoder solutions. We currently offer ten set-top box solutions for use in the home entertainment market, including multi-standard compliant HDTV and SDTV semiconductor solutions. We believe our ability to provide integrated solutions with customized software and support, which we develop through close collaboration with our end customers, has been a key to our success in addressing the characteristics of the home entertainment market in emerging markets. Our collaborative approach, which we believe significantly benefits from our close proximity to our end customers, allows us to develop extensive localized knowledge of a large, fragmented market with diverse technical and service requirements.

We have also focused our development efforts on designing memory interface solutions targeting the cloud computing market by leveraging our expertise in high performance, low power mixed-signal semiconductor design technologies and proximity to key industry participants in Asia. Memory interface solutions must meet stringent high performance and low power requirements and must have the ability to process high frequency signals. Our technology platform enables us to address these requirements. We currently offer two memory interface solutions for use in the cloud computing market, consisting of register buffers for use in RDIMMs and memory buffers for use in LRDIMMs. Both of these solutions are compatible with DDR3 DRAM technology, the most prevalent industry standard. Sales of LRDIMM memory buffers for DDR3 accounted for 27.9% and

 

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32.6% of our revenue from memory interface solutions, and 1.7% and 3.1% of our total revenue, in 2012 and the six months ended June 30, 2013, respectively. We expect revenue from our LRDIMM memory buffers to increase as a percentage of our total revenue beginning in 2013, driven largely by growth in cloud computing. Achieving and maintaining Intel validation for our LRDIMM memory buffers is extremely important to our market position and the prospects of our memory interface solutions business, as the server OEMs who adopt Intel’s server platforms will only purchase components of their servers from Intel validated vendors.

We have sold our set-top box solutions primarily through distributors to over 150 end customers worldwide. Our end customers include nine of the ten largest set-top box manufacturers in China who sell solutions optimized for viewers in emerging markets. We sell substantially all of our memory interface solutions directly to memory module manufacturers. We have sold our memory interface solutions to the world’s four largest DRAM manufacturers and the world’s largest third-party DRAM module supplier as measured by 2012 revenues.

We operate a fabless business model and use third-party foundries and assembly and test manufacturing contractors to manufacture, assemble and test our semiconductor products. This outsourced manufacturing approach allows us to focus our resources on the design, development and marketing of our solutions and reduces overhead and our exposure to semiconductor industry cyclicality risks.

Since inception, we have invested significant resources in our research and development activities. Our engineering design teams are located in Shanghai, Suzhou and Hangzhou in China and in Taipei and Hsinchu in Taiwan. As of June 30, 2013, we had 290 engineers in our research and development organization of which 141 hold post-graduate engineering degrees. We believe our future success depends on our ability to continuously enhance our solutions and technology platform to meet the rapidly changing needs and requirements of our end customers. As a result, we intend to continue to invest in our research and development efforts.

Our revenue has grown from $29.1 million in 2010 to $78.2 million in 2012, representing a compound annual growth rate of 64%, and from $33.9 million in the six months ended June 30, 2012 to $45.4 million in the six months ended June 30, 2013, representing an annual growth rate of 34%. In 2012, we generated 94% of our revenue from sales of set-top box solutions and 6% from sales of memory interface solutions. In the six months ended June 30, 2013, 91% of our revenue was generated from set-top box solutions and 9% was generated from memory interface solutions. Our net income (loss) was $(8.5) million in 2010, $5.0 million in 2011, $18.3 million in 2012 and $8.8 million in the six months ended June 30, 2013.

Significant Factors Affecting Our Operating Results

Market Demand. Demand for our solutions, and semiconductors in general, may fluctuate depending on various factors, including macroeconomic conditions and changing or evolving technologies, viewer preferences, customer requirements and technical standards. In emerging markets, the satellite set-top box market is currently larger than the cable and terrestrial set-top box markets in terms of total number of units sold by Chinese manufacturers, while the cable set-top box market is expected to expand rapidly in coming years. In the cloud computing market, next generation server platforms will require LRDIMM technologies to increase memory capacity within servers. Due to the evolving nature of our markets, our results of operations depend on our ability to accurately anticipate and respond to changes in technologies, viewer preferences and other market conditions.

Introduction of New Solutions. Our ability to grow our revenue has depended, and will continue to depend, on our ability to develop new semiconductor solutions and to successfully market those solutions to new and existing customers. We have expanded our set-top box solutions to include a wide range of multi-standard compliant HDTV and SDTV solutions, and we are continuing to expand our portfolio to capture additional segments of the market. For example, we launched an HDTV decoder solution in early 2013 and are growing our cable set-top box solutions business. In the cloud computing market, we are working closely with key industry participants, including JEDEC, leading CPU and memory module manufacturers and server OEMs to develop the

 

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first generation of DDR4-compliant memory interface solutions, including a registering clock driver and a data buffer. In July 2013, we introduced our DDR4 registering clock driver and data buffer for DDR4 RDIMMs and LRDIMMs, which we believe is the industry’s first JEDEC 0.92 specifications compliant DDR4 registering clock driver and data buffer. Our success depends in large part on our ability to leverage our established customer base, which includes most of the leading set-top box manufacturers in China, to quickly increase revenue from our new solutions offerings.

Revenue Mix among Our Solutions. Our revenue and gross margin in any given period can be significantly affected by the relative proportion of revenue from our different solutions. For example, our integrated set-top box solutions generally have higher average selling prices and higher gross margins than our stand-alone tuner, demodulator and decoder solutions. In addition, newly launched solutions which incorporate more complex configurations generally have higher margins, subject to market-specific supply and demand. However, we expect that as our existing solutions and target markets mature, the average unit selling price may decline over time.

Life Cycles of Our Solutions. Our semiconductor solutions are subject to life cycles and experience gradually declining average selling prices. In general, set-top boxes targeting the emerging markets have life cycles lasting a number of years, depending on technological or other changes affecting the market, with average selling prices declining moderately during the life cycle. For memory interface solutions, our solutions are designed to support a specific CPU or server platform developed by CPU manufacturers and depend on the life cycle of the platform we are supporting of the CPU manufacturer. The life cycle of a CPU or server platform typically ranges from 24 to 36 months.

Attach Rate. In the cloud computing industry, the attach rate for a specific component within the server is expressed in terms of the percentage of servers sold with that particular component. As an example, the percentage of servers sold with LRDIMMs would be expressed as the attach rate of LRDIMMs to total servers. As one of only two LRDIMM memory buffer suppliers currently validated by Intel Corporation for DDR3 memory buffers, the attach rate for LRDIMMs can have a significant effect on our addressable market and revenue.

Seasonality. Our quarterly revenue and operating results have fluctuated in the past and may continue to fluctuate significantly depending upon numerous factors. In particular, we typically have lower sales during the first quarter of each year, with the fourth quarter typically having the highest quarterly revenue. This fluctuation is driven primarily by the effect of Chinese Lunar New Year, which occurs in the first quarter, on the purchasing patterns of our distributors and end customers. Our relatively stronger performance in the fourth quarter has been largely due to increased demand from our end customers in anticipation of increased demand for set-top boxes during the Chinese Lunar New Year holiday season.

Research and Development Expenses/Tape-out Costs. The semiconductor industry requires substantial investment in research and development in order to develop and bring to market new and enhanced technologies and products. All of our solutions have originated from our research and development efforts, which provided us with a significant competitive advantage. While we are committed to investing in new solution development in order to remain competitive in our target markets, sufficient resources to maintain the level of investment in research and development activities is crucial to our competitiveness and results of operations. In the event that we are unable to put in sufficient resources in research and development activities, which may or may not become commercially successful, our results of operations may be adversely affected. Our research and development expense may be significantly affected by tape-out costs, which include product engineering mask costs and prototype integrated circuit packaging and test costs. The timing of tape-out costs may be difficult to accurately predict and may lead to fluctuations in our quarterly or annual research and development expense and net income.

Jumpstart Our Business Startups Act

Under the Jumpstart Our Business Startups Act, or the JOBS Act, “emerging growth companies” can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We

 

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have elected not to take advantage of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not “emerging growth companies.”

Description of Certain Statement of Operations Items

The following describes the line items set forth in our consolidated statements of operations.

Revenue

We generate revenue from sales of our set-top box and memory interface solutions to set-top box and memory module manufacturers, either directly or through our distributors. Substantially all of our set-top box end customers purchase products indirectly from us through distributors, while we sell substantially all of our memory interface solutions directly to our end customers.

In 2012 and the six months ended June 30, 2013, we generated 94% and 91% of our revenue from sales of set-top box solutions, respectively, and 6% and 9% from sales of memory interface solutions, respectively. We expect sales of set-top box solutions to continue to account for the substantial majority of our revenue; however, we expect revenue from sales of memory interface solutions as a percentage of our total revenue to grow in the next several years. We have generated the significant majority of our revenue from sales to end customers located in Asia. Although our end customers are primarily manufacturers located in Asia, our semiconductor solutions are incorporated into finished products sold globally.

Cost of Revenue and Gross Margin

Cost of revenue primarily includes the cost of finished silicon wafers processed by third-party foundries; costs associated with our outsourced packaging, assembly and testing; shipping costs; and costs of personnel, logistics and quality assurance. Cost of revenue also includes indirect costs, such as warranty, inventory valuation reserves and other overhead costs.

Gross profit is revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of revenue. We expect that our gross margin may fluctuate from period to period, primarily as a result of changes in average selling price, revenue mix among our solutions, and manufacturing costs. In addition, we may reserve against the value at which we carry our inventory based upon the solution’s life cycle and conditions in the markets in which we sell. Any declines in average selling prices may be paired with improvements in our cost of revenue, which may offset some of the gross margin reduction that could result from lower selling prices.

Operating Expenses

Our operating expenses consist of research and development expense and sales, general and administrative expense.

Research and Development. Research and development expense primarily includes personnel-related expenses, including salaries, bonuses, share-based compensation and employee benefits. Research and development expense also includes the costs of developing new products as well as supporting existing products, including tape out costs, computer-aided design software license costs, intellectual property license costs, reference design development costs, development testing and evaluation costs and depreciation expense. Research and development activities include the design of new products, refinement of existing products and design of test methodologies to ensure compliance with required specifications. All research and development costs are expensed as incurred. We expect our research and development expense to increase as we continue to expand our available solutions.

Sales, General and Administrative. Sales, general and administrative expense primarily includes personnel-related expenses, including salaries, bonuses, share-based compensation and employee benefits. Sales, general

 

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and administrative expense also includes field application engineering support, commissions to independent sales representatives, travel costs, professional and consulting fees, legal fees, trade shows, depreciation expense and occupancy costs. We expect our sales, general and administrative expense to increase as we expand our organization to better support our customers and our anticipated growth. Additionally, these expenses will increase as we establish the necessary infrastructure to operate effectively as a public company.

Interest Income (Expense), Net

Interest income consists of interest earned on our cash, cash equivalents and short-term investment balances. Interest expense primarily consists of interest on our borrowings.

Fair Value Change in Warrant Liability

Fair value change in warrant liability relates to the change in fair value of our Series B-2 preferred share warrants issued to certain of our investors in October 2009. The change in fair value was remeasured at June 30, 2010, when the warrants were exercised in full. We determined the fair value of the warrants with the assistance of an independent third-party valuation specialist. The change in fair value was recorded as a non-cash charge in our consolidated statements of operations and comprehensive income (loss) in 2010.

Other Income (Expense), Net

Other income (expense), net generally consists of income (expense) generated from minor non-operating transactions.

Provision (Benefit) for Income Tax

We are an exempted company registered in the Cayman Islands and conduct business in several countries including China, Hong Kong, Taiwan and the United States. We are subject to taxation in each of these jurisdictions in which we conduct business. As a result, our worldwide income is subject to the tax rates in which our income is generated and as such our effective tax rate may fluctuate based on the geographic distribution of our earned income or losses and the applicable tax laws in which those earnings or losses were generated.

Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, dividend payments made by us are not subject to withholding tax in the Cayman Islands. Our Hong Kong and Taiwan operating subsidiaries are subject to income tax rates at 16.5% and 17%, respectively. Our U.S. subsidiary is subject to U.S. federal income tax at graduated tax rates from 15% to 35% and the income allocated and apportioned to the state of California is subject to California income tax at 8.8%.

The generally applicable corporate income tax rate in China, or an enterprise income tax rate, is 25%. Our principal PRC operating subsidiary enjoys certain preferential tax rates due to its qualification as a qualified integrated circuit design enterprise and a high and new technology enterprises, or HNTE. As a qualified integrated circuit design enterprise, our principal PRC operating subsidiary is entitled to a two-year enterprise income tax exemption followed by a three-year 50% enterprise income tax rate reduction commencing from the first profit-making year, which was 2010. As a result, our principal PRC operating subsidiary was exempt from PRC enterprise income tax in 2010 and 2011 and enjoys a preferential enterprise income tax rate of 12.5% from 2012 through 2014. PRC preferential tax treatments are subject to review and may be adjusted or revoked at any time in the future. The discontinuation of any preferential tax treatments available to us will cause our effective tax rate to increase, which will decrease our net income and materially and adversely affect our financial condition and results of operations. See “Risk Factors—Risk Factors Related to Regulations Applicable to Us—Our business has benefited from certain preferential tax treatment and government subsidies. Discontinuation or revocation of the preferential tax treatments and government subsidies available to us could decrease our net income and materially and adversely affect our financial condition and results of operations.”

 

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Results of Operations

The following table sets forth our consolidated statement of operations data (in thousands) for the periods indicated.

 

     Year Ended December 31,     Six Months Ended June 30,  
     2010     2011     2012     2012     2013  
    

(in thousands, except share and per share
data)

    (unaudited)  

Statement of Operations Data:

          

Revenue

   $ 29,078      $ 50,338      $ 78,245      $ 33,937      $ 45,392   

Cost of revenue(1)

     (21,248     (22,840     (31,736     (13,691     (16,589
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     7,830        27,498        46,509        20,246        28,803   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expense:

          

Research and development(1)

     (11,078     (13,651     (17,568     (8,469     (12,473

Sales, general and administrative(1)

     (5,046     (5,895     (9,792     (3,232     (6,801
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

     (16,124     (19,546     (27,360     (11,701     (19,274
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (8,294     7,952        19,149        8,545        9,529   

Interest income (expense), net

     (44     (36     207        4        302   

Fair value change in warrant liability

     (37     —          —          —          —     

Other income (expense), net

     (114     (307     153        233        (87
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (8,489     7,609        19,509        8,782        9,744   

Provision for income tax

     (54     (2,637     (1,228     (553     (972
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (8,543   $ 4,972      $ 18,281      $ 8,229      $ 8,772   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to ordinary shareholders—Basic

   $ (11,056   $ 77      $ 3,114      $ 1,357      $ 1,558   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

          

Basic

   $ (2.66   $ 0.02      $ 0.72      $ 0.32      $ 0.34   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (2.66   $ 0.02      $ 0.66      $ 0.29      $ 0.31   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per share:

          

Basic

     4,157,498        4,260,192        4,319,243        4,294,131        4,598,436   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     4,157,498        5,924,390        6,366,682        6,246,974        6,572,366   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes share-based compensation as follows:

 

     Year Ended December 31,      Six Months Ended June 30,  
         2010              2011              2012              2012              2013      
    

(in thousands)

     (unaudited)  

Cost of revenue

   $ 31       $ 13       $ 19       $ 10       $ 28   

Research and development

     358         356         497         210         578   

Sales, general and administrative

     389         262         473         169         688   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 778       $ 631       $ 989       $ 389       $ 1,294   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Comparison of the six months ended June 30, 2012 and 2013

Revenue

 

     Six Months Ended
June 30,
     %
Change
 
     2012      2013     
     (unaudited, in thousands,
except percentage data)
 

Revenue

   $ 33,937       $ 45,392         34

Revenue in the six months ended June, 2013 increased by $11.5 million, or 34%, from the same period in 2012 primarily due to an increase in revenue from sales of our set-top box solutions, which increased from $32.0 million to $41.1 million. Total number of units shipped for our set-top box solutions increased by 12% in the six months ended June 30, 2013 from the same period in 2012 due to increased demand reflecting greater market acceptance of our integrated set-top box solutions which increasingly became the primary source of our set-top box revenue. A substantial portion of the increase in revenue was attributable to the continued increase in shipments of our integrated set-top box solutions, which have higher average selling prices than our stand-alone solutions. Our revenue from memory interface solutions in the six months ended June 30, 2013 increased by $2.3 million, or 117%, from the same period in 2012 due to increased number of units shipped, which increased by 103%, as well as higher average selling prices, primarily as a result of sales of our LRDIMM solutions, which have significantly higher average selling prices than our other memory interface solutions.

Cost of Revenue and Gross Profit

 

     Six Months Ended
June 30,
    %
Change
 
     2012     2013    
    

(unaudited, in thousands,
except percentage data)

 

Cost of revenue

   $ 13,691      $ 16,589        21

% of revenue

     40     37  

Gross profit

   $ 20,246      $ 28,803        42

Gross margin

     60     63  

Cost of revenue in the six months ended June 30, 2013 increased by $2.8 million, or 21%, from the same period in 2012. The increase in cost of revenue was primarily due to the increase in number of units shipped in the six months ended June 30, 2013 compared to the same quarter in 2012. Gross margin increased from 60% in the six months ended June 30, 2012 to 63% in the six months ended June 30, 2013 primarily due to improved economies of scale resulting from the increase in shipment volume as well as increased sales of our higher gross margin integrated set-top box and LRDIMM solutions.

Operating Expenses

 

     Six Months Ended
June 30,
    %
Change
 
     2012     2013    
    

(unaudited, in thousands,
except percentage data)

 

Research and development

   $ 8,469      $ 12,473        47

% of revenue

     25     27  

Sales, general and administrative

   $ 3,232      $ 6,801        110

% of revenue

     10     15  

 

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Research and development expenses in the six months ended June 30, 2013 increased by $4.0 million, or 47%, from the same period in 2012, primarily as a result of an increase in personnel-related expenses of $3.3 million and increased share-based compensation expense of $0.4 million attributable to new share option grants, partially offset by a decrease of $0.8 million in external consulting services. The primary reason for the increase in personnel-related expenses was the increase in headcount as we ended this period with 290 research and development employees, an increase of 75 employees compared to June 30, 2012.

Sales, general and administrative expenses in the six months ended June 30, 2013 increased by $3.6 million, or 110%, from the same period in 2012, primarily as a result of an increase in personnel-related expenses of $1.0 million. The overall increase in expenses also included an increase of $0.8 million for professional service fees, primarily including fees for accounting and legal services, an increase of $0.6 million for amortization of intangible assets and an increase of $0.5 million in share-based compensation expense attributable to new grants of share options and restricted share awards. The primary reason for the increase in personnel-related expenses was the increase in headcount as we ended this period with 133 sales, general and administrative employees, an increase of 13 employees compared to the June 30, 2012.

Interest Income (Expense), Net and Other Income (Expense), Net

 

     Six Months Ended
June 30,
 
         2012              2013      
     (unaudited, in thousands)  

Interest income (expense), net

   $ 4       $ 302   

Other income (expense), net

     233         (87

Interest income (expense), net increased in the six months ended June 30, 2013 from the same period in 2012, primarily due to increased interest income from higher cash and short-term investment balances. Additionally, interest expense decreased in the six months ended June 30, 2013 from the same period in 2012, primarily due to the repayment of $1.6 million of bank borrowings during this period. During the six months ended June 30, 2013, we paid off an existing balance due on a bank line of credit.

Other income (expense), net was income of $0.2 million in the six months ended June 30, 2012 as compared to expense of $87,000 in the same period of 2013. The other income we recorded in the six months ended June 30, 2012 was primarily from a non-project related government subsidy received during the period. The other expense we recorded in the six months ended June 30, 2013 primarily reflected a $0.2 million foreign exchange loss partially offset by a government subsidy of $0.1 million.

Provision (Benefit) for Income Taxes

Our provision for income tax was $1.0 million in the six months ended June 30, 2013 compared to $0.6 million in the six months ended June 30, 2012, due to an 11% increase in our income before income taxes in the quarter ended June 30, 2013 as compared to the same period in 2012 and increase in year-to-date tax rate. The tax rate increase was mainly due to the increase in our total income before tax and the increase in income before tax in jurisdictions with higher tax rates compared to the prior year.

Comparison of the Years Ended December 31, 2010, 2011 and 2012

Revenue

 

     Year Ended December 31,      % Change  
      2010      2011      2012      2011     2012  
     (in thousands, except percentage data)  

Revenue

   $ 29,078       $ 50,338       $ 78,245         73     55

 

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Revenue in 2012 increased by $27.9 million, or 55%, from 2011 primarily due to an increase in revenue from sales of our set-top box solutions, which increased from $49.0 million to $73.6 million, primarily as a result of a 50% increase in the number of units shipped for our set-top box solutions driven by increased demand reflecting greater market acceptance of our integrated set-top box solutions which increasingly became the primary source of our set-top box revenue. A substantial portion of this increase was attributable to the continued increase in shipments of our integrated set-top box solutions. Our memory interface solutions revenue also increased significantly in 2012, increasing from $1.3 million in 2011 to $4.6 million in 2012 due to an increase of 169% in the number of units shipped, as well as higher average selling prices, primarily as a result of sales of our LRDIMM solutions, which have significantly higher average selling prices than our other memory interface solutions. We began generating meaningful revenue from LRDIMM sales in 2012.

Revenue in 2011 increased by $21.2 million, or 73%, from 2010 primarily due to the increase in revenue of our set-top box solutions, which increased from $27.9 million to $49.0 million. Total number of units shipped for our set-top box solutions increased by 19% in 2011 reflecting greater market acceptance of our integrated set-top box solutions which became the primary source of our set-top box revenue. The increase in our set-top box solutions revenue was attributable primarily to increased shipments of our integrated solutions, which accounted for a significantly higher proportion of our revenue from set-top box solutions in 2011 compared to 2010.

Cost of Revenue and Gross Profit

 

    Year Ended December 31,     % Change  
    2010     2011     2012     2011     2012  
    (in thousands, except percentage data)  

Cost of revenue

  $ 21,248      $ 22,840      $ 31,736        8%       39%  

% of revenue

    73     45     41    

Gross profit

  $ 7,830      $ 27,498      $ 46,509        251%        69%  

Gross margin

    27     55     59    

Cost of revenue increased by $8.9 million, or 39%, from 2011 to 2012. The increase in cost of revenue was primarily due to increased shipments, in particular for integrated solutions for set-top box applications. Gross margin increased from 55% to 59% during the same period due primarily to improved economies of scale resulting from the increase in shipment volume.

Cost of revenue increased by $1.6 million, or 8%, from 2010 to 2011, primarily due to increased shipments, in particular for integrated solutions for set-top boxes. Gross margin increased from 27% to 55% during the same period as a result of an increase in sales of our integrated solutions due to their relatively higher average selling prices and gross margins compared to our stand-alone tuner, demodulator and decoder solutions. We also had a $1.6 million write-down of obsolete inventory primarily related to our memory interface solutions that supported servers utilizing DDR2 memory in 2010.

Our gross profit benefited $30,000, $0.6 million and $0.3 million from sales of product that was previously written down to net realizable value for 2010, 2011 and 2012, respectively.

Operating Expenses

 

    Year Ended December 31,     % Change  
    2010     2011     2012     2011     2012  
    (in thousands, except percentage data)  

Research and development

  $ 11,078      $ 13,651      $ 17,568        23%        29%   

% of revenue

    38     27     22    

Sales, general and administrative

  $ 5,046      $ 5,895      $ 9,792        17%        66%   

% of revenue

    17     12     13    

 

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Research and development expense for 2012 increased by $3.9 million, or 29%, from 2011 primarily as a result of an increase in headcount to support the number of product development projects in process during the year. The increase in personnel-related expenses of $4.8 million was the largest component of the change and a direct result of the increase of 85 employees in our research and development organization as we ended the year with 270 research and development employees. The increase was partially offset by proceeds received for government funding of research and development projects that passed the government review process during the year, which reduced research and development expenses by $1.0 million.

Research and development expense for 2011 increased by $2.6 million, or 23%, from 2010. The increase in personnel-related expenses of $1.9 million was the largest component of the change and a direct result of the increase of 69 employees in our research and development organization as we ended the year with 185 research and development employees.

Sales, general and administrative expense for 2012 increased by $3.9 million, or 66%, from 2011, primarily as a result of an increase in personnel-related expenses of $2.0 million, which primarily resulted from an increase of 24 sales, general and administrative employees during 2012 as we ended the year with 126 sales, general and administrative employees. In addition, the increase in sales, general and administrative expenses was partially due to a $1.1 million increase in consulting and professional fees.

Sales, general and administrative expense for 2011 increased by $0.8 million, or 17%, from 2010 due to an increase in personnel-related expenses of $0.8 million, which primarily resulted from an increase of 16 sales, general and administrative employees as we ended the year with 102 sales, general and administrative employees.

Interest Income (Expense), Net, Fair Value Change in Warrant Liability and Other Income (Expense), Net

 

     Year Ended December 31,  
     2010     2011     2012  
     (in thousands)  

Interest income (expense), net

   $ (44   $ (36   $ 207   

Fair value change in warrant liability

   $ (37     —          —     

Other income (expense), net

   $ (114   $ (307   $ 153   

Interest income (expense), net increased to $207,000 in 2012 from $(36,000) in 2011 primarily due to earnings on higher cash and short term investment balances.

Fair value change in warrant liability of $37,000 in 2010 was the result of the revaluation of warrants issued to our Series B-2 preferred shareholders in 2009 that were exercised in 2010. The expense reflected the increase in the value of the warrant from the time they were issued to the time they were exercised by shareholders.

We had other income, net in 2012 of $0.2 million compared with other expense, net of $0.3 million in 2011. Our other expense, net increased from $0.1 million in 2010 to $0.3 million in 2011.

Provision (Benefit) for Income Tax

Our provision for income tax was $1.2 million in 2012 compared to $2.6 million in 2011. Our effective income tax rate decreased to 6.3% in 2012 from 34.7% of 2011. In 2011, we recorded a one-time income tax provision of $2.8 million for research and development expenses that were non-deductible for tax purposes. We had provision for income tax of $54,000 in 2010.

 

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Selected Quarterly Results of Operations

The following table presents our unaudited quarterly results of operations for the six quarters ended June 30, 2013. This unaudited quarterly information has been prepared on the same basis as our audited consolidated financial statements and includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the information for the quarters presented. You should read this table together with our audited consolidated financial statements and the related notes thereto included elsewhere in this prospectus. Our quarterly results of operations will vary in the future. The results of operations for any quarter are not necessarily indicative of any future results.

 

    Three Months Ended  
    Mar. 31,
2012
    Jun. 30,
2012
    Sept. 30,
2012
    Dec. 31,
2012
    Mar. 31,
2013
    Jun.  30,
2013
 
    (unaudited) (in thousands)  

Statement of Operations Data:

   

Revenue

  $ 14,704      $ 19,233      $ 20,601      $ 23,707      $ 20,084      $ 25,308   

Cost of revenue

    6,554        7,137        7,683        10,362        7,769        8,820   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    8,150        12,096        12,918        13,345        12,315        16,488   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expense:

           

Research and development

    4,238        4,231        3,835        5,264        5,700        6,773   

Sales, general and administrative

    1,427        1,805        2,382        4,178        3,100        3,701   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

    5,665        6,036        6,217        9,442        8,800        10,474   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    2,485        6,060        6,701        3,903        3,515        6,014   

Interest income (expense), net

    (13     17        71        132        129        173   

Fair value change in warrant liability

    —           —           —           —           —           —      

Other income (expense), net

    18        215        20        (100     16        (103
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    2,490        6,292        6,792        3,935        3,660        6,084   

Provision for income tax

    (153     (400     (427     (248     (371     (601
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 2,337      $ 5,892      $ 6,365      $ 3,687      $ 3,289      $ 5,483   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table presents the unaudited quarterly results of operations as a percentage of revenue:

 

    Three Months Ended  
    Mar. 31,
2012
    Jun. 30,
2012
    Sept. 30,
2012
    Dec. 31,
2012
    Mar. 31,
2013
    Jun.  30,
2013
 
    (unaudited)  

Statement of Operations Data:

   

Revenue

    100     100     100     100     100     100

Cost of revenue

    45        37        37        44        39        35   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    55        63        63        56        61        65   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expense:

           

Research and development

    29        22        19        22        28        27   

Sales, general and administrative

    10        9        12        18        15        15   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

    39        31        30        40        43        42   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    17        32        33        16        18        23   

Interest income (expense), net

    0        0        0        1        0        1   

Fair value change in warrant liability

    0        0        0        0        0        0   

Other income (expense), net

    0        1        0        0        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    17        33        33        17        18        24   

Provision for income tax

    (1     (2     (2     (1     (2     (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    16     31     31     16     16     22
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We typically experience seasonal fluctuations in our quarterly revenue, with the first fiscal quarter normally being the lowest revenue quarter and the fourth quarter being the highest revenue quarter. This seasonality is primarily the result of increased sales into the set-top box market in the fourth quarter of each year as our end customers build inventory in preparation for the holiday shopping season. In contrast, we normally experience lower sales in the first quarter of each year as our end customers generally manufacture fewer set-top boxes as a result of the Chinese New Year holiday, which falls in January or February of each year.

Our cost of revenue and gross margin generally varies with our revenue mix among our solutions. Typically, solutions incorporated into more complex configurations, such as our integrated set-top box solutions generally have higher sales prices and enjoy higher profit margins as compared to stand-alone solutions. Similarly, our current LRDIMM memory buffers have a higher sales price and higher profit margin compared to our RDIMM register buffers. We expect that our gross margin may continue to vary from quarter to quarter primarily based on the mix of solutions that we sell in each of our target markets. Additionally, our gross margin can be affected by the timing of new product introductions and the effect of the valuation of our inventories.

Research and development expense generally increased on a quarter-on-quarter basis primarily due to an increase in engineering headcount and the costs associated with new product development. We expect our headcount to increase in order to support our growing new product development activities. Our research and development expense may be significantly affected by tape-out costs in support of these development activities as the timing of tape-out costs may be difficult to accurately predict and may lead to fluctuations in our quarterly or annual research and development expense and net income. The relatively lower research and development expense in the quarter ended September 30, 2012 was primarily due to proceeds received for government funding of research and development projects that passed the government review process, which reduced research and development expenses by $1.0 million during that quarter.

Sales, general and administrative expense generally increased on a quarter-on-quarter basis primarily due to increases in headcount to support the growth in our business, business development efforts to support our growing sales and marketing efforts and other professional services to support our legal and accounting

 

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requirements. Sales, general and administrative expense as a percentage of revenue will fluctuate from quarter to quarter primarily based on the timing of these expenses.

We incurred relatively high operating expenses, resulting in lower income from operations, in the quarter ended December 31, 2012 primarily due to relatively higher professional fees for accounting, tax and legal services relating to our initial public offering in the three months ended December 31, 2012 that were not eligible for capitalization. We typically do not expect operating expenses as a percentage of revenue to be materially higher in the fourth quarter than in other quarters.

Liquidity and Capital Resources

As of June 30, 2013, we had $36.9 million of cash, cash equivalents and short-term investments. Since 2011, we have financed our operations primarily through net cash from operating activities. Prior to 2011, we financed our operations primarily by net proceeds of approximately $43.1 million from the sales of preferred shares. We believe our current cash, cash equivalents and net cash from operating activities will be sufficient to satisfy our liquidity requirements for the next 12 months. However, management may in the future elect to finance operations by further utilizing bank loans, credit facilities or selling equity securities.

The ability of our PRC subsidiaries to make dividend and other payments to us may be restricted by applicable PRC foreign exchange laws and other PRC laws and regulations. Current PRC regulations permit our subsidiaries in China to pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds until such reserves have reached at least 50% of their respective registered capital. These reserves are not distributable as cash dividends. Further, loans or investments outside of China by PRC companies are subject to restrictions and approval requirements. Therefore, it may be difficult for us to transfer funds from our PRC subsidiaries to us quickly. We do not expect the restrictions on transferring funds out of China will have a material effect on our liquidity because we believe our cash, cash equivalents and other assets located outside of China are sufficient to meet our expected needs and our revenues are primarily generated outside of China in U.S. dollars. We generate the substantial majority of our revenue, and incur our working capital requirements relating to purchases of inventory from third-party foundries, through our non-PRC operating entities. The working capital requirements of our PRC operating subsidiaries, which include research and development and sales, general and administrative expenses, are primarily funded by their operating income generated from providing services to our non-PRC operating entities.

Below is a summary of our cash flows provided by (used in) operating activities, investing activities and financing activities for the periods indicated:

 

     Year Ended December 31,     Six Months Ended June 30,  
     2010     2011     2012     2012      2013  
     (in thousands)     (unaudited)  

Net cash provided by (used in) operating activities

   $ (937   $ 11,187      $ 9,404      $ (559)       $ 11,909   

Net cash used in investing activities

     (824     (807     (10,503     (4,276)         (17,635

Net cash provided by (used in) financing activities

     2,415        (636     (553     (2,044)         (1,802

Effect of exchange rates on cash and cash equivalents

     131        281        (111     (16)         (131
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 785      $ 10,025      $ (1,763   $ (6,895)       $ (7,659
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Net Cash Provided by (Used in) Operating Activities

Our primary uses of cash are to fund operating expenses and purchases of inventory. Cash used to fund operating expenses excludes the impact of non-cash items such as depreciation and share-based compensation and is impacted by the timing of when we pay these expenses as reflected in the change in our outstanding accounts payable and accrued expenses.

Our primary sources of cash are cash receipts on accounts receivable from our shipment of products to distributors and direct customers. Aside from an increase in amounts billed to our customers, net cash collections of accounts receivable are impacted by the efficiency of our cash collections process, which can vary from period to period depending on the payment cycles of our major distributor customers. Our accounts receivable, net at year end as a percentage of our revenue during the year were 5%, 12% and 10% in 2010, 2011 and 2012, respectively.

Net cash provided by operating activities in the six months ended June 30, 2013 primarily reflected our net income of $8.8 million, depreciation and amortization of $1.3 million and share-based compensation of $1.3 million.

Net cash used in operating activities in the six months ended June 30, 2012 primarily reflected a decrease in accounts payable, deferred margin and accrued expenses of $2.0 million, $4.4 million, and $1.1 million, respectively, and an increase in inventory of $2.8 million, partially offset by our net income of $8.2 million, depreciation and amortization of $0.3 million, share-based compensation of $0.4 million, and a decrease of tax payable of $0.5 million.

Net cash provided by operating activities in 2012 primarily reflected our net income of $18.3 million, share-based compensation of $1.0 million, depreciation of $1.2 million, inventory write-downs of $0.5 million, and increases in accrued expenses and taxes payable of $0.9 million and $1.1 million, respectively, partially offset by an increase in accounts receivable and inventory of $2.0 million and $4.7 million, respectively, and reductions in accounts payable and deferred margin of $3.1 million and $3.9 million, respectively. Our accounts receivable and inventory grew as a result of our increased sales activity.

Net cash provided by operating activities in 2011 primarily reflected our net income of $5.0 million, share-based compensation of $0.6 million, depreciation of $0.6 million, inventory write-downs of $0.5 million, and an increase in accounts payable, deferred margin, tax payable and accrued expenses of $4.1 million, $4.3 million, $3.3 million and $2.4 million, respectively, offset by increases in accounts receivable and inventory of $4.4 million and $5.1 million, respectively. Our accounts receivable and inventory grew as a result of our increased sales activity.

Net cash used in operating activities in 2010 of $0.9 million primarily reflected our net loss of $8.5 million, and decrease in deferred margin of $1.2 million, offset by non-cash charge of share-based compensation, depreciation and inventory write-downs of $0.8 million, $0.8 million and $1.6 million, respectively, decreases in accounts receivable of $3.6 million and increase in accrued expenses of $1.6 million. We wrote-down $1.6 million of obsolete inventory primarily related to our memory interface solutions that supported servers utilizing DDR2 memory in 2010.

Net Cash Used in Investing Activities

Our capital expenditures have primarily consisted of purchases of property, equipment and software. In 2010, 2011 and 2012 and the six months ended June 30, 2013, our capital expenditures did not significantly affect our liquidity position. We expect our capital expenditures to increase as we grow our business. We currently expect to finance our capital expenditures primarily or exclusively through net cash from operating activities, but we may in the future finance our capital expenditure requirements through issuances of debt or equity securities or bank borrowings.

 

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Net cash used in investing activities in the six months ended June 30, 2013 primarily related to $25.3 million of purchases of short-term investments, $0.9 million for purchases of property, equipment and software and $0.4 million for purchase of intangible assets, partially offset by $9.0 million of proceeds from maturities of short-term investments. Net cash used in investing activities in the six months ended June 30, 2012 primarily related to $4.8 million of purchases of short-term investments and $1.1 million for purchases of property, equipment and software, partially offset by $1.6 million of proceeds from maturities of short-term investment. Net cash used in investing activities in 2012 primarily related to $11.2 million of purchases of short-term investments and $2.1 million for purchases of property, equipment and software, partially offset by $4.8 million of proceeds from maturities of short-term investments. Our net cash used in investing activities in 2010 and 2011 primarily related to purchases of property, equipment and software of $0.7 million in 2010 and $0.6 million in 2011.

Net Cash Provided by (Used in) Financing Activities

Net cash used in financing activities in the six months ended June 30, 2013 consisted primarily of $1.6 million for the repayment of bank borrowings, partially offset by $0.3 million expenses in connection with our initial public offering. Net cash used in financing activities in the six months ended June 30, 2012 consisted primarily of $2.1 million for the repayment of bank borrowings. Net cash used in financing activities in 2012 consisted primarily of $2.1 million for the repayment of bank borrowings, partially offset by $1.6 million in proceeds from new bank borrowings. Net cash used in financing activities in 2011 consisted primarily of $3.8 million for the repayment of bank borrowings, partially offset by proceeds from bank borrowings of $3.1 million. Net cash provided by financing activities in 2010 consisted primarily of $3.8 million in new bank borrowings and $1.5 million of net proceeds from the exercise of warrants to purchase our Series B-2 shares, partially offset by $3.0 million for the repayment of loans.

Contractual Obligations

The following table summarizes our outstanding contractual obligations as of December 31, 2012:

 

     Payments Due by Period  
     Total      Less Than
1  Year
     1-3
Years
     3-5
Years
 
     (in thousands)  

Operating lease obligations

   $ 1,775       $ 992       $ 783       $   

Purchase obligations

     1,086         1,086                   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 2,861       $ 2,078       $ 783       $   
  

 

 

    

 

 

    

 

 

    

 

 

 

During 2012, we entered into a 32 month non-cancelable operating lease agreement for additional office space in our Shanghai facility. The lease commenced in April 2012 with an option to extend the lease for an additional three years. Future minimum annual payments under the operating lease for the years 2013 and 2014 are $0.6 million and $0.6 million, respectively.

Future minimum lease payment under non-cancelable operating leases having initial terms in excess of one year as of June 30, 2013 (unaudited) are as follows:

 

     Payment Due by Period  
     Total      Less than
9 Months
     1-3
Years
     3-5
Years
 
    

(In thousands)

 

Operating lease obligations

   $ 1,841       $ 666       $ 1,175       $   

Purchase obligations

     6,508         6,508                   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 8,349       $ 7,174       $ 1,175       $   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Off-Balance Sheet Arrangements

As of June 30, 2013, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

We had cash, cash equivalents and short-term investments of $36.9 million as of June 30, 2013, which was held for working capital purposes. We do not enter into investments for trading or speculative purposes. We do not believe that we have any material exposure to changes in the fair value of these investments as a result of changes in interest rates due to their short-term nature. Declines in interest rates, however, will reduce future investment income.

Foreign Currency Risk

The functional currency of Montage Technology Group Limited and our non-PRC subsidiaries is the U.S. dollar. The functional currency of our subsidiaries in the PRC is the Renminbi. Monetary assets and liabilities in currency denomination other than the functional currency are translated into the functional currency at the rate of exchange in effect at the balance sheet date. Transactions in currencies other than the functional currency during the reporting period are converted into the functional currency at the applicable exchange rate on the day transaction occurred. Accordingly, the effects of exchange rate fluctuations on the net assets of each of our group entities are accounted for as translation gains or losses in accumulated other comprehensive income within shareholders’ equity. In addition, our revenue is primarily denominated in U.S. dollars and since a significant portion of our assets and expenses are in the PRC, they are in the denominated in Renminbi. As a result, our results of operations and financial condition are subject to risks associated with exchange rate fluctuations, in particular in relation to the exchange rates between the Renminbi and the U.S. dollar. We do not believe that a change of 10% in such foreign currency exchange rates would have a material impact on our financial position or results of operations.

Critical Accounting Policies and Estimates

Our consolidated financial statements and the related notes included elsewhere in this prospectus are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and any related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and our actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

We believe that the following accounting policies involve a greater degree of judgment and complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to understanding and evaluating our consolidated financial condition and results of operations.

Revenue Recognition

Our revenue is generated from the sale of our semiconductor solutions sold into the home entertainment and cloud computing markets. In the home entertainment market, we sell set-top box solutions which consist of highly integrated semiconductors and embedded software. We do not deliver software as a separate product in connection with the sale of our solutions nor is any software upgrade offered after the sale of our solutions.

 

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We recognize revenue only when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonably assured.

We evaluate each of these criteria as follows:

Evidence of an arrangement We generally use a customer’s purchase order to establish the existence of an arrangement.

Delivery We consider delivery to occur when title has been transferred to the customer.

Fixed or determinable fee – We assess whether fees are fixed or determinable at the time of sale. We only consider the fee to be fixed or determinable if the fee is not subject to adjustment.

Collection is deemed probable We deem collection probable if we expect that the customer will be able to pay amounts under arrangement as payments become due.

We sell our set-top box solutions primarily through third-party independent distributors under agreements allowing for pricing credits and/or rights of return and to a lesser extent, directly to set-top box manufacturers. We sell our memory interface products directly to memory module manufacturers. For direct sales to end customers, we recognize revenue at the time of shipment to our end customers when all of the above criteria are met. For sales through distributors, we defer the recognition of revenue and related product costs until the sale and delivery by the distributor to the end customer occurs because we cannot reliably estimate returns or price adjustments due to rapid changes in technology, consumer preferences and prices. Upon shipment to the distributor, we record an accounts receivable based on the amount we are entitled to bill the distributor according to the contractual arrangement between the distributor and us. This amount is recorded, net of the costs of products delivered, as deferred margin, net on our consolidated balance sheet. We do not accept product returns from customers except for returns to satisfy warranty claims of products previously delivered.

Deferred Margin, Net

We defer revenue recognition on sales to distributors until our products are sold by our distributors to end customers, which is when the selling price to the distributor is fixed or determinable. Deferred margin, net is calculated as: 1) deferred revenue that is recorded based on the amount of the sale price that we are entitled to bill the distributor at the time of shipment to the distributor based on terms of the distribution agreement, less 2) deferred cost of revenue, representing the costs of products shipped to the distributor.

Under our contract with LQW Technology Company Limited, or LQW, which has been a distributor for our products since October 2011 and was our largest distributor in 2012 and the six months ended June 30, 2013, we are entitled to bill only a portion of the total sale price at the time of shipment (deferred revenue), with the remainder billed upon sale by LQW to the end customer. Upon sale by LQW to the end customer, we bill the remaining sale price to LQW and recognize this amount as revenue directly (rather than initially as deferred revenue) as the sale price is fixed and determinable and all criteria for revenue recognition is met.

For our other distributors, we are typically entitled to bill the entire sale price at the time of shipment to the distributors, which is recorded as deferred revenue upon shipment and recognized as revenue when sales from the distributors to the end customers occur.

The distributors resell our products to end customers at a range of individually negotiated prices based on a variety of factors, including the identity of the end customer and its historical relationship with us, the type of product sold and sales quantity. With reference to these factors, according to the terms of our distribution agreement with the distributor, we adjust the original sale price to the distributor based on the actual resale price

 

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from the distributor to end customer. Primarily because of the uncertainty related to the final price, we defer recognition of revenue and cost of sales to distributors until the products are sold by the distributors to end customers. The amount of gross margin we recognize in future periods may be more than or less than the originally recorded deferred margin, net as a result of any price adjustment. We record price adjustments against deferred margin, net at the time of the distributor’s sale to the end customer.

For the years ended December 31, 2010, 2011 and 2012 and six months ended June 30, 2012 and 2013, the total net price adjustments were a downward adjustment of $1.4 million, or 4.9% of total revenue, an upward adjustment of $0.3 million, or 0.7% of total revenue, and a downward adjustment of $0.3 million, or 0.3% of total revenue, a downward adjustment of $62,000, or 0.2% of total revenue and a downward adjustment of $98,000, or 0.2% of total revenue, respectively. The decreasing trend in total price adjustments from 2010 to 2011 and 2012 was primarily due to increased sales of solutions that had relatively stable pricing and an increasing proportion of sales to LQW for which the majority of the sale price was billed at the time LQW completed its sales to the end customer. For the portion of sales to LQW that we bill at the time LQW completes the sale to the end customer, we record the billed amount directly to revenue, and therefore no price adjustment is necessary.

Deferred cost of revenue, a component of deferred margin, net, is stated at the lower of cost or market value. We evaluate whether our deferred cost of revenue has been impaired based on expected net cash flows to be received for the deferred items. There was no impairment for deferred cost of revenue for the years ended December 31, 2010, 2011 and 2012 and the six months ended June 30, 2012 and 2013. Please see the discussion contained in Note 8, Deferred Margin, Net, to our consolidated financial statements for the year ended December 31, 2012 included elsewhere in this prospectus for further details.

Allowance for Doubtful Accounts

We perform ongoing credit evaluations of our distributors and end customers to whom we sell directly and adjust credit limits based on creditworthiness of each, as determined by our review of current credit information. We continuously monitor collections and payments from our distributors and end customers to whom we sell directly and maintain an allowance for doubtful accounts based upon our historical experience, our anticipation of uncollectible accounts receivable and any specific customer collection issues that we have identified. While our credit losses have historically been insignificant, we may experience higher credit loss rates in the future than we have in the past. Our accounts receivable are concentrated in relatively few distributors, with three of our distributors in the aggregate accounting for 83% of our total accounts receivable, net as of June 30, 2013. Therefore, a significant change in the liquidity or financial position of any one significant distributor or end customer could make collection of our accounts receivable more difficult, require us to increase our allowance for doubtful accounts and negatively affect our working capital.

Inventory Valuation

We continually assess the salability of our inventory based on assumptions about demand and market conditions. Forecasted demand is determined based on historical sales and expected future sales. We value our inventory at the lower of cost or its current estimated market value. We reduce our inventory to the estimated lower of cost or market value on a part-by-part basis to account for its obsolescence or lack of marketability. Reductions are calculated as the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required that may adversely affect our operating results. If actual market conditions are more favorable, we may have higher gross profits when products are sold.

Intangible assets

Our intangible assets include acquired assembled workforce and licenses and are amortized on a straight-line basis over their estimated useful lives, which range from 18 to 36 months.

 

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On August 23, 2012, Montage Technology Hong Kong Limited, one of our wholly owned subsidiaries, entered into agreements with a third party to acquire research and development workforce, intellectual property, or IP, and computers and office equipment for total cash consideration of $2.0 million. The acquisition was completed in September 2012. We determined that the acquisition of research and development workforce, IP and computers and office equipment should be accounted for as an asset acquisition as the group of assets that we acquired did not meet the definition of a business as pursuant to ASC 805. We allocated the total consideration to the acquired research and development workforce, IP (which was obsolete) and computers and office equipment with the amount of $1.9 million, $0 million, and $0.1 million, respectively. The research and development workforce is recorded as assembled workforce and amortized on a straight line basis over 18 months as we expected the acquired workforce provides economic benefit to us during this period based on our prior experience in the area of developing our research and development workforce and conducting research and development activities.

For long-lived assets including amortizable intangible assets, we evaluate for impairment whenever events or changes (triggering events) indicate that the carrying amount of an asset may no longer be recoverable. We assess the recoverability of the long-lived assets by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to receive from use of the assets and their eventual disposition. Such assets are considered to be impaired if the sum of the expected undiscounted cash flows is less than the carrying amount of the assets. The impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. There were no impairments for long-lived assets and intangible assets for the years ended December 31, 2010, 2011 and 2012.

Reverse Share Split

On September 6, 2013, our shareholders approved and effected a reverse share split such that every 2.5 issued and unissued ordinary and preferred shares of par value US$0.005 were consolidated into one share with a par value of US$0.0125 each. All share-related disclosures, including par value, share price, number of ordinary shares, preferred shares, share options, restricted shares and warrants, exercise price of share options, restricted shares and warrants and related fair value per share, and net income (loss) per share calculations, have been recast to reflect the 2.5-for-1 reverse share split for all periods presented.

Income Taxes

We account for income taxes using the asset and liability approach. We record deferred tax assets and liabilities for the tax consequences attributable to the differences between the carrying amounts of existing assets and liabilities in our financial statements and their respective tax basis, and operating loss carry-forwards. We measure deferred tax assets and liabilities using tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The deferred tax assets would be recovered when the benefits are realized. In the event we were to determine that it is more likely than not that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance for the deferred tax asset would be made.

We are subject to income taxes in China, Hong Kong, Taiwan and the United States, and are subject to routine corporate income tax audits in these jurisdictions. We believe that our tax return positions are fully supported, but tax authorities may challenge certain positions, which may not be fully sustained. However, our income tax expense includes amounts intended to satisfy income tax assessments that result from these challenges. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgment and estimates. We believe that our provision for uncertain tax positions, including related interest and penalties, is adequate based on information currently available to us. The amount ultimately paid upon resolution of audits could be materially different from the amounts previously included in income tax expense and therefore could have a material impact on our tax provision, net income and cash flows. Our overall provision requirement could change due to the issuance of new regulations or new case

 

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law, negotiations with tax authorities, resolution with respect to individual audit issues, or the entire audit, or the expiration of statutes of limitations.

Share-Based Compensation

Effective with the adoption of our 2006 Share Incentive Plan in June 2006, we implemented the authoritative guidance for share-based compensation, which requires us to measure the cost of employee services received in exchange for equity incentive awards, including share options, based on the grant date fair value of the award. The fair value is estimated using the Black-Scholes option pricing model. The resulting cost is recognized over the period during which the employee is required to provide services in exchange for the award, which is referred to as the requisite service period. We recognize compensation expense over the vesting period using the straight-line method and classify these amounts in the statements of operations based on the department to which the related employee reports.

We account for share options issued to non-employees in accordance with authoritative guidance for equity based payments to non-employees. Share options issued to non-employees are accounted for at their estimated fair value determined using the Black-Scholes option-pricing model. The fair value of options granted to non-employees is re-measured as they vest, and the resulting increase in value, if any, is recognized as expense during the period the related services are rendered.

For purposes of determining our share-based compensation expense, we used the Black-Scholes option pricing model to calculate the fair value of share options on the grant date for share options granted to employees and as of each balance sheet date until the date when services are rendered for share options granted to non-employees. This model requires inputs such as the expected term of the option, expected volatility, the risk-free interest rate, dividend yield and fair value of the underlying share at grant date. These inputs are subjective and generally require significant judgment. For each of the three years ended December 31, 2010, 2011 and 2012 and the six months ended June 30, 2013, we estimated the fair value of share options using the Black-Scholes option pricing model with the following range of assumptions:

 

     Year Ended December 31   Six Months Ended
June 30
     2010   2011   2012   2013
                 (unaudited)

Risk-free interest rate

   2.37-4.53%   1.42-4.52%   1.10-3.13%   1.11-3.19%

Dividend yield

        

Expected term (years)

   6 to 10   6 to 10   6 to 10   6 to 10

Expected volatility

   50.21-63.99%   49.29-57.46%   39.97-52.66%   39.69-48.82%

Risk-Free Interest Rate. We derived the risk-free interest rate assumption from the yield-to-maturity of the USD dominated China International Government bond with the maturity period that can cover the expected term of the share options.

Dividend Yield. Expected dividend yields are assumed to be 0% for all grant dates, as our dividend policy is to retain earning for reinvestment purpose and we do not intend to distribute dividend in the foreseeable future.

Expected Term. The expected term represents the period that our share-based awards are expected to be outstanding. The expected term was estimated based on the date of the grant, expiration date and vesting period as stated in the share option grant. The expected term for directors, officers and employees was six years from each measurement date. The expected term for external consultants was ten years from the grant date.

Expected Volatility. We estimated volatility based upon the average share price volatility of comparable listed companies over a period comparable to the expected term of the options. We believe the average share price volatility of the selected comparable companies is a reasonable benchmark in estimating the expected

 

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volatility of our ordinary shares. When making the selections of our industry peer companies to be used in the volatility calculation, we also considered their stage of development, size and financial leverage.

In addition to determining the fair value of share options granted to employees, we also estimate the forfeiture rate to calculate the amount of compensation expense recognized for each reporting period. We utilized our historical forfeiture rates to estimate our future forfeiture rate, which is 5.6%. We will continue to evaluate the appropriateness of estimating the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors. Estimated forfeiture rates also affect the amount of aggregate compensation costs recognized for each reporting period. Quarterly changes in the estimated forfeiture rate can have a significant effect on share-based compensation expense as the cumulative effect of adjusting the rate for all shares compensation expense amortization is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the share-based compensation expense recognized in the consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the share-based compensation expense recognized in the consolidated financial statements. The effect of forfeiture adjustments during 2010, 2011, 2012 and the six months ended June 30, 2013 was insignificant. We will continue to use judgment in evaluating the expected term, volatility and forfeiture rate related to our share-based compensation on a prospective basis and incorporating these factors in the option pricing model.

If in the future, we determine that other methods are more reasonable, or other methods for calculating these assumptions are prescribed by authoritative guidance, the fair value calculated for our share options could change significantly. Higher volatility and longer expected lives result in an increase to share-based compensation expense determined at the date of grant. Share-based compensation expense affects our cost of revenue, research and development expense and our sales, general and administrative expense.

In order to determine the fair value of share options using the Black Scholes model, we are required to determine the fair value of our ordinary shares. The following table summarizes, by grant date, the number of share options granted since March 19, 2012 and the associated per share exercise price for each of these grants and the fair value of the ordinary shares used to calculate our share-based compensation:

 

Grant Date

   Number of
Options
Granted
     Exercise Price
($)
     Fair Value of
Underlying
Ordinary Shares
as of the Grant
Date

($)
 

March 19, 2012

     34,800         2.20         7.83   

March 19, 2012

     47,200         9.43         7.83   

June 15, 2012

     21,200         9.43         9.20   

September 17, 2012

     340,720         9.43         12.20   

December 13, 2012

     96,000         9.43         15.28   

February 25, 2013

     120,800         16.03         17.20   

April 23, 2013

     1,179,960         17.85         17.98   

August 13, 2013

     30,000         17.85         17.98   

None of the option grants set forth in the above table were Incentive Share Options.

On April 23, 2013, upon the recommendation of our chief executive officer, our compensation committee approved the grant of restricted shares, primarily to our employees, covering a total of 317,120 ordinary shares. The estimated fair value on the grant date was $17.98 per ordinary share.

In addition, on August 13, 2013, our compensation committee approved the grant of restricted shares, primarily to our employees, covering a total of 13,500 ordinary shares. The estimated fair value on the grant date was $17.98 per ordinary share.

 

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Historically, given the absence of an active market for our ordinary shares, our board of directors determined the exercise prices of share options granted by referencing to objective and subjective factors affecting value of our ordinary shares. The factors considered by our board of directors included the following:

 

   

retrospective valuations performed by independent third-party valuation specialist;

 

   

the prices of our convertible preferred shares sold to outside investors in arm’s-length transactions;

 

   

the rights, preferences and privileges of our convertible preferred shares relative to those of our ordinary shares;

 

   

our operating and financial performance and revenue outlook;

 

   

the introduction of new products;

 

   

the hiring of key personnel;

 

   

the status of product development and qualifications;

 

   

the fact that option grants involve illiquid securities in a private company;

 

   

the public trading prices of the ordinary shares of companies whose business is comparable to ours;

 

   

the general economic outlook;

 

   

the risks inherent in the development of our products and expansion of our target markets; and

 

   

the likelihood of achieving a liquidity event, such as an initial public offering or sale of our company, given prevailing market conditions.

In determining our share-based compensation expense using the Black Scholes model, we engaged an independent third-party valuation specialist to assist us with the valuation of ordinary shares on a retrospective basis. However, our management and board of directors have assumed full responsibility for the estimates. We have performed valuations of our ordinary shares in a manner consistent with the methods outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. These valuations were prepared in a consistent manner and involved a two-step process. First, we established our enterprise value using the income approach and the market approach. The income approach, which relies on a discounted cash flow analysis, measures the value of a company as the present value of its future economic benefits by applying an appropriate risk-adjusted discount rate to expected cash flows, based on forecasts of revenue and costs. The market approach, which relies on analysis of comparable public companies and comparable acquisitions, measures the value of a company through comparison to comparable companies and transactions. Consideration is given to the financial condition and operating performance of the company being valued relative to those of publicly traded companies operating in the same or similar lines of business. When choosing the comparable companies to be used for the market approach, we focused on companies in the semiconductor industry. Some of the specific criteria we used to select comparable companies within our industry included the business description, business size, projected growth, financial condition and historical operating results. For each valuation report, we prepared a financial forecast to be used in the computation of the enterprise value for both the market approach and the income approach. The financial forecasts took into account our past experience and future expectations. The risks associated with achieving these forecasts were assessed in selecting the appropriate discount rate. As discussed below, there is inherent uncertainty in these estimates. We applied a discount for lack of marketability to reflect the increased risk arising from the inability of holders to readily sell the shares and then allocated the resulting equity value among the securities that comprise our capital structure using the Option-Pricing Method. The aggregate value of the ordinary shares derived from the Option-Pricing Method was then divided by the number of ordinary shares outstanding to arrive at the per share common value.

In each valuation, we considered the market approach based on an analysis of comparable public companies. In forming our opinion, we relied upon the income approach to prepare the equity value analysis of the company, due to factors such as lack of a long business history compared with the comparable public companies,

 

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differential of business scopes, significant sales increase beginning in 2011, as well as short reporting periods of net profit. Since the fair value of our ordinary shares has been ultimately determined by our discounted cash flow analyses, our valuations have been heavily dependent on our estimates of revenue, costs and related cash flows. These estimates are highly subjective and subject to frequent change based on both new operating data as well as various macroeconomic conditions that impact our business. Each of our valuations was prepared using data that was consistent with our then-current operating plans that we were using to manage our business.

Discussion of Significant Factors in Fair Value Determinations

The fair values of the underlying ordinary shares were determined with the assistance of an independent third-party valuation specialist. To estimate the fair value of the ordinary shares, we first determined our enterprise value by means of a discounted cash flow analysis using the retrospective approach. The cash flow derived by company management considered the nature of our business, our future business plan, specific business and financial risks, the stage of development of our operations, and economic and competitive elements affecting our business, industry and market. We also used other general assumptions, including following: no major changes in the existing political, legal, fiscal and economic conditions in China; no major changes in the current taxation laws in the jurisdictions in which we operate; our ability to retain competent management, key personnel and technical staff to support our ongoing operating; and no significant deviations in industry trends and market conditions from our current economic forecasts. The cash flow is discounted using the weighted average cost of capital of 20% as of December 31, 2010 and 18% as of June 30, 2012, which were benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 20% and 15% were applied to arrive at the estimated enterprise value as of December 31, 2010 and June 30, 2012. The lack of marketability discount takes into consideration the plans for the status of our proposed initial public offering.

The following discusses the significant factors and probabilities of various outcomes considered by our board of directors in determining the estimated fair value of our ordinary shares at each of the grant dates specified below. Our board of directors estimated the fair value of our ordinary shares, however, the fair value of the underlying ordinary shares was subsequently revisited by our board of directors for financial reporting purposes and reassessed on a retrospective basis.

March 19, 2012

On March 19, 2012, our board of directors granted share options with an exercise price equal to the fair value of the ordinary shares as of June 30, 2012, as determined by an independent valuation specialist. The share options granted on this date included options to purchase 34,800 ordinary shares which were committed to existing employees but which had not been submitted to our board of directors for approval. These prior commitments were made to employees with an exercise price of $2.20 per share prior to the receipt of an independent valuation. With respect to these awards, our board of directors determined to honor our prior exercise price commitment to the employees. With respect to other grants approved on March 19, 2012, our board of directors considered an independent valuation as of June 30, 2012 reflecting a fair value of $9.43 per share and determined to establish the exercise price for these options at $9.43 per share.

The significant assumptions used in the June 30, 2012 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 15% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the current status of our plan for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 55%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

 

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June 15, 2012

On June 15, 2012, our board of directors granted share options with an exercise price equal to the fair value of the ordinary shares as of June 30, 2012, as determined by an independent valuation specialist. Subsequent to making the grants, the board of directors considered an independent valuation as of June 30, 2012 reflecting a fair value of $9.43 per share and determined to establish the exercise price for these options at $9.43 per share.

The significant assumptions used in the June 30, 2012 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 15% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 55%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

September 17, 2012

On September 17, 2012, our board of directors granted share options with an exercise price of $9.43 per share. In estimating the fair value of our ordinary shares to set the exercise price of such options, our board of directors considered a number of factors, including an improving revenue forecast, particularly for memory buffer products and our continued strong set-top box revenues. Although our business prospect improved, the changes were deemed not material and as a result our board of directors considered the most recent independent valuation report of June 30, 2012 that reflected a fair value of our ordinary shares of $9.43 per share and the exercise price for these options remained at $9.43 per share.

The significant assumptions used in the June 30, 2012 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 15% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 55%. Similarly, the second most probable outcome applied was a change of control of the company, with a probability set at 30%.

December 13, 2012

On December 13, 2012, our board of directors granted share options with an exercise price of $9.43 per share. In estimating the fair value of our ordinary shares to set the exercise price of such options, our board of directors considered a number of factors, including initial revenue from our LRDIMM memory interface products and our continued strong set-top box solutions revenue growth. However, our board of directors noted the high degree of volatility in the U.S. public markets, citing in particular that the NASDAQ Global Market declined 6% since our prior quarterly board meeting. As a result, the board of directors estimated that the fair value of our ordinary shares continued to be $9.43 per share based on an independent valuation as of June 30, 2012 and the exercise price for the options approved at this meeting be at $9.43 per share.

The significant assumptions used in the June 30, 2012 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 15% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 55%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

In January 2013, our board of directors requested our independent third party valuation specialists to perform a full set of retrospective valuations of our ordinary shares at various dates since our inception. In

 

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February 2013, our valuation specialist delivered to our board of directors valuation reports which valued our ordinary shares as of December 31, 2010, September 30, 2011, June 30, 2012 and December 31, 2012. Our valuation specialist valued our ordinary shares at each of these dates at $2.35, $5.20, $9.43 and $15.90, respectively. The significant assumptions used in the December 31, 2012 independent valuation report which was delivered by our valuation specialist in February 2013 included an increase in forecasted revenue for our memory interface solutions as we began initial shipment of our LRDIMM solutions. The valuation also included a discounted weighted average cost of capital of 18%, which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 11% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with the probability of an initial public offering set at 60%. Similarly, the second most probable outcome applied was a change in control of the company, with the probability set at 30%. As a result, for the ordinary shares underlying the options, we have attributed a fair value for each grant date. This fair value input at each option grant date was determined by the linear relationship with reference to the fair values of the ordinary shares as of the closest key valuation dates. We believe the linear relationship between key dates to derive the fair value of ordinary shares input for share option pricing is reasonable during these periods. We determined that share-based compensation expense that we would record should be calculated with the revised estimated fair value of our ordinary shares at each grant date for all the share option grants.

February 25, 2013

On February 25, 2013, our compensation committee granted share options with an exercise price of $16.03 per share. In estimating the fair value of our ordinary shares to set the exercise price of such options, our compensation committee considered a number of factors, including increasing revenue from our LRDIMM memory interface products and our continued strong set-top box revenue growth. In addition, our board of directors was increasingly looking into the possibility of an initial public offering for the company. Our compensation committee estimated that the fair value of our ordinary shares was $6.41 per share based on a independent valuation as of December 31, 2012. As a result, the exercise price for the options approved at this meeting was at $16.03 per share.

The significant assumptions used in the December 31, 2012 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 11% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the then current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 60%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

April 23, 2013

On April 23, 2013, our compensation committee granted share options with an exercise price of $17.85 per share based on a preliminary report from our independent valuation specialist that determined the fair value of our ordinary shares as of March 31, 2013 to be $17.85. In estimating the fair value of our ordinary shares to set the exercise price of such options, our compensation committee considered a number of factors, including increasing revenue from our LRDIMM memory interface products and our continued strong set-top box revenue growth. In addition, our board of directors was increasingly looking into the possibility of an initial public offering for the company. We subsequently estimated that the fair value of our ordinary shares was $17.98 per share based on the final result of the independent valuation as of March 31, 2013.

The significant assumptions used in the March 31, 2013 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 6% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the then current status of our plans for a

 

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proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 60%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

August 13, 2013

On August 13, 2013, our compensation committee granted share options with an exercise price of $17.85 per share based on the preliminary report from our independent valuation specialist that determined the fair value of our ordinary shares as of March 31, 2013 to be $17.85. In estimating the fair value of our ordinary shares to set the exercise price of such options, our compensation committee considered a number of factors, including increasing revenue from our LRDIMM memory interface products and our continued strong set-top box revenue growth. In addition, our board of directors was increasingly looking into the possibility of an initial public offering for the company. We subsequently estimated that the fair value of our ordinary shares was $17.98 per share based on the final result of the independent valuation as of March 31, 2013. The significant assumptions used in the March 31, 2013 independent valuation report included a discounted weighted average cost of capital of 18% which was benchmarked with discount rates of comparable listed companies. In addition, a lack of marketability discount of 6% was applied to arrive at the estimated enterprise value. The lack of marketability discount took into consideration the then current status of our plans for a proposed initial public offering. The expected outcomes were heavily weighted based on the probability of a public offering, with a probability of an initial public offering set at 60%. Similarly, the second most probable outcome applied was a change in control of the company, with a probability set at 30%.

As a result of our Black-Scholes option fair value calculations and the allocation of value to the vesting periods using the straight-line vesting attribution method, we recognized employee share-based compensation in the statements of operations as follows:

 

     Year Ended December 31,      Six Months
Ended
June 30,
 
     2010      2011      2012      2013  
     (in thousands)      (unaudited)  

Cost of revenue

   $ 31       $ 13       $ 19       $ 15   

Research and development

     358         356         497         399   

Sales, general and administrative

     389         262         473         661   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 778       $ 631       $ 989       $ 1,075   
  

 

 

    

 

 

    

 

 

    

 

 

 

The total compensation cost related to unvested share option grants not yet recognized as of June 30, 2013 was $13.9 million, and the weighted-average period over which these grants are expected to vest is 3.92 years. In future periods, we expect our share-based compensation expense to increase as a result of our unrecognized share-based compensation to be recognized as these awards vest and as we issue additional share-based awards to attract and retain employees.

On April 23, 2013, we granted 317,120 restricted shares, under our 2006 Share Incentive Plan. The estimated fair value on the grant date of the restricted shares was $17.98 per ordinary share. We calculated the share-based compensation expense for these restricted shares by multiplying the estimated fair value of our ordinary shares on the date of grant by the number of restricted shares, less the forfeitures. The share-based compensation expense is recorded on a straight-line basis over the requisite service period of the restricted shares.

On August 13, 2013, we granted 13,500 restricted shares under our 2006 Share Incentive Plan. The estimated fair value on the grant date of the restricted shares was $17.98 per ordinary share. We calculated the share-based compensation expense for these restricted shares by multiplying the estimated fair value of our ordinary shares on the date of grant by the number of restricted shares, less the forfeitures. The share-based compensation expense is recorded on a straight-line basis over the requisite service period of the restricted shares.

 

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We recognized share-based compensation expense for restricted shares as follows:

 

     Year Ended
December 31,
     Six Months
Ended
June 30,
 
     2010      2011      2012      2013  
     (in thousands)      (unaudited)  

Cost of revenue

   $ 0       $ 0       $ 0       $ 13   

Research and development

     0         0         0         179   

Sales, general and administrative

     0         0         0         27   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 0       $ 0       $ 0       $ 219   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2013, there was $4,674 of unrecognized compensation costs, net of forfeitures related to restricted share awards granted under our 2006 Share Incentive Plan. The unrecognized compensation cost is expected to be recognized over a weighted average period of 4.22 years.

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This update requires an entity to disclose both gross and net information about instruments and transactions eligible for offset in the statements of financial position as well as instruments and transactions executed under a master netting or similar arrangement and was issued to enable users of financial statements to understand the effects or potential effects of those arrangements on their financial position. This update is required to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with ASC 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with ASC 210-20-45 or ASC 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. The effective date is the same as the effective date of ASU 2011-11. The adoption of this update did not have a material impact on our consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, “Intangibles — Goodwill and Other: Testing Indefinite Lived Intangible Assets for Impairment.” The update applies to all entities, both public and nonpublic, that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. Per the Update, an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if financial statements for the most recent annual or interim period have not yet been issued. The adoption of this update did not have a material impact on our consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This update does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, this update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP

 

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to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The adoption of this update did not have a material impact on our consolidated financial statements.

On April 22, 2013, the FASB issued Accounting Standards Update No. 2013-07, Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting. This guidance addresses when and how an entity should apply the liquidation basis of accounting. The amendments in this Update are being issued to clarify when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. The amendments apply to all entities that issue financial statements that are presented in conformity with U.S. GAAP except investment companies that are regulated under the Investment Company Act of 1940 (the 1940 Act). The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The adoption of this update is not expected to have a material impact on our consolidated financial statements.

In March 2013, the FASB issued ASU 2013-05, “Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity”. This update provides that when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity, the parent is required to apply the guidance in Subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. However, this treatment does not apply to an equity method investment that is not a foreign entity. In those instances, the cumulative translation adjustment is released into net income only if the partial sale represents a complete or substantially complete liquidation of the foreign entity that contains the equity method investment. Additionally, the amendments in this update clarify that the sale of an investment in a foreign entity includes both (1) events that result in the loss of a controlling financial interest in a foreign entity (that is, irrespective of any retained investment) and (2) events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date (sometimes also referred to as a step acquisition). Accordingly, the cumulative translation adjustment should be released into net income upon the occurrence of those events. This update is effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013.

On July 18, 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Income Taxes — Topic 740). This Update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized

 

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tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled. The amendments in this update do not require new recurring disclosures. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. We are currently evaluating the impact on our financial statements of adopting this update.

 

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BUSINESS

Overview

We are a global fabless provider of analog and mixed-signal semiconductor solutions currently addressing the home entertainment and cloud computing markets. Our expertise in analog and radio frequency solutions, digital signal processors and high speed interfaces serves as the foundation for our technology platform. These technical capabilities enable us to design high performance, low power semiconductors. In the home entertainment market, our technology platform enables us to design highly integrated solutions with customized software and support for set-top boxes. Our solutions are designed to optimize signal processing performance under the challenging operating conditions typically found in emerging market environments, where often broadcast signals coming into the set-top box may be weak, distorted or off-specification. Our solutions contain a number of different technologies that allow for enhanced signal processing that improves overall video quality under the typically limited existing broadband network infrastructure in emerging markets. In the cloud computing market, we offer high performance, low power memory interface solutions that enable memory-intensive server applications. Our technology platform approach allows us to provide integrated solutions that meet the expanding needs of our customers through our continuous innovation, cost- and power-efficient efficient design and rapid product development. Since our inception in 2004, we have sold over 230 million integrated circuits which have been shipped to over 150 end customers worldwide.

While analog and mixed-signal technology is applicable to a broad array of end markets, we have been highly selective in identifying our initial target end markets. We focus on markets which we believe have compelling long-term growth prospects and are also characterized by complex product design, long life cycles and stringent qualification requirements. We believe that these market characteristics coupled with our significant investment in our technology platform have created high barriers to entry for our set-top box solutions in emerging markets. Initially, we developed commercial solutions for the home entertainment market to address the rapidly growing demand for television in China, Southeast Asia and other emerging markets. According to iSuppli, in 2012, 154 million set-top boxes were sold by Chinese manufacturers, primarily targeting emerging markets. According to iSuppli, the total number of set-top boxes sold by Chinese manufacturers is expected to grow to over 243 million. This would represent a compound annual growth rate of 12% from 2012 to 2016. A key to our success in addressing the characteristics of the home entertainment market in emerging markets is our ability to provide integrated solutions with customized software and support, which we develop through close collaboration with our end customers. Our collaborative approach allows us to develop extensive localized knowledge of a large, fragmented market with diverse technical and service requirements, deepening our customer relationships and yielding design wins across multiple product generations. Our end customers in the home entertainment market include nine of the ten largest set-top box manufacturers in China as measured by units sold in 2012.

More recently, we released our memory interface solutions to pursue opportunities arising from the rapid growth in the cloud computing market. Our close collaboration with key industry participants, including CPU manufacturers, memory module manufacturers and server OEMs, has enabled us to successfully develop high performance, low power memory interface solutions for cloud computing environments. We sell our memory interface solutions to memory module manufacturers, which incorporate our memory interfaces into dual in-line memory modules, or DIMMs, which are devices used to add memory capacity to a CPU. The most advanced cloud computing data servers operating today currently use DDR3 memory technology and load-reduced DIMMs, or LRDIMMs, which require memory interfaces that buffer data signals in addition to command and address signals. Memory interface vendors like us are unable to sell their solutions to memory module manufacturers without those solutions first being validated by manufacturers of CPUs. We are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers. Sales of LRDIMM memory buffers for DDR3 accounted for 27.9% and 32.6% of our revenue from memory interface solutions, and 1.7% and 3.1% of our total revenue, in 2012 and the six months ended June 30, 2013, respectively. We expect revenue from our LRDIMM

 

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memory buffers to increase as a percentage of our total revenue beginning in 2013, driven largely by growth in cloud computing. Achieving and maintaining Intel validation for our LRDIMM memory buffers is extremely important to our market position and the prospects of our memory interface solutions business, as the server OEMs who adopt Intel’s server platforms will only purchase components of their servers from Intel validated vendors. Our customers in the cloud computing market include the world’s four largest DRAM manufacturers and the world’s largest third-party DRAM module supplier as measured by 2012 revenues.

We offer ten solutions for use in the home entertainment market and two memory interface solutions for use in the cloud computing market. In 2012 and the six months ended June 30, 2013, 94% and 91%, respectively, of our revenue was generated from sales of set-top box solutions targeting the home entertainment market in emerging markets, while the remaining 6% and 9%, respectively, of our revenue was generated from sales of memory interface solutions targeting the cloud computing market. Our solutions are built upon our foundation of 37 issued patents and an additional 46 pending patent applications. As of June 30, 2013, we had 290 engineers in our research and development organization, of which 141 hold post-graduate engineering degrees. We sell our solutions principally through distributors to over 150 end customers worldwide. Our revenue has grown from $29.1 million in 2010 to $78.2 million in 2012, representing a compound annual growth rate of 64%, and from $33.9 million in the six months ended June 30, 2012 to $45.4 million in the six months ended June 30, 2013, representing a compound annual growth rate of 34%. We had a net loss of $8.5 million in 2010 and net income of $5.0 million in 2011, $18.3 million in 2012 and $8.8 million in the six months ended June 30, 2013.

Our Target Markets

Our solutions primarily serve large target markets: (i) home entertainment, in particular set-top boxes for emerging markets; and (ii) the cloud computing market, in particular memory interface solutions for data center servers.

Home Entertainment Market

In emerging markets, such as China, India, the Middle East, Latin America, Africa and Southeast Asia, television content is broadcast and accessed through satellite transmissions, cable network connections or terrestrial over-the-air transmissions. Viewers often access content from these three signal transmission systems using set-top boxes that are connected to televisions within the home. According to iSuppli, in 2012, 154 million set-top boxes were sold by Chinese manufacturers. We believe that set-top boxes sold by Chinese manufacturers primarily target China and other emerging markets. Of the 154 million units sold, 66% were exported outside of China. The number of set-top boxes sold by Chinese manufactures is expected to grow to over 243 million units in 2016 according to iSuppli, with 58% of these units expected to be exported. This would represent a compound annual growth rate of 12% from 2012 to 2016.

A number of factors determine whether a viewer accesses television broadcasts through a satellite, cable or terrestrial connection including location, existence of wired cable infrastructure and desire for premium content. Within emerging markets, satellite television circumvents expensive capital deployment of wired infrastructure, which makes satellite broadcast a particularly attractive signal transmission solution in rural areas. As a result, the satellite set-top box market is the largest market in terms of total number of units sold by Chinese manufacturers, with over 83 million units sold, representing 54% of the total number of units sold by Chinese manufacturers in 2012, according to iSuppli. In addition, the market for high-definition satellite set-top boxes produced by Chinese manufacturers is expected to grow from 17.3 million units in 2012 to 36.2 million units in 2016, according to iSuppli. This would represent a compound annual growth rate of 20% from 2012 to 2016. Cable television is often accessed in these markets through local or regional providers who utilize multiple standards that differ by region, resulting in a highly fragmented market. Given the proliferation of cable operators, iSuppli estimates that the market for cable set-top boxes produced by Chinese manufacturers is expected to grow 87% from 2012 to 2016, which is faster than the terrestrial and satellite set-top box markets. The market for high-definition cable set-top boxes produced by Chinese manufacturers is expected to grow from 7.0 million units in 2012 to 24.3 million units in 2016

 

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according to iSuppli. This would represent a compound annual growth rate of 37% from 2012 to 2016. Terrestrial broadcast is also a highly fragmented market with viewers having free access to limited, non-premium content. Across the satellite, cable and terrestrial set-top box markets, individual operators typically have their own specialized system requirements that require customized set-top box solutions.

Overall, television content access rates in emerging markets are lower than those in developed markets. However, a number of powerful trends are driving the rapid growth in television viewership. Increasing disposable household income enables viewers who previously could not afford television access to purchase set-top boxes and access standard programming and premium content. In some emerging markets, such as China, the broadcasting signal of television content is transitioning from analog to digital due to government sponsored programs requiring the replacement or addition of television access equipment. For example, China has a goal of shutting down analog TV signals by 2015 and transitioning to digital TV in most regions. Similar to the U.S. market, analog broadcast in emerging markets is expected to transition completely to digital broadcast to enable more channels and provide high-definition service, driving demand for digital signal receivers. As content quality improves and continues to shift from standard definition to high definition video, viewers in emerging markets are expected to increasingly purchase set-top boxes that can receive and display high definition video content. High-definition set-top boxes represented only 28% of the total set-top box shipment in 2012, and iSuppli estimates the number of high definition set-top boxes sold to grow by 106% from 2012 to 2016. These trends, which are already prevalent in more advanced television markets, are currently taking hold in emerging markets and are driving an increasing demand for set-top box solutions.

A number of key components within a set-top box drive performance, including the tuner, demodulator and decoder. In order to optimize for superior and robust system performance and deliver cost-efficient solutions to set-top box manufacturers, semiconductor providers are integrating these functions into a single silicon package. The integration process requires significant analog and mixed-signal engineering expertise and deep system level knowledge to ensure maximum functionality while at the same time delivering value to the manufacturer. Given the unique system requirements that individual network operators demand, a high level of collaboration is required between set-top box manufacturers and semiconductor providers. These integrated solutions also require customized embedded software and field application support to ensure proper functionality and system level performance.

The key factor for home entertainment in emerging markets is delivering low cost entertainment to viewers. Set-top box solutions typically found in advanced television markets provide features that are not required by viewers in emerging markets and therefore are priced too high for emerging markets. Cost-effective yet high-performance solutions that can address the demanding operating conditions typically found in emerging market environments are required. According to iSuppli, the market for semiconductors addressing set-top boxes manufactured in China totaled $995 million in 2012, 74% of which was SoC solutions, and is expected to grow to $1,316 million in 2016, of which 77% is expected to be SoC solutions with sales of integrated semiconductor solutions outpacing the growth of the overall market from 2012 to 2016. This would represent a compound annual growth rate of 7% from 2012 to 2016.

 

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Cloud Computing Market

Global data center IP traffic will increase from 1.8 zettabytes in 2011 to 6.6 zettabytes in 2016, according to Cisco. This would represent a compound annual growth rate of 30% from 2011 to 2016. The proliferation of mobile devices, cloud-based software applications and streaming video pose significant challenges for network data centers. In addition, the rate at which data is consumed is growing much faster than the rate of mobile device growth. The number of mobile devices will increase by three times from 2010 to 2015, and the amount of data being consumed will increase six times during that same period, according to International Data Corporation, or IDC. The limited memory and processing speed of mobile devices has led to a majority of content viewed on mobile devices being accessed using cloud computing technology.

 

LOGO

Source: Cisco Global Cloud Index

To meet the rising demands being placed on networks, data center operators have had to increase the number of servers within their facilities. It has been estimated that for every 120 tablets sold, an additional server must be added to handle the traffic generated. To address the expanding demands on servers, next generation server platforms utilize a higher number of CPUs while at the same time the computing performance of the CPUs themselves is also increasing. Higher computing performance for CPUs has generally been accomplished by increasing the number of cores within the CPU. The maximum number of cores per CPU has increased from one core in 2004 to 16 cores for the latest CPU platform developed by Intel Corporation. We believe that as cloud-based applications increase, additional cores will be added to CPUs to address the need for greater computing performance.

In cloud computing environments where a significant number of memory-intensive applications are simultaneously run on a server, the processing performance of CPUs is limited by the amount of memory available to each CPU. Additional memory capacity is required to ensure servers perform at optimal levels, which is critical for on-demand applications like cloud computing and virtualization. Memory capacity is added to a server through the use of dual in-line memory modules, or DIMMs, which house dynamic random access memory, or DRAM. Memory performance is enhanced through the use of interface devices called memory buffers that efficiently facilitate the rapid flow of data between the CPUs and memory. As the number of cores in the CPU increases, the number of DIMMs required to achieve higher performance also increases. According to IDC, the amount of DRAM per entry level server will increase from 45 gigabits per server in 2013 to 90 gigabits per server in 2017. The need for greater amounts of

 

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DRAM to support high performance computing is expected to drive the development of higher capacity DIMMs, where a greater amount of gigabit storage is placed on a single DIMM. According to Gartner, the memory content within the overall server market is expected to grow to $3,129 million in 2016. This would represent a compound annual growth rate of 22% from 2012 to 2016.

The rise of computing power in a server also drives a significant increase in the energy costs required to operate the server. Therefore, data center operators are increasingly focused on the power efficiency of each component within a server system and ascribe significant value to low power solutions that can drive energy savings without compromising performance.

CPU manufacturers create technology platforms that server OEMs use as the basis for their server design. A CPU manufacturer sets the specifications for many of the key components to be used in each generation of its server platforms. In the case of memory interface solutions for DIMMs, CPU manufacturers impose strict guidelines and generally qualify only a few vendors to provide memory interface solutions for their server platforms. With each new server platform released by CPU manufacturers, providers of memory interface solutions must be validated for use on the new platform. Validation only occurs after expending a considerable amount of development resources and successfully completing a rigorous validation process. Because a small number of CPU manufacturers account for a significant amount of the CPUs used in cloud computing environments, this validation has a significant impact on memory interface vendors attempting to address this market. Once validation is received, memory interface vendors must then attempt to sell their solution to memory module manufacturers by competing against the limited number of companies who have also obtained validation by the leading CPU manufacturers.

The technical requirements for memory interfaces have also increased as historically memory performance was enhanced by the use of register buffers which only buffered the command and address signals between the CPUs and DIMMs. However, increasing CPU performance and memory capacity now requires data signals to be buffered in addition to command and address signals. DIMMs that include memory interface semiconductors that buffer the address, command and data signals are called load-reduced dual in-line memory modules, or LRDIMMs, which support higher data processing capacity on a single load and reduce electrical loading of the DRAM chips onto the memory bus. These memory buffers create higher degrees of complexity and greater requirements for performance, signal integrity and low power, and they command significantly higher average selling prices than register buffers used in RDIMMs. Based on our knowledge gained through qualification processes with CPU and memory module manufacturers, we believe higher capacity DIMMs with memory densities equal to or above 32 gigabits will require the use of LRDIMM technology to ensure the highest server performance. Furthermore, new server platforms will need to expand the capacity for the number of DIMMs to address the increasing amount of data being transmitted over public and private networks. The number of machines using LRDIMM is expected to grow from 2.3 million in 2014 to 3.1 million in 2016, while the average number of LRDIMMs used on a single machine is expected to grow from 4.8 in 2014 to 18.3 in 2016, according to Jon Peddie Research. The increase in number of machines using LRDIMMs and average number of LRDIMMs per machine is expected to drive rapid growth in the estimated potential available market of LRDIMM chipsets, which Jon Peddie Research estimates will increase from up to $312 million in 2014 to as much as $1,958 million in 2016, according to Jon Peddie Research. This would represent a compound annual growth rate of 151% from 2014 to 2016. However, industry forecasts and actual industry results are necessarily subject to a high degree of uncertainty and risk, vary among industry participants, and may be lower than suggested by these forecasts, particularly in a relatively new and evolving market such as the LRDIMM market. In terms of unit volume, Jon Peddie Research estimates the potential available market for LRDIMM chipsets will increase from up to 18.4 million units in 2014 to as much as 93.2 million units in 2016. This would represent a compound annual growth rate of 125% from 2014 to 2016.

 

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Key Requirements for Our Target Markets

Within the home entertainment market, set-top box manufacturers in emerging markets have the following critical needs which must be addressed when identifying semiconductor solutions for their products:

 

   

Integration The ability to combine the functionality of multiple semiconductors onto a single integrated circuit to increase signal integrity and performance, while shrinking component size and lowering overall costs.

 

   

High level of field support Given the fragmented market of network operators and the disparate nature of system requirements, set-top box manufactures require high levels of field support to ensure high performance across multiple networks.

 

   

Exceptional performance and signal processing in challenging environments Often in emerging markets, limitations in existing broadcast network infrastructure pose challenges, requiring the signal processing and performance capabilities for semiconductor solutions to be more robust than in developed markets.

 

   

Embedded software and comprehensive system-level solutions Customized embedded software can significantly improve performance and provide the set-top box manufacturer with a complete solution.

 

   

Cost effective In emerging markets, set-top boxes must be reasonably priced to ensure significant viewer acceptance, requiring solutions incorporated into set-top boxes to be cost effective.

 

   

Ease of manufacture By providing comprehensive semiconductor solutions, set-top box manufacturers can simplify their manufacturing processes.

Within the cloud computing market, server OEMs have the following critical needs which must be addressed when identifying memory interface solutions for their products:

 

   

High performance and low power Solutions must optimize processing speed and accuracy while minimizing energy requirements.

 

   

Signal integrity The ability to process high frequency signals ensuring an efficient link between the CPU and memory which ultimately drives superior performance.

 

   

Built-in self-test The ability for memory interface solutions to give customers the capability to efficiently validate their products.

To successfully compete in the home entertainment and cloud computing markets, semiconductor providers must possess strong design capabilities in both analog and mixed-signal technologies as well as system level design expertise. In addition design solutions must effectively meet the foregoing requirements and offer an attractive value proposition for both set-top box manufacturers and server OEMs alike.

Our Competitive Strengths

We believe our key competitive strengths include the following:

High performance low power analog and mixed-signal technology platform. Our technology platform is built upon our foundation of high performance, low power expertise and is comprised of a versatile and comprehensive set of hardware and software building blocks that serve both our home entertainment and cloud computing markets. For example in the cloud computing market, we are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers. We believe our memory interface solutions consume significantly less power than the only other Intel Corporation- validated DDR3 LRDIMM offering based on our communications with our memory module manufacturer customers. We also believe our unique and proprietary low power designs allow us to compete effectively against competitors who may utilize smaller semiconductor

 

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process geometries that result in higher engineering and manufacturing costs and longer production cycles. Our low power designs are especially critical for certain applications such as data centers where the cost of energy often exceeds the cost of the server over the lifetime of the server.

Deep technology expertise. Our research and development team of 290 professionals, of which 141 have advanced degrees, has extensive digital signal processing, radio frequency and analog and mixed-signal design experience and includes engineers who have participated in the development of key industry standards such as JEDEC and MPEG. Our world-class management team, which oversees our entire team of engineers, has strong technical backgrounds and prior experience at leading US-based semiconductor companies. We have internally developed our technology platform and our intellectual property portfolio consists of 83 issued and pending patents as of June 30, 2013. Our core system-level expertise and understanding of system requirements enables us to optimize our product roadmap and identify attractive opportunities. We supplement our research and development engineers with 53 application and field application engineers, who collaborate with our customers to provide comprehensive solutions, including embedded software, that reinforce barriers to entry. Our application expertise allows us to partner with industry leading OEMs to develop solutions for a broad range of home entertainment and cloud computing technologies.

High levels of integration. We believe our integrated solutions result in superior performance and lower material costs for our customers, enhancing our attractive value proposition. Our integrated solutions have significant advantages over competing discrete products such as improving signal integrity, reducing size and ultimately driving superior system performance. Our technology optimizes signal paths from entry to exit, resulting in highly efficient and robust performance. We believe our integrated, comprehensive and customized solutions help optimize performance and simplify manufacturing for our customers by reducing the number of discrete components within their systems and may lower overall system costs. For example, we believe we are currently the only Asia-based semiconductor provider to make an integrated tuner, demodulator and decoder into a single chip in the satellite set-top box solutions market in which we compete. We believe that the enhanced performance and cost-effectiveness created by the high level of integration in our solutions allows us to deliver additional value to our end customers, which increases customer loyalty and positions us to benefit from demand for future product upgrades from end customers. We believe this product cycle helps position us to sustain our profitability, which enables us to continue our investment in research and development activities in an effort to maintain our competitive advantage.

Close collaboration and relationships with customers and industry participants. We primarily collaborate with our customers and industry participants through high levels of support from our field application engineers. Our extensive customer interaction, combined with our deep understanding of our customers’ needs, fosters customer loyalty and increases visibility of evolving customer requirements and market opportunities within our business. Our close proximity to our customers, which are primarily located in Asia, also provides us with a better understanding of local system requirements and allows us to achieve faster time to market with our solutions. We believe this close collaboration on a local level and deep knowledge of local market requirements is particularly important due to the fragmentation and diverse technical and service requirements in the home entertainment market in emerging markets, which not only create barriers to entry for competitors without significant resources located in Asia, but also help to enhance customer loyalty. Our close collaboration with key industry participants, including server OEMs such as Dell Inc., Hewlett-Packard Company and International Business Machines Corporation, has enabled us to successfully develop high performance memory interface solutions for cloud computing environments, proven by the fact that we are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology.

Broad customer base and attractive market opportunities in home entertainment. We sell our solutions principally through distributors to over 150 set-top box customers worldwide. Our versatile home entertainment solutions allow us to address the satellite, cable and terrestrial television in emerging markets. Our end customers include nine of the ten largest set-top box manufacturers in China as measured by units sold in 2012, who manufacture products optimized for end users in emerging markets. We believe the increase in TV viewership

 

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penetration, individual disposable income in emerging markets and demand for greater home entertainment options will continue to expand our addressable market. We believe our solutions with customized software and support are critical to our set-top box end customers and create a high degree of customer loyalty. We were a leading provider of semiconductors used in set-top boxes manufactured in China in terms of units sold in 2012, and we had the highest growth rate from 2009 to 2012 among digital set-top box solution providers with 10% or greater market share in China in 2012, according to iSuppli.

Well positioned to capitalize on opportunities in cloud computing. We believe we offer the highest performance and lowest power memory interface solutions for memory-intensive cloud computing applications. We are currently one of two LRDIMM memory buffer suppliers validated by Intel Corporation for DDR3 technology, the most prevalent industry standard for memory integrated circuits used in servers. We closely follow current and next generation server and DRAM technology roadmaps to ensure our memory interface solutions promptly meet their qualification windows. We believe we are the only integrated circuit supplier to produce Intel-validated solutions for every generation of memory buffers beginning with DDR2 advanced memory buffers. We have sold our memory interface solutions to Samsung Electronics, SK Hynix Semiconductor, Inc., Elpida Memory, Inc. and Micron Technology, Inc., the world’s four largest memory module manufacturers as measured by revenue generated in 2012, and to Kingston Technology, the world’s largest third-party DRAM module supplier as measured by revenue generated in 2012.

Our Growth Strategies

Our goal is to be the market leader in analog and mixed-signal semiconductor solutions for our target markets. Key elements of our growth strategies include:

Invest to maintain technology leadership position across product lines. We intend to continue our focus on retaining and attracting high quality engineering staff and investing in our intellectual property portfolio to further extend our leading high performance, low power technologies in our markets. We believe our new product development initiatives will improve our overall average selling price and introduce increasingly diverse revenue streams. In our home entertainment market, the average selling price of our set-top box solutions has increased as we have integrated more functionality in our solutions. Additionally, we believe our average selling price will increase further as high definition grows in popularity in emerging markets and more complex functionality is added to our solutions. Similarly, in the cloud computing market, the average selling price for our memory interface solutions for LRDIMMs is significantly higher than our historical average selling prices for memory interface solutions for DIMMs. To supplement our existing engineering resources, we intend to opportunistically acquire engineering talent by adding new or complementary technologies, such as our recruitment of the research and development team from Hangzhou Motorola Technologies Limited in June 2011.

Strengthen our relationships with customers and industry participants. We believe our close relationships with our customers and industry participants provide us with strong visibility into their design cycles, allowing us to optimize our engineering resources. We intend to continue to build upon and strengthen our collaborative relationships to increase our customers’ dependence on us and drive greater demand for our solutions. We intend to continue educating set-top box manufacturers, memory module manufacturers and server OEMs on the benefits of our high performance low power solutions to achieve future design wins. We also intend to continue participating in the development of key industry standards to better align our future roadmap.

Expand product offering and market share in emerging home entertainment markets. We will continue to leverage our engineering expertise to increase our market share in the globally fragmented home entertainment market. For example, we intend to continue to increase our presence in emerging markets where advances in television-related standards and infrastructure are driving increased demand for our solutions. We intend to continue to introduce solutions with higher levels of product functionality and integration, similar to our complete solution that combines a tuner, demodulator and decoder, as we seek to significantly increase our total average selling price per set-top box. To date, substantially all of our revenue is derived from solutions servicing

 

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the standard definition market. However, as broadcasting technologies and requirements continue to evolve, we believe our business will experience growth within the digital TV market from solutions including demodulators for second generation digital video broadcasting standards for satellite, terrestrial and cable, such as DVB-S2, DVB-T2, DVB-C2, as well as TV tuners. Furthermore, we believe the China Terrestrial Television Broadcast standard, which will be required compliance for all TVs sold in China beginning in 2015, will help drive growth for our solutions. Within the set-top box market, we believe significant opportunities exist to sell more complete solutions compliant with the DVB-T2 standard.

Continue to position ourselves for growth in the cloud computing market. We believe the growth in cloud computing and the resulting strain on existing server infrastructure will continue to drive the need for enhanced memory interface solutions. We intend to provide validated solutions for future generations of memory buffers including DDR4. We believe our memory interface solutions will be able to efficiently address the increase in channels, memory capacity and higher throughput speeds required by DDR4. We intend to further penetrate our existing customer base and collaborate with new memory module partners to increase our revenue. We also intend to further develop our relationship with leading CPU manufacturers and remain aligned with their current and next generation server and DRAM technology roadmaps.

Our Technology Platform

Our technology platform leverages our high performance and low power design expertise, proprietary hardware building blocks and customized software to design analog and mixed-signal solutions for the set-top box solutions for emerging markets and memory interface solutions for the cloud computing markets. Additionally, we provide a high level of field application support to ensure high performance of our solutions. In the home entertainment market, our technology platform enables us to design highly integrated solutions for set-top boxes used in the emerging markets. In the cloud computing market, our technology platform has enabled us to produce memory interface solutions that improve server performance while minimizing energy costs.

 

LOGO

The foundation of our technology platform is our analog and mixed-signal design capabilities, which are used to optimize our solutions for high performance and low power. This expertise is combined with a number of internally developed building blocks that are used in the development of our high performance, low power semiconductor solutions. The use of internally developed building blocks provides us with an advantage over competitors who are required to license third party solutions, which increases their costs. Furthermore, the use of internally developed building blocks allows us to maximize the integration of multiple functionalities into our solutions and rapidly and cost-efficiently develop new semiconductor solutions by utilizing our building block

 

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technologies across a range of offerings and multiple product generations. For example, if a particular solution design requires a function that may be costly to develop, we can draw from our set of technology building blocks to cost-effectively address this required functionality. We believe this design flexibility provided by our technology platform is a significant competitive advantage in the set-top box market as it allows us to more effectively satisfy diverse local market requirements. Our proprietary building blocks include analog and radio frequency front end solutions, digital signal processors, SoC technologies, high-speed interfaces and memory buffers. Additionally we develop customized software to increase the functionality of our solutions within our customers’ products. Finally, to ensure optimal performance and build customer loyalty, we provide extensive field application support to our customers.

 

LOGO

Our Solutions

We design, develop and market a range of analog and mixed-signal semiconductor solutions for set-top boxes targeting emerging markets as well as memory interface solutions for the cloud computing markets. Our solutions comprise one or more analog and mixed-signal semiconductors combined with field application and other support services. In 2012, sales of our set-top box and memory interface solutions accounted for 94% and 6%, respectively, of our total revenue. We expect sales of memory interface solutions to grow as a percentage of our total revenue in 2013 and beyond.

Set-Top Box Solutions

We market a range of high performance and multi-standard compliant HDTV and SDTV semiconductor solutions for set-top boxes, including tuners, demodulators and decoders as well as integrated solutions with customized software and support. We provide an integrated solution by combining our RF and analog hardware design and customized software. Our integrated solutions can combine tuner, demodulator and decoding technology in a single semiconductor solution. We support our solutions with our extensive team of field application engineers who are geographically close to our customers and work extensively to deepen our customer relationships. We believe our set-top box solutions deliver high performance because we offer strong signal processing capabilities to address the challenges that are commonly found in emerging markets, where the limited and oftentimes substandard broadcast network infrastructure requires more robust signal processing and

 

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performance capabilities than in developed markets. We offer set-top box solutions for satellite, cable and terrestrial broadcasts, with a particular strength in satellite and cable set-top boxes aimed at emerging markets. While solutions for the satellite set-top box market have contributed, and we expect will continue to contribute, a majority of our set-top box solutions revenue, we expect solutions for the cable set-top box market to contribute to our revenue growth over the next several years.

Our tuner and demodulator solutions are compatible with both SDTV and HDTV signals. Currently, we primarily market our decoder solutions for SDTV. We also launched an HDTV decoder solution in early 2013. In 2010, we launched what we believe was the first integrated DVB-S tuner/demodulator/decoder solution in the home entertainment market in which we compete. To date, substantially all of our set-top box solution revenue has been generated from the SDTV market. We expect to launch at least three new set-top box solutions by the end of 2014, including an integrated satellite HDTV set-top box solution, an integrated cable HDTV set-top box solution and an SDTV set-top box solution supporting DVB-T2 broadcast standards.

We currently offer 11 set-top box solutions, supporting the following broadcast standards:

 

LOGO

Memory Interface Solutions

By combining our expertise in high performance, low power mixed-signal semiconductor design technologies, we have designed and developed advanced memory interface solutions that provide ultra-low power consumption and high performance, including high speed processing as well as signal integrity, for use in data center servers. We design our memory interface solutions in close collaboration with our memory module manufacturer end customers as well as server OEMs and CPU manufacturers to meet required design specifications. We believe our memory interface solutions are high performance, because they can achieve better signal integrity than our competitors in our market, which allow our solutions to efficiently operate at higher speeds thereby increasing memory capacity and improving server performance. Additionally, our built-in self-test capabilities help memory module manufacturers and server OEMs to rapidly validate memory performance.

Our current memory interface solutions include register buffers for DDR3 RDIMMs and memory buffers for DDR3 LRDIMMs. All our memory interface solutions for DDR3 are JEDEC standard-compliant, and have passed component- and system-level validation by Intel Corporation and other industry-leading companies. Based on our internal testing, we believe our current generation of LRDIMM solutions consume up to 30% less power than our primary competitor. We are working closely with JEDEC and other key industry participants, including leading CPU and memory module manufacturers, to develop the first generation of DDR4-compliant memory interface solutions, including a registering clock driver and a data buffer. In July 2013, we introduced our DDR4 registering clock driver and data buffer for DDR4 RDIMMs and LRDIMMs, which we believe is the industry’s first JEDEC 0.92 specification-compliant DDR4 registering clock driver and data buffer.

 

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Our memory interface solutions that are currently in volume production include:

 

Standards/Applications

 

Speed

  Intel/OEM Validation  

Register Buffer

  1600 Mbps and 2133 Mbps   ü     

Memory Buffer - Generation 2

  1600 Mbps and 1866 Mbps   ü     

Our memory interface solutions that are sampling include:

 

Standards/Applications

 

Speed

  Intel/OEM Validation

Register

  2400 Mbps   In process

Data Buffer

  2400 Mbps   In process

Sales and Distribution

In line with general market practice, we typically sell our set-top box solutions to our end customers through distributors. Once our end customers assemble various components into set-top boxes, the set-top boxes are then sold to set-top box retailers or cable network operators. Our set-top box solutions have been incorporated in set-top boxes sold globally to retail outlets and cable network operators in China, Southeast Asia, India, the Middle East, Africa and other emerging market geographies. The diagram below shows how our set-top box solutions are sold to our customers and reach network operators and retailers:

 

LOGO

While our set-top box solutions are typically sold through distributors, we collaborate with our customers and industry participants through high levels of support from our field application engineers.

Sales through our distributors accounted for 82% of our total revenue in 2012. Sales through our three largest distributors, LQW Technology Company Limited, Qinuo International Co., Ltd. and China Electronic Appliance Shenzhen Co., Ltd., accounted for 50%, 18% and 9%, respectively, of our total revenue in 2012. We typically enter into distribution agreements with our distributors, with each distributor covering a defined customer base and/or geographic area. In addition, our distribution agreements are typically negotiated and entered into on an annual basis and prohibit the distributor from selling products or solutions competing with ours. Our distributors primarily handle the logistics and payment in connection with our sales for us, but we maintain direct relationships, both pre- and post-sale with the end customers.

We typically sell our memory interface solutions directly to memory module manufacturers.

End Customers

We sell our set-top box solutions, directly and through distributors, to end customers who are manufacturers of set-top boxes or televisions in China and internationally and to cable network operators in China. Our set-top box solutions have been shipped to more than 150 end customers, including nine of the ten largest set-top box manufacturers in China as measured by units sold in 2012. In 2012, only one of our set-top box end customers, Shenzhen Changhong Digital Technology Limited, accounted for more than 10% of our total revenue for the year, and our five largest end customers accounted for in aggregate 41% of our total revenue for the year.

We sell our memory interface solutions to leading memory module manufacturers globally. We have sold our memory interface solutions to Samsung Electronics, SK Hynix Semiconductor, Inc., Elpida Memory Inc.,

 

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and Micron Technology, Inc., the world’s four largest memory module manufacturers as measured by revenue generated in 2012, and to Kingston Technology, the world’s largest third-party DRAM module supplier as measured by revenue generated in 2012.

Sales to end customers in Asian countries accounted for 96%, 97% and 94% of our total revenue in 2010, 2011 and 2012, respectively. Although our end customers are primarily manufacturers located in Asia, our integrated circuits are incorporated into finished products sold globally.

Marketing and Customer Support

We work directly with our end customers to provide them with application-specific product information for their system design, engineering and procurement groups. Our technical marketing, sales and field application engineers actively engage potential customers during their design processes to introduce them to our product capabilities and target applications. We design solutions in an effort to meet the increasingly complex and specific design requirements of our end customers.

We work with our set-top box end customers to design integrated solutions, including both hardware and software applications, to maximize the performance and efficiency of their set-top boxes. When we provide integrated, customized solutions, we typically undertake a multi-month sales and development process with the end customer’s system designers and management. Volume production can begin from several months to up to one year after an end customer confirms its decision to use our solutions, depending on the complexity of the end customer’s product and other factors. Once one of our solutions is incorporated into an end customer’s design, it is likely to be used for the life cycle of the customer’s product. We believe this to be the case because a redesign would generally be time-consuming and expensive. We support our solutions with our extensive team of field application engineers who are geographically close to our end customers and work extensively to deepen our relationships with them. Moreover, our extensive customer interaction, combined with our deep understanding of our end customers’ needs, fosters customer loyalty and increases visibility within our business.

In the cloud computing market, our sales and marketing team maintains relationships with technology leaders, which enables us to anticipate and solve next generation challenges facing our customers. We also participate actively in setting industry standards with organizations such as JEDEC to have representation in the definition of future market trends, thereby helping us to maintain our leadership position in the memory interface market.

Research and Development

We believe that our future success depends on our ability to introduce enhancements to our existing products and to develop new products as well as continue to develop and enhance our technology platform to meet the rapidly changing needs and requirements of our end customers. For our set-top box solution offerings, we are currently focused on enhancing our existing integrated solutions to serve HDTV applications. For our memory interface solution offerings, we are currently focused on DDR4 memory interface solutions. We have devoted substantial resources to our research and development activities, and have assembled a team of highly qualified semiconductor and embedded software design engineers who have strong design expertise in high performance and low power analog and mixed-signal semiconductors and related hardware and software application design.

Our engineering design teams are located in Shanghai, Suzhou and Hangzhou in China and in Taipei and Hsinchu in Taiwan. As of June 30, 2013, we had 290 employees in our research and development department, representing approximately 65% of our total employees. Nearly half of our engineers hold advanced degrees. These engineers and designers are involved in advancing our core technologies, as well as applying these core technologies to our product development activities across a number of areas including consumer electronics, multi-media, telecommunications transport systems, enterprise networking equipment, data centers and enterprise servers, storage platforms and test and measurement systems. In 2010, 2011, 2012 and the six months

 

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ended June 30, 2013, our research and development expenses were $11.1 million, $13.7 million, $17.6 million and $12.5 million, respectively.

All of our currently offered solutions and substantially all of the building blocks comprising our technology platform have been designed in-house with core technology based on our internally developed intellectual property. While we use commercially available simulation tools to predict overall system performance based on the functionality, architecture and design of our semiconductors, we do not license any material intellectual property from third parties. After our semiconductors are manufactured, we perform system measurements and refine our design to improve the semiconductors’ performance and predictive ability. As a result, our design methodology has improved over time and we have been able to very accurately predict overall system performance prior to fabricating a part.

Our research and development team works closely with our sales and marketing and manufacturing teams to develop new and commercially attractive products. We have completed our development and have begun customer qualification for a high-definition decoder. We currently expect to commence volume production of this set-top box solution in 2013. We are also currently in the advanced stages of development of our DDR4 register and memory buffers. We are working with key industry participants, including JEDEC, to develop these DDR4 memory interface solutions, and we currently expect to begin volume production of this product by the end of 2014.

Manufacturing

We operate a fabless business model and use third-party foundries and assembly and test manufacturing contractors to manufacture, assemble and test our semiconductor products. For quality control purposes, we also inspect and test the final products manufactured by the third party suppliers in our laboratories by way of sampling before the products are delivered to our distributors or customers. This outsourced manufacturing approach allows us to focus our resources on the design, development and marketing of our solutions and reduces overhead and our exposure to cyclicality risks. In addition, we believe outsourcing manufacturing and assembly activities provides us the flexibility needed to respond to new market opportunities, simplifies our operations and significantly reduces our capital requirements.

We subject our third-party manufacturing contractors to qualification requirements in order to meet the high quality and reliability standards required of our products. We carefully qualify each of our partners and processes before applying the technology to our products. Our engineers work closely with our foundries and other contractors to increase yield, lower manufacturing costs and improve product quality.

Wafer Fabrication. We currently maintain active relationships with a number of world-class semiconductor foundries. We choose the semiconductor process and foundry that we believe provides the best combination of performance and cost-effectiveness attributes for any particular product. For each of our products, we typically utilize a single foundry for semiconductor wafer production. Nonetheless, to ensure adequate wafer supply, we also take into account technologies of other foundries during our design process to ensure that the production of our products can be transferred to other backup foundries if needed. Our principal foundries are Semiconductor Manufacturing International Corporation in China, Fujitsu Semiconductor Limited in Japan and United Microelectronics Corporation in Taiwan.

Packaging, Assembly and Testing. Upon the completion of processing at the foundry, the finished wafers are shipped to our third-party assemblers for packaging, assembly and testing. Currently, our principal packaging, assembly and testing contractors are STATS ChipPAC Ltd. in Singapore and Korea and Siliconware Precision Industries Co., Ltd. in Taiwan and Suzhou, China. The products are then shipped to us, where we also perform testing in our Shanghai, Suzhou and Hangzhou facilities by way of sampling before delivery to our end customers.

We are committed to maintaining the highest level of quality in our products. Our objective is that our products meet all of our customer requirements, are delivered on-time and function reliably throughout their

 

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useful lives. As of the date of this prospectus, we have lowered our defective parts per million, or DPPM, to below 100. In addition, we have achieved an on-time delivery rate of more than 98.5%. As part of our total quality assurance program, our quality management system has been certified to ISO 9001:2008 standards in 2006. Our manufacturing partners are also ISO 9001 certified.

Competition

The markets in which we operate are highly competitive. We compete with numerous semiconductor companies, some of which have greater financial and other resources with which to pursue technology development, product design, manufacturing, marketing, sales and distribution of their products. Currently, our competitors range from large, international companies offering a wide range of semiconductor solutions to smaller companies specializing in set-top box or memory interface solutions. Our primary competitors in the set-top box market include semiconductor companies that sell to emerging markets such as HiSilicon Technologies Co., Ltd., ALi Corporation, RDA Microelectronics, Inc., Airoha Technology Corporation and STMicroelectronics NV, as well as smaller semiconductor design companies based in China. We believe that we provide a more comprehensive suite of set-top box solutions for emerging markets than any of our Asia-based competitors. Our market share for set-top box chipset solutions in China in terms of units sold was 7% in 2009 and 14% in 2012, according to iSuppli. Our competitors in the memory interface market include Inphi Corporation, Integrated Device Technology, Inc. and Texas Instruments Inc.

Our ability to compete successfully depends on elements both within and outside of our control, including industry and general economic trends. Intense competition could result in price pressure, reduced profitability and loss of market share, any of which could materially and adversely affect our business, revenue and operating results. Moreover, our markets are characterized by evolving technologies, industry standards and customer preferences.

We compete or plan to compete in different target markets to various degrees on the basis of a number of principal competitive factors, including but not limited to:

 

   

our ability to offer integrated, high performance and low power semiconductor solutions that differentiate us from our competitors;

 

   

our success in identifying and developing new and emerging technologies, solutions and markets;

 

   

the performance and cost-effectiveness of our solutions;

 

   

our ability to provide innovative and high-quality functionality and features, including integrated solutions, and superior service;

 

   

our ability to recruit high-level talent, including engineers and chip designers;

 

   

our ability to maintain and grow our relationship with key industry players; and

 

   

our ability to protect our intellectual property.

Specifically, in the home entertainment market we compete primarily on the basis of our customization and field application support capabilities, level of integration of our solutions, performance and price. In the cloud computing market, we primarily compete on the basis of high performance, power efficiency and our track record of achieving validation for our memory solutions with leading CPU manufacturers. We believe we compete favorably with respect to these factors.

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