F-1 1 d730817df1.htm F-1 F-1
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As filed with the Securities and Exchange Commission on October 16, 2014

Registration No. 333-            

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM F-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

VeriSilicon Holdings Co., Ltd.

(Exact name of registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)

 

Cayman Islands   7379   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Room 20A, No. 560 Songtao Road

Zhangjiang Center, Zhangjiang Hi-Tech Park

Pudong New Area

Shanghai 201203

People’s Republic of China

86 (21) 5131-1118

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

VeriSilicon, Inc.

4699 Old Ironsides Drive, Suite 350

Santa Clara, CA 95054

(408) 844-8560

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

Copies to:

 

Thomas C. DeFilipps, Esq.

Eric S. Haueter, Esq.

Justin L. Bastian, Esq.

Karen K. Dreyfus, Esq.

Sidley Austin LLP

1001 Page Mill Road, Building 1

Palo Alto, California 94304

Tel: (650) 565-7000

 

Wayne Wei-Ming Dai

Room 20A, No. 560 Songtao Road

Zhangjiang Center, Zhangjiang Hi-Tech Park

Pudong New Area

Shanghai 201203

People’s Republic of China

Tel: 86 (21) 5131-1118

 

James J. Masetti. Esq.

Heidi E. Mayon, Esq.

Pillsbury Winthrop Shaw Pittman LLP

2550 Hanover Street

Palo Alto, California 94304

Tel: (650) 233-4500

 

 

Approximate date of commencement of proposed sale to the public: as soon as practicable after the effective date of this registration statement.

If any of the 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, please 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 earliest 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.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

 

Proposed

maximum

aggregate

offering price(1)(2)

 

Amount of

registration fee

Ordinary shares, par value $0.001 per share(3)

  $75,000,000   $8,715

 

 

(1) 

Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act.

(2) 

Includes ordinary shares represented by ADSs offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes ordinary shares represented by ADSs that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares represented by ADSs are not being registered for the purpose of sales outside the United States.

(3) 

American Depositary Shares issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6. Each American Depositary Share represents                 ordinary shares.

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, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, dated October 16, 2014

PROSPECTUS

 

 

            American Depositary Shares

Representing             Ordinary Shares

 

LOGO

 

 

This is an initial public offering of American Depositary Shares, or ADSs, of VeriSilicon Holdings Co., Ltd. We are offering             ADSs. Each ADS represents              ordinary shares, par value $0.001 per share. The ADSs are evidenced by American Depositary Receipts, or ADRs. No public market currently exists for our ADSs or ordinary shares.

We intend to apply to have the ADSs listed on the NASDAQ Global Market under the symbol “VERI.”

We anticipate that the initial public offering price per ADS will be between $         and $        .

We are an “emerging growth company” under the federal securities laws and will be subject to reduced public company reporting requirements.

Investing in our ADSs involves risks. See Risk Factors beginning on page 17 of this prospectus.

 

     Per
ADS
     Total  

Initial public offering price

     $                     $               

Underwriting discount

     $                     $               

Proceeds, before expenses, to us

     $                     $               

We have granted the underwriters an option to purchase                  additional ADSs on the same terms and conditions set forth above if the underwriters sell more than                  ADSs in this offering.

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

The underwriters expect to deliver the ADSs on or about                     , 2014.

 

 

 

Barclays   Jefferies   Stifel

Wells Fargo Securities

 

 

Oppenheimer & Co.

Prospectus dated                     , 2014.


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LOGO

Photographs reflect the general types of end products that can incorporate our solutions. We do not design or manufacture these end products. Our solutions incorporated into 3D motion sensors for game consoles, DVD/Blu-ray players and various audio products, mobile phones and high-definition televisions (similar to the ones reflected in the photographs above) each generated 5% or more of our total revenue during one or more of the years ended December 31, 2011, 2012 and 2013; our solutions incorporated into the other types of end products reflected in the photographs above each generated less than 5% of our total revenue during each of the three years ended December 31, 2013.


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TABLE OF CONTENTS

 

     Page  

Prospectus

  

Conventions That Apply to This Prospectus

     ii   

Prospectus Summary

     1   

The Offering

     10   

Summary Consolidated Financial Information

     12   

Risk Factors

     17   

Special Note Regarding Forward-Looking Statements and Market Data

     57   

Our History and Corporate Structure

     58   

Use of Proceeds

     59   

Dividend Policy

     60   

Capitalization

     61   

Dilution

     63   

Selected Consolidated Financial Information

     65   

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

     67   

Business

     94   

Regulation

     114   

Management

     122   

Principal Shareholders

     133   

Related Party Transactions

     136   

Description of Share Capital

     138   

Description of American Depositary Shares

     150   

Shares Eligible For Future Sale

     162   

Taxation

     164   

Underwriting

     171   

Enforceability of Civil Liabilities

     177   

Expenses Relating to This Offering

     179   

Legal Matters

     180   

Experts

     180   

Where You Can Find Additional Information

     181   

Index to Consolidated Financial Statements

     F-1   

Dealer Prospectus Delivery Obligation

Through and including                     , 2014 (the 25th day after the date of this prospectus), all dealers effecting transactions in the ADSs, 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 underwriters have authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we may 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 ADSs offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

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CONVENTIONS THAT APPLY TO THIS PROSPECTUS

In this prospectus, except where the context otherwise requires, references to:

 

   

“ARM” refers to ARM Holdings plc;

 

   

“ASIC” refers to application-specific integrated circuits;

 

   

“ASSP” refers to application-specific standard products;

 

   

“CMOS” refers to complementary metal-oxide semiconductor;

 

   

“DSP” refers to digital signal processors;

 

   

“EDA” refers to electronic design automation;

 

   

a “fabless” semiconductor company outsources fabrication of integrated circuits to a third party foundry;

 

   

“FDSOI” refers to fully-depleted silicon on insulator;

 

   

“FinFET” refers to fin-shaped field effect transistors;

 

   

“first silicon success” refers to qualification of a design in accordance with the customer’s specifications in the initial tape out without any significant redesigns;

 

   

“HUI” refers to human user interface;

 

   

“IDM” refers to integrated device manufacturer;

 

   

“IoT” refers to internet of things;

 

   

“MEMS” refers to microelectromechanical systems;

 

   

“NRE” refers to non-recurring engineering;

 

   

“ODM” refers to original design manufacturer;

 

   

“OEM” refers to original equipment manufacturer;

 

   

“PRC” refers to the People’s Republic of China;

 

   

“RMB” refers to Renminbi, the legal currency of the PRC;

 

   

“shares” or “ordinary shares” refers to our ordinary shares, par value of $0.001 per share;

 

   

“SiP” refers to system in a package;

 

   

“SiPaaS” refers to silicon platform as a service;

 

   

“SoC” refers to system on a chip;

 

   

“system level functionality” refers to the interaction of chips, components and software;

 

   

“tape out” is the final result of the design process for integrated circuits, the point at which the design is sent to the foundry to begin manufacturing;

 

   

“U.S. dollars”, “$” and “dollars” refer to the legal currency of the United States;

 

   

“wafer” refers to a thin piece of semiconductor material on which an integrated circuit is built; and

 

   

“we”, “us”, “our company”, “our” and “VeriSilicon” refer to VeriSilicon Holdings Co., Ltd. (and its predecessor) and its subsidiaries.

 

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PROSPECTUS SUMMARY

This summary does not contain all of the information you should consider before investing in our ADSs. You should read this entire prospectus carefully, especially the information set forth under Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes appearing at the end of this prospectus, before making an investment decision.

BUSINESS

Our Vision and Mission

Our business model, which we refer to as Silicon Platform as a Service (SiPaaS), is an IP-centric, platform-based, end-to-end semiconductor design service, which enables us to provide custom silicon solutions. Our mission is to mitigate the time, cost, and risks of semiconductor design and manufacturing for semiconductor companies, original equipment manufacturers, original design manufacturers and large Internet platform companies, allowing them to focus on their core competencies such as product definition, system architecture, software development and branding. Our business model is designed to enable the semiconductor industry to transition to a design-lite model, similar to the way in which independent wafer foundries gave rise to the fabless semiconductor industry by providing access to independent, advanced semiconductor manufacturing services.

Company Overview

We are a SiPaaS company that provides our customers with the ability to rapidly, efficiently and effectively bring to market custom silicon solutions that address a wide range of applications across a variety of end markets, including mobile devices, networking, the Internet of Things (IoT), wearable electronics, smart homes and automotive electronics. We believe that the breadth and flexibility of our SiPaaS solution make it a compelling alternative development model designed to reduce operating expenses and improve return on investment for our customers, which include both emerging and established semiconductor companies, original equipment manufacturers (OEMs), original design manufacturers (ODMs) and large Internet platform companies involved in the development of proprietary systems technology. Our SiPaaS solution offers end-to-end semiconductor design services, from architectural design and physical implementation to managing the manufacturing and shipping of fully packaged and tested semiconductor devices. We originated the term SiPaaS to describe our business model, but we believe that it also describes a developing trend towards engaging third parties for the design and production of custom silicon solutions.

Our SiPaaS solution consists of our system on a chip (SoC) platforms, which are differentiated by our broad, licensable intellectual property (IP) portfolio that includes digital signal processor (DSP) IP, high definition (HD) video IP, over 1,000 proprietary reusable units of mixed signal and radio frequency (RF) IP for processes ranging from 180nm to 28nm bulk complementary metal-oxide semiconductor (CMOS) and 28nm fully depleted silicon on insulator (FDSOI), foundation libraries (standard cell, memory compiler and input/output (I/O)), and third-party IP. As of June 30, 2014, we had 49 patents issued and five patents pending in the U.S. and five patents issued and 13 patents pending in China. Each of our SoC platforms integrates key components of one or more of our families of IP and can be optimized for a variety of applications such as HD video, HD audio, HD voice, wireless baseband, and human user interface (HUI), which includes technologies related to voice recognition, 3D motion sensing, and handwriting recognition.

We believe our manufacturing and product engineering experience makes our business scalable by being in a position to offer a wide variety of services across many different types of processes, technologies and target

 

 

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markets. Our manufacturing and product engineering services include test hardware and test software, rapid prototype validation, device qualification, engineering prototype to volume production, yield management, failure analysis, and quality and reliability management for SoC and system in a package (SiP) products. By using these services, our customers can benefit from shortened design cycles, enhanced product performance and quality, and reduced costs.

Our SiPaaS solution is vendor neutral, positioning us to utilize a best-in-class approach for our customers for whom we can leverage our deep relationships that span the semiconductor ecosystem, including electronic design automation (EDA) and IP companies, wafer foundries, and packaging and testing vendors.

Our global, diversified customer base included over 200 customers in 2013. Since 2009, over one billion chips have been manufactured based on our custom silicon solutions and over 700 million chips have been shipped using our IP from which we have collected royalties. Over the past five years, we have, on average, completed one tape out each week. A tape out refers to the final result of the design process for integrated circuits (the point at which the design is sent to the foundry to begin manufacturing). In the past two years, over 98% of the designs for these products were qualified in accordance with the customer’s specifications in the initial tape out without any significant re-designs, which we refer to as first silicon success.

We generate revenue from (i) sales of turnkey products, (ii) non-recurring engineering (NRE) design services and (iii) license fees and royalties generated from our IP, including third-party IP for which we have a right to sublicense. Our turnkey products revenue is derived from volume production and shipping of semiconductor wafers, chips or finished integrated circuits that we previously designed through our NRE design services. Our NRE design services revenue is derived from fees charged to our customers for the development of semiconductor designs of integrated circuits in accordance with our customers’ specifications. Revenue derived from license fees and royalties represents fees earned by licensing our IP to our customers and the subsequent royalty payments when our customers sell products containing our IP to their end customers.

We generated revenue of $127.4 million in 2013 and $77.0 million in the six months ended June 30, 2014. Our revenue for 2013 grew 71% over 2012 and our revenue in the six months ended June 30, 2014 grew 32% over the six months ended June 30, 2013. Our net loss was $28.1 million in 2013 and our net loss was $26.2 million in the six months ended June 30, 2014. Our adjusted net loss was $1.1 million in 2013 and our adjusted net income was $1.8 million in the six months ended June 30, 2014. Adjusted net loss and adjusted net income are non-GAAP financial measures. A reconciliation of U.S. GAAP to non-GAAP financial information has been provided in the section entitled “Summary Consolidated Financial Information—Non-GAAP Financial Measures.” We had 453 employees as of June 30, 2014, with approximately 70% of our employees dedicated to research, development and custom silicon design and over 70% of our employees based in Shanghai, China. We were founded in 2001. Our headquarters are located in Shanghai, China and we operate six research and development centers and nine sales centers located in Asia, North America and Europe.

Industry Background

The Semiconductor Market is Large and Diversified

The semiconductor market is a large, global growth opportunity. According to Gartner, worldwide revenue for semiconductor devices was $315 billion in 2013.1 Semiconductor devices are used in a wide variety of products and applications and our SiPaaS solution addresses a broad range of end markets, including mobile

 

1  Gartner, “Semiconductor Forecast Database, Worldwide, 2Q14 Update,” June 2014. The Gartner Reports described herein, (the “Gartner Reports”) represent data, research opinion or viewpoints published as part of a syndicated subscription service, by Gartner, Inc. (“Gartner”), and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this filing) and the opinions expressed in the Gartner Reports are subject to change without notice.

 

 

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devices, networking, the IoT, wearable electronics, smart homes and automotive electronics. Growth in mobile data traffic is driving the expansion of semiconductors used in numerous applications involved in the collection, storage, communication and presentation of such data. Global mobile data traffic is projected to grow from 1.5 exabytes per month in 2013 to 15.9 exabytes per month in 2018, representing a compound annual growth rate (CAGR) of 61%, according to the Cisco Visual Networking Index. In addition to end market diversification, the semiconductor market is also broadly diversified by geography, with China being a leading driver of growth due to increased electronics consumption by local consumers and the country’s proximity to a large part of the electronics supply chain. According to PricewaterhouseCoopers, Chinese semiconductor consumption grew from $31 billion in 2003 to $153 billion in 2012, representing a CAGR of 20%.

Increasing Semiconductor Device Complexity and Customization is Driving Higher Design Costs

Robust demand for electronics coupled with increased device complexity is currently driving competition in the semiconductor industry. To meet the demand for semiconductor-enabled devices and applications, semiconductor providers must deliver increasing levels of performance while facing the challenges of shorter time to market and shorter product life cycles. According to publicly available data, research and development expenses as a percentage of revenue for the top ten fabless semiconductor companies, as ranked by IC Insights, Inc. (IC Insights), increased from an average of 19% in 2004 to 25% in 2013 due to higher chip complexity and shorter product life cycles. As a result of this trend, we believe that semiconductor companies are seeking more efficient and lower cost product development strategies.

Moore’s Law is Stressed

Historically, conventional wisdom within the semiconductor industry has been that advances in manufacturing process technology should enable engineers to approximately double the number of transistors in an integrated circuit approximately every 24 months, a trend referred to as Moore’s Law. The ability to increase the number of transistors per integrated circuit on an ongoing basis has enabled increasing functional integration and driven annual reductions in the average cost per transistor of approximately 30% from 1975 through 2004 (according to data from the Federal Reserve Board), which has been a critical factor in the manufacture of increasingly complex, high performance, low power semiconductor solutions. As semiconductor feature sizes have reached a deep submicron scale, the physical challenges of patterning semiconductor transistors at today’s most advanced process nodes have reversed the historical cost reduction curve of Moore’s Law. Specifically, at advanced process nodes below 28nm the cost per transistor is flattening out for the first time in the last 40 years. As a result, we believe that design innovation, rather than the migration of a design to the next advanced process node, is now a vital element in reducing the cost per transistor. While the industry has identified certain technologies to address these challenges, the commercial viability and availability of these solutions are not expected for a number of years. We believe that this dynamic, now commonly referred to in the industry as “Moore Stress” has driven semiconductor companies to focus on cost reduction.

Increasing Costs Create Industry Wide Paradigm Shifts

As the semiconductor market has expanded over the last few decades, the industry has undergone multiple waves of change to address the increasing costs associated with semiconductor design and manufacturing, including:

 

   

Shift from IDM to Fabless. From the industry’s beginnings in the 1950s through the 1980s, semiconductor companies generally operated as IDMs, owning and operating fabs in order to have in-house manufacturing capabilities and to deliver technically advanced solutions. Due to the increasing capital investments required to keep pace with the ongoing increases in the number of transistors per integrated circuit and higher research and development costs attributable to investment in both product and process development, we believe that the semiconductor industry has increasingly shifted to a

 

 

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structure wherein semiconductor companies seek to reduce research and development costs and capital investments by engaging third party manufacturing services, resulting in the fab-lite and fabless business model.

 

   

Shift from Fabless to Design-lite. We believe that the increased level of complexity in, and the desire to differentiate and customize, semiconductor devices have resulted in increased research and development spending focused on semiconductor design, driving companies to consider alternative development models to reduce operating expenses and improve return on investment. While emerging and established semiconductor companies continue to focus on integrating system functions in a single chip, we believe that OEMs and ODMs are increasingly developing their own semiconductor devices for differentiation and customization of their end products. We believe that these categories of companies are beginning to engage third-party service providers for design services at an increasing rate. This situation has resulted in the migration to a design-lite model, which allows companies to focus on their core competencies, such as product definition, system architecture, software development and branding, while relying on a service provider for semiconductor design implementation, production engineering and supply chain management in a cost effective manner. We believe that these current industry dynamics are driving participants to increase utilization of third-party semiconductor development platforms that are able to provide an advantage relative to the participants’ own internal design resources, extending the historical practice of selectively augmenting internal development efforts with external EDA tools and licensed IP. We believe the SiPaaS model will help accelerate the design-lite paradigm shift, providing an IP-centric, platform-based, end-to-end semiconductor design service model that offers a complete solution from architectural design through design implementation to volume production and delivery. We believe our SiPaaS model allows fabless and IDM semiconductor companies, OEMs, ODMs, and large Internet platform companies to rapidly implement their silicon strategies and bring to market devices or applications that utilize custom semiconductors.

The SiPaaS model is designed to address the needs of a variety of customer types, including:

 

   

Emerging Fabless Semiconductor Companies. A startup company generally has limited resources and can face daunting cost and time-to-market requirements. Given the decline in venture capital investment in semiconductor startups in the past several years and the resulting need to minimize costs, there can be significant pressure on these companies to achieve first silicon success on their products. By providing turnkey services, a SiPaaS company can enable emerging fabless semiconductor companies to focus internal resources on its core competencies, such as product definition, system architecture, firmware, software, branding and reference system design and applications. For example, a startup fabless company had limited resources to develop a 3D motion sensing product. The company engaged us to design and manufacture an ASIC in order to focus on its core competencies in motion sensing algorithms and systems software. As a result, the company achieved a major design win with only the resources from its initial funding.

 

   

Established Fabless and IDM Semiconductor Companies. Due to “Moore Stress,” we believe that established fabless companies and IDMs face increasing challenges as their research and development expenses increase. As IDMs increasingly outsource manufacturing of advanced technologies to external wafer foundries, we believe that they become more open to engaging third parties to provide design services as well. Similarly, a large semiconductor company may look to SiPaaS companies for IP and design services for an application-specific SoC because they may not have the requisite expertise, internal IP or resources. For example, an established fabless semiconductor company with strong internal semiconductor development expertise on application processor designs for mobile devices has engaged us to design products in adjacent markets, such as multi-function printers and media processors.

 

 

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OEMs and ODMs. In order to provide differentiation and customization, OEMs and ODMs face increasing challenges as more system-level functionality (which we define as the interaction of chips, components and software) is integrated into SoC semiconductor solutions. Some OEMs and ODMs do not have specific semiconductor design expertise to develop custom silicon solutions to add value and quickly meet specific product requirements. Due to “Moore Stress” and the longer lifespan of more advanced process nodes, such as 28nm, we believe that OEMs and ODMs have more of an incentive to engage directly with a SiPaaS company for custom silicon solutions rather than continuing to rely on standard semiconductor products from fabless semiconductor companies. For example, an OEM that develops light emitting plasma technology needed a smart lighting silicon solution, but did not have the necessary expertise to design it internally. By engaging us from specification to production of a silicon solution, this OEM benefited from our strong mixed signal and high voltage CMOS IP skills and digital and analog integration expertise. We significantly reduced the overall cost of the silicon solution by eliminating hundreds of components on the board, while increasing system-level functionality and enhancing the reliability of the entire lighting system.

 

   

Large Internet Platform Companies. Global and increasingly diversified large Internet platform companies have broad reach and brand recognition, but may have limited internal semiconductor design teams. These companies are generally focusing on the development of customized computing, networking and storage solutions to address the performance requirements of particular service offerings and may seek to differentiate their solutions at both the software and semiconductor level. For example, a large Internet platform company engaged us to design an HD video SoC from specification to volume production that was ultimately incorporated into consumer devices branded by this company and other OEMs. This project utilized our in-depth knowledge of HD video IP and prior experience with similar custom silicon design projects targeted for notebook and video conferencing applications.

Challenges with Traditional Design Services Providers

We believe that the traditional providers of semiconductor design services have not adequately addressed the evolving requirements of the semiconductor industry, primarily due to the following shortcomings:

 

   

Lack of a Comprehensive Platform Approach. Traditional design service companies may not offer the breadth of IP portfolios and SoC platforms required to address the variety of applications used by an increasingly wide range of customers interested in developing semiconductor solutions.

 

   

Anchored to Specific Wafer Foundries. We believe that traditional design service firms, in general, have a narrow set of strategic relationships with wafer foundries, and in some cases only one.

 

   

Anchored to Specific Geography. Traditional design service firms may provide services in a few specific geographies.

We believe that there is an increasing need within the industry for advanced semiconductor design service providers possessing strong system and software expertise, technology integration capabilities and a proven track record of delivering functional and reliable silicon solutions that can also flexibly deliver a customized and differentiated solution cost effectively and on a worldwide basis.

Our Competitive Strengths

We believe our key competitive strengths include:

 

   

Comprehensive Platform-based SiPaaS Solution. The SiPaaS business model is designed to deliver the type of services that we believe are necessary to enable the industry shift to a design-lite model. We believe our SiPaaS model offers our customers an IP-centric, platform-based, end-to-end

 

 

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semiconductor solution, providing the full range of services necessary to produce a custom silicon solution from architectural design and design implementation through the manufacturing process with our strategic relationships with wafer foundries and packaging and testing vendors. In addition, our SiPaaS solution provides an open hardware platform that integrates with the open software platform of large Internet platform companies, and is designed to meet the needs of companies looking for silicon solutions that fit within their product strategy.

 

   

Broad, Differentiated and Platform-Based IP. Our IP and technology expertise covers a wide scope of applications, including HD video, HD audio, HD voice, wireless baseband and HUI, such as voice or motion activated interfaces. We have an extensive portfolio of, and know-how relating to, proprietary hardware designs, software, firmware code and algorithms, which we are able to utilize to help our customers reduce redundant research and development investments and design cycle time. We augment our SoC platforms not only with our internally developed IP but also with IP we license from ARM, Cadence, Synopsys and Vivante for a variety of applications and foundation libraries for certain foundry manufacturing processes. Pursuant to contracts entered into with our customers, we generally retain ownership of IP we develop in connection with individual customer engagements and, as a result, we generally retain the right to use that IP for other customer engagements.

 

   

Vendor Agnostic Strategy across Leading Ecosystem Participants. We have established relationships throughout the semiconductor ecosystem and we are vendor agnostic to EDA and IP companies, wafer foundries, and packaging and testing vendors. Our vendor-agnostic approach enables us to develop leading edge designs applicable to a custom silicon solution. For example, in addition to bulk CMOS technology, we are able to offer our customers designs utilizing FDSOI 28nm technology employed by Samsung’s foundries.

 

   

Strong, Long-term Customer Relationships. Some of our most valuable customers have utilized our platforms to design multiple derivative products and multiple generations of products, demonstrating the strength and long-term nature of our customer relationships. Our collaborative relationships with customers may result in new product designs owned by the customer, but for which we own typically the key IP building blocks. Our IP licensing strategy to identify and leverage reusable IP is designed to provide us with an advantage in terms of extending our customer relationships and making it more difficult for our competitors to penetrate our customers.

 

   

Extensive Global Engineering Resources and Capabilities. The foundation of our business is our engineering talent which collectively represented approximately 70% of our employees around the world as of June 30, 2014. Of these engineers, over 70% have an advanced engineering degree. We devote significant time and resources to develop our employees and cultivate an innovative and creative environment, which has resulted in our high employee retention rate. Our engineering talent helps create a compelling pipeline of new IP and platforms by leveraging our substantial IP and technology base to accelerate product design and meet the qualification standards of our customers. For example, a number of products from one of our key customers have met the strict standards of the European automotive supply chain. Our six development centers around the world provide deep technical expertise to customers, especially large and international customers, so that system and complete semiconductor solutions can be jointly developed globally.

 

   

Local Presence and Expertise in the Expanding Chinese Semiconductor Market. We believe we are well positioned as a global semiconductor service provider, particularly in China. Our presence in Asia facilitates close contact with our customers’ key strategic partners, enabling us to be responsive to their needs and enhancing our visibility into new product opportunities, markets and technology trends. Additionally, our proximity to the electronics supply chain is important because Asia, and specifically China, is a central hub of semiconductor manufacturing.

 

 

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Our Growth Strategies

Our mission is to mitigate the time, cost and risks of design and manufacturing for semiconductor companies, OEMs, ODMs and large Internet platform companies involved in the development of proprietary systems technology. Key elements of our strategy to achieve our mission include:

 

   

Grow Our Customer Base of OEMs, ODMs and Large Internet Platform Companies. We believe that OEMs, ODMs and large Internet platform companies generally have limited semiconductor design expertise, despite an increasing need for optimized semiconductor and software solutions. We believe that these companies are generally pursuing broad market opportunities, such as wearable electronics. The wearable electronics market is projected to grow from approximately $10 billion in 2013 to over $25 billion by 2017, representing a CAGR of 26%, according to IHS, Inc. (IHS). The IoT market and, in particular, the wearable electronics market, are fragmented, and therefore offer compelling opportunities for us to deliver custom silicon solutions based on our IoT SoC platforms to OEMs and large Internet platform companies. For example, we provided a leading Internet platform company with turnkey products for multiple-format video decoder and encoder SoCs for multiple consumer products. We are a semiconductor channel and development partner of Google’s WebM Project which distributes Hantro video IP, enabling its end users to rapidly stream and view video content including ultra-high definition and 4K resolution video.

 

   

Leverage Expertise to Expand Services with Existing Customers and Diversify End Markets. We expect to further partner with our leading customers to deliver additional products and services as we have done with certain key customers to date. For example, we have successfully expanded our 3D MEMS sensors for the mobile device market to automotive based applications for one of our key customers. We have now been qualified by, and are shipping to, Robert Bosch GmbH’s automotive division. In addition to the automotive market, we believe medical devices, such as digital X-Ray, MEMS gyroscopes for medical instruments, home-based health monitoring and medical implants, will be one of the emerging areas for continued diversification among existing and new customers.

 

   

Further Develop our Intellectual Property. We continue to develop and expand our IP portfolio. We intend to expand our semiconductor IP partners and the technology we license from them to integrate with our existing technology and know-how to deliver increasingly innovative solutions for our customers. For example, as a member of the SOI Industry Consortium, we established an FDSOI task force to study FDSOI three years ago, simulated and evaluated FDSOI devices in collaboration with certain members of the consortium, designed mixed signal IP and conducted a benchmark comparison on ARM Holdings plc (ARM) processors between 28nm FDSOI and 28nm bulk CMOS technologies. As a result, we are a leader in IP and design experience with FDSOI technology.

 

   

Opportunistically Pursue Complementary Acquisitions. We may pursue acquisitions of technologies, design teams and companies that complement our strengths and help us execute our strategies. Our acquisition strategy is designed to accelerate our revenue growth, expand our technology portfolio, grow our addressable market and create shareholder value. For example, we successfully completed the acquisition of the ZSP’s assets, including the ZSP DSP IP, and integrated the associated engineering team from LSI Logic Corporation in 2006.

 

   

Expand Our Strategic Foundry Relationships. We intend to continue to build our strategic ecosystem relationships to continue to offer our customers best-in-class foundry capabilities. For example, we have strategic relationships with Samsung and other industry leaders to design and manufacture semiconductors on their FDSOI 28nm process technology for mobile platforms. At the same time, we are actively pursuing designs targeting 16nm and 14nm fin-shaped field effect transistors on bulk CMOS technology for high performance applications.

 

 

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Continue to Improve Operational Efficiency. Our goal is to grow revenue from our NRE design services and license and royalties businesses in an amount sufficient to cover a majority of our total operating expenses, thereby allowing revenue from our turnkey products business, which can grow with limited incremental investment, to drive improvements in our results of operations and operating margin.

Our SiPaaS Solution

Our SiPaaS solution is differentiated by our strong IP and know-how. Our IP portfolio serves as the foundation of our SoC platforms. Our SoC platforms are critical to our overall business and growth strategy, serve as a key differentiator against our competitors and are a primary reason why our customers purchase our design services on a repeat basis.

IP Portfolio

 

   

ZSP DSP IP

 

   

Hantro HD video IP

 

   

Mixed Signal and RF IP Portfolio

 

   

Foundation Libraries

 

   

Third-Party IP

Our SoC Platforms

 

   

Hantro HD Video SoC Platforms

 

   

ZSP-Based HD Audio SoC Platforms

 

   

ZSP-Based HD Voice SoC Platforms

 

   

ZSP-Based Wireless Baseband SoC Platforms

 

   

Human User Interface (HUI) Platforms

ZSP DSP IP is a family of IP related to digital signal processors. Hantro video IP is a family of IP related to HD video. We believe these two families of IP are key to our business.

Risks Affecting Us

We believe some of the major risks and uncertainties that may materially and adversely affect our operations include the following:

 

   

Our customer base is concentrated, with sales to Robert Bosch GmbH (Bosch) accounting for 38% and 45% of our total revenue in 2013 and the six months ended June 30, 2014, respectively, and sales to our top five customers (including Bosch) accounting for 57% and 65% of our total revenue in 2013 and the six months ended June 30, 2014, respectively, and our business may be materially and adversely affected if we lose one or more or our significant customers;

 

   

We rely on third parties to manufacture, package and test the semiconductor products comprising our solutions and we do not have long-term supply contracts with wafer foundries or our other vendors;

 

   

The markets that we target may not adopt our SiPaaS solution;

 

   

We may be unable to develop and maintain relationships with key industry and technology leaders to enhance our SiPaaS solution and market position;

 

 

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We may be unable to develop new and enhanced technology to compete effectively;

 

   

Changes in our revenue mix may result in reduced overall operating margin;

 

   

We could lose rights under intellectual property licenses with third parties that are important to our business;

 

   

We face intense competition and expect competition to increase in the future;

 

   

We do not enter into long-term contracts or purchase commitments with our NRE design services or turnkey products customers and we have no contractual arrangements for future sales of our solutions to existing customers and, as a result, our customer orders and ordering patterns for our NRE design services and turnkey products can change quickly, making it difficult for us to predict our revenue and making it possible that our actual revenue may vary materially from our expectations;

 

   

We have not identified any specific uses for the net proceeds of this offering beyond working capital and general corporate purposes and we may invest or spend the proceeds of this offering in ways with which you may not agree or in ways with which may not yield a return; and

 

   

We have significant operations in China, and there may be adverse changes in the political and economic policies of the PRC government that materially and adversely affect our operations.

Company Information

Our principal executive offices are located at Room 20A, No. 560 Songtao Road, Zhangjiang Center, Zhangjiang Hi-Tech Park, Pudong New Area, Shanghai, 201203, PRC and our telephone number is 86 (21) 5131-1118. Our website address is http://www.verisilicon.com. The information on our website does not form a part of this prospectus. Our agent for service of process in the United States is VeriSilicon Inc., located at 4699 Old Ironsides Drive, Suite 350, Santa Clara, California 95054 with telephone number 408-844-8560.

“VeriSilicon,” “ZSP” and our logo are our trademarks and we have filed an application to register the trademarks “SiPaaS” and “Hantro.” 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 unless the context indicates otherwise.

 

 

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THE OFFERING

 

ADSs offered by us

             ADSs

 

Option to purchase additional ADSs

We have granted the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an

additional              ADSs.

 

ADSs outstanding immediately after this offering

             ADSs (or              ADSs if the underwriters exercise in full their option to purchase additional ADSs from us)

 

Ordinary shares outstanding immediately after this offering

             ordinary shares (or              ordinary shares if the underwriters exercise in full the option to purchase additional ADSs from us)

 

The ADSs

Each ADS represents              of our ordinary shares, par value $0.001 per ordinary share. The ADSs will be evidenced by American Depositary Receipts, or ADRs.

 

  The depositary will hold the ordinary shares underlying your ADSs and you will have rights as provided in the deposit agreement among us, the depositary and holders of ADSs from time to time.

 

  You may turn in your ADSs to the depositary in exchange for ordinary shares underlying your ADSs. The depositary will charge you fees for any exchange.

 

  We may amend or terminate the deposit agreement without your consent, and if you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

 

  You should carefully read the section in this prospectus entitled “Description of American Depositary Shares” to better understand the terms of the ADSs. You should also read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

 

Use of proceeds

We estimate our net proceeds from this offering will be approximately $         million (or approximately $         million if the underwriters exercise in full their option to purchase additional ADSs from us), based on an assumed initial public offering price of $         per ADS, which is the midpoint of the initial public offering 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 intend to use the net proceeds from this offering for working capital and general corporate purposes, which may include acquisitions of complementary businesses, technologies or other assets, although we have not entered into any agreements or

 

 

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commitments with respect to any specific acquisitions. We will also use up to $         million from the proceeds to redeem certain preference shares, if issued. See the section titled “Description of Share Capital—Shadow Preference Shares” for additional information.

 

  See the section titled “Use of Proceeds” for additional information.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before deciding to invest in our ADSs.

 

NASDAQ Global Market trading symbol

VERI

Depositary

 

Timing and settlement for ADSs

The underwriters expect to deliver the ADSs against payment on                     , 2014 through the facilities of The Depository Trust Company.

The number of ordinary shares to be outstanding following this offering is based on 65,477,292 ordinary shares outstanding as of June 30, 2014 and excludes as of June 30, 2014:

 

   

360,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.91 per share and 120,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.5522 per share, all of which will expire on December 31, 2015;

 

   

any Shadow Preference Shares (as that term is defined under “Description of Share Capital”), which, depending on the midpoint of the initial public offering price range set forth on the cover page of this prospectus, will either not be issuable or will be issued prior to the completion of this offering and then redeemed for cash using proceeds from this offering, immediately after the completion of this offering;

 

   

15,429,366 ordinary shares issuable upon exercise of outstanding stock options at a weighted-average exercise price of $0.53 per ordinary share; and

 

   

145,130 ordinary shares reserved for future issuance under our 2012 Equity Incentive Plan.

Unless otherwise indicated, all information in this prospectus assumes:

 

   

that our amended and restated memorandum and articles of association, which we will file in connection with the completion of this offering, is in effect;

 

   

the automatic conversion immediately prior to the completion of this offering of all 50,011,211 outstanding preference shares as of June 30, 2014 into 50,011,211 ordinary shares;

 

   

the exercise for cash immediately prior to the completion of this offering of all warrants to purchase our Series E Preference Shares that are outstanding as of June 30, 2014 and the resulting issuance of 815,122 ordinary shares;

 

   

no exercise of the outstanding warrants referred to in the first bullet point of the prior paragraph or any of our stock options; and

 

   

no exercise by the underwriters of their option to purchase up to              additional ADSs from us.

 

 

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SUMMARY CONSOLIDATED FINANCIAL INFORMATION

The following table summarizes our consolidated financial data. We have derived the following summary consolidated statements of operations data for the years ended December 31, 2011, 2012 and 2013 and the summary consolidated balance sheet data as of December 31, 2013 from our audited consolidated financial statements included elsewhere in this prospectus and we have derived the following summary consolidated statement of operations data for the six months ended June 30, 2013 and 2014 and the summary consolidated balance sheet data as of June 30, 2014 from our unaudited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 have been restated to correct an error in the calculation and allocation of fair value of the bifurcated embedded derivative features of our Series C, D and E Preference Shares. See Note 22 to our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 included elsewhere herein. Our unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. Our historical results are not necessarily indicative of the results that may be expected in the future. Our summary consolidated financial data also includes certain non-GAAP measures, which are not required by, or presented in accordance with, U.S. GAAP, but are included because we believe they are indicative of our operating performance and are used by investors and analysts to evaluate companies in our industry. The following summary consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     Year Ended December 31,     Six Months Ended June 30,  
     2011     2012     2013     2013     2014  
     (As restated)     (As restated)     (As restated)              
     (in thousands, except for share and per share data)  
Summary Consolidated Statements of Operations Data:           

Revenue

          

Turnkey products

   $ 41,522      $ 35,655      $ 79,806      $ 35,082      $ 48,128   

NRE design services

     17,221        18,360        22,337        12,460        18,474   

License and royalties

     18,774        20,529        25,267        10,619        10,363   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     77,517        74,544        127,410        58,161        76,965   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost and expenses:

          

Cost of revenue

          

Turnkey products

     (39,097     (31,340     (64,787     (28,692     (38,500

NRE design services

     (18,076     (14,927     (20,188     (11,000     (15,532

License and royalties

     (951     (2,242     (1,959     (1,505     (213
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue(1)

     (58,124     (48,509     (86,934     (41,197     (54,245
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of intangible assets

     (2,533     (2,897     (3,047     (1,503     (1,888

Research and development expenses(1)

     (14,632     (14,403     (17,863     (8,305     (8,632

Sales and marketing expenses(1)

     (8,875     (10,977     (11,955     (5,965     (6,472

General and administrative expenses(1)

     (6,038     (6,586     (6,704     (2,902     (3,366
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (12,685     (8,828     907        (1,711     2,362   

Other income (expense):

          

Interest income

     18        8        6        3        86   

Interest expense

     (521     (738     (1,041     (426     (605

Increase in fair value of warrants to purchase convertible redeemable preference shares and ordinary shares

     (490     (346     (764     (514     (897

Decrease (increase) in fair value of liquidation features of Series A, B, C, D and E convertible redeemable preference shares

     (5,188     (4,570     (4,127     (6,197     13,264   

Increase in fair value of equity options of Series C, D and E convertible redeemable preference shares

     (7,067     (10,620     (21,573     (11,568     (39,942

Other, net

     348        (2     (126     (203     349   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss before income tax expense

     (25,585     (25,096     (26,718     (20,616     (25,383

Income tax expense

     (955     (564     (1,393     (414     (785
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (26,540   $ (25,660   $ (28,111   $ (21,030   $ (26,168
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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     Year Ended December 31,     Six Months Ended June 30,  
     2011     2012     2013     2013     2014  
     (As restated)     (As restated)     (As restated)              
     (in thousands, except for share and per share data)  

Net loss per share

          

Basic and diluted

   $ (2.14   $ (1.99   $ (2.16   $ (1.63   $ (1.91
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of ordinary shares used in calculating basic and diluted net loss per share

     12,373,357        12,868,970        12,987,154        12,934,136        13,699,195   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Information(2)

          

Adjusted net income (loss)

   $ (13,266   $ (9,622   $ (1,141   $ (2,488   $ 1,779   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ (8,715   $ (4,618   $ 5,104      $ 216      $ 5,450   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro Forma(3):

          

Pro forma net loss per share:

          

Basic and diluted

       $ (0.50     $ (0.46
      

 

 

     

 

 

 

Weighted average number of shares used in calculating pro forma basic and diluted net loss attributable to ordinary shareholders per share

         55,864,919          56,884,363   
      

 

 

     

 

 

 

 

(1) 

Includes employee share-based compensation as follows:

 

     Year Ended December 31,      Six Months Ended June 30,  
         2011              2012              2013              2013              2014      
     (in thousands)  

Cost of revenue

   $ 28       $ 26       $ 51       $ 23       $ 41   

Research and development

             10                 26                 52                 23                 34   

Sales and marketing

     11         17         33         16         31   

General and administrative

     18         18         27         10         97   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 67       $ 87       $ 163       $ 72       $ 203   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
(2) 

See “—Non-GAAP Financial Measures” for additional information and a reconciliation of net income (loss), the most directly comparable U.S. GAAP financial measure, to each of adjusted net income (loss) and adjusted EBITDA.

(3) 

The pro forma data gives effect to the transactions described in clauses (i) and (ii) of note (1) to the consolidated balance sheet data below, which transactions include the assumed exercise for cash of warrants to purchase our Series E Preference Shares. Note (1) to the consolidated balance sheet data below includes additional information concerning pro forma net loss per share assuming that the warrants to purchase our Series E Preference Shares were exercised on a cashless basis. Such pro forma data is illustrative only and does not purport to reflect what our actual results of operations would have been for any prior period nor do they purport to be indicative of our results of operations for any future period.

 

     As of
December 31,
2013
    As of June 30, 2014
     Actual     Actual     Pro
Forma(1)(3)
    Pro Forma  as
Adjusted(2)(3)
     (As restated)                  
     (in thousands)

Consolidated Balance Sheet Data:

        

Cash and cash equivalents

   $ 9,303      $ 32,882      $ 34,439     

Working capital

     (15,926     4,640        6,197     

Total assets

     57,868        94,419        95,976     

Total liabilities

     123,248        154,316        73,338     

Convertible preference shares

     71,979        94,235        —       

Accumulated deficit

     (148,866     (175,035     (175,035  

Total stockholders’ equity (deficit)

   $ (137,359   $ (154,132   $ 22,638     

 

(1)

The pro forma column in the consolidated balance sheet data table above reflects (i) the automatic conversion of all of our issued and outstanding preference shares into ordinary shares, (ii) the assumed exercise for cash of warrants to purchase our Series E Preference Shares immediately prior to completion of this offering and the resulting issuance of ordinary shares and our receipt of approximately $1.6 million as a result of the assumed payment of the exercise price of those warrants in cash and (iii) the reclassification of warrants to purchase preference shares and ordinary shares from liability to additional paid-in capital. Although the warrants to purchase our Series E Preference Shares will expire immediately prior to the completion of this offering, the holders of those warrants are under no obligation to exercise them for cash or at all or may exercise them on a “cashless” basis by paying the exercise price by forfeiting a portion of the

 

 

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  ordinary shares issued on exercise with a value equal to the aggregate exercise price. However, if the fair market value of the shares issuable on exercise of the warrants to purchase Series E Preference Shares exceeds the exercise price, then any such warrants that are not exercised by the holders prior to completion of this offering will be deemed to have been automatically exercised on a cashless basis, except for warrants owned by a holder that has elected by prior written notice to us to allow its warrants to purchase Series E Preference Shares to expire. If any of the warrants to purchase our Series E Preference Shares are not exercised or if some or all of the warrants are exercised on a cashless basis (either by the holders or automatically), then the amount of our cash and cash equivalents, working capital, total assets, and total stockholders’ equity on a pro forma and a pro forma as adjusted basis would be lower than the amounts reflected in the foregoing table. For example, if all of the warrants to purchase Series E Preference Shares were exercised on a cashless basis immediately prior to the completion of this offering, then, assuming that the shares to be issued on exercise had a value equal to $         per share (the midpoint of the initial public offering price range set forth on the cover page of this prospectus), our cash and cash equivalents would have been $         and $        , our working capital would have been $         and $        , our total assets would have been $         and $         and our total stockholders’ equity would have been $         and $         as of June 30, 2014, on a pro forma and pro forma as adjusted basis, respectively, our pro forma net loss per share (basic and diluted) for the year ended December 31, 2013 and the six months ended June 30, 2014 would have been $         and $        , respectively, and the weighted average number of shares used in calculating pro forma basic and diluted net loss attributable to ordinary shareholders per share would have been              shares and                  shares, respectively.
(2)

The pro forma as adjusted column in the consolidated balance sheet data table above reflects the items described in (1) above and the receipt of the estimated net proceeds from the sale of              ADSs offered by us in this offering at an assumed initial offering price of $         per ADS, the midpoint of the initial public offering price range set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated expenses payable by us as if all of those transactions had occurred as of June 30, 2014. Each $1.00 increase (decrease) in the assumed initial public offering price of $         per ADS, the midpoint of the initial public offering price range set forth on the cover page of this prospectus, would increase (decrease) pro forma as adjusted cash and cash equivalents, working capital, total assets and total stockholders’ equity by approximately $         million, assuming that the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated expenses payable by us. Similarly, each one million share increase (decrease) in the number of ADSs offered by us would increase (decrease) pro forma as adjusted cash and cash equivalents, working capital, total assets and total shareholders equity by approximately $         million, assuming the assumed initial public offering price of $             per ADS remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

(3) 

The pro forma and pro forma as adjusted information set forth above is illustrative only and does not purport to reflect what our actual financial condition would have been had the transactions referred to above occurred as of the date set forth above nor do they purport to be indicative of our financial condition as of future dates. Our actual balance sheet information after this offering will be determined in part by the actual public offering price and number of ADSs sold by us and other terms of this offering.

Non-GAAP Financial Measures

Adjusted Net Income (Loss) and Adjusted EBITDA

To provide investors with additional information regarding our financial results, we have disclosed in the table above and within this prospectus adjusted net income (loss) and adjusted EBITDA, all of which are non-GAAP financial measures. We have provided reconciliations below between net income (loss), the most directly comparable U.S. GAAP financial measure, and each of adjusted net income (loss) and adjusted EBITDA.

We have included these non-GAAP financial measures in this prospectus because they are key measures used by our management to evaluate our operating performance, generate future operating plans and make strategic decisions. Accordingly, we believe that these non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

We define adjusted net income (loss) as net income (loss) excluding share-based compensation expense; amortization of intangible assets resulting from business acquisition; change in fair value of warrants to purchase preference shares and ordinary shares; change in fair value of the liquidation feature of our Series A, B, C, D and E Preference Shares; and change in fair value of equity options of our Series C, D and E Preference Shares.

We define adjusted EBITDA as net income (loss) before interest income, interest expense, depreciation and amortization, and income tax expenses and excluding share-based compensation expense; amortization of intangible assets resulting from business acquisition; change in fair value of warrants to purchase preference

 

 

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shares and ordinary shares; change in fair value of the liquidation feature of our Series A, B, C, D and E Preference Shares; and change in fair value of equity options of our Series C, D and E Preference Shares.

We believe that the use of these non-GAAP measures facilitates investors’ assessment of our operating performance from period to period by backing out differences caused by variations in items such as capital structures, including the characteristics of our preference shares and warrants to purchase our ordinary shares and preference shares, the amortization of intangibles (affecting relative amortization expenses), and other non-cash expenses (affecting share-based compensation expense). We also present these non-GAAP measures because we believe these non-GAAP measures are frequently used by securities analysts, investors and other interested parties as measures of the financial performance of companies in our industry.

While we believe that these non-GAAP financial measures are useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for the related financial information prepared in accordance with U.S. GAAP. We believe it is useful to exclude non-cash charges, such as amortization of intangible assets resulting from business acquisition; share-based compensation expense; change in the fair value of warrants to purchase preference shares and ordinary shares; change in fair value of the liquidation feature of our Series A, B, C, D and E Preference Shares; and change in fair value of equity options of our Series C, D and E Preference Shares, from our non-GAAP financial measures, because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations.

These non-GAAP financial measures are not defined under U.S. GAAP and are not presented in accordance with U.S. GAAP. These non-GAAP financial measures have limitations as analytical tools. Some of these limitations include, but are not limited to:

 

   

they do not reflect changes in, or cash requirements for, our working capital needs;

 

   

they do not reflect the interest expenses, or the cash requirements necessary to service interest or principal payments, on our debt;

 

   

they do not reflect income taxes or the cash requirements for any tax payments;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and adjusted net income (loss) and adjusted EBITDA do not reflect any cash requirements for such replacements;

 

   

they do not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;

 

   

while share-based compensation expense is a component of cost of revenue and operating expenses, the impact to our consolidated financial statements compared to other companies can vary significantly due to such factors as assumed life of the options and assumed volatility of our ordinary shares; and

 

   

other companies may calculate these measures differently than we do, limiting the usefulness of these non-GAAP measures as comparative measures.

Because of the aforementioned limitations, you should consider adjusted net income (loss) and adjusted EBITDA together with financial performance measures, including net income (loss), cash flow and our financial results presented elsewhere in this prospectus in accordance with U.S. GAAP.

 

 

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The following table reconciles our adjusted net income (loss) and adjusted EBITDA in the periods presented to the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP.

 

     Year Ended December 31,     Six Months
Ended June 30,
 
     2011     2012     2013     2013     2014  
     (As restated)     (As restated)     (As restated)              
     (in thousands)  

Net loss

   $ (26,540   $ (25,660   $ (28,111   $ (21,030   $ (26,168

Share–based compensation expense

     67        87        163        72        203   

Amortization of intangible assets resulting from business acquisition

     462        415        343        191        169   

Increase in fair value of warrants to purchase convertible redeemable preference shares and ordinary shares

     490        346        764        514        897   

Decrease (increase) in fair value of liquidation features of Series A, B, C, D and E convertible preference shares

     5,188        4,570        4,127        6,197        (13,264

Increase in fair value of equity options of Series C, D and E convertible redeemable preference shares

     7,067        10,620        21,573        11,568        39,942   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income (loss)

   $ (13,266   $ (9,622   $ (1,141   $ (2,488   $ 1,779   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (26,540   $ (25,660   $ (28,111   $ (21,030   $ (26,168

Share–based compensation expense

     67        87        163        72        203   

Amortization of intangible assets resulting from business acquisition

     462        415        343        191        169   

Increase in fair value of warrants to purchase convertible redeemable preference shares and ordinary shares

     490        346        764        514        897   

Decrease (increase) in fair value of liquidation features of Series A, B, C, D and E convertible preference shares

     5,188        4,570        4,127        6,197        (13,264

Increase in fair value of equity options of Series C, D and E convertible redeemable preference shares

     7,067        10,620        21,573        11,568        39,942   

Interest income

     (18     (8     (6     (3     (86

Interest expense

     521        738        1,041        426        605   

Depreciation and amortization

     3,093        3,710        3,817        1,867        2,367   

Income tax expense

     955        564        1,393        414        785   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ (8,715   $ (4,618   $ 5,104      $ 216      $ 5,450   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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RISK FACTORS

An investment in our ADSs involves significant risks. You should carefully consider all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. 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 ADSs. Any of these risks could result in a decline in the market price of our ADSs, in which case you could lose all or part of your investment.

Risk Factors Related to Our Business and Our Industry

We have a history of losses and may not achieve or sustain profitability in the future.

Prior to 2014, we had incurred significant net losses in each period since our inception. We incurred net losses of $26.5 million, $25.7 million, $28.1 million and $26.2 million in 2011, 2012 and 2013 and the six months ended June 30, 2014, respectively. As of June 30, 2014, we had an accumulated deficit of $175.0 million. We currently expect to increase our expenses to support our business growth and to comply with our obligations as a public company. We will need to grow our revenue in order to achieve profitability and there can be no assurance that we will ever be profitable. In that regard, our revenue grew substantially in 2013 and the six months ended June 30, 2014 compared to 2012 and the six months ended June 30, 2013, respectively. There can be no assurance that our revenue will continue to grow at these rates or will not decline, which may cause our net losses to increase. If our expenditures do not result in increased revenue growth or there is a significant time lag between these expenses and our revenue growth, or if our revenue grows at a slower rate than in recent periods or declines, we may never become profitable. Because many of our expenses are fixed in the short term, or are incurred in advance of anticipated sales of our services, we may not be able to decrease our expenses in a timely manner to offset any shortfall of revenue. We cannot assure you that we will achieve profitability in the future or that, if we do, we will sustain profitability.

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

We experienced significant growth in revenue in the six months ended June 30, 2014 compared to the six months ended June 30, 2013 and in 2013 as compared to 2012. Our revenue increased from $58.2 million in the six months ended June 30, 2013 to $77.0 million in the six months ended June 30, 2014, and also increased from $74.5 million in 2012 to $127.4 million in 2013. We may not achieve similar rates of growth in future periods. We have experienced decreases in revenue in the past, including in 2012 as compared to 2011. You should not rely on our results of operations for any prior quarterly or annual period as an indication of our future performance.

Our future revenue will depend in particular on the success of our turnkey products. Revenue from our turnkey products, NRE design services, and license and royalties was $48.1 million, $18.5 million and $10.4 million, respectively, for the six months ended June 30, 2014 and $79.8 million, $22.3 million and $25.3 million, respectively, for the year ended December 31, 2013. We believe that a significant portion of our future revenue growth will come from our turnkey products, although there can be no assurance that we will achieve such growth or that our revenue will not decline. If we are unable to realize growth in our turnkey products revenue, our overall business and financial performance will likely decline and the market price of our ADSs may decline.

Our results of operations can fluctuate from period to period.

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:

 

   

changes in demand for our SiPaaS solution due to fluctuations in demand for our customers’ products and due to constraints in our customers’ budgets for research and development;

 

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competition in the markets in which we compete, which can change rapidly due to industry or customer consolidation and technological innovation;

 

   

the receipt, reduction, delay or cancellation of purchase orders for turnkey products by our customers;

 

   

the gain or loss of significant customers;

 

   

our ability to meet development objectives in our NRE design services projects, which if delayed could damage our relationships and our ability to engage NRE design service customers in the future;

 

   

changes in our revenue mix among our turnkey products, NRE design services, and IP license and royalties;

 

   

changes in our revenue mix among our customers, including emerging and established semiconductor companies, original equipment manufacturers (OEMs), original design manufacturers (ODMs) and large Internet platform companies;

 

   

market acceptance of our customers’ products;

 

   

the timing and extent of research and development costs;

 

   

our dependence on a relatively small number of turnkey customers for a large portion of our revenue and any order cancellations or changes in order patterns from these customers;

 

   

the number of license agreements that we enter into, and the type of IP that we license in a particular quarter;

 

   

fluctuations in the business of our licensees who pay us license and royalty fees;

 

   

the impact of seasonality of our business, which typically results in higher revenue in our third quarter and lower revenue in our first quarter;

 

   

significant warranty claims;

 

   

loss of access or rights to third-party IP we license to customers; and

 

   

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

As a result of these and other factors, our operating results in one or more future periods may fail to meet or exceed the expectations of securities analysts or investors. In that event, the trading price of our ADSs would likely decline.

Changes in our revenue mix may result in reduced overall operating margin and the market price of our ADSs may be materially and adversely affected.

We believe that a significant portion of our future revenue growth will come from our turnkey products, although there can be no assurance that we will achieve growth in any of our revenue categories. Our revenue from license fees and royalties has a more favorable impact on our results of operations than our other product categories because we incur limited additional expenses to tailor our IP for our customers’ needs. After we deliver an IP solution to our customer, we typically recognize revenue without incurring any incremental costs. However, our costs associated with our turnkey products and NRE design services consist of fees charged by independent third-party contractors, such as our vendors for mask sets, multi-purpose wafers and prototype wafers for our NRE design customers, and wafer foundries and packaging and testing vendors of volume production wafers for our turnkey product customers, all of which generally increase to the extent that our turnkey products and NRE design services revenue increases. If revenue from our turnkey products and NRE design services grows at a faster rate than revenue from our license fees and royalties, thereby changing our revenue mix, we may experience a decrease in our operating margin. If our overall operating margin decreases, it is possible that the market price of our ADSs may be materially and adversely affected.

 

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Our customer base is concentrated. The loss of one or more of our significant customers, or a failure to diversify our customer base, could harm our business.

Historically, a majority of our revenue has been derived from relatively few customers. Sales to our five largest customers in 2011, 2012 and 2013 and the six months ended June 30, 2014 together accounted for 45%, 41%, 57% and 65% of our revenue, respectively. In 2013 and the six months ended June 30, 2014, sales to Robert Bosch GmbH (Bosch) of a variety of microelectromechanical systems (MEMS) sensors accounted for 38% and 45% of our total revenue, respectively. In 2012, sales to Bosch accounted for 18% of our total revenue. The loss of Bosch (or any other significant customer) as a customer or a significant reduction in orders from Bosch or any other significant customers could materially and adversely affect our business, financial condition and results of operations.

There is no assurance that the market will adopt our SiPaaS solution and the markets that we target with our SiPaaS solution are evolving. Changing market conditions, such as the introduction of new technologies or changes in customer preferences, may negatively affect demand for our solution. If we fail to properly anticipate or respond to changing market conditions, our business prospects and results of operations will suffer.

There is no assurance that the market will adopt our SiPaaS solution. Further, our SiPaaS solution is used in technologically advanced and rapidly evolving markets, including mobile devices, networking, the IoT, wearable electronics, smart homes and automotive. The technologies used in these markets are constantly being improved and new technologies that compete with existing technologies may be developed. For example, semiconductor products transition over time to increasingly more advanced processing nodes. This requires us to adapt our design capabilities to these new technologies, which requires expertise in new procedures. Our failure to successfully design products with smaller geometry manufacturing processes could impair our competitive position. Furthermore, some of these markets are highly fragmented and subject to changes in customer requirements and technical standards. New technologies may be introduced that make the current technologies that our SiPaaS solution utilizes less competitive or obsolete. Due to the evolving nature of our customers’ end user markets, our future success depends on our and our customers’ ability to accurately anticipate and respond to changes in technologies, consumer preferences and other market conditions. Any decrease in demand for our SiPaaS solution or our IP portfolio, due to the emergence of competing technologies, changes in end user preferences and requirements or other factors, could materially and adversely affect our business, results of operations and prospects.

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

The competitiveness of our technology impacts all aspects of our business. In order to compete effectively, we must continually design, develop and introduce new and improved technology 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. Our research and development expenses were approximately $14.6 million, $14.4 million, $17.9 million and $8.6 million for the years ended December 31, 2011, 2012 and 2013 and in the six months ended June 30, 2014, respectively. Currently, we are devoting significant resources to develop technologies related to mobile devices, networking, the IoT, wearable electronics, smart homes and automotive. However, we may not be successful in developing and marketing these new platforms and enhanced technologies. In addition, to the extent our engineering resources are deployed to develop NRE projects, we may not have sufficient engineering resources to develop our other internal IP, which may negatively impact our license and royalties revenue in future periods. If we are unable to successfully develop and market new and enhanced technologies, our results of operations and financial condition will be materially and adversely affected.

 

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We may experience delays in developing new IP or may have to invest more resources in research and development than anticipated which could negatively impact our revenue or substantially increase our costs.

The continuous development and enhancement of our IP offerings and SiPaaS solution to address new and changing markets is highly complex. We occasionally have experienced delays in development, and we could experience delays in the future. Unanticipated problems in developing our IP portfolio could also divert substantial engineering resources, which may negatively impact revenue from NRE design services. Any failure to successfully develop new IP would have a material adverse effect on our business, financial condition and results of operations.

Additionally, we may have to invest more resources in research and development than anticipated, which could increase our operating expenses and negatively affect our operating results. New competitors, technological advances in the semiconductor industry or by competitors, potential acquisitions, entry into new markets, or other competitive factors may require us to invest significantly greater resources than we anticipate. If we are required to invest significantly greater resources than anticipated without a corresponding increase in revenue, our operating results and financial condition will be materially and adversely affected.

Even if we gain a design win, our customer may not immediately commence volume production of the customer’s product or at all.

Even after we gain a design win and qualify our silicon solution for use in our customer’s product, our customer may postpone the commencement of volume production of the product, or may decide not to produce the product at all. If our customer decides to postpone the commencement of volume production or not produce its product at all, we will not be able to generate turnkey products revenue relating to that product and our revenue and results of operations may be materially and adversely affected.

Our license and royalties revenue is uncertain from period to period, and we may be unable to attract new license customers or expand our relationship with existing license customers in the future, which would materially and adversely affect our results of operations.

Most of our license agreements do not require us to customize our IP for the licensee, and therefore, we generally recognize all of the corresponding license fees as license revenue in the financial quarter that we enter into the license agreement and deliver the IP to the licensee. As a result, our past license revenue may not be indicative of the amount of license revenue in any future period, and a significant portion of our future license revenue will likely depend upon our success in attracting new licensing customers or expanding our relationships with existing customers. Revenue recognized from licensing arrangements varies significantly from period to period, depending on, among other factors, the number and size of deals closed during a financial quarter, and is difficult to predict. Our ability to increase our license revenue will depend on a variety of factors, including the performance, quality, breadth and depth of our current and future IP, as well as our sales and marketing capabilities. In addition, some of our licensees may in the future decide to satisfy their needs through in-house design and production. Our failure to obtain future licensing customers would negatively affect our revenue, and our results of operations and financial condition will be materially and adversely affected.

We could lose rights under our intellectual property licenses with third parties that are important to our business.

We license certain IP from third parties, some of which is material to our business. In particular, we have a non-exclusive, worldwide perpetual license from Google, Inc. to the VP8 and VP9 video codecs that are the core of the Hantro HD video IP. We consider the Hantro HD video IP to be a key component of our IP portfolio, and we rely on our right to sublicense the VP8 and VP9 video codecs to our customers in order to generate license and royalties revenue. In that regard, the Hantro HD video IP accounted for a significant portion of our license and royalties revenue for the years ended December 31, 2011, 2012 and 2013 and the six months ended June 30, 2014. Our Hantro HD video IP license may be terminated by Google, Inc. in certain circumstances, including,

 

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among other events, our uncured breach or our bankruptcy. Our right to sublicense the Hantro HD video IP to third parties is subject to limitations in our agreement with Google, Inc. and the agreement also provides that such right to sublicense may be further limited by Google, Inc. from time to time at its discretion. Some of our other license agreements also permit the licensors to terminate or limit the license or right to sublicense in certain circumstances. If a license agreement is terminated, it would prevent us from using or including the applicable IP in our solutions, which would prevent us from selling solutions incorporating that IP. Likewise, our right to sublicense the applicable IP is necessary for us to generate license and royalties revenue by sublicensing that IP and any loss or material limitation of our right to sublicense the Hantro HD video IP or other IP could prevent us from generating license and royalties revenue from sublicenses of that IP. Accordingly, the termination of our Hantro HD video IP license or any other third-party IP license that is important to our business, our failure to renew any such license on acceptable terms following its expiration, or any limitation on our right to sublicense third-party IP to our customers could have a material and adverse effect on our business, results of operations and financial condition.

We do not report gross margin and reliance on third-party calculations of gross margin may result in an inaccurate view of our financial results.

We do not report gross margin because we do not believe that it is a useful measure for understanding our financial results or representative of the performance of our underlying business. Any third party could independently calculate a measure that they believe represents our gross margin, which calculation may not be accurate and could fluctuate on a quarterly basis. Any reliance on such calculation might result in an inaccurate view of our financial results and result in a decline in the trading price of our ADSs.

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 may be materially and adversely affected.

We face competition from a large number of competitors, including Global Unichip Corp., Faraday Technology Corporation, eSilicon Corporation and Open-Silicon, Inc. in our turnkey products and NRE design services revenue categories. In our licensing and royalties revenue category, we face competition from a number of companies who have designed and license their own technologies, including Ceva Inc., Cadence Design Systems, Inc. and Synopsys, Inc. in the design of digital signal processing IP and Imagination Technologies Group PLC and Chips&Media, Inc. in the design of video processing IP. We expect to face increased competition in the future. Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development, promotion and sales of their solutions than we can. Our competitors may develop and introduce new solutions that have lower prices, provide superior performance, provide greater processing power or achieve greater market acceptance than our solutions. It is possible that new competitors or alliances among existing competitors could emerge and rapidly acquire significant market share, which could materially and adversely affect our business, revenue and operating results. If we fail to compete successfully, our business would suffer and we may lose or be unable to gain market share.

Aggressive competition in the consumer electronics markets could result in substantial declines in the license fees and royalty rates that we are able to charge our customers for our IP, as well as the number of turnkey and NRE projects that we generate. In the past, some of our competitors have sought to increase their share of certain markets by reducing their license fees and royalty rates or the fees that they charge for their design or engineering services and may do so in the future.

We face competition from internal engineering teams at semiconductor companies and if such companies choose to complete their design work internally, our revenue and results of operations will be adversely affected.

We compete with internal engineering teams at semiconductor companies that design certain IP in-house for their own use. When these companies design IP in-house, they do not license that specific IP from us and thus we

 

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do not receive license or royalty revenue. In addition, if these companies complete designs in-house, we do not generate revenue in our NRE design services or turnkey products categories. Thus, if companies choose to perform more design work in-house in the future, our revenue and results of operations may be adversely affected.

If we fail to keep pace with changing technologies, our business and results of operations may be materially and adversely affected.

Rapidly changing customer requirements, evolving technologies and industry standards characterize the mobile device, networking, the IoT, wearable electronics, smart homes and automotive markets. To achieve our goals, we need to continue to update and upgrade the IP used in our SiPaaS solution to keep pace with these continuing changes in industry standards, as well as other requirements and customer preferences. For example, Dolby Laboratories, Inc., which is not presently a customer but which is a pioneer in high end audio technology, regularly releases updates to its audio encoding and decoding standards, which requires updates to the software or hardware included in our ZSP-based audio SoC platform. In addition, the International Telecommunications Union is responsible for updating the industry standards for HD video requiring similar changes to our SoC platform. If we cannot keep pace with these changes, or cannot implement changes to accommodate such industry standards in a cost-effective manner, our business and results of operations may be materially and adversely affected.

We do not enter into long-term contracts with our NRE design services or turnkey customers and the loss of, or reduced ordering by, significant customers in either of these categories could adversely affect our results.

We do not enter into long-term contracts or purchase commitments with our NRE design services or turnkey products customers, and we have no contractual arrangements for future sales of our solutions to existing customers. Because we sell our turnkey products on the basis of purchase orders rather than long term commitments, our customers can issue purchase orders on a weekly or daily basis. These customers can reduce the number of turnkey products that they purchase pursuant to each purchase order or reduce the rate at which they place new purchase orders. Additionally, we contract with our NRE customers on a project-by-project basis, and there can be no guarantee that one project will lead to an additional project from that same customer. Our customers may cancel, change or delay their purchase orders with little or no notice to us and without penalty. This in turn could cause our revenue to decline and materially and adversely affect our results of operations.

We may experience fluctuations in revenue and operating results due to cyclical demand in our customers’ markets, which could cause the price of our ADSs to decline.

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, particularly to the extent we increase sales into the consumer electronics market. As a result of this cyclicality, demand for our solutions and our results of operations may decline in any given period, which could cause the trading price of our ADSs to decline.

Customer orders and ordering patterns in our turnkey products revenue category can change quickly, making it difficult for us to predict our revenue and making it possible that our actual revenue may vary materially from our expectations, which could harm our results of operations and ADS price.

Sales to our major turnkey products customers are made on the basis of purchase orders rather than long term purchase commitments. Because our customers can issue purchase orders on a weekly or daily basis, these customers can reduce the number of turnkey products that they purchase pursuant to each purchase order or reduce the rate at which they place new purchase orders, whether because of changing market conditions for their products or other reasons, without any significant penalty. The success of our turnkey products business is particularly impacted by the success of these customers’ end products. For example, in 2010, one of our major customers began volume production of a product for a popular online game console, and as a result, our turnkey products revenue significantly increased. However, during 2011 and through early 2012, the market for online

 

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game consoles became saturated and, as a result, our turnkey products revenue also decreased materially. While we generally hold very limited inventory, our customers will purchase turnkey products from us for their own inventory and our turnkey products revenue is subject to inventory fluctuations experienced by our customers. When the demand for our customers’ end products is lower than anticipated, our customers may experience an inventory correction and reduce the number of turnkey products they order from us for a period of time. As a result, our turnkey products revenue decreases during that period. These factors could cause our revenue to decline or cause our turnkey products revenue to fluctuate on a quarterly or annual basis, which could materially and adversely affect our results of operations and could cause the trading price of our ADSs to decline.

Prices of our turnkey products are based on estimated costs and deviations from our estimates could result in losses.

We set the price for our turnkey products based on estimated costs, including costs to be charged by wafer foundries and packaging and testing vendors. There is no assurance that our estimates will be accurate on any given project. Deviations from our estimates could result in higher than expected costs, which could result in reduced profitability or losses for our turnkey products. This would negatively affect our results of operations.

Delays in meeting development objectives for our NRE design services customers could adversely affect our revenue in a particular period and damage our reputation.

Our NRE design services customers set certain development objectives that we must achieve during our design process. These objectives usually depend on the timely delivery of the customer’s deliverables to us, our internal development deliverables, and also other third parties’ deliverables (such as IP licensed from third parties). A design project can be delayed by the customer’s deliverables, our internal development deliverables, or third-party deliverables. If a project is delayed, payments from customers may be delayed and our NRE design services revenue could decrease in a given quarter. In addition, our failure to achieve customer development objectives could adversely impact our reputation among our customers and within our industry. This could result in decreased demand for our NRE design services. Thus, delays in meeting development objectives could adversely affect our revenue and operating results.

Cancellation by our customers for NRE designs could adversely affect our revenue in a particular period.

Our customers operate in very competitive, technologically advanced and rapidly evolving electronics markets, including mobile devices, networking, the IoT, wearable electronics, smart homes and automotive. The technologies used in these markets are constantly being improved and new technologies that compete with existing technologies are continuously developed. Cancellation of projects due to a variety of factors could adversely affect our revenue. For example, a customer may discover that a project contracted to us, while still in design, needs substantial changes in the feature set or performance target due to competitive pressures or changing end customer preferences, and decide to either substantially change the specification or cancel the project entirely. Such changes and cancellations could adversely affect our NRE design services revenue recognized in a given period and in future periods.

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

In connection with our turnkey products, we manage the outsourcing of the manufacturing, packaging and testing of such products to wafer foundries and packaging and testing vendors. We generally use a single foundry for the production of each turnkey product and select foundries and packaging and testing vendors for each customer based in part on that particular customer’s needs. However, we do not exclusively use any particular wafer foundry nor do we have any long-term production or similar agreements with any wafer foundries, which may result in wafer foundries allocating resources to their exclusive customers, or customers that are more significant to them

 

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than we are, during periods in which wafer manufacturing capacity is constrained. In 2013, we outsourced manufacturing to five wafer foundries, packaging to six vendors and testing to eight vendors. It is possible that our suppliers could shorten payment terms or that we might be unable to pay our suppliers in a timely manner in the future. This could adversely affect our results of operations as well as our reputation with our suppliers.

Relying on wafer foundries and packaging and testing vendors presents a number of risks, including:

 

   

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 IP;

 

   

limited warranties on wafers or products supplied to us; and

 

   

potential increases in prices.

We currently do not have long-term supply contracts with our vendors, and we typically negotiate pricing on a per-purchase order basis. Therefore, our vendors 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 in which wafer manufacturing capacity is constrained, wafer foundries and packaging and testing vendors 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 and our customers. 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 additional wafer foundries or packaging and testing vendors because of constrained capacity, or if we are unable to obtain timely and adequate deliveries from wafer foundries or vendors, we might not be able to quickly retain other wafer foundries or vendors in a cost-effective manner to satisfy our and our customers’ requirements. In the event that we need to shift the production of a solution to a new wafer foundry, we estimate that it may take approximately nine to 12 months to allow a smooth transition to such foundry. Such a transition might require a qualification process by our customers and our revenue may materially decline during the transition period to a new wafer foundry or other vendor.

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

We develop silicon solutions for use in systems that are driven by industry and technology leaders, in particular in mobile devices, networking, the IoT, wearable electronics, smart homes and automobiles. In developing these silicon solutions, we frequently incorporate certain technology or IP from industry leaders. Such relationships are essential to the performance, completeness and competitive value of our SiPaaS solution. If our relationships with these participants were to deteriorate or if we were unable to build and maintain new relationships, our business, financial condition and results of operations would be materially and adversely affected. These relationships, including licenses to applicable IP, may not remain in place, and we may not be able to obtain new or replacement relationships and licenses in the future on commercially reasonable terms, if at all.

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

The wafer manufacturing 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, wafer foundries may experience manufacturing defects and reduced manufacturing yields

 

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related to errors or problems in their manufacturing processes or the interrelationship of their processes with our designs. In some cases, 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 turnkey products, we assume that manufacturing yields will continue to improve, even as the complexity of our customers’ needs increases. Once our turnkey products are initially qualified with wafer foundries, minimum acceptable yields are established. We are required to purchase 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 new turnkey products are generally lower at first and gradually improve as volume production is achieved. Unacceptably low product yields or other product manufacturing problems could substantially increase the overall production time and costs and materially and adversely impact our operating results. Product yield losses will increase our costs and reduce our net income or increase our net loss, as the case may be. In addition to significantly harming our operating results and cash flow, poor yields may delay shipment to our customers and harm our relationships with them and damage our reputation with potential customers.

Our customers require our solutions and our third-party vendors 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 results of operations may suffer.

Customers for our turnkey products require that our solutions and our third-party vendors undergo extensive qualification processes. This involves testing of our solutions and our customers’ semiconductor integrated circuits or systems, as well as testing for reliability. This qualification process typically may take between three and six months to complete. If there are difficulties qualifying the third-party vendors that we select for our turnkey products, or if we experience difficulties qualifying our solutions, there may be delayed or reduced revenue. Even if we successfully qualify our solutions with a customer, such customer may need to qualify other components being sourced for its system and qualify its system as a whole with its end customers. Any difficulties our customer may experience in completing these qualifications are entirely outside of our control. If we are unsuccessful or delayed in qualifying any of our solutions with a customer, or such customer is unsuccessful or delayed in qualifying any of its other components or its system as a whole, sales of those solutions to the customer may be precluded or delayed, which may impede our growth and cause our business to suffer.

Royalty rates could decrease for existing and future license agreements which could materially and adversely affect our operating results.

Royalty payments to us under existing and future license agreements could be lower than currently anticipated for a variety of reasons. Average selling prices for our customers’ products, particularly those incorporated into consumer electronic products, generally decrease over time during the lifespan of a product and if a customer pays us royalties as a percentage of their product’s selling price, any decrease in their product’s selling price would reduce royalties we receive. As a result, notwithstanding the existence of a license agreement, our customers may demand that royalty rates for our solutions be lower than our historic royalty rates. We have in the past, and may be pressured in the future, to renegotiate existing license agreements with our customers, particularly in the event our customers merge thereby increasing the leverage of our existing customers to extract concessions from us. In addition, certain of our license agreements provide that royalty rates may decrease in connection with the sale of larger quantities of products incorporating our technology. Our royalty revenue will also decrease as the sales of our customers’ products incorporating our IP decrease. Furthermore, our competitors may lower the royalty rates for their comparable products to win market share which may force us to lower our royalty rates as well. As a consequence of these factors, as well as unforeseen factors in the future, the royalty rates we receive for use of our IP could decrease, thereby decreasing future anticipated revenue and cash flow.

 

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Our future license and royalties revenue is dependent in part upon our existing customer base continuing to license or purchase additional services.

Our existing licensing and royalty customer base has traditionally generated additional new license, service and maintenance revenue for us. In future periods, these customers may not necessarily license additional IP from us. Our customers, including established semiconductor companies, OEMs, ODMs and large Internet platform companies, often have significant bargaining power in negotiations with us. Mergers or acquisitions of our customers can reduce the total level of purchases of our software and services, and in some cases, increase customers’ bargaining power in negotiations with their suppliers, including us.

In addition, we own or have rights to license certain IP, including our ZSP and Hantro IP, which command higher license and royalties revenue than our other IP. If we are not successful in licensing these higher-priced IP technologies in the future, then our licensing and royalties revenue will be negatively affected.

Licensees of our IP may incorrectly report product sales subject to royalty revenue, which might not be identified by our audit process or, if identified, might be identified in a subsequent period.

We depend on IP licensees to correctly report their product sales subject to royalty payments. Our regular audits of our IP license arrangements may not discover any irregularities in these reports or, if we do discover errors, we might not identify them in the reporting period in which they occurred. Any undiscovered reporting errors could result in a loss of royalty revenue and errors identified in subsequent periods could result in fluctuations in our quarterly or annual results of operations.

The complexity of our solutions could result in defects, and, as a result, our customers may require us to incur redesign costs if the defects result from our design errors or errors in our solution testing processes.

Our custom silicon solutions are incorporated into multiple product categories including mobile devices, networking, the IoT, wearable electronics, smart homes and automotive products sold by our 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 testing to third parties. We have parts inspected and tested in order to screen out parts that may be weak or potentially suffer a defect incurred during the manufacturing process. If our designs or our testing processes are defective, we may be required to redesign the solution and thus incur additional costs. In addition, redesigning defective solutions results in delayed sales of these solutions. 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. Our testing procedures will not prevent all design defects and there can be no assurance that they will be sufficient to prevent the repetition of previous defects. Thus, defects and associated redesign costs could materially and adversely affect our business prospects and financial condition.

We may not be able to adequately protect our IP rights.

Our success depends in part upon our ability to protect our IP. To accomplish this, we rely on a combination of IP rights, including patents, copyrights, trademarks and trade secrets in the United States, China and other jurisdictions. The process of seeking patent protection can be long and expensive and patents may not be issued from currently pending or future applications. We may be subject to interference proceedings in the U.S. Patent and Trademark Office, foreign patent offices and U.S. and foreign courts, which can require significant financial resources. Effective protection of our IP 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;

 

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our IP rights will provide competitive advantages to us;

 

   

our ability to assert our IP 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 IP 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 IP rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned;

 

   

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

 

   

our trademarks, copyrights, trade secrets and other IP rights will be of sufficient scope or strength to provide meaningful IP protection or any commercial advantage to us.

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, these contractual protections and security measures may be breached, and we may not have adequate remedies for any such breach. Further, our suppliers, employees or consultants may assert rights to IP against us arising out of these contracts.

Monitoring unauthorized use of our IP is difficult and costly. In addition, IP rights and confidentiality protection in China and developing countries is generally considered less effective than in the United States or other developed countries. Unauthorized use of our IP may have occurred or may occur in the future. Any failure to identify unauthorized use and otherwise adequately protect our IP would materially and adversely affect our business.

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

The semiconductor industry is characterized by companies that hold patents and other IP rights and that vigorously pursue, protect and enforce these IP rights. From time to time, third parties may assert against us and our customers patent and other IP rights to technologies that are important to our business. Further, we may receive notifications from customers or licensees asserting that we have indemnification or other obligations related to infringement claims made against them by third parties. We are currently, and in the future, may be involved in legal proceedings or claims regarding alleged patent infringement, other IP rights, contracts and other matters. For example, in May 2014, a complaint was filed against us alleging patent infringement regarding a patent that had expired in 2013.

Claims that our silicon solutions or technology infringes third-party IP 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 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, including pursuant to indemnification commitments made to our customers;

 

   

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

 

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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.

Any assertion of IP rights by a third party against us could result in our customers becoming the target of litigation and we may be bound to indemnify such customers under the terms of our license agreements. Our indemnification obligations could result in substantial expenses to us, which could have a material adverse effect on our business, financial condition and results of operations. In addition to the time and expense required for us to indemnify our customers, our customers’ development, marketing and sales of products incorporating our silicon solutions could be severely disrupted or discontinued as a result of litigation, which in turn could also have a material adverse effect on our business, financial condition and results of operations.

In addition to the time and expense required for us to satisfy our support and indemnification obligations to our customers and strategic partners, any litigation could severely disrupt or shut down the business of our customers and strategic partners, which in turn could damage our relations with them and have a material adverse effect on our business, financial condition and results of operations.

The use of open source software in our products may expose us to additional risks and compromise our proprietary IP.

Certain of the IP in our IP portfolio uses and incorporates software that is subject to an open source license. Open source software is typically freely accessible, usable and modifiable. Certain open source software licenses, such as the GNU General Public License, require a user who intends to distribute the open source software as a component of such user’s software to disclose publicly part or all of the source code to such user’s software. In addition, certain open source software licenses require the user of such software to make any derivative works of the open source code available to others on terms unfavorable to the user or at no cost. This can subject previously proprietary software to open source license terms. While we attempt to limit use of open source software to specific IP in our IP portfolio and try to ensure that no open source software is used in such a way as to require us to disclose the source code to such related IP when we do not wish to do so, such use could inadvertently occur. Additionally, if a third-party software provider has incorporated certain types of open source software into software we license from such third parties we could, under certain circumstances, be required to disclose the source code to the IP. This could materially harm our IP position and our business, results of operations and financial condition.

Security breaches could compromise sensitive information belonging to us or our customers and could harm our business and reputation.

We store sensitive data, including IP, our proprietary business information and that of our customers, and confidential employee information, in our data centers and on our networks. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions that could result in unauthorized disclosure or loss of sensitive information. Because the techniques used to obtain unauthorized access to networks, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Furthermore, in the operation of our business we also use third-party vendors that store certain sensitive data, including confidential information

 

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about our employees, and these third parties are subject to their own cybersecurity threats. Any security breach of our own or a third-party vendor’s systems could cause us to be non-compliant with applicable laws or regulations, subject us to legal claims or proceedings, disrupt our operations, damage our reputation, and cause a loss of confidence in our solutions, any of which could adversely affect our business.

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 Wayne Wei-Ming Dai, Xiaoning (Shannon) Gao, Sheng Wu and Haocheng (Victor) Fan, as well as other significant employees. The loss of any member of our senior management team or our significant employees could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

Failure to comply with existing or future governmental regulations by us, our third-party wafer foundries or our customers could reduce our sales, increase our costs or require design modifications.

The semiconductors manufactured using our designs and the technologies used in our business may be subject to legislation and regulations regarding importation or exportation, as well as various other standards established by authorities in the countries in which we operate. Failure to comply with existing or evolving governmental regulation or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business by reducing our sales, requiring modifications to our technology that we license to foreign third parties, or requiring extensive modifications to our designs that may be too expensive for our customers’ products. Governmental restrictions may make competitors facing less stringent controls on their processes and their customers’ products more competitive in the global market than we are.

If we become subject to unfair hiring claims, we could be prevented from hiring needed employees, incur liability for damages and incur substantial costs in defending ourselves.

When companies in our industry lose employees to competitors, they frequently claim that these competitors have engaged in unfair hiring practices or that the employment of these persons would involve the disclosure or use of trade secrets. These claims could prevent us from hiring employees or cause us to incur liability for damages. We could also incur substantial costs in defending ourselves or our employees against these claims, regardless of their merits. Defending ourselves from these claims could also divert the attention of our management away from our operations.

Consolidation among our customers, as well as within the industries in which we operate, may negatively impact our operating results.

A number of business combinations, including mergers, asset acquisitions and strategic partnerships, among our customers and in the semiconductor and electronics industries have occurred recently, and more could occur in the future. Consolidation among our customers leads to fewer customers or the loss of customers, increased customer bargaining power, or reduced customer spending for our services. We may need to convince an acquirer of an existing customer of the value of our solutions in order to maintain a relationship with the acquirer. However, we may not be able to engage with an acquirer for many reasons, including the acquirer’s internal resources, development strategy and prior relationships with our competitors. Moreover, business combinations within the industries in which we compete may result in stronger competition from companies that are better able to compete as sole source vendors to customers. The loss of customers or reduced customer spending as a result of consolidation could adversely affect our business and financial condition.

 

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Competitive pressures may require us to change our pricing, which could have an adverse effect on our results of operations.

The highly competitive markets in which we do business can put pressure on us to reduce the prices of our services. If our competitors offer deep discounts on competing services in an effort to recapture or gain market share, we may then need to lower our prices or offer other favorable terms to compete successfully. When we sell our services, our customers’ evaluation of the differentiators between our competitors’ design services and our design services can be subjective. Accordingly, when we compete for a new customer, we may be forced to provide lower pricing terms in order to initially establish a relationship with this new customer. In order to continue to win new orders from existing customers, we may be required to lower prices as our competitors attempt to disrupt our customer relationship based on price alone. Any downward adjustments on our pricing could adversely affect our operating results, while any failure to reduce our prices in response to lower prices offered by our competitors could result in a loss of business and cause our sales to decline, perhaps materially. If we cannot offset price reductions with a corresponding increase in contracts for services or with lower spending, then the reduced revenue resulting from lower prices could have a material and adverse effect on our results of operations.

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 may pursue acquisitions in the future that we believe may complement our business, custom silicon solutions or technologies. 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 significant 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 services;

 

   

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

 

   

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.

 

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Our revenue and operating results could be adversely affected by customer financial difficulties, which may cause delays, defaults, modifications or cancellations of orders or licenses.

Occasionally, our customers experience financial difficulties and may delay or default on their payment obligations to us, file for bankruptcy or modify or cancel plans to use our services or license our solutions. For instance, if our customers are not successful in generating sufficient cash or are precluded from securing financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us, or make other payments that are owed to us under purchase orders or licenses, although these obligations are generally not cancelable. Our customers’ inability to fulfill payment obligations, in turn, may adversely affect our revenue and cash flow. Additionally, our customers have, in the past, sought, and may, in the future, seek, to renegotiate pre-existing contractual commitments. Payment defaults by our customers or significant reductions in existing contractual commitments could have a material adverse effect on our financial condition and operating results. Moreover, the capital and credit markets are volatile and unpredictable and, if we were to seek funding from the capital or credit markets in response to any material level of customer defaults, we may not be able to secure funding on terms acceptable to us, or at all, which may have a material negative effect on our business.

Our revenue and results of operations could be adversely affected by macroeconomic conditions, including recessions, that result in a decline in demand or reduced revenue growth for our SiPaaS solution.

Our business and operating results may be adversely impacted by economic conditions in various countries and markets in which we operate or in which our solutions are sold. While the global economy is improving, there are still uncertainties surrounding the strength of the recovery. Weakness in the global economy has adversely affected consumer confidence and the growth of the semiconductor industry in recent years, causing semiconductor companies to behave cautiously and focus on their costs, including their research and development budgets. For example, uncertainty caused by the global recession caused some of our customers to postpone their decision-making, decrease their spending and/or delay their payments to us. Continuing caution by semiconductor companies could have a material negative effect on the demand for our silicon solutions or the products into which our solutions are incorporated and, among other things, could limit our ability to maintain or increase our revenue or recognize revenue from committed contracts and in turn adversely affect our business, operating results and financial condition. The demand for our SiPaaS solution is driven, in large part, by our customer’s products in the mobile devices, networking, IoT, wearable electronics, smart homes and automotive markets. A downturn in general economic conditions in these markets could result in a decline in demand for our SiPaaS solutions.

We are subject to the risks of doing business internationally.

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;

 

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limitations on our ability under local laws to protect our IP;

 

   

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

 

   

nationalization and expropriation;

 

   

changes in tax laws and taxes on funds that are transferred to us or our subsidiaries in other jurisdictions;

 

   

currency fluctuations relating to our international operating activities; and

 

   

difficulty in obtaining distribution and support.

We conduct our operations primarily in China and our solutions are sold globally. Political and economic conditions in these markets can be unstable or unpredictable. 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.

We must maintain effective internal control over financial reporting, and if we are unable to do so, the accuracy and timeliness of our financial reporting may be adversely affected.

We must maintain effective internal control over financial reporting in order to accurately and timely report our results of operations and financial condition. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, requires, among other things, that we assess the effectiveness of our internal control over financial reporting beginning as of the end of our fiscal year 2015, and the effectiveness of our disclosure controls and procedures quarterly. If we are not able to comply with the requirements of the Sarbanes-Oxley Act in a timely manner, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC, or other regulatory authorities, which would diminish investor confidence in our financial reporting and require additional financial and management resources, each of which may adversely affect our business and operating results.

We and our independent registered public accounting firm identified a material weakness in our internal control over financial reporting that has led to a restatement of our financial statements. If we are unable to remediate this material weakness or if we otherwise fail to establish and maintain effective internal control over financial reporting, the accuracy and timeliness of our financial reporting may be adversely affected, which may adversely affect investor confidence in us and, as a result, the market price of our ADSs.

The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, requires us to maintain effective internal control over financial reporting in order to accurately and timely report our results of operations and financial condition. If we are not able to maintain effective internal control over financial reporting or otherwise fail to comply with the requirements of the Sarbanes-Oxley Act in a timely manner, we could be subject to sanctions or investigations by the SEC, or other regulatory authorities, which would diminish investor confidence in our financial reporting and require additional financial and management resources, each of which may adversely affect our business, operating results and the market price of our ADSs.

In connection with the preparation of our consolidated financial statements, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. For additional information, see Note 22 to our audited consolidated financial statements included elsewhere herein.

Neither we nor our independent registered public accounting firm has undertaken a comprehensive assessment of our internal control for purposes of identifying and reporting material weakness, significant deficiencies and other control deficiencies in our internal control over financial reporting and neither we or they will be required to do so for several years. In particular, we will not be required, under the Sarbanes-Oxley Act, to furnish a report by

 

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management on the effectiveness of our internal control over financial reporting until our annual report on Form 20-F for the year ending December 31, 2015. Additionally, the Sarbanes-Oxley Act requires an attestation of the effectiveness of an issuer’s internal control over financial reporting by an independent registered public accounting firm. However, as an emerging growth company, we will not be required to comply with this attestation requirement until we file our annual report for the year ending December 31, 2019 with the SEC, provided we maintain our status as an emerging growth company for the full five-year period. Had we performed a formal assessment of our internal control over financial reporting or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, additional material weaknesses, significant deficiencies or control deficiencies may have been identified.

The material weakness that we identified relates to our lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP reporting requirements to properly address complex U.S. GAAP accounting issues relating to the calculation and allocation of fair value of the bifurcated embedded derivative features of the Series C, D and E Preference Shares. This led to errors in our financial statements and the correction of these errors in turn required us to restate our consolidated financial statements for the three years ended December 31, 2013. We have begun taking steps and plan to take additional measures to remediate the underlying causes of this material weakness. We have designed and implemented additional review procedures on the allocation of fair value of the equity options of our preference shares in the determination of the fair values of their embedded derivatives. In addition, we plan to take additional measures to address these matters, including:

 

   

monitoring the implementation of the abovementioned review procedures and assessing their effectiveness on an ongoing basis; and

 

   

providing our internal accounting staff more training in the subjects of accounting and fair value of complex financial instruments.

However, we cannot assure you that implementation of these measures will remediate this material weakness in our internal control over financial reporting. Likewise, we cannot assure you that we or our registered public accounting firm will not detect other material weaknesses, significant deficiencies or control deficiencies in the future. For example, material weaknesses may be found to exist when we report on the effectiveness of our internal control over financial reporting as required by the reporting requirements under Section 404 of the Sarbanes-Oxley Act beginning as of the end of our fiscal year ending December 31, 2015. The standards required for a Section 404 assessment under the Sarbanes-Oxley Act will require us to implement additional financial controls and procedures and corporate governance practices and adhere to a variety of reporting requirements. Our management may not be able to effectively and timely implement controls and procedures that adequately respond to the increased regulatory compliance and reporting requirements that will be applicable to us as a public company. Our failure to remediate this existing material weakness, or the occurrence of other material weaknesses or significant deficiencies in our internal control over financial reporting, could harm our reputation and investor confidence in our financial reporting and have a material adverse effect on the market price of our ADSs.

We are not able to estimate with reasonable certainty the costs that we will incur to implement these and other measures designed to improve our internal control over financial reporting. If we fail to remediate the existing material weakness and control deficiencies or otherwise fail to establish and maintain internal control over financial reporting adequate to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, our business and reputation may be harmed and the market price of our ADSs may decline. Furthermore, investor perceptions of us may be adversely affected, which could also cause a decline in the market price of our ADSs.

 

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Indebtedness and the terms of our revolving credit facility may impair our ability to respond to changing business and economic conditions and harm our operating results.

We had $16.2 million of outstanding debt as of June 30, 2014. In the past, we have borrowed under our revolving credit facility (which is secured by a majority of our assets) and two separate credit agreements with separate Chinese banks to fund working capital and other cash needs and we may incur additional indebtedness in the future to provide working capital and finance our other cash needs and, if applicable, any future acquisitions we may make. In addition, the terms of our revolving credit facility require, and any debt instruments we enter into in the future may require, that we comply with a number of significant restrictions and covenants. The amount of this indebtedness and these restrictions and covenants could have a material adverse effect on our business, results of operations or financial conditions by, among other things, requiring that we apply available cash to pay interest and principal; requiring that we comply with financial covenants, thereby limiting our financial flexibility; increasing our vulnerability to adverse economic and industry conditions; and placing us at a competitive disadvantage relative to our competitors who have less indebtedness or less burdensome covenants. If we breach or are unable to comply with a covenant or other agreement contained in a debt instrument, the lender would generally have the right to declare all borrowings outstanding under that debt instrument, together with accrued interest, to be immediately due and payable, the interest rate may increase and, in the case of secured borrowings, the lender would generally have the right to seize and sell the collateral pledged to secure those borrowings. In that regard, we have in the past failed to comply with covenants under our revolving credit facility and, although the lending bank has in the past granted us waivers of those defaults, it may not grant similar waivers in the future. As a result, any breach or failure to comply with covenants contained in our revolving credit facility or any future debt instruments could have a material adverse effect on us. We may in the future need to obtain waivers or amendments under our credit facility or any other debt instruments we may enter into in the future in order to avoid a breach or default, particularly if our business deteriorates or does not perform in accordance with our expectations. There can be no assurance that we will not breach the covenants or other terms of our revolving credit facility or any other debt instruments in the future and, if a breach occurs, there can be no assurance that we will be able to obtain necessary waivers or amendments from the lender or to refinance the related indebtedness on terms we find acceptable, or at all. As a result, any breach or default of this nature could have a material adverse effect on our results of operations, financial condition and business.

We may require additional capital in the future. However, we may be unable to raise capital or unable to raise capital on terms acceptable to us, which would have a material adverse effect on our business.

We may require additional external capital in the future to, among other things, finance our working capital, capital expenditures or other cash needs or to finance all or a portion of the cost of any acquisitions or investments we may make in the future. If that occurs, we may seek external financing through the issuance of equity or debt securities or through additional borrowings. If we raise funds or finance acquisitions or investments by issuing equity or debt securities, our shareholders may experience dilution. Debt financing, if available, may involve burdensome financial and other covenants, may require that we pledge collateral to secure the debt and will require us to use cash to pay interest and principal. Additional debt or equity financing may not be available in amounts, at times or on terms acceptable to us, or at all. If we are unable to obtain additional financing as and when needed, it would likely have a material and adverse effect on our business, results of operations and financial condition and could require, among other things, that we curtail our operations, sell assets, reduce research and development and other expenses and take other measures that could have a material adverse effect on our business.

There are inherent limitations on the effectiveness of our controls and compliance programs.

Regardless of how well designed and operated it is, a control system can provide only reasonable assurance that its objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Moreover, although we have implemented compliance programs and compliance training for employees, such measures may not prevent our employees, contractors or

 

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agents from breaching or circumventing our policies or violating applicable laws and regulations. Failure of our control systems and compliance programs to prevent error, fraud or violations of law could have a material adverse impact on our business.

Our operations and our suppliers’ operations are subject to natural disasters and other events outside of our control that may disrupt our business and harm our operating results.

Our corporate headquarters and most wafer foundries and packaging and testing vendors that we use are situated in Asia or near seismically active regions and are subject to periodic earthquakes and tsunamis. In the event of natural disasters, political unrest, war, labor strikes, work stoppages or public health crises, we or one or more of our vendors may be unable to continue operations for a period of time, which may be lengthy, or may be unable to resume operations altogether. This could cause significant delays in shipments of our turnkey products until we are able to shift manufacturing, packaging or testing from the affected contractor to another third-party vendor. There can be no assurance that alternative capacity could be obtained on favorable terms, if at all. Any such problems in our operations or supply chain could adversely affect our ability to market and sell our products and therefore materially and adversely affect our business, financial conditions and results of operations.

We are subject to risks related to exchange rate fluctuations.

Our revenue is primarily denominated in U.S. dollars, while a substantial majority of our 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 subsidiaries in Shanghai, Beijing and Chengdu (collectively, our PRC subsidiaries), 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 ADSs or for other business purposes. Conversely, to the extent that we need to convert U.S. dollars we receive into Renminbi to fund our operations in China, an appreciation of Renminbi against the U.S. dollar would decrease the Renminbi amount we would receive from such conversion. The functional currency of our other non-U.S. subsidiaries is generally the local currency rather than the U.S. dollar, which poses similar risks, and those risks will grow to the extent that our assets and operations in other non-U.S. jurisdictions increase.

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.

We expect to grow our headcount. In order to scale our NRE design services, we must continue to add talented engineers and grow our workforce, both in China and internationally. We must also continue to expand our operational 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 are successful in growing our business but fail to adequately manage our growth, or improve our operational, financial and management information systems, or effectively motivate or manage our new and future employees, the quality of our solutions and the management of our operations could suffer, which could adversely affect our operating results.

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

 

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asset. If we are successful in generating more opportunities to provide NRE design services, we must continue to increase our engineering talent pool. The loss of the services of one or more of 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. Once we hire new engineers, we must integrate them into our systems and procedures. If we fail to effectively integrate new engineers, particularly if we grow at a more rapid pace in the future, our ability to deliver effective NRE design services and innovative technology platforms would suffer.

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 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 to our employees, some of which have not yet vested. Such retention awards may cease to be effective to retain our current employees once the share options 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 qualified design and technical personnel, 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.

Risks Related to Our ADSs and This Offering

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

Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. We have applied to list our ADSs on Nasdaq. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiations between us and our underwriters and may bear no relationship to the market price for our ADSs after this initial public offering. We cannot assure you that an active trading market for our ADSs will develop or be sustained after this offering, or that the market price of our ADSs will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

In the future the trading prices of our ADSs may be volatile and affected by factors beyond our control, which could result in substantial losses to investors.

The trading prices of our ADSs may be volatile and could fluctuate widely due to factors beyond our control. For example, this may happen because of broad market and industry factors, like the performance and fluctuation of the market prices of other companies in the technology industry or with business operations located mainly in China that have listed their securities in the U.S. In the past, the market values of stocks of technology companies have been volatile. Recently, the widespread negative publicity of alleged fraudulent accounting practices and poor corporate governance of certain public companies publicly traded in the U.S. with operations in China are believed to have negatively affected investors’ perception and sentiment towards companies with connections to China, which significantly and negatively affected the trading prices of some companies’ securities listed in the U.S. Once we become a public company, any similar negative publicity or sentiment may affect the trading price of our ADSs, even if this publicity or sentiment is untrue. A number of PRC companies have listed or are in the process of listing their securities on U.S. stock markets. The securities of some of these companies have experienced significant volatility, including price declines in connection with their initial public offerings. The trading performances of these PRC companies’ securities after their offerings may affect the attitudes of investors toward PRC companies listed in the U.S. in general and consequently may impact the trading performance of our ADSs, regardless of our actual operating performance.

 

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In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

   

the financial projections that we may choose to provide to the public, any changes in those projections or our failure for any reason to meet those projections;

 

   

variations in our revenue, earnings and cash flow;

 

   

announcements of new investments, acquisitions, strategic partnerships, or joint ventures;

 

   

announcements of new products, services and expansions by us or our competitors;

 

   

changes in financial estimates by securities analysts;

 

   

additions or departures of key personnel;

 

   

release of lock-up or other transfer restrictions on our outstanding equity securities or sales of additional equity securities;

 

   

potential litigation or regulatory investigations or other proceedings involving us; and

 

   

fluctuations in market prices for our products or services.

In the past, shareholders of a public company often brought securities class action suits against the company following periods of instability in the market price of that company’s securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations, which could harm our results of operations and require us to incur significant expenses to defend the suit. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

As a company with less than $1.0 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption for a period of time from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important or material weaknesses or significant deficiencies in our system of financial control may go undetected.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (a) the last day of our fiscal year during which we have total annual gross revenue of at least $1.0 billion; (b) the last day of our fiscal year following the

 

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fifth anniversary of the completion of this offering; (c) the date on which we have, during the previous three-year period, issued more than $1.0 billion in nonconvertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public companies and subject to reporting obligations that, to some extent, are more lenient and less frequent than those of a U.S. issuer.

Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

 

   

the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K;

 

   

the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act;

 

   

the sections of the Exchange Act requiring insiders to file public reports of their share ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

   

the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases and furnish these press releases to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely as compared to that required to be filed with the SEC by United States domestic issuers. As a Cayman Islands company listed on the NASDAQ Global Market, we are subject to the NASDAQ Global Market corporate governance listing standards. However, NASDAQ Global Market rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the NASDAQ Global Market corporate governance listing standards. Although we do not currently plan to utilize the home country exemption for corporate governance matters, to the extent that we choose to do so in the future, our shareholders may be afforded less protection than they otherwise would under the NASDAQ Global Market corporate governance listing standards applicable to U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a United States domestic issuer.

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

The trading market for our ADSs depends, in part, on the research reports and ratings that securities or industry analysts or ratings agencies publish about us, our business and the semiconductor market in general. We do not have any control over these analysts or agencies. If one or more of the analysts or agencies who cover us downgrades us or our ADSs or lowers their expectation with respect to our future operating results, the price of our ADSs may decline. If one or more of these analysts ceases coverage of our company or fails to regularly publish reports on us, we could lose visibility in the financial markets, which could cause the price of our ADSs or trading volume to decline. In addition, we believe that a trend is developing for short-sellers to target companies with substantial operations in China by issuing what they purport to be research reports containing alleged improprieties of the targeted company. Whether or not these allegations prove to be true, these so-called research reports can cause the trading price of a company’s shares to significantly decline, could distract management’s attention from the business, and may require us to incur significant expenses in connection with

 

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any resulting investigation. As a company with substantial operations in China, we may be susceptible to this tactic from short-sellers and the trading price of our ADSs may decline if a short-seller research report is issued about us irrespective of the veracity of any such report.

We may invest or spend the proceeds of this offering in ways with which you may not agree or in ways which may not yield a return.

Apart from using net proceeds from this offering to redeem any Shadow Preference Shares that may be issued, we have not identified any specific uses for the net proceeds of this offering beyond working capital and general corporate purposes and we may invest or spend the proceeds of this offering in ways with which you may not agree or in ways with which may not yield a return. Our management will have considerable discretion in the application of the net proceeds of this offering, and you will not have the opportunity, as part of your investing decision, to assess whether the proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase our operating results or market value. Until the net proceeds are used, they may be placed in investments that do not produce significant income or that may lose value.

If the midpoint of the initial public offering price range set forth on the cover page of this prospectus is equal to or below $        , we will be required to spend a portion of the proceeds of this offering to redeem Shadow Preference Shares.

Under the terms of our Series C Preference Shares, Series D Preference Shares and Series E Preference shares, each such preference share will convert into one ordinary share and, if the midpoint of the initial public offering price range set forth on the cover page of this prospectus is equal to or below $        , and assuming the warrants to acquire Series C, Series D and Series E Preference Shares are exercised in full for cash, a total of 22,439,012 Shadow Preference Shares (as defined under “Description of Share Capital”). However, the number of Shadow Preference Shares that will be issued under this circumstance will be proportionately reduced from this maximum number to the extent that the midpoint of the initial public offering price range is greater than $             and no Shadow Preference Share will be issued if the midpoint of such price range is equal to or greater than $             .

If Shadow Preference Shares are issued, we will use proceeds of this offering to redeem all of the Shadow Preference Shares immediately following the completion of this offering. If the maximum number of Shadow Preference Shares is issued, the aggregate redemption price will be approximately $39.3 million and if less than the maximum amount of Shadow Preference Shares is issued there will be a proportionate reduction in the aggregate redemption price. For additional information, see “Description of Share Capital—Shadow Preference Shares.”

Because the initial public offering price is substantially higher than our pro forma as adjusted net tangible book value per share, you will incur immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately $         per ADS (assuming no exercise by the underwriters of their option to acquire additional ADSs), representing the difference between the assumed initial public offering price of $         per ADS, the midpoint of the initial public offering price range set forth on the cover page of this prospectus, and our pro forma as adjusted net tangible book value per ADS as of             , after giving effect to this offering and certain other transactions. In addition, you may experience further dilution to the extent that our ordinary shares are issued upon exercise of share options or warrants with exercise prices less than the initial public offering price per ADS. See “Dilution” for a more complete description of how we calculate pro forma as adjusted net tangible book value and how the value of your investment in our ADSs will be diluted upon completion of this offering.

 

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Substantial future sales or the expectation of substantial sales of our ADSs in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have             ordinary shares outstanding, including             ordinary shares represented by ADSs. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act. The remaining ordinary shares outstanding upon completion of this offering will be available for sale upon the expiration of the 180-day lock-up period beginning from the date of this prospectus and, in the case of the ordinary shares that certain option holders will receive when they exercise their share options, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the underwriters. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

We intend to file a registration statement on Form S-8 to register the              ordinary shares issuable upon the exercise of stock options outstanding and the              ordinary shares available for future issuance under our equity incentive plan, in each case as of June 30, 2014. That registration statement is expected to be filed and become effective as soon as practicable after the closing of this offering. Accordingly, shares registered under that registration statement will be available for sale in the open market following its effective date, subject to the vesting of such options and shares, the Rule 144 volume limitation applicable to our affiliates and any applicable lockup agreements. For a more detailed description, please see the section of this prospectus entitled “Shares Eligible for Future Sale—Equity Incentive Plan.”

In addition, as of June 30, 2014, we had outstanding warrants to purchase 240,000 of our ordinary shares, 120,000 of our Series C Preference Shares, 120,000 of our Series D Preference Shares and 815,122 of our Series E Preference Shares. All of the warrants to purchase ordinary shares, Series C Preference Shares and Series D Preference Shares will expire on December 31, 2015. All of the warrants to purchase Series E Preference Shares will expire immediately prior to the completion of this offering, unless earlier exercised by the holder or automatically. All of these warrants to purchase Preference Shares will convert into warrants to purchase ordinary shares in connection with this offering. If the market value of the shares issuable upon exercise of any warrant is greater than the exercise price of $1.5522 (in the case of warrants to purchase Series C Preference Shares) or $1.91 per share (in the case of warrants to purchase ordinary shares, Series D Preference Shares and Series E Preference Shares), then we believe that the holders of warrants to purchase our ordinary shares, Series C and Series D Preference Shares will likely exercise them prior to the December 31, 2015 expiration date, and the holders of our warrants to purchase our Series E Preference Shares will likely exercise them (or they will be automatically exercised) prior to the completion of this offering, which will in each case result in dilution to investors purchasing ADSs in this offering and increase the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public market could adversely affect the market price of our ADSs.

Finally, certain of our shareholders have the right to cause us to register the sale of their shares under the Securities Act upon the occurrence of certain circumstances. See “Description of Share Capital—Registration Rights.” 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 of these shares. Sales of these registered shares in the public market could cause the price of our ADSs to decline.

A small number of existing shareholders control a significant portion of our voting stock and their interests may differ from other shareholders.

The interests of our largest shareholders may differ from the interests of our other shareholders. Immediately after the completion of this offering, our executive officers and directors, together with our greater than 5% shareholders, will beneficially own             ordinary shares, representing approximately     % of the aggregate voting power of our company. Accordingly, our executive officers and directors, together with our

 

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existing major shareholders, could have significant influence or control in determining the outcome of any corporate transaction or other matter submitted to the shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. Without the consent of some or all of these shareholders, we may be prevented from entering into transactions that could be beneficial to the interest of other shareholders.

Our post-offering amended and restated memorandum and articles of association contain anti-takeover provisions that could discourage a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including ordinary shares represented by our ADSs, at a premium.

Our amended and restated memorandum and articles of association, which will become effective immediately prior to the completion of this offering, contain provisions that limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. 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 a similar transaction. For example, our board of directors has the authority to cause the issuance of any authorized but unissued preference shares, without further action by our shareholders. These preference shares may have better voting rights than our ordinary shares, in the form of ADSs or otherwise, and could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preference shares, the price of our ADSs may fall and the voting rights of the holders of our ordinary shares and ADSs may be diluted.

Holders of our ADSs have fewer rights than our shareholders and must act through the depositary to exercise those rights.

Holders of our ADSs do not have the same rights as our shareholders and may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. If you wish to directly vote the ordinary shares represented by your ADSs, you will be required to deliver your ADSs to the depositary for cancellation and withdraw the underlying ordinary shares. Under our post-offering amended and restated memorandum and articles of association, the minimum notice period required to convene a general meeting is 10 days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, if you continue to hold ADSs, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your ADSs. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote, where such failure or other actions result from reasons beyond their control. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ADSs are not voted as you requested. In addition, in your capacity as an ADS holder, you will not be able to call a shareholders’ meeting unless you withdraw your ordinary shares by canceling your ADSs. However, we do not expect that a trading market for our ordinary shares will develop and you will therefore likely be required to deposit your ordinary shares in exchange for ADSs should you wish to dispose of those ordinary shares. We expect that the depositary will charge you a fee for both withdrawing and depositing ordinary shares. See “Description of American Depositary Shares” for additional information.

You may not receive distributions on our ordinary shares or any value for them if such distribution is illegal or if any required government approval cannot be obtained in order to make such distribution available to you.

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it receives on ordinary shares or other deposited securities underlying our ADSs, after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the

 

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depositary is not responsible if it decides that it is unlawful, inequitable or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if the underlying securities require registration under the Securities Act but have not been properly registered or distributed under an applicable exemption from registration. The depositary may also determine that it is not feasible to distribute certain property through the mail. Additionally, the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may determine not to distribute such property. We have no obligation to register under U.S. securities laws any ADSs, ordinary shares, rights or other securities received through such distributions. We also have no obligation to take any other action to permit the distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us or the depositary to make them available to you. These restrictions may cause a material decline in the value of our ADSs.

We do not expect to pay dividends in the foreseeable future and you may have to rely on price appreciation of our ADSs for any return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source of future dividend income.

Our board of directors has complete discretion as to whether to distribute dividends. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flows, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in our ADSs.

You may be subject to limitations on transfers of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. Also, under the deposit agreement, the depositary will not make rights available to you unless the distribution to ADS holders of both the rights and any related securities are either registered under the Securities Act, or exempted from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.

 

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We may be classified as a passive foreign investment company for United States federal income tax purposes, which could result in adverse United States federal income tax consequences to United States investors in our ADSs or ordinary shares.

Depending upon the value of our assets, which may be determined based, in part, on the market value of our ordinary shares and ADSs, and the nature of our assets and income over time, we could be treated as a passive foreign investment company, or a PFIC. Under United States federal income tax law, we will be treated as a PFIC for any taxable year if either (i) 75% or more of our gross income for the taxable year is passive income or (ii) 50% or more of the value of our assets (determined on the basis of a quarterly average) is attributable to assets that produce or are held for the production of passive income. Based on our current and projected income and assets, including the proceeds from this offering, and projections as to the value of our assets, based in part on the estimated market value of our ADSs following this offering, we do not expect to be treated as a PFIC for the current taxable year or in the foreseeable future. While we do not anticipate being a PFIC, changes in the nature of our income or assets or the value of our assets may cause us to become a PFIC for the current or any subsequent taxable year.

Because PFIC status is a factual determination made annually after the close of each taxable year on the basis of the composition of our income and the value of our active versus passive assets, there can be no assurance that we will not be a PFIC for the current or any future taxable year. The overall level of our passive assets will be affected by how, and how quickly, we spend our liquid assets and the cash raised in this offering. Under circumstances where revenue from activities that produce passive income significantly increase relative to our revenue from activities that produce non-passive income or where we determine not to deploy significant amounts of cash for active purposes, our risk of being classified as a PFIC may substantially increase.

If we were to be or be treated as a PFIC, a U.S. Holder (as defined in “Taxation—United States Federal Income Tax Considerations”) may incur significantly increased United States income tax on gain recognized on the sale or other disposition of our ADSs or ordinary shares and on the receipt of any distribution on our ADSs or ordinary shares to the extent such gain or distribution is treated as an “excess distribution” under United States federal income tax rules. Each U.S. Holder is urged to consult its tax advisor concerning the United States federal income tax consequences of purchasing, holding and disposing of our ADSs or ordinary shares if we are or become treated as a PFIC, including the possibility of making a mark-to-market election and the unavailability of the election to treat us as a qualified electing fund. For more information, see “Taxation—United States Federal Income Tax Considerations—Passive Foreign Investment Company Rules.”

We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than that under U.S. law, you may have less protection for your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, the Cayman Islands Companies Law (as amended) and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, 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 that 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 precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less extensive body of securities laws than the United States. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands.

As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as shareholders of a corporation incorporated in a jurisdiction in the United States.

 

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You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us, our management or the experts named in this prospectus.

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. A significant portion of our current operations are conducted in the PRC. In addition, a majority of our directors and officers reside outside the United States. As a result, it may be difficult for you to effect service of process within the United States or elsewhere outside China upon these persons. It may also be difficult for you to enforce in PRC or Cayman Islands courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. It may be difficult or impossible for you to bring an action against us in the Cayman Islands or the PRC if you believe your rights under the U.S. securities laws have been infringed. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state and it is uncertain whether such Cayman Islands or PRC courts would hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the United States or any state. See “Enforceability of Civil Liabilities.”

We will incur increased costs as a result of being a public company, and will incur additional costs after we cease to qualify as an “emerging growth company.”

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC, impose various requirements on the corporate governance practices of public companies. We expect these rules and regulations applicable to public companies to increase our accounting, legal and financial compliance costs and to make certain corporate activities more time-consuming and costly and that these costs and other burdens will increase once we cease to qualify as an “emerging growth company.” Our management will be required to devote substantial time and attention to our public company reporting obligations and other compliance matters. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. Our reporting and other compliance obligations as a public company may place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

Under the deposit agreement for the ADSs, if you do not vote and the vote is taken by poll, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings unless:

 

   

we have failed to timely provide the depositary with notice of the meeting and related voting materials;

 

   

we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

   

we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting; or

 

   

a matter to be voted on at the meeting would have a material adverse impact on shareholders.

 

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Risks Related to Doing Business in China

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on our business.

Substantially all of our assets and business operations are located in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The economy in China differs from the economies of most developed countries in many respects, including:

 

   

degree of government involvement;

 

   

level of development;

 

   

rate of economic growth;

 

   

control of foreign exchange rates and currency conversion;

 

   

access to financing; and

 

   

allocation of resources.

Although China has been transitioning from a planned economy to a more market-oriented economy since the 1970s, the PRC government continues to exercise significant control over China’s economy through resource allocation, foreign exchange control, monetary policies and administrative regulations of certain industries and entities. The continued control of these assets and other aspects of the national economy by the government could affect our access to key resources and materially and adversely affect our business. While the Chinese economy has grown significantly in the past 30 years, the growth has been uneven geographically, among various sectors of the economy and during different periods. We cannot assure you that the Chinese economy will continue to grow, that any growth will be steady and uniform or that any slowdown will not have a negative effect on our business.

In particular, our growth strategy is based in part upon the assumption that demand in China for electronics products that use semiconductors will continue to grow. Therefore, any decrease in consumer demand in China for products that use semiconductors, such as computers, mobile phones or other consumer electronics, could have a material adverse effect on our business. In addition, our business model assumes that an increasing number of global electronics manufacturers and systems companies will establish operations in China and require the use of products developed and manufactured in China. Any decline in the rate of migration to China of companies that require semiconductors as components for their products could adversely affect our business and results of operations.

Our business is subject to government regulation and benefits from certain government incentives, and changes in these regulations or incentives could adversely affect our business and results of operations.

China’s government has broad discretion and authority to regulate the technology industry in China. China’s government has also implemented policies to regulate economic expansion in China and plays a significant role in regulating industrial development. It also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. New regulations or the readjustment of previously implemented regulations could require us to change our business model, increase our costs or limit our ability to sell products and conduct activities in China, which could adversely affect our business and results of operations.

In addition, the central government of China as well as provincial and municipal governments and other authorities have provided, and may from time to time in the future provide, various incentives to domestic companies in the semiconductor industry, including our PRC subsidiaries, in order to encourage development of the industry. Such incentives may include tax rebates, reduced tax rates, favorable lending policies and other measures. Any of these incentives could be reduced or eliminated by governmental authorities at any time in the future. For example, VeriSilicon Chengdu is granted tax rebates and other incentives under the investment agreement between VeriSilicon Hong Kong and Chengdu local government. We cannot assure you that we will

 

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continue to enjoy these incentives in the future. Any such reduction or elimination of incentives currently provided to us could adversely affect our business and results of operations. See “Regulation—Preferential Industrial Policies Relating to Integrated Circuit Design Enterprises.”

Uncertainties with respect to the interpretation and enforcement of PRC laws and regulations could limit the legal protections available to you and us.

The Chinese legal system is largely a civil law system based on written statutes. Unlike the common law system, prior court decisions in a civil law system may be cited for reference but have limited precedential value. Since 1979, Chinese legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and the Chinese legal system continues to rapidly evolve, interpretations of many laws, regulations and rules are not always consistent, and enforcement involves uncertainties, which may limit the availability of certain legal protections.

From time to time, we may have to resort to administrative and court proceedings to enforce our legal rights. However, since the Chinese administrative and court authorities have significant discretion in interpreting and implementing or enforcing statutory rules and contractual terms, and it may be more difficult to predict the outcome of administrative and court proceedings and the level of legal protection we have in China than under some more developed legal systems. Furthermore, the PRC legal system is based in part on government policies and internal rules (some of which are not published in a timely manner or at all) that may have retroactive effect. As a result, we may not be aware of our violation of these policies and rules until sometime after the violation. These uncertainties may affect our judgment on the relevance of legal requirements and our decisions on the measures and actions to be taken to fully comply therewith, and may affect our ability to enforce our contractual or tort rights. Such uncertainties may therefore increase our operating expenses and costs and materially and adversely affect our business and results of operations.

Contract drafting, interpretation and enforcement in China involves significant uncertainty.

We have entered into a number of contracts governed by Chinese laws, many of which are material to our business. As compared with contracts in the United States, contracts governed by Chinese laws in traditional style tend to contain less detail and are not as comprehensive in defining contracting parties’ rights and obligations. As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract interpretation and enforcement in China are not as developed as in the United States, and the result of any contractual dispute resolution is subject to significant uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material contracts, and if such disputes arise, we cannot assure you that we will prevail. Due to the materiality of certain contracts to our business, any dispute involving such contracts, even without merit, may materially and adversely affect our reputation and our business operations, and may cause the price of our ADSs to decline.

Any requirement to obtain prior approval from the China Securities Regulatory Commission, or CSRC, could delay this offering and a failure to obtain this approval, if required, could have a material adverse effect on our business, operating results, reputation and the trading price of our ADSs.

On August 8, 2006, six Chinese regulatory agencies, namely, the Ministry of Commerce, or MOFCOM, the State Assets Supervision and Administration Commission, or SASAC, the State Administration of Taxation, or SAT, the State Administration for Industry and Commerce, or SAIC, the CSRC and the State Administration on Foreign Exchange, or SAFE, jointly adopted Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, which became effective on September 8, 2006, and were amended on June 22, 2009. The M&A Rules require, among other things, offshore special purpose vehicles, or SPVs, formed for the purpose of seeking a public listing of PRC onshore interests on an overseas stock exchange, and controlled directly or indirectly by Chinese companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange.

 

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While the application of the M&A Rules remains unclear, we believe, based on the advice of our China legal counsel, Fangda Partners, that CSRC’s approval is not required for this offering because our first foreign invested company was established in 2001, prior to the adoption of the M&A Rules, and we established our PRC subsidiaries by means of direct investment in newly established entities rather than by merger with, or acquisition of, equity interests or assets of a Chinese domestic company owned by Chinese companies or individuals that are our beneficial owners as defined in the M&A Rules. However, our China legal counsel has further advised us that there remains uncertainty as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering and the opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations of competent government authorities in any form relating to the M&A Rules. We cannot assure you that the relevant Chinese government agencies, including the CSRC, would reach the same conclusion as our China legal counsel. If the CSRC or other Chinese 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 Chinese regulatory agencies. In such an event, these regulatory agencies may impose fines and penalties on our operations in China, limit our operating privileges in China, delay or restrict the repatriation of 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, and prospects, as well as the trading price of our ADSs. The CSRC or other Chinese regulatory agencies may also take actions requiring us to halt this offering before the settlement and delivery of the ADSs 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 certain acquisitions of Chinese companies by foreign investors more time-consuming and complex, including requirements in some instances that MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor takes control of a Chinese domestic enterprise. In addition, the Notice on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the National Security Review Rules, issued by the State Council in 2011, subjects acquisitions by foreign investors of domestic companies engaged in military-related or certain other industries that are crucial to national security to prior security review. Moreover, the Anti-Monopoly Law requires clearance of anti-monopoly review with MOFCOM in advance of any concentration of undertaking if certain thresholds are triggered. We may expand our business in part by acquiring complementary businesses. Complying with the requirements of the M&A Rules, National Security Review Rules and other PRC regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from 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.

Chinese regulation of loans and direct investment by offshore holding companies to Chinese entities may limit the use of the proceeds we receive from this offering for our expansion or operations.

In utilizing the proceeds we receive from this offering in the manner described in “Use of Proceeds,” as an offshore holding company with PRC subsidiaries, we may (i) make additional capital contributions to our PRC subsidiaries, (ii) establish new PRC subsidiaries and make capital contributions to these new PRC subsidiaries, (iii) make loans to our PRC subsidiaries or (iv) acquire offshore entities with business operations in China in an offshore transaction. However, most of these uses are subject to Chinese regulations and approvals. For example:

 

   

capital contributions to our PRC subsidiaries, whether existing or newly established, must be approved by MOFCOM or its local bureaus; and

 

   

loans by us to our PRC subsidiaries, which are foreign-invested enterprises, to finance their activities cannot exceed statutory limits and must be registered with SAFE or its local bureaus.

In addition, on August 29, 2008, SAFE promulgated SAFE Circular No. 142, a notice regulating the conversion by a foreign-invested company of its capital contribution in foreign currency into Renminbi. It

 

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requires that the capital in Renminbi converted from foreign currency-denominated capital of a foreign-invested enterprise may only be used for purposes within the business scope of such foreign-invested companies approved by the relevant government authority and may not be used to make equity investments in China, unless specifically provided otherwise. Moreover, the approved use of such Renminbi funds may not be changed without approval from SAFE or its local bureaus.

Renminbi funds converted from foreign exchange may not be used to repay loans in Renminbi if the proceeds of such loans have not yet been used within the permitted scope. Any violation of SAFE Circular No. 142 and other relevant SAFE regulations may result in severe penalties, including substantial fines. We expect that if we convert the net proceeds from this offering into Renminbi pursuant to SAFE Circular No. 142, our use of such Renminbi funds will be for purposes within the approved business scope of our PRC subsidiaries. However, we may not be able to use such Renminbi funds to make equity investments in China through our PRC subsidiaries. Furthermore, SAFE promulgated SAFE Circular No. 59 in November 2010, which tightens the regulations over settlement of net proceeds from overseas offerings like this offering and requires that the settlement of net proceeds must be consistent with the description in the prospectus for the offering. SAFE further promulgated SAFE Circular No. 45 in November 2011, which, among other things, restricts a foreign-invested enterprise from using Renminbi converted from its registered capital to provide entrusted loans or repay loans between non-financial enterprises. These circulars may significantly limit our ability to convert the net proceeds into Renminbi to fund our PRC subsidiaries’ investments in or acquisitions of any other Chinese companies in China.

We expect that Chinese regulations of loans and direct investment by offshore holding companies to Chinese entities may continue to limit our use of proceeds of this offering. There are no costs associated with registering loans or approval of capital contributions with relevant China governmental authorities, other than nominal processing charges. Under China laws and regulations, the Chinese governmental authorities are required to process and grant such approvals or registrations or deny such application within a prescribed time period, which is usually less than 90 days. The actual time taken, however, may be longer due to administrative delay. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all, with respect to our future plans to use the U.S. dollar proceeds we receive from this offering for our expansion and operations in China. If we fail to receive such registrations or approvals, our ability to use the proceeds of this offering and to capitalize our China operations may be negatively affected, which could materially and adversely affect our liquidity and ability to fund and expand our business.

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 Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, or Circular 75, which requires PRC residents to register with local branches of SAFE in connection with their establishment or control of an offshore special purpose vehicle established for the purpose of overseas equity financing with assets or equity interests of onshore companies held by the PRC residents. 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 increases or decreases in the offshore special purpose company’s share capital, transfers or swaps of its shares, mergers or divisions, long-term equity or debt investments, the creation of any security interest and certain other material changes. Moreover, the PRC subsidiaries of an offshore special purpose company are required to, in a timely manner, coordinate and supervise the filing of SAFE registrations by the offshore special purpose company’s shareholders who are PRC residents. 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 the Administrative Measures for Personal Foreign Exchange promulgated by the People’s Bank of China in 2006 and its Implementing Rules promulgated by SAFE in 2007

 

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respectively, to register with the competent SAFE authority for any offshore direct investment, including by subscribing for shares in our offshore holding companies. Due to the lack of detailed implementation rules regarding registration requirements and uncertainty in implementation and interpretation of the foregoing general SAFE regulations governing offshore direct investment by individuals, our beneficial owners who are PRC resident individuals have not yet conducted foreign exchange registration for offshore direct investment.

On July 4, 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or Circular 37, which replaced Circular 75. Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in Circular 37 as a “special purpose vehicle”. The term “control” under Circular 37 is broadly defined as the operation rights, beneficiary rights or decision-making rights acquired by the PRC residents in the offshore special purpose vehicles or PRC companies by such means as acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls.

Circular 37 provides that PRC residents include both PRC citizens, meaning any individual who holds a PRC passport or resident identification card, and individuals who are non-PRC citizens but habitually reside in the PRC due to their economic ties to the PRC. We have requested all of our current shareholders and/or beneficial owners to disclose whether they or their shareholders or beneficial owners fall within the ambit of Circular 37 and its guidance and will urge relevant shareholders and beneficial owners, upon learning they are PRC residents, to make the necessary applications, filings and amendments as required under Circular 37 and other related SAFE regulations and rules. However, we cannot assure you that they can successfully complete their registrations with the local SAFE branch in compliance with applicable laws in a timely fashion or at all, or that they or we will not be punished due to any prior non-compliance with SAFE regulations. In addition, we may not be informed of the identities of all the PRC residents holding a direct or indirect interest in our company, and we cannot provide any assurances that these PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by Circular 37 or other related rules. Failure by our current or future shareholders or beneficial owners who are PRC residents to comply with the SAFE regulations may subject us to fines or other legal sanctions, restrict our cross-border investment activities, limit our PRC subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

Furthermore, since Circular 37 was recently promulgated and it is unclear how this regulation and any future regulation concerning offshore or cross-border transactions will be interpreted, amended and implemented by the relevant government authorities, we cannot predict how these regulations will affect our business operations or future strategy. For example, we may be subject to a more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our financial condition and results of operations. In addition, if we decide to acquire a PRC domestic company, either we or the owners of such company, as the case may be, may not be able to obtain the necessary approvals or complete the necessary filings and registrations required by the foreign exchange regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.

 

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Failure to comply with the registration requirements for employee share option plans may subject our China equity incentive plan participants or us to fines and other legal or administrative sanctions.

Pursuant to Circular 37, PRC residents who participate in share incentive plans in overseas non-publicly-listed companies may submit applications to SAFE or its local branches for the foreign exchange registration with respect to offshore special purpose companies. Our directors, executive officers and other employees who are PRC citizens or who have resided in the PRC for a continuous period of not less than one year and who have participated in our share incentive plans may follow Circular 37 to apply for the foreign exchange registration before our company becomes an overseas listed company. After our company becomes an overseas listed company upon the completion of this offering, we and our directors, executive officers and other employees who are PRC citizens or who have resided in the PRC for a continuous period of not less than one year and who have participated in our share incentive plans will be subject to the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, issued by SAFE in February 2012, according to which, employees, directors, supervisors and other management members participating in any stock incentive plan of an overseas publicly listed company who are PRC citizens or who are non-PRC citizens residing in China for a continuous period of not less than one year, subject to limited exceptions, are required to register with SAFE through a domestic qualified agent, which could be a PRC subsidiary of such overseas listed company, and complete certain other procedures. Failure to complete the SAFE registrations may subject them to fines and legal sanctions and may also limit the ability to make payment under our equity incentive plans or receive dividends or sales proceeds related thereto, or our ability to contribute additional capital into our wholly-foreign owned enterprises in China and limit our wholly-foreign owned enterprises’ ability to distribute dividends to us. We also face regulatory uncertainties that could restrict our ability to adopt additional equity incentive plans for our directors and employees under PRC law.

Some of our employees in China who are PRC resident individuals have exercised their stock options under our share incentive plan prior to our becoming a publicly listed company. Such option exercises may be viewed by SAFE as having violated SAFE regulations. Remedial registration with local SAFE for these employees is theoretically allowed under Circular 37. Since there is substantial uncertainty in interpretation and implementation of Circular 37, we cannot assure you that they can successfully complete their registrations with the local SAFE branch in compliance with applicable laws in a timely fashion or at all. See “—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.”

In addition, the State Administration for Taxation has issued circulars concerning employee share options or restricted shares. Under these circulars, employees working in the PRC who exercise share options, or whose restricted shares or RSUs vest, will be subject to PRC individual income tax. The PRC subsidiaries of an overseas listed company have obligations to file documents related to employee share options or restricted shares with relevant tax authorities and to withhold individual income taxes of those employees related to their share options, restricted shares or RSUs. If the employees fail to pay, or the PRC subsidiaries fail to withhold, their income taxes according to relevant laws, rules and regulations, the PRC subsidiaries may face sanctions imposed by the tax authorities or other PRC government authorities. See “—We are obligated to withhold and pay Chinese individual income tax on behalf of our employees who have exercised stock options. We have not withheld or paid such individual income tax in accordance with applicable Chinese regulations and, as a result, we may be required to pay the related tax deficiencies and may be subject to penalties under Chinese laws.”

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 consequently, investors may be deprived of the benefits of such inspection.

The independent registered public accounting firm that issues the audit report included in this prospectus, 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 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

 

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with applicable 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.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, and such deficiencies 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, and to the extent that such inspections might have facilitated improvements in our auditor’s audit procedures and quality control procedures, investors may be deprived of such benefits.

Proceedings instituted 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 Exchange Act.

In late 2012, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese affiliates of the ‘‘big four’’ accounting firms (including our auditors) and also against Dahua (the former BDO affiliate in China). The Rule 102(e) proceedings initiated by the SEC relate to these firms’ failure to produce documents, including audit work papers, in response to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act of 2002, as auditors located in the PRC are not in a position to lawfully produce documents directly to the SEC because of restrictions under PRC law and specific directives issued by the CSRC. The issues raised by the proceedings are not specific to our auditors or to us, but affect equally all audit firms based in China and all China-based businesses with securities listed in the United States.

In January 2014, the administrative judge reached an initial decision that the “big four” accounting firms should be barred from practicing before the Commission for six months. However, it is currently impossible to determine the ultimate outcome of this matter as the accounting firms have filed a petition for review of the initial decision and pending that review the effect of the initial decision is suspended. It will, therefore, be for the Commissioners of the SEC to make a legally binding order specifying the sanctions, if any, to be placed on these audit firms. Once such an order is made, the accounting firms have a further right to appeal to the U.S. federal courts, and the effect of the order might be further suspended pending the outcome of that appeal.

Depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which may result in, among other things, their securities being delisted by the applicable U.S. securities exchanges. If the “big four” China-based accounting firms, including our independent registered public accounting firm, were denied, temporarily or permanently, the ability to practice before the SEC, and we are unable to timely find 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 in connection with this offering under the Securities Act of 1933, as amended, or the Securities Act, or those of public companies registered under the Exchange Act after our completion of this offering. Such a determination could ultimately lead to the delay or abandonment of this offering, or, after the completion of this offering, delisting of our ADSs from NASDAQ or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States. Moreover, any negative news about the proceedings against these audit firms may erode investor confidence in China-based, United States listed companies. Any of the foregoing events may have a material adverse effect on the market price of our ADSs and may make it substantially more difficult for investors to purchase or sell our ADSs.

 

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Our global income and the dividends we may receive from our PRC subsidiaries may be subject to Chinese taxes under the PRC Enterprise Income Tax Law, which could have a material adverse effect on our results of operations, and non-Chinese shareholders may be subject to Chinese tax on dividends and gains, if any, which may reduce returns on their investments in our shares or ADSs.

Under the PRC Enterprise Income Tax Law, an enterprise established outside of the PRC with “de facto management bodies” within China is considered a “resident enterprise,” meaning it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes, requiring it to pay enterprise income tax on income derived from sources inside and outside China, although the dividends paid to one resident enterprise from another may qualify as “tax-exempt income.” The implementation rules of the PRC Enterprise Income Tax Law define a “de facto management body” as a body that has substantial and overall management and control over the production and business operations, personnel and human resources, finances and properties of an enterprise, and provide that if the foreign enterprise is deemed to be a Chinese resident enterprise, dividends and other income received by its non-China resident enterprise shareholders from the deemed Chinese resident enterprise will be considered PRC-source income and subject to a 10% PRC withholding tax, which may be reduced depending on provisions in any double taxation agreement between China and the relevant country. A circular issued by SAT on April 22, 2009 and thereafter amended and supplemented by the SAT on January 29, 2014, or SAT Circular 82, specifies that certain foreign enterprises controlled by a Chinese company or a Chinese company group will be classified as Chinese “resident enterprises” if the following requirements are satisfied: (i) the senior management personnel and core management departments in charge of its daily production operations and management are located mainly in China; (ii) its financial and human resources decisions are subject to determination or approval by persons or bodies in China; (iii) its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in China; and (iv) at least half of the enterprise’s directors with voting rights or senior management habitually reside in China. Further to SAT Circular 82, the SAT issued the Administrative Measures for Enterprise Income Tax of Chinese-controlled Offshore Incorporated Resident Enterprises (For Trial Implementation), or the SAT Bulletin 45, which took effect on September 1, 2011, to provide more guidance on the implementation of SAT Circular 82 and clarify the reporting and filing obligations of such “Chinese-controlled offshore-incorporated resident enterprises.” SAT Bulletin 45 provides procedures and administrative details for the determination of PRC resident enterprise status and administration on post-determination matters. Although Circular 82 and Bulletin 45 only apply to offshore enterprises controlled by Chinese enterprises or Chinese enterprise groups and not those controlled by Chinese individuals or by foreign individuals or enterprises, the criteria set forth therein may reflect SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, regardless of whether they are controlled by Chinese enterprises or Chinese individuals.

Currently, a substantial majority of the members of our management team are located in China. However, Circular 82 and Bulletin 45 apply 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 tax resident status of an enterprise is subject to determination by the Chinese tax authorities and they may take the view that the determining criteria set forth in Circular 82 and Bulletin 45 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, and we may therefore be considered a resident enterprise and be subject to Chinese enterprise income tax at 25% on our global income.

If we are considered a resident enterprise and earn income other than dividends from our Chinese subsidiaries, a 25% enterprise income tax on our global income could significantly increase our tax burden and materially and adversely affect our cash flows and results of operations. Moreover, the “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-Chinese resident enterprise shareholders, and a 10% PRC tax is imposed on gains derived by our non-Chinese resident enterprise shareholders from transferring our ordinary shares or ADSs, unless the holder is eligible for a reduced rate under an applicable treaty.

 

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It is unclear whether our non-Chinese individual shareholders would be subject to any PRC tax on dividends or gains, if any, received by such non-Chinese individual shareholders in the event that we are determined to be a Chinese resident enterprise. If any PRC tax were to apply to such dividends or gains received by such non-Chinese individual shareholders, it would generally apply at a rate of 20%, unless a reduced rate is available under an applicable tax treaty. It is also unclear whether non-Chinese shareholders of VeriSilicon Holdings Co., Ltd. would be able to claim the benefits of any tax treaties between their tax residence countries and China in the event that VeriSilicon Holdings Co., Ltd. is treated as a Chinese resident enterprise. This could have the effect of increasing our and our shareholders’ effective income tax rates and may require us to deduct withholding tax from any dividends we pay to our non-Chinese shareholders. In addition to the uncertainty regarding how the “resident enterprise” classification may apply, it is also possible that the rules may change in the future, possibly with retroactive effect.

If we are required under the PRC Enterprise Income Tax Law to withhold PRC income tax on dividends, if any, payable to our non-Chinese enterprise or non-Chinese individual shareholders and ADS holders or our shareholders and ADS holders are subject to PRC tax on gains, if any, derived from transferring our ordinary shares or ADSs, their investment in our ordinary shares or ADSs may be materially and adversely affected.

We may rely on dividends paid to us by our subsidiaries for our cash needs, and any limitation on the ability of our subsidiaries to make dividend payments to us, or any tax implications of making dividend payments to us, could limit our ability to pay our holding company level expenses.

We are a holding company and conduct substantially all of our business in China through our PRC subsidiaries, which are limited liability companies in China. We may rely on dividends paid to us by our PRC subsidiaries for our cash needs, including the funds necessary to pay operating and other expenses at the holding company level, to service any debt we may incur at the holding company level and to pay dividends, if any, that we may elect to pay to holders of our ADSs or ordinary shares.

Payment of dividends by entities organized in China is subject to certain limitations. In particular, regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Each of our subsidiaries in China is also required to set aside at least 10% of its after-tax profit each year, if any, based on Chinese accounting standards, to its general reserves until the cumulative amount of such reserves reaches 50% of its registered capital and to allocate a portion of its after-tax profit to its staff welfare and bonus fund at the discretion of its board of directors. These reserves are not distributable as cash dividends. Our PRC subsidiaries historically have not allocated any of their after-tax profits to staff welfare and bonus funds, but they may nevertheless decide to set aside such funds in the future. There is no maximum amount of after-tax profit that a company may contribute to such a fund. Any direct or indirect limitation on the ability of our PRC subsidiaries to distribute dividends and other distributions to us could materially and adversely limit our ability to make investments or acquisitions or pay expenses at the holding company level, pay dividends or otherwise fund and conduct our business.

Furthermore, SAT promulgated the Notice on How to Understand and Determine the Beneficial Owners in Tax Treaty in October 2009, or Circular No. 601, which provides guidance for determining whether a resident of a contracting state is the “beneficial owner” of an item of income under China’s tax treaties and tax arrangements. According to Circular No. 601, a beneficial owner generally must be engaged in substantive business activities. An agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. A conduit company normally refers to a company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. We cannot assure you that we will be entitled to the benefits under the relevant tax treaties and arrangements, if any, for any dividends to be distributed by our subsidiaries to us. In particular, we cannot assure you that VeriSilicon Hong Kong, our wholly-owned subsidiary incorporated in Hong Kong, and also the direct equity owner of VeriSilicon Chengdu, one of our PRC subsidiaries, will be entitled to the 5% reduced tax rate. If VeriSilicon Hong Kong is subject to the 10% tax rate instead of the 5% tax rate for dividends paid to it, our results of operations and financial condition will be negatively affected.

 

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Limitations on our ability to transfer funds to our PRC subsidiaries could adversely affect our ability to expand our operations, make investments that could benefit our businesses and otherwise fund and conduct our business.

The transfer of funds from us to our PRC subsidiaries, either as a shareholder loan or as an increase in registered capital, is subject to registration with or approval by Chinese governmental authorities, including relevant branches of SAFE or the relevant examination and approval authority. Our PRC subsidiaries may also experience difficulties in converting our capital contributions made in foreign currencies into Renminbi due to changes in China’s foreign exchange control policies. Therefore, it may be difficult to change capital expenditure plans once the relevant funds have been remitted from us to our PRC subsidiaries. These limitations and the difficulties our PRC subsidiaries may experience on the free flow of funds between us and our PRC subsidiaries could restrict our ability to act in response to changing market situations in a timely manner. Chinese regulatory authorities may impose more stringent restrictions on the convertibility of Renminbi, especially with respect to foreign exchange transactions. Existing restrictions and any additional restrictions imposed in the future could have an adverse effect on our ability to utilize the cash we generate from our operations, which could slow our growth.

Limits placed on imports into and exports from China by other countries could substantially harm our business and results of operations.

The growth of our business will depend on the ability of our suppliers to export, and our ability to import, equipment, materials, spare parts, process know-how and other technologies and hardware into China. Any restrictions placed on the import and export of these products and technologies could adversely impact our growth and substantially harm our business. In particular, the United States requires our suppliers and us to obtain licenses to export certain products, equipment, materials, spare parts and technologies from the United States. If we or our suppliers are unable to obtain export licenses in a timely manner, our business and results of operations could be adversely affected.

Licenses may be required for certain shipments to China as a result of the technical specifications of the item exported, the end use of the item exported, or the end user of the item exported. These licensing requirements are the result of both multilateral restrictions, as well as unilateral sanctions imposed by the United States. To the extent that technology, equipment, or materials used in our manufacturing processes are or become subject to the restrictions of the arrangement, our ability to procure these products and technology could be impaired, which could adversely affect our business and results of operations. There could also be a change in the export license regulatory regime in the countries from which we purchase our equipment, materials and spare parts that could delay our ability to obtain export licenses for the equipment, materials, spare parts and technology we require to conduct our business.

If the Chinese government determines that we did not obtain requisite Chinese governmental approvals for, or register with the Chinese government, our current and past import and export of technologies, we could be subject to sanctions.

China imposes controls on technology import and export. The term “technology import and export” is broadly defined to include the transfer or license of patents, software and know-how, and the provision of services in relation to technology. Depending on the nature of the relevant technology, the import and export of technology require either approval by, or registration with, the relevant PRC governmental authorities. If any of our PRC subsidiaries are found to be, or has been, in violation of Chinese laws or regulations, the relevant regulatory authorities have broad discretion to deal with such violation, including, but not limited to, issuing a warning, levying fines, restricting us from remitting royalties or any other fees, if any, relating to these technologies outside of China, confiscating our earnings generated from the import or export of such technology or even restricting our future export and import of any technology. Even if our PRC subsidiaries successfully obtain such approval or complete such registration, if the Chinese government determines that our past import and export of technology were inconsistent with, or insufficient for, the proper operation of our business, we could be subject to similar sanctions. Any of these or similar sanctions could cause significant disruption to our business operations or render us unable to conduct a substantial portion of our business operations and may adversely affect our business and results of operations.

 

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We are obligated to withhold and pay Chinese individual income tax on behalf of our employees who have exercised stock options. We have not withheld or paid such individual income tax in accordance with applicable Chinese regulations and, as a result, we may be required to pay the related tax deficiencies and may be subject to penalties under Chinese laws.

The SAT has issued several circulars concerning employee stock options. Under these circulars, our employees working in China (which could include both Chinese employees and expatriate employees subject to Chinese individual income tax) who exercise stock options will be subject to Chinese individual income tax. Our PRC subsidiaries have the obligation to file documents related to employee stock options with relevant tax authorities and withhold and pay individual income taxes for those employees who exercise their stock options. However, the relevant tax authority has orally advised us that due to the difficulty in determining the fair market value of our shares as a private company, we need not withhold and pay the individual income tax for the exercises until after the completion of this offering. Thus we have not withheld and paid the individual income tax for the option exercises. However, we cannot assure you that the tax authority will not act otherwise and request us to withhold and pay the individual income tax immediately and impose sanctions on us.

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

On June 29, 2007, the National People’s Congress of China enacted the Labor Contract Law, which became effective on January 1, 2008 and was amended on December 28, 2012. The Labor Contract Law established new restrictions and increased costs for employers to dismiss employees, including specific provisions related to fixed-term employment contracts, temporary employment, probation, consultation with the labor union and employee assembly, employment without a contract, dismissal of employees, compensation upon termination and overtime work, and collective bargaining. According to the Labor Contract Law, an employer is obliged to sign a labor contract with an unlimited term with an employee if the employer continues to hire the employee after the expiration of two consecutive fixed-term labor contracts subject to certain conditions or after the employee has worked for the employer for ten consecutive years. The employer also has to pay compensation to an employee if the employer terminates a labor contract except for certain statutory causes. Such compensation is also required when the employer refuses to renew a labor contract that has expired, unless the employee refuses to extend the expired contract. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the Labor Contract Law may limit our ability to effect those changes in a desirable or cost-effective manner, which could adversely affect our business and results of operations. In addition, under the Regulations on Paid Annual Leave for Employees, which became effective on January 1, 2008 and its Implementation Rules on Paid Annual Leave for Employees, which became effective on September 18, 2008, employees who have served more than one year for an employer are entitled to a paid vacation ranging from five to 15 days, depending on their length of service. Employers who fail to allow for such vacation time must compensate their employees three times their regular salaries for each vacation day disallowed, unless such employees waive their right to such vacation days in writing. As a result of the foregoing laws and regulations designed to enhance labor protection, our labor costs in China may increase in the future.

We face uncertainties with respect to application of the Circular on Strengthening the Administration of Enterprise Income Tax for Share Transfer by Non-Chinese Resident Enterprises.

Pursuant to the Circular on Strengthening the Administration of Enterprise Income Tax for Share Transfers by Non-PRC Resident Enterprises, or Circular No. 698, issued by SAT, in December 2009, with retroactive effect from January 1, 2008, where a non-resident enterprise transfers the equity interests of a Chinese resident enterprise indirectly by disposition of the equity interests of an overseas holding company, or an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate of less than 12.5% or (ii) does not impose income tax on foreign income of its residents, the non-resident enterprise, being the transferor, shall report this Indirect Transfer to the competent tax authority of the Chinese resident enterprise. Applying a “substance over form” principle, the Chinese tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of

 

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reducing, avoiding or deferring Chinese tax. As a result, gains derived from such an Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. Circular No. 698 also provides that where a non-Chinese resident enterprise transfers its equity interests in a Chinese resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.

On March 28, 2011, SAT released the SAT Public Notice (2011) No. 24, or SAT Public Notice 24, to clarify several issues related to Circular No. 698. SAT Public Notice 24 became effective on April 1, 2011. According to SAT Public Notice 24, the term “effective tax” refers to the effective tax on the gain derived from a disposition of any equity interests of an overseas holding company. The term “does not impose income tax” refers to cases where the gain derived from such a disposition of equity interests of an overseas holding company is not subject to income tax in the country or jurisdiction where the overseas holding company is a resident.

There is uncertainty as to the application of Circular No. 698. For example, while the term “Indirect Transfer” is not clearly defined, it is understood that the relevant Chinese tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or made any formal declaration as to the process and format for reporting an Indirect Transfer to the competent tax authority of the relevant Chinese resident enterprise. In addition, there are not any formal declarations concerning how to determine whether a foreign investor has adopted an arrangement for the purpose of reducing, avoiding or deferring PRC tax. Circular No. 698 may be determined by the tax authorities to be applicable to our private equity financing transactions where non-resident investors were involved, if any of such transactions were determined by the tax authorities to lack reasonable commercial purpose. As a result, we and our non-resident investors may be at risk of being taxed under Circular No. 698 and may be required to expend resources to comply with Circular No. 698 or to establish that we and our non-resident enterprise investors should not be taxed under Circular No. 698, which may have an adverse effect on our financial condition and results of operations or such non-resident investors’ investments in us.

Failure to obtain any preferential tax treatments or the discontinuation, reduction or delay of any of the preferential tax treatments that may be available to us in the future could materially and adversely affect our business, financial condition and results of operations

Under the PRC Enterprise Income Tax Law, effective from January 1, 2008, foreign-invested companies, such as our PRC subsidiaries, are subject to a unified income tax rate of 25%. Various favorable income tax rates are, however, available to qualified enterprises in certain encouraged sectors of the economy. Companies that qualify as “Integrated Circuit Design Enterprises” are exempt from PRC income tax for two years and subject to a preferred income tax rate of 12.5% for the following three years, starting from the first profit making year. VeriSilicon Shanghai has been qualified as an Integrated Circuit Design Enterprise and is eligible for such preferential tax treatment commencing from the year 2011. In addition, VeriSilicon Shanghai has qualified as a “key” Integrated Circuit Design Enterprise and, therefore, is entitled to a preferential tax rate of 10% after the end of the two-year tax exemption and three-year 50% tax exemption period (i.e. beginning in 2016).

However, if any of our PRC subsidiaries that qualified for preferential tax treatment fails to continue to qualify in a subsequent year, our income tax expenses would increase, which may have a material adverse effect on our results of operations.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND MARKET DATA

This prospectus contains forward-looking statements, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. You can generally identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions that concern our expectations, strategy, plans or intentions. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our business, financial condition and results of operations. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in “Risk Factors” and elsewhere in this prospectus. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those projected in the forward-looking statements. Forward-looking statements contained in this prospectus include statements about:

 

   

our goals and strategies;

 

   

future business development;

 

   

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

 

   

existing and new customers and the markets in which we compete;

 

   

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; and

 

   

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

We caution you that the foregoing list may not contain all of the forward-looking statements made in this prospectus. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this prospectus may not occur.

The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

This prospectus also contains statistical, market and industry data, estimates and forecasts that are based on independent industry publications, governmental publications, reports by market research firms, other independent sources or other publicly available information, while other information is based on our good faith estimates or other internal sources. Although we believe that these third-party sources referred to in this prospectus are reliable, neither we nor the underwriters have independently verified the information provided by these third parties. While we are not aware of any misstatements regarding any third-party information presented in this prospectus, their estimates, in particular, as they relate to projections, involve numerous assumptions, are subject to risks and uncertainties, and are subject to change based on various factors, including those discussed under “Risk Factors.”

 

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OUR HISTORY AND CORPORATE STRUCTURE

In August 2001, our predecessor, VeriSilicon Microelectronics (Shanghai) Co., Ltd., or VeriSilicon Shanghai, was established as a foreign-invested enterprise to conduct operations in China. In order to facilitate investments in our company from outside of the PRC, VeriSilicon Holdings Co., Ltd. was incorporated under the laws of the Cayman Islands in June 2002 and VeriSilicon Shanghai became its wholly-owned subsidiary. In order to expand our business, we subsequently established additional wholly-owned subsidiaries, each of which is an operating entity, in China, the United States, Japan, Finland, France, Taiwan, the Netherlands and Hong Kong.

The following diagram illustrates our corporate structure, including our subsidiaries, each of which is wholly-owned, and the place of incorporation of each named entity:

LOGO

Our corporate headquarters are in Shanghai, China, where we also conduct research and development, sales, operations logistics and procurement, and engineering operations services. We conduct research and development activities at our offices in Beijing and Chengdu, China; Oulu, Finland; and Plano, Texas. We conduct sales activities at our offices in Santa Clara, California; Tokyo, Japan; Nice, France; Taipei, Taiwan; the Netherlands; and Hong Kong. In addition, we conduct operations logistics and procurement, and engineering operations services at our office in Taipei, Taiwan.

Our business in China does not fall within the “restricted” or “prohibited” categories of foreign investment under the PRC Catalog for Guidance of Foreign Investment Industries or other applicable regulations. Our principal business within China, the design of integrated circuits, is categorized as an “encouraged” industry under the PRC Catalog for Guidance of Foreign Investment Industries.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately $         million, or approximately $         million if the underwriters exercise in full their option to purchase additional ADSs from us, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. These estimates are based upon an assumed initial offering price of $         per ADS, the midpoint of the initial public offering price range set forth on the cover page of this prospectus. Each $1.00 change in the assumed initial public offering price of $         per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease, the net proceeds we receive from this offering by approximately $         million, or approximately $         million if the underwriters exercise in full their option to purchase additional ADSs from us, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. Similarly, each one million share increase (decrease) in the number of ADSs offered by us would increase (decrease) the net proceeds that we receive from this offering by approximately $         million, assuming the assumed initial public offering price of $             per ADS remains the same and after deducting the underwriting discounts and commissions and the estimated offering expenses payable by us. The amount of estimated net proceeds discussed above is illustrative only and the actual net proceeds will be determined in part by the actual public offering price and number of ADSs sold by us and the other terms of this offering.

The principal purposes of this offering are to obtain additional capital, to create a public market for our ADSs and to facilitate our future access to the public equity markets. We plan to use the net proceeds of this offering for working capital and general corporate purposes. We will also use up to approximately $         million of the proceeds to redeem our Shadow Preference Shares, if issued, immediately following the completion of this offering. For more information regarding our Shadow Preference Shares, see “Description of Share Capital—Shadow Preference Shares.” We may also use a portion of the net proceeds received by us from this offering for acquisitions of complementary businesses, technologies or other assets. We have not entered into any agreements or commitments with respect to any specific acquisitions and have no understandings or agreements with respect to any such acquisition at this time. Pending application of the net proceeds from this offering for the foregoing purposes, we may invest such net proceeds in bank accounts or other short term investments.

We cannot specify with certainty the particular uses for the net proceeds to be received by us from this offering. Accordingly, our management team will have broad discretion in using the net proceeds to be received by us from this offering. Chinese law may limit or prevent us from investing net proceeds in or loaning net proceeds to our PRC subsidiaries. See “Risk Factors—Risks Related to Doing Business in China—Chinese regulation of loans and direct investment by offshore holding companies to Chinese entities may limit the use of the proceeds we receive from this offering for our expansion or operations.”

 

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DIVIDEND POLICY

We have not previously declared or paid cash dividends and we have no plan to declare or pay any cash dividends in the foreseeable future. We currently intend to retain most, if not all, of our available funds to operate and expand our business. In addition, our revolving credit agreement restricts our ability to pay dividends.

Our board of directors has complete discretion as to whether to distribute dividends. Our shareholders may by ordinary resolution declare dividends, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future results of operations, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. Under Cayman Islands law, we may declare and pay dividends on our ordinary shares only out of our profit or our share premium account, provided always that, even if we have sufficient profit or share premium, we may not pay a dividend if this would result in our being unable to pay our debts as they fall due in the ordinary course of business. In addition, PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends to our parent company. See “Regulation—Regulations on Dividend Distribution.” If we pay any cash dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares and ADSs, if any, will be paid in U.S. dollars.

 

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CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2014:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect (i) the automatic conversion of all of our issued and outstanding preference shares into an aggregate of 50,011,211 ordinary shares, (ii) the assumed exercise for cash of all warrants to purchase our Series E Preference Shares immediately prior to completion of this offering and the resulting issuance of 815,122 ordinary shares and our assumed receipt of approximately $1.6 million in cash as a result of the payment of the exercise price of those warrants, and (iii) the reclassification of warrants to purchase preference shares and ordinary shares from liability to additional paid-in capital; and

 

   

on a pro forma as adjusted basis to reflect (i) the transaction described in the immediately preceding bullet point and (ii) the issuance and sale of                  ADSs by us in this offering at an assumed initial public offering price of $         per ADS, the midpoint of the initial public offering price range shown on the cover page of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

The pro forma and pro forma as adjusted information set forth below is illustrative only and does not purport to reflect what our actual capitalization would have been had the transactions referred to above occurred as of the date set forth below nor does it purport to be indicative of our capitalization as of future dates. Our actual capitalization after this offering will be determined in part by the actual public offering price and number of ADSs sold by us and other terms of this offering. You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of June 30, 2014
     (in thousands)
     Actual     Pro Forma     Pro Forma  as
adjusted(2)

Debt(1)

   $ 16,213      $ 16,213     

Preference shares, $0.001 par value, 79,625,000 shares authorized, 50,011,211 shares issued and outstanding actual;                  shares authorized, zero issued and outstanding, pro forma;                  shares authorized, issued and outstanding, pro forma as adjusted

     94,235        —       

Shareholders’ deficit:

      

Ordinary shares, $0.001 par value, 116,000,000 shares authorized; 14,650,959 shares issued and outstanding actual; 116,000,000 shares authorized, 65,477,292 shares issued and outstanding, pro forma;                  shares authorized,                  issued and outstanding, pro forma as adjusted

     15        65     

Additional paid-in capital(2)

     20,775        197,495     

Accumulated other comprehensive income

     113        113     

Accumulated deficit

     (175,035     (175,035  
  

 

 

   

 

 

   

 

Total shareholders’ equity (deficit)

     (154,132     22,638     
  

 

 

   

 

 

   

 

Total capitalization

   $ (43,684   $ 38,851     
  

 

 

   

 

 

   

 

 

(1) 

Our debt consists of amounts outstanding under our revolving credit facility that is secured by a majority of our assets and our bank loans with two Chinese banks.

(2) 

Each $1.00 increase (decrease) in the assumed initial public offering price of $         per ADS, the midpoint of the initial public offering price range set forth on the front page of this prospectus, would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by approximately $         million,

 

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  assuming that the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated expenses payable by us. Similarly, each one million share increase (decrease) in the number of ADSs offered by us would increase (decrease) additional paid-in capital, total shareholders’ equity and total capitalization by approximately $         million, assuming the assumed initial public offering price of $             per ADS remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

The warrants to purchase our Series E Preference Shares will expire immediately prior to the completion of this offering and we have therefore assumed that all of those warrants will be exercised for cash for purposes of calculating the pro forma and pro forma as adjusted data set forth in the above table. However, the holders of those warrants are under no obligation to exercise them for cash or at all or may exercise them on a “cashless” basis by paying the exercise price by forfeiting a portion of the shares issued on exercise with a value equal to the aggregate exercise price. However, if the fair market value of the shares issuable on exercise of the warrants to purchase Series E Preference Shares exceeds the exercise price, then any such warrants that are not exercised by the holders prior to completion of this offering will be deemed to have been automatically exercised on a cashless basis, except for warrants owned by a holder that has elected by prior written notice to us to allow its warrants to purchase Series E Preference Shares to expire. If any of the warrants to purchase our Series E Preference Shares are not exercised, or if some or all of the warrants are exercised on a cashless basis (either by the holders or automatically), then pro forma and pro forma as adjusted ordinary shares, additional paid-in capital, total shareholders’ equity, total capitalization and ordinary shares issued and outstanding would be lower than the amounts reflected in the above table. For example, if all of the warrants to purchase Series E Preference Shares were exercised on a cashless basis immediately prior to the completion of this offering, then, assuming that the shares to be issued on exercise had a value equal to $         per share (the midpoint of the initial public offering price range set forth on the cover page of this prospectus), our ordinary shares would have been $         and $        , our additional paid-in capital would have been $         and $         , our total shareholders’ equity would have been $         and $        , our total capitalization would have been $         and $         and our ordinary shares issued and outstanding would have been        shares and        shares, as of June 30, 2014, on a pro forma and pro forma as adjusted basis, respectively.

If the underwriters’ option to purchase additional ADSs is exercised in full, pro forma as adjusted ordinary shares, additional paid-in capital, total shareholders’ equity, and total capitalization as of June 30, 2014 would be $        , $        , $        , and $        , respectively and the number of pro forma as adjusted ordinary shares issued and outstanding as of June 30, 2014 would have been          ordinary shares.

The table above excludes, as of June 30, 2014:

 

   

360,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.91 per share and 120,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.5522 per share, all of which will expire on December 31, 2015;

 

   

15,429,366 ordinary shares issuable upon exercise of stock options outstanding at a weighted-average exercise price of $0.53 per share; and

 

   

145,130 ordinary shares reserved for future issuance under our 2012 Plan.

 

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DILUTION

If you invest in our ADSs in this offering, your ownership interest will be diluted to the extent of the difference between the initial public offering price per ADS and the pro forma as adjusted net tangible book value per ADS immediately after this offering.

Our net tangible book value as of June 30, 2014 was approximately $(5.02) per ordinary share, which is equal to approximately $         per ADS. Net tangible book value per ordinary share represents the amount of total tangible assets, minus the amount of total liabilities, divided by the total number of ordinary shares outstanding including, if applicable, ordinary shares underlying ADSs. Dilution is determined by subtracting net tangible book value per ordinary share from the assumed initial public offering price per ordinary shares (which is calculated by dividing the assumed initial public offering price per ADS by the number of ordinary shares represented by each ADS).

After giving effect to (i) the automatic conversion of all of our issued and outstanding preference shares into 50,011,211 ordinary shares immediately prior to the completion of this offering, (ii) the assumed exercise for cash of all warrants to purchase our Series E Preference Shares and the resulting issuance of 815,122 ordinary shares immediately prior to completion of this offering and our receipt of approximately $1.6 million as a result of the assumed payment of the exercise price of those warrants in cash, and (iii) the reclassification of warrants to purchase preference shares and ordinary shares from liability to additional paid-in capital, our pro forma net tangible book value at June 30, 2014 would have been $0.14 per outstanding ordinary share. This represents an immediate increase in net tangible book value of $5.16 per ordinary share compared to our actual net tangible book value as of June 30, 2014. After giving effect to the transactions described in the immediately preceding sentence and the issuance and sale of ADSs by us in this offering at an assumed initial public offering price of $         per ADS, the midpoint of the estimated initial public offering price range shown on the cover page of this prospectus and, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value at June 30, 2014 would have been $         per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, or $         per ADS. Our pro forma as adjusted net tangible book value per share set forth in the immediately preceding sentence represents an immediate increase in net tangible book value of $         per ordinary share to existing stockholders compared to our actual net tangible book value as of June 30, 2014, and an immediate dilution in net tangible book value of $         per ordinary share or $         per ADS to purchasers of ADSs in this offering.

The following table illustrates this dilution per ordinary share (including ordinary shares underlying ADSs) and per ADS, in each case assuming that the initial public offering price is $        per ADS:

 

     Per
Ordinary
Share
     Per ADS  

Assumed initial public offering price

     

Pro forma as adjusted net tangible book value per ordinary share and ADS as of June 30, 2014

   $         $     
  

 

 

    

 

 

 

Increase in pro forma as adjusted tangible book value per ordinary share and ADS attributable to new investors

     

Dilution in as adjusted net tangible value book value per ordinary share and ADS to new investors in the offering

   $                    $                
  

 

 

    

 

 

 

A $1.00 change in the assumed public offering price of $        per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease our pro forma as adjusted net tangible book value by $        million, the pro forma as adjusted net tangible book value per ordinary share and per ADS by $        per ordinary share and $        per ADS and the dilution in pro forma as adjusted net tangible book value per ordinary share and per ADS to new investors in this offering by $        per ordinary share and $        per ADS, assuming no

 

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change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only. Our actual net tangible book value following the completion of this offering will be determined in part by the actual public offering price and number of ADSs sold by us and other terms of this offering.

The following table summarizes, on a pro forma as adjusted basis as of June 30, 2014, the differences between our shareholders 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 and ADS paid. We have calculated data in the following table with respect to new investors assuming an initial public offering price of $         per ADS (which is the mid-point of the estimated price range set forth on the cover page of this prospectus) and, where applicable, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, and the data in the following table with respect to new investors reflects ordinary shares evidenced by ADSs sold in this offering. Data in the following table regarding average price per ADS paid by existing shareholders has been calculated by multiplying the average price per ordinary share paid by existing shareholders by the number of ordinary shares evidenced by each ADS.

 

         Ordinary Shares Purchased         Total Consideration     Average
Price Per
Ordinary
Share
     Average
Price Per
ADS
 
     Number      Percent     Amount      Percent               

Existing shareholders

     65,477,292                $ 108,515,449                $ 1.66       $               

New investors

               $                                     $        $               
  

 

 

    

 

 

   

 

 

    

 

 

      

Total

        100.0   $                      100.0     
  

 

 

    

 

 

   

 

 

    

 

 

      

A $1.00 change in the assumed initial public offering price of $        per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease total consideration paid by new investors, total consideration paid by all shareholders, average price per ordinary share and average price per ADS paid by new investors by $        , $        , $        and $        , respectively, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

Assuming that the underwriters’ option to purchase additional ADSs is exercised in full, then the percentage of ordinary shares purchased and the percentage of total consideration paid by existing shareholders set forth in the foregoing table would be reduced to     % and     %, respectively, the number of ordinary shares purchased by new investors would increase to              shares, and the percentage of ordinary shares purchased and the percentage of total consideration paid by new investors would increase to     % and     %, respectively.

As of June 30, 2014, there were:

 

   

360,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.91 per share and 120,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $1.5522 per share, all of which will expire on December 31, 2015;

 

   

15,429,366 ordinary shares issuable upon exercise of outstanding stock options at a weighted-average exercise price of $0.53 per ordinary share; and

 

   

145,130 ordinary shares reserved for future issuance under our 2012 Plan.

The foregoing discussion and tables do not give effect to the issuance of any of these ordinary shares. To the extent that any of these options or warrants are exercised and those options or warrants have an exercise price that is lower than the initial public offering price in this offering, or to the extent we issue additional options to purchase ordinary shares with exercise prices less than the initial public offering price in this offering, there may be further dilution to new investors.

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

The following selected consolidated statements of operations data for the years ended December 31, 2011, 2012 and 2013 and selected consolidated balance sheet data as of December 31, 2012 and 2013 have been derived from our audited consolidated financial statements included elsewhere in this prospectus and we have derived the following selected consolidated statement of operations data for the six months ended June 30, 2014 and the selected consolidated balance sheet data as of June 30, 2014 from our unaudited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 have been restated to correct an error in the calculation and allocation of fair value of the bifurcated embedded derivative features of our Series C, D and E Preference Shares. See Note 22 to our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 included elsewhere herein. Our unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results are not necessarily indicative of the results that may be expected for future periods. Our selected consolidated financial data also includes certain non-GAAP measures, which are not required by, or presented in accordance with, U.S. GAAP but are included because we believe they are indicative of our operating performance and are used by investors and analysts to evaluate companies in our industry. You should read this Selected Consolidated Financial Information section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

     Year Ended December 31,     Six Months Ended June 30,  
     2011     2012     2013     2013     2014  
    

(As restated)

    (As restated)     (As restated)              
     (in thousands except for share and per share data)  

Selected Consolidated Statements of Operations Data:

        

Revenue

          

Turnkey products

   $ 41,522      $ 35,655      $ 79,806      $ 35,082      $ 48,128   

NRE design services

     17,221        18,360        22,337        12,460        18,474   

License and royalties

     18,774        20,529        25,267        10,619        10,363   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     77,517        74,544        127,410        58,161        76,965   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost and expenses:

          

Cost of revenue

          

Turnkey products

     (39,097     (31,340     (64,787     (28,692     (38,500

NRE design services

     (18,076     (14,927     (20,188     (11,000     (15,532

License and royalties

     (951     (2,242     (1,959     (1,505     (213
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue(1)

     (58,124     (48,509     (86,934     (41,197     (54,245
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of intangible assets

     (2,533     (2,897     (3,047     (1,503     (1,888

Research and development expenses(1)

     (14,632     (14,403     (17,863     (8,305     (8,632

Sales and marketing expenses(1)

     (8,875     (10,977     (11,955     (5,965     (6,472

General and administrative expenses(1)

     (6,038     (6,586     (6,704     (2,902     (3,366
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (12,685     (8,828     907        (1,711     2,362   

Other income (expense):

          

Interest income

     18        8        6        3        86   

Interest expense

     (521     (738     (1,041     (426     (605

Increase in fair value of warrants to purchase convertible redeemable preference shares and ordinary shares

     (490     (346     (764     (514     (897

Decrease (increase) in fair value of liquidation features of Series A, B, C, D and E convertible redeemable preference shares

     (5,188     (4,570     (4,127     (6,197     13,264   

Increase in fair value of equity options of Series C, D and E convertible redeemable preference shares

     (7,067     (10,620     (21,573     (11,568     (39,942

Other, net

     348        (2     (126     (203     349   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss before income tax expense

     (25,585     (25,096     (26,718     (20,616     (25,383

Income tax expense

     (955     (564     (1,393     (414     (785
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (26,540   $ (25,660   $ (28,111   $ (21,030   $ (26,168
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share

          

Basic and diluted

   $ (2.14   $ (1.99   $ (2.16   $ (1.63   $ (1.91
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Year Ended December 31,     Six Months Ended June 30,  
    2011     2012     2013     2013     2014  
    (in thousands except for share and per share data)  

Weighted average number of ordinary shares used in calculating basic and diluted net loss per share

    12,373,357        12,868,970        12,987,154        12,934,136        13,699,195   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial Information(2)

         

Adjusted net income (loss)

  $ (13,266   $ (9,622   $ (1,141   $ (2,488   $ 1,779   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ (8,715   $ (4,618   $ 5,104      $ 216      $ 5,450   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes employee share-based compensation as follows:

 

     Year Ended
December 31,
     Six Months Ended
June 30,
 
     2011      2012      2013      2013      2014  
    

(in thousands)

 

Cost of revenue

   $ 28       $ 26         $51       $ 23         $41   

Research and development

           10               26               52               23               34   

Sales and marketing

     11         17         33         16         31   

General and administrative

     18         18         27         10         97   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation

   $ 67       $ 87       $ 163       $ 72       $ 203   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(2) 

See “Prospectus Summary—Summary Consolidated Financial Information—Non-GAAP Financial Measures” for additional information and a reconciliation of net income (loss), the most directly comparable U.S. GAAP financial measure, to each of adjusted net income (loss) and adjusted EBITDA.

 

     As of December 31,     As of June 30,  
     2012     2013     2014  
     (As restated)     (As restated)        
     (in thousands)  

Consolidated Balance Sheet Data:

      

Cash and cash equivalents

   $ 5,387      $ 9,303      $ 32,882   

Working capital

     (15,817     (15,926     4,640   

Total assets

     48,653        57,868        94,419   

Total liabilities

     86,397        123,248        154,316   

Convertible preference shares

     71,979        71,979        94,235   

Accumulated deficit

     (120,755     (148,866     (175,035

Total stockholders’ deficit

   $ (109,723   $ (137,359   $ (154,132

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Information” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 have been restated to correct an error in the calculation and allocation of fair value of the bifurcated embedded derivative features of our Series C, D and E Preference Shares. See Note 22 to our consolidated financial statements as of December 31, 2012 and 2013 and for the three years ended December 31, 2013 included elsewhere herein.

Overview

Our business model, which we refer to as Silicon Platform as a Service (SiPaaS), is an IP-centric, platform-based, end-to-end semiconductor design service which enables us to provide custom silicon solutions. Our mission is to mitigate the time, cost, and risks of semiconductor design and manufacturing for semiconductor companies, original equipment manufacturers, original design manufacturers and large Internet platform companies, allowing them to focus on their core competencies such as product definition, system architecture, software development and branding. Our business model is designed to enable the semiconductor industry to transition to a design-lite model, similar to the way in which independent wafer foundries gave rise to the fabless semiconductor industry by providing access to independent, advanced semiconductor manufacturing services.

In the 1980s, there was a shift within the semiconductor industry towards the fabless business model as semiconductor companies began to outsource manufacturing in order to reduce research and development costs and capital investments. We believe that increasing research and development costs arising from advances in manufacturing technology processes is also causing fabless companies to engage third parties such as our company to provide semiconductor design services from architecture design and physical implementation to managing and shipping fully packaged and tested semiconductor devices, which is the design-lite model.

We established VeriSilicon Microelectronics (Shanghai) Co., Ltd., our wholly-owned subsidiary, in 2001 to conduct our operations in China. We initially focused on licensing IP components such as standard cell libraries, input/output cell libraries, and memory compilers, NRE design services and turnkey products services. In 2006, we acquired the ZSP assets and associated engineering team from LSI Logic Corporation (subsequently LSI Corporation, which was later acquired by Avago Technologies Limited). The assets acquired included the IP relating to the digital signal processor (DSP) technology, employees and customer agreements entered into by LSI Logic Corporation relating to the DSP technology. The acquisition helped to expand each category of our business and significantly strengthened our IP portfolio. Since 2009, over one billion chips have been manufactured based on our solution, and we have collected royalties with respect to our IP from over 700 million chips.

We generate revenue from (i) sales of turnkey products, (ii) NRE design services and (iii) license fees and royalties generated from our IP, including third-party IP which we have a right to sublicense. Our turnkey products revenue is derived from volume production and shipping of semiconductor wafers or chips that we previously designed through our NRE design services. We ship our turnkey products to our customers in accordance with purchase orders placed by our customer. Our NRE design services revenue is derived from fees charged to our customers for the development of semiconductor designs of integrated circuits in accordance with our customers’ specifications. Our NRE design services include procurement and integration of third-party IP, procurement of semiconductor masks, multi-purpose wafers, and prototype wafers manufactured by third-party vendors, and procurement of packaging and testing services of prototype wafers performed by third-party vendors. Revenue

 

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derived from license fees and royalties represents fees earned by licensing our IP to our customers and the subsequent royalty payments when our customers sell products containing our IP to their end customers.

Key Factors Affecting Our Performance

Demand for Turnkey Products. Demand for our turnkey products may fluctuate depending on various factors, including macroeconomic conditions and the market demand for our customers’ end products that incorporate the semiconductors we design based on their specifications and sell to them. Even after we gain a design win and qualify our silicon solution for use in our customer’s product, our customer may postpone the commencement of volume production of the product, or may decide not to produce the product at all, in which case we will not be able to generate turnkey products revenue relating to that product and our revenue and results of operations may be materially and adversely affected.

Operational Efficiency. Our goal is to grow revenue from our NRE design services and license and royalties businesses in an amount sufficient to cover a majority of our total operating expenses, thereby allowing revenue from our turnkey products business, which can grow with limited incremental investment, to drive improvements in our results of operations and operating margin. As we develop new silicon solutions, we intend to continue to leverage our SoC platforms to provide us economies of scale in our research, development and engineering investments. We also reduce design costs for silicon solutions by re-using core IP. Our ability to continue to locate our people and processes in strategic, cost-effective regions is also intended to improve our operational efficiency.

Demand for Custom Silicon Solutions. We believe that ODMs, OEMs and large Internet platform companies are increasingly seeking customized silicon solutions for their businesses. ODMs and OEMs face increasing challenges as more system-level functionality is integrated into SoC semiconductor solutions but they often lack the design expertise to quickly meet specific product requirements. Large Internet platform companies continue to gather significant amounts of data and content, each of which may require customized computing, networking and storage solutions. The success of our SiPaaS solution will depend, in part, on the continuation of these trends and the continued growth in demand for custom silicon solutions.

Enhancement of IP Portfolio. In order to continue to license our IP, we must continually enhance our IP portfolio. The development of new IP or enhancements to our existing IP requires significant research and development activities and time. We also must anticipate market trends to better ensure that the technology we develop will be in demand for next generation technologies.

Revenue Mix. Our revenue mix in a given financial period impacts our operating margin. An increase in revenue from license fees and royalties has a more favorable impact on our operating margins than our turnkey products and NRE design services because we incur limited additional expenses to tailor our IP for our customers’ needs. After we deliver an IP solution to our customer, we recognize royalty revenue without incurring any incremental costs. However, our costs associated with our turnkey products and NRE design services consist of fees charged by independent third-party contractors, such as our vendors for mask sets, multi-purpose wafers and prototype wafers for our NRE design customers, and wafer foundries and packaging and testing vendors of volume production wafers for our turnkey product customers, all of which generally increase to the extent that our turnkey products and NRE design services revenues increase. If revenue from our turnkey products and NRE design services grows at a faster rate than revenue from our license fees and royalties, thereby changing our revenue mix, we may experience a decrease in our operating margin.

Seasonality. Our quarterly revenue and operating results have fluctuated in the past and may continue to fluctuate significantly depending upon numerous factors. In particular, our financial performance is impacted by seasonality in our business. We typically have lower revenue during the first quarter of each year primarily as a result of business slowdowns caused by the Lunar New Year holiday, while the third quarter typically has the highest quarterly revenue. This fluctuation in the third quarter is driven primarily by the effect of the Christmas

 

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holiday season, as many of our customers for turnkey products compete in the mobile device market and ramp production in the third quarter in anticipation of the Christmas holiday demand. This seasonality may be offset in part, by increased revenue from a significant ramp-up of turnkey products for designs we previously had won. For additional information see “—Quarterly trends” below.

Research and Development Expenses. Our research and development expenses fluctuate from quarter to quarter. Unlike many semiconductor product companies which report all of their research and development engineering expenses as operating expenses, U.S. GAAP requires us to report the engineering costs associated with our NRE design services as cost of revenue, not as operating expenses. Only the engineering costs associated with our internal development of new or additional IP and SoC platforms are reported as operating expenses. If we are engaged for more NRE design projects during one quarter as compared to the prior quarter, our cost of revenue for NRE design services will generally be higher and our research and development expenses will generally be lower.

Principal Statement of Operations Line Items

Revenue

We generate revenue from (i) sales of turnkey products, (ii) NRE design services and (iii) license fees and royalties generated from our IP, including third-party IP for which we have a right to sublicense.

Turnkey products. Our turnkey products revenue is derived from volume production and shipping of semiconductor wafers, chips or finished integrated circuits that we previously designed through our NRE design services. We ship our turnkey products to our customers in accordance with purchase orders placed by our customer.

NRE design services. Our NRE design services revenue is derived from fees charged to our customers for the development of designs of integrated circuits in accordance with our customer’s specifications. Our NRE design services include procurement and integration of third-party IP, procurement of semiconductor masks, multi-purpose wafers and prototype wafers manufactured by third-party vendors, and procurement of packaging and testing services of prototype wafers performed by third-party vendors.

License and royalties. Revenue derived from license fees and royalties represents fees earned by licensing our IP to our customers and the subsequent royalty payments we receive when our customers sell products containing our IP to their end customers.

The following table summarizes our revenue for the periods presented, both in dollars and as a percentage of total revenue:

 

    Year Ended December 31,     Six Months Ended June 30,  
    2011     % of
Total
Revenue
    2012     % of
Total
Revenue
    2013     % of
Total
Revenue
    2013     % of
Total
Revenue
    2014     % of
Total
Revenue
 
    (in thousands, except percentages)  

Turnkey products

  $ 41,522        54   $ 35,655        47   $ 79,806        62   $ 35,082        61   $ 48,128        63

NRE design services

    17,221        22     18,360        25     22,337        18     12,460        21     18,474        24

License and royalties

    18,774        24     20,529        28     25,267        20     10,619        18     10,363        13
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

  $ 77,517        100   $ 74,544        100   $ 127,410        100   $ 58,161        100   $ 76,965        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue

Turnkey products. Our cost of revenue with respect to our turnkey products consists of costs associated with the procurement and manufacturing of volume production, packaging and testing, shipping and the operations labor cost related to our turnkey products. Because we operate on a build-to-order basis and generally do not

 

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purchase wafers for our turnkey products without a purchase order from a customer, we typically do not hold material amounts of inventory. During periods when wafer manufacturing capacity is constrained, we will on occasion, purchase wafers based on anticipated purchase orders, which we carry as inventory. Thus, our cost of revenue also includes inventory write-down on wafers we have purchased as a result of anticipated purchase orders from our customers.

NRE design services. Our cost of revenue with respect to our NRE design services includes engineering costs and payments for third-party IP, masks, multi-purpose wafers, prototype wafers and packaging and testing vendors.

License and royalties. Our cost of revenue associated with our license revenue consists of engineering costs directly associated with customizing and delivering IP and services based on our customer’s requirements, and license payments to third-party IP vendors. The amortization of intangible assets, such as EDA tools and IP licenses, is not included in the cost of revenue for either NRE design services or license and royalties. There are no costs associated with royalty revenue.

The following table summarizes our cost of revenue for the periods presented, both in dollars and as a percentage of total revenue:

 

    Year Ended December 31,     Six Months Ended June 30,  
    2011     2012     2013     2013     2014  
    $     % of
Total
Revenue
    $     % of
Total
Revenue
    $     % of
Total
Revenue
    $     % of
Total
Revenue
    $     % of
Total
Revenue
 
                      (in thousands, except percentages)                    

Turnkey products

  $ 39,097        51   $ 31,340        42   $ 64,787        50   $ 28,692        49   $ 38,500        50

NRE design services

    18,076        23     14,927        20     20,188        16     11,000        19     15,532        20

License and royalties

    951        1     2,242        3     1,959        2     1,505        3     213        0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

  $ 58,124        75   $ 48,509        65   $ 86,934        68   $ 41,197        71   $ 54,245        70
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We do not separately report gross profit (loss) or gross margins as we do not believe these measures are meaningful measures of our operating performance, in addition to the reasons stated above regarding cost of revenue of NRE design services and license and royalties revenues. We believe that operating income (loss) and operating margins are more meaningful measures than gross profit (loss) and gross margins because unlike many semiconductor product companies which report all of their research and development engineering expenses as operating expenses, the costs associated with our engineering resources are included within either cost of revenue or operating expenses depending on the type of work that the engineer is performing. Specifically, we are required to report engineering costs associated with our NRE design services as a cost of revenue and engineering costs associated with our internal development of new or additional IP and technology platforms as operating expenses. Once our customer engages us for a NRE design project, we assign engineering resources to that NRE design project, and during the period that the engineer works on that project, our cost of revenue will increase, with a corresponding and equivalent decrease in research and development expenses. As a result, depending on the number of NRE design projects for which we are engaged during a quarter, our cost of revenue with respect to the NRE design services may be higher or lower than in a prior quarter. If we are engaged for more NRE design projects during one quarter as compared to the prior quarter, our cost of revenue for NRE design services likely will be higher than during the prior quarter, assuming the fees we charge for each NRE design project is the same, and our research and development expenses will likely be lower. As a result of this shift of costs between cost of revenue and operating expenses from period to period, we do not believe gross profit or gross margin are meaningful measures of our business.

Operating Expenses

Operating expenses consist primarily of amortization of intangible assets, research and development expenses, sales and marketing expenses, and general and administrative expenses.

 

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Amortization of Intangible Assets. Amortization of intangible assets includes amortization of license agreements with EDA tool vendors, license agreements related to other third-party IP and intangible assets resulting from business acquisition. We may need to purchase additional EDA licenses as our headcount increases in future years or for other reasons.

Research and Development. Research and development expenses primarily includes personnel-related expenses, including salaries, bonuses, share-based compensation and employee benefits. Research and development expenses also includes the costs of developing new or additional IP, technologies and platforms, consulting fees, tooling costs related to prototyping, costs related to development of reference boards, depreciation and facilities-related expenses. Research and development activities include the research, development, and verification of IP for our IP portfolio, development of IP for existing IP in our portfolio, and development related to packaging and testing service offerings. All research and development costs are expensed as incurred.

Sales and Marketing. Sales and marketing expenses primarily includes personnel-related expenses, including salaries, commissions, bonuses, share-based compensation and employee benefits. Sales and marketing expenses also includes travel costs, trade shows, consulting fees, depreciation, and facilities-related expenses.

General and Administrative. General and administrative expenses primarily includes personnel-related expenses, including salaries, bonuses, share-based compensation and employee benefits. General and administrative expenses also includes professional and consulting fees, depreciation and facilities-related expenses.

We expect our research and development, sales and marketing and general and administrative expenses to increase as we build our business.

Critical Accounting Policies and Estimates

Our consolidated financial statements and the related notes included elsewhere in this prospectus are prepared in accordance with U.S. GAAP. 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, and we evaluate our estimates and assumptions on an ongoing basis. Because the use of estimates is an integral component of the financial reporting process, actual results could differ significantly from the estimates made by our management. 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.

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could have a material impact on our consolidated financial statements. We believe that the following accounting policies involve a greater degree of judgment and complexity in their application than our other accounting policies and require us to make significant accounting estimates. Accordingly, these are the policies we believe are the most critical to understanding and evaluating our consolidated financial condition and results of operations. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Revenue Recognition

Overview

We recognize revenue when persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is reasonably assured. If any of these

 

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criteria are not met, we defer recognizing the revenue until such time as all criteria are met. Determination of whether or not these criteria have been met may require us to make judgments, assumptions and estimates based upon current information and historical experience.

Our revenue is generated from the following categories: (i) sales of turnkey products, (ii) NRE design services and (iii) license fees and royalties generated from our IP including third-party IP for which we have a right to sublicense.

Turnkey products. Under our standard master turnkey agreement, we are generally responsible for the manufacturing, packaging and testing of the wafers or integrated circuits. Under these agreements, we assume the risks and rewards of ownership of the wafers or integrated circuits until the products are sold and delivered to our customer. As such, revenue is recognized on a gross basis upon the delivery of the product, assuming all other revenue recognition criteria have been fulfilled.

NRE design services. NRE design service arrangements are generally fixed-price contracts in which we agree to perform the specified design of integrated circuits for a pre-determined price, normally taking at least six months to a year to complete. We recognize NRE design services revenue using the percentage-of-completion method of accounting over the period that services are performed. Progress-to-completion is measured by design service costs incurred, which include labor costs and other service costs. We review our estimates of contract revenue, costs and operating profit on a monthly basis. Prior to contract completion, we may adjust the estimates on one or more occasions as a result of changes in cost estimates, change orders to the original contract, collection disputes with the customer on amounts invoiced or claims against the customer for increased costs incurred by us due to customer-induced delays and other factors. Contract losses are recognized in the fiscal period when the loss is evident. Contract profit estimates are also adjusted in the fiscal period in which it is evident that an adjustment is required.

License Fees and Royalties. We generate license fees through the sale of licenses to our IP. Such IP may be licensed as a standard package or may be customized or designed to meet customer specifications. Our sale of licenses is usually bundled with one year maintenance service from the inception of the licensing term. Such an arrangement constitutes a multiple-element arrangement. For multiple-element arrangements involving only software and software-related deliverables, vendor-specific objective evidence, or VSOE, must exist to allocate the total fee among all delivered and undelivered elements, or if VSOE of all undelivered elements exists, revenue is recognized using the residual method. Under the residual method, the VSOE of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized up-front as the elements are delivered. If VSOE does not exist for all elements to support the allocation of the total fee among all elements of the arrangement, or if VSOE does not exist for all undelivered elements to apply the residual method, revenue is recognized ratably over the term of the undelivered elements.

For IP licenses that do not require significant customization, revenue is recognized upon delivery of the licensed IP, assuming all other revenue recognition criteria are met using the residual method, and maintenance is recognized ratably over the maintenance term.

For IP licenses that require significant customization or development and design, revenue is recognized using the percentage-of-completion method of accounting over the period the design services are performed. Progress-to-completion is measured as contract costs, which include personnel costs and other project costs, are incurred. If we are unable to reasonably estimate contract costs, revenue is recognized under the completed contract method. A provision for estimated losses on contracts is made in the period in which the loss becomes probable.

We provide maintenance and support services that are generally sold with license agreements. Revenue for maintenance and support services is recognized ratably over the term of the maintenance and support period when support and maintenance is sold separately or VSOE fair market value exists if bundled in a multi-element arrangement.

 

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We earn royalty revenue when our customers produce chips or wafers containing our IP. Royalty revenue is generally recognized one quarter in arrears when a production volume report is received from the customer or foundry.

Under some circumstances, we license to our customers IP that we license from third parties. Revenue from third party license is recognized upon delivery of the IP and recorded net of amounts paid to the third-party IP vendor. We obtain the original licensor’s warranties and support for the licenses we distribute.

Fair Value Change in Warrants, Liquidation Features, Equity Options, and Embedded Derivatives of Liquidation Features and Conversion Features of Convertible Redeemable Preference Shares

The fair value change in warrants results from a revaluation of warrants to purchase our ordinary shares, Series C Preference Shares, and Series D Preference Shares issued to Cathay Bank and warrants to purchase shares of our Series E Preference Shares issued to purchasers of our Series E Preference Shares. The change in fair value is re-measured quarterly and the expense reflects the change in the value of the warrants based upon such re-measurement.

The fair value change in liquidation feature relates to the change in fair value of the liquidation feature related to our Series A Preference Shares, Series B Preference Shares, Series C Preference Shares, Series D Preference Shares and Series E Preference Shares. The change in fair value is re-measured quarterly. As of June 30, 2014, we have recorded a liability of $1.7 million for the fair value of the liquidation feature of our Series A Preference Shares and Series B Preference Shares. The liquidation features of our Series C Preference Shares, Series D Preference Shares, and Series E Preference Shares was extinguished in connection with our issue of Series G Preference Shares on June 24, 2014. We expect the fair value of the liquidation feature of our Series A Preference Shares and Series B Preference Shares to change until the completion of this offering. The change in fair value was recorded as a non-cash charge in our consolidated statements of operations for the years ended December 31, 2011, 2012 and 2013 and the six months period ended June 30, 2014. We will incur a non-cash charge (or credit, as the case may be) in our consolidated statements of operations in the quarter in which we complete this offering equal to the amount of the most recent change in fair value of the liquidation feature.

The fair value change in equity options relates to the change in fair value of our Series C Preference Shares, Series D Preference Shares and Series E Preference Shares. In connection with the issuance and sale of our Series C Preference Shares, Series D Preference Shares and Series E Preference Shares, we agreed to issue to the purchasers of those shares, a certain number of Series C-1 Preference Shares, Series D-1 Preference Shares and Series E-1 Preference Shares, respectively, which we refer to collectively as the Shadow Preference Shares, under certain circumstances. For more information regarding the Shadow Preference Shares, see “Description of Share Capital—Shadow Preference Shares.” These Shadow Preference Shares in substance represent the right to receive our ordinary shares without forgoing the rights of a preference shareholder. The change in fair value is re-measured quarterly. The change in fair value was recorded as a non-cash charge in our consolidated statements of operations for the years ended December 31, 2011, 2012 and 2013 and the six months period ended June 30, 2014. The equity options of our Series C Preference Shares, Series D Preference Shares and Series E Preference Shares were extinguished in connection with our issuance of Series G Preference Shares on June 24, 2014.

In connection with the issue of Series G Preference Shares in June 2014, we modified the terms of our Series C, D and E Preference Shares. The modification is considered an extinguishment of the existing Series C Preference Shares, Series D Preference Shares and Series E Preference Shares and related liquidation features and equity options. As a result, we recorded $9.4 million of deemed contribution from preference shareholders representing the difference between the fair value of the modified Series C, D, and E Preference Shares and the carrying value of the existing Series C Preference Shares, Series D Preference Shares, and Series E Preference Shares and related liquidation features and equity options immediately prior to the modification.

The fair value change of embedded derivatives of liquidation features and conversion features relates to the change in fair value of our Series C Preference Shares, Series D Preference Shares and Series E Preference Shares.

 

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The fair value change of embedded derivatives of liquidation features and conversion features of our Series C Preference Shares, Series D Preference Shares and Series E Preference Shares was immaterial for the six months period ended June 30, 2014. We expect the fair value of the embedded derivatives of the liquidation features and conversion features to change until the completion of this offering. We will incur a non-cash charge (or credit, as the case may be) in our consolidated statements of operations in the quarter in which we complete this offering in the amount equal to the most recent change in fair value of the embedded derivatives of the liquidation features and conversion features.

Upon the completion of the offering, the warrants to purchase preference shares and ordinary shares, the liquidation feature of our Series A and B Preference Shares, and the embedded derivative of liquidation features and conversion features of our Series C, D and E Preference Shares will all be reclassified to additional paid-in capital.

Warrants to purchase ordinary shares and preference shares

Management determined the estimated fair value of warrants to purchase ordinary shares and preference shares using the Black-Scholes option pricing model. The key assumptions used in the valuation of the warrants included the risk-free interest rate, volatility, and expected dividend yield. The risk-free interest rate used is based on the U.S. Treasury yield curve in effect at the date of issuance, adjusted for the country risk premium of China. The expected volatility of our future ordinary share price was estimated based on the price volatility of the shares of comparable public companies that operate in the same or similar businesses, since we did not have a trading history for our shares sufficient to calculate our own historical volatility. The dividend yield was estimated based on our expected dividend policy over the expected term of the warrants.

We engaged a third-party valuation specialist in connection with the management’s determination of estimated fair value of warrants. The investigation and analysis undertaken by the third-party valuation specialist included, among other things, discussions with our management with regards to our history, operations, and prospects of our business and studies of our industry and general economy, analysis of our historical and prospective financial results, and research on comparable companies. Our management has assumed full responsibility for the determination of fair value and only considered the third-party valuation as one of the factors in determining the fair value of our warrants.

Income Tax

We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for operating losses and tax credit carry-forwards. Management is required to make assumptions, judgments and estimates to determine our current provision for income taxes and our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant tax authorities. Our assumptions, judgments and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the income taxes recorded in our combined and consolidated statements of operations data. Our assumptions, judgments and estimates related to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax

 

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obligations to differ from our estimates and, thus, materially impact our financial position and results of operations. Income tax liability is calculated based on a separate return basis as if we had filed separate tax returns for all the periods presented. As of December 31, 2011, 2012 and 2013, we had provided for a full valuation allowance for the deferred tax asset. As of June 30, 2014, we recognized $0.1 million in deferred tax assets for one of our subsidiaries which became profitable and provided a full valuation allowance for the remaining deferred tax assets.

We recognize a tax benefit associated with an uncertain tax position when, in our judgment, it is more likely than not that the position will be sustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, we initially and subsequently measure the tax benefit as the largest amount that we judge to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. Our liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period in which they are identified. Our effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by management. We classify interest and penalties recognized on the liability for unrecognized tax benefits as income tax expense.

Impairment Assessment on Goodwill and Indefinite-lived Intangible Assets

We test annually, or whenever events or circumstances indicate that the carrying value of assets exceeds the recoverable amounts, whether goodwill and indefinite-lived intangible assets have suffered any impairment.

We have one reporting unit. For the assessment of goodwill impairment, we compare the fair value of the reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of the reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. For intangible assets, we perform an impairment assessment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. These assessments primarily use cash flow projections based on financial forecasts prepared by management and an estimated terminal value. The expected growth in revenue and operating margin, timing of future capital expenditures, an estimate of weighted average cost of capital and terminal growth rate are based on actual and prior year performance and market development expectations. The periods of the financial forecasts generally range from three to five years. Judgment is required to determine key assumptions adopted in the cash flow projections and changes to key assumptions can significantly affect these cash flow projections and the results of the impairment tests.

 

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Share-Based Compensation

In 2002, we adopted our 2002 Share Plan and in 2013, we adopted our 2012 Plan. Each such plan permits us to grant stock options, share appreciation rights, restricted share units and restricted shares to employees, directors and consultants of our company. Under the 2002 Share Plan, a total of 12,297,858 ordinary shares were initially authorized for issuance. From June 2010 to January 2012, we amended the 2002 Plan to increase the number of ordinary shares reserved for issuance under the plan from 12,297,858 ordinary shares to 17,942,247 ordinary shares, and such plan has since expired. Under the 2012 Equity Incentive Plan, a total of 2,103,019 ordinary shares plus any shares not issued under or returned to the 2002 Share Plan were approved for issuance. In May 2014 and July 2014, we amended the 2012 Plan to increase the number of ordinary shares reserved for issuance under the plan by 2,200,000 ordinary shares and 400,000 ordinary shares, respectively. The following table sets forth the options granted under the 2012 Equity Incentive Plan for the year ended December 31, 2013 and through June 30, 2014:

 

Date of Option Grant

   Options Granted      Exercise Price      Fair Value of
Option
     Fair Value Per
Ordinary Shares
 

January 30, 2013

     161,000       $ 0.56       $ 0.28       $ 0.56   

April 22, 2013

     633,916         0.63         0.30         0.63   

July 24, 2013

     200,000         0.68         0.33         0.68   

November 6, 2013

     108,000         0.97         0.45         0.97   

January 23, 2014

     517,000         1.04         0.53         1.07   

February 19, 2014

     12,000         1.04         0.62         1.21   

May 22, 2014

     2,976,000         1.39         1.21         2.06   

All share-based awards to employees, directors and consultants, such as stock options, are measured at the grant date based on the fair value of the awards. Share-based compensation, net of forfeitures, is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. Share-based compensation expense is classified in the consolidated statements of operations based upon the job function of the grantee. We estimate a forfeiture rate at the time of grant, which is revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. We recognize the estimated compensation of employee service-based options based on the fair value of our ordinary shares on the date of the grant. Share-based compensation is recorded only for those share-based awards that are expected to vest. If actual forfeitures differ materially from our estimated forfeitures, we may need to revise those estimates used in subsequent periods.

In connection with determining the estimated fair value of our share options, we engaged an independent third-party valuation specialist. The key assumptions used in the valuation of share options included risk-free interest rate, volatility, and expected dividend yield. The risk-free interest rate used is based on the U.S. Treasury yield curve in effect at the time of grant, adjusted for the country risk premium of China. The expected volatility of our future ordinary share price was estimated based on the price volatility of the shares of comparable public companies that operate in the same or similar businesses, since we did not have a trading history for our shares sufficient to calculate our own historical volatility. The dividend yield was estimated based on our expected dividend policy over the expected term of the options. Changes in these assumptions could significantly affect the fair value of share options and hence the amount of share-based compensation we recognize in our consolidated financial statements. The investigation and analysis undertaken by the third-party valuation specialist included, among other things, discussions with our management with regards to our history, operations, and prospects of our business and studies of our industry and general economy, analysis of our historical and prospective financial results, and research on comparable companies. Our management has assumed full responsibility for the determination of fair value of these share options and only considered the third-party valuation as one of the factors in determining the fair value of our share options.

Fair Value of Our Ordinary Shares

We have determined the fair value of our ordinary shares using the income approach because our revenue model had been established and we could project our revenue, costs and expenses, changes in working capital

 

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and incremental capital expenditures. We also used the market approach which is based upon an analysis of comparable public companies. This approach is consistent with the guidelines outlined in the American Institute of Certified Public Accountants’ Practice Aid, Valuation of Privately-Held Company Equity Securities Issued as Compensation (the Practice Aid). Finally, we also engaged an independent third-party valuation specialist to assist us with the valuation. The investigation and analysis undertaken by the third-party valuation specialist included, among other things, discussions with our management with regards to our history, operations, and prospects of our business and studies of our industry and general economy, analysis of our historical and prospective financial results, and research on comparable companies. Our board of directors has assumed full responsibility for the determination of fair value of our ordinary shares and only considered the third-party valuation as one of the factors in determining the fair value of our ordinary shares.

The income approach involves applying the discounted cash flow analysis based on our projected cash flow using our best estimate as of the valuation dates. Estimating future cash flow requires us to analyze projected revenue growth, gross margins, effective tax rates, capital expenditures and working capital requirements. Our projected revenue was based on expected annual growth rates derived from a combination of our historical experience and the general trend in the global semiconductor industry. The revenue and cost assumptions we used are consistent with our long-range business plan and market conditions in the semiconductor industry. We also had to make complex and subjective judgments regarding our unique business risks, the liquidity of our shares and our limited operating history and future prospects at each valuation date. Other assumptions we used in deriving the fair value of our equity included:

 

   

no material changes will occur in the applicable future periods in the existing political, legal, fiscal or economic conditions and in the global semiconductor industry;

 

   

no material changes will occur in the current taxation law in the countries in which we operate and the applicable tax rates will remain unchanged;

 

   

exchange rates and interest rates in the applicable future periods will not differ materially from the current rates;

 

   

our future growth will not be constrained by lack of funding;

 

   

we have the ability to retain competent management and key personnel to support our on-going operations; and

 

   

industry trends and market conditions for the global semiconductor industry will not deviate significantly from current forecasts.

Our cash flows were discounted to present value using discount rates that reflect the risks we perceived as being associated with achieving the forecasts and were based on the estimate of our weighted average cost of capital, or WACC, on the valuation date. The WACCs were derived by using the capital asset pricing model, a method that market participants commonly use to price securities. Under the capital asset pricing model, the discount rate was determined considering the risk-free rate, industry-average correlated relative volatility coefficient, equity risk premium, small size premium, country risk premium and company specific premium. The risks associated with achieving our forecasts were appropriately assessed as company specific premium when we determined the appropriate discount rates. If different discount rates had been used, the valuations could have been significantly different.

We used the option-pricing method to allocate enterprise value to preference and ordinary shares, taking into account the guidance prescribed by the Practice Aid. The method treats preference and ordinary shares as call options on the enterprise’s value, with exercise prices based on the liquidation preference of the preference shares. The strike prices of the options are based on the characteristics of our capital structure, including number of shares of each class of equity, seniority levels, liquidation preferences, and conversion values for the preference shares.

The option-pricing method also involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our company or an initial public offering, and estimates of the volatility of our equity

 

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securities. The anticipated timing is based on the plans of our board of directors and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for the shares, and therefore it was determined by using the volatility of the comparable companies as of the valuation date. Had we used different estimates of liquidity event timing and volatility, the allocations between preference and ordinary shares would have been different. In evaluating comparable companies, we determined they should:

 

   

operate in the same or similar businesses;

 

   

have a trading history comparable to the remaining life of our share options as of each valuation date; and

 

   

either have operations in China, as we operate primarily in China, or are listed companies with similar businesses in the United States, as we plan to become a public company in the United States.

We also applied a discount for lack of marketability to reflect the fact that, at the time of the grants, we were a closely held company and there was no public market for our equity securities. To determine the discount for lack of marketability, we and the third-party valuation specialist used the Black-Scholes Option model. Pursuant to that model, we used the cost of a put option, which can be used to hedge the price change before a privately held share can be sold, as the basis to determine the discount for lack of marketability. A put option was used because it incorporates certain company-specific factors, including timing of the expected initial public offering and the volatility of the share price of the guideline companies engaged in the same industry.

The following table sets forth the fair value of our ordinary shares estimated at different times with assistance from our third-party valuation specialist.

 

Effective Date of Valuation

   Fair Value Per
Ordinary
Share
     Discount for Lack of
Marketability
    Discount Rate  

January 25, 2013

   $ 0.56         17.5     18.5

April 15, 2013

   $ 0.63         12.0     18.5

July 17, 2013

   $ 0.68         9.5     18.5

October 30, 2013

   $ 0.97         8.0     18.5

January 16, 2014

   $ 1.07         9.5     18.5

April 17, 2014

   $ 1.44         8.5     18.5

June 30, 2014

   $ 2.75         7.0     18.5

The computation of the fair value of our ordinary shares is subject to a number of estimates, assumptions and uncertainties, including estimates with respect to our future results of operations. If different estimates and assumptions had been used, the valuation of our ordinary shares could have been significantly different. Moreover, these estimates of the fair value of our ordinary shares do not purport to reflect the market price of the ADSs or our ordinary shares following this offering, and investors should not rely on these valuations in deciding whether or not to purchase our ADSs.

Significant Factors Contributing to the Difference in Fair Value Determined

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 the grant dates specified below.

Our board of directors estimated the fair value of our ordinary shares at the time of the grant.

The determined fair value of our ordinary shares increased from $0.56 per share as of January 25, 2013 to $1.07 per share as of January 16, 2014. We believe this increase in the fair value of our ordinary shares was primarily attributable to the following factors:

 

   

improvement of our financial and operating performance in 2013, which was primarily attributable to the growth of our turnkey products and NRE design services revenue;

 

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the release and availability of new IP for license; and

 

   

management’s adjustment of our financial forecasts to reflect the above-mentioned developments.

The determined fair value of our ordinary shares increased from $1.07 per share as of January 16, 2014 to $2.75 per share as of June 30, 2014. We believe the increase in the fair value of our ordinary shares was primarily attributable to the following factors:

 

   

the closing of the initial sale of our Series G Preference Shares at a price per share of $2.80;

 

   

the improved capital market sentiment in the United States, in particular with respect to China-based semiconductor companies;

 

   

the achievement of our financial and operating performance plan in the six months ended June 30, 2014 which was primarily attributable to the growth of turnkey products revenue and the increased NRE design revenue; and

 

   

management’s adjustment of our financial forecasts to reflect the above-mentioned developments.

Taxation

Cayman Islands Profits Tax

Under Cayman Islands law, we are not subject to income, corporation or capital gains tax, and no withholding tax is imposed upon the payment of dividends.

Hong Kong Tax

VeriSilicon Hong Kong is subject to profits tax rate of 16.5% in fiscal years 2011, 2012 and 2013. VeriSilicon Hong Kong records revenue generated from NRE design services and turnkey products outside each of China, including Taiwan, and the United States.

Hong Kong imposes a tax on profits on non-residents for royalty payments made by Hong Kong entities for the right to use IP. The effective withholding tax rates is 4.95%. Payment by VeriSilicon Hong Kong to VerSilicon Cayman for the right to use the IP which is held by VeriSilicon Cayman is subject to withholding tax in Hong Kong.

Taiwan Tax

VeriSilicon Taiwan is subject to profits tax rate of 17.0% in fiscal years 2011, 2012 and 2013. VeriSilicon Taiwan records revenue generated from NRE design services and turnkey products from customers in Taiwan.

Taiwan Income Tax law imposes a 20.0% withholding tax for dividends distributed by a Taiwan entity to a non-resident entity. This tax is also applicable to other payments including license fees, royalties, and technical service fees paid by a Taiwan resident to a non-resident enterprise. A lower tax rate is applied if there is a tax treaty arrangement between Taiwan and the jurisdiction of the non-resident enterprise.

U.S. Income Tax

VeriSilicon U.S. is subject to U.S. federal and state income tax rates, which are approximately 35.0% and 9.0%, respectively. VeriSilicon U.S. primarily records revenue generated in the United States.

Dutch Income Tax

VeriSilicon B.V. is subject to Dutch income tax at graduated tax rates. A tax rate of 20.0% applies on the first €200,000 of taxable profits and 25.0% applies to taxable profits exceeding €200,000. VeriSilicon B.V. records revenue generated from license and royalty revenue from outside China and United States.

 

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PRC Income Tax

Under the PRC Enterprise Income Tax Law, or EIT Law, the standard enterprise income tax rate is 25.0%. Entities qualifying as High and New Technology Enterprises, or HNTE, can enjoy a preferential tax rate of 15.0%. Entities recognized as IC design enterprises are exempt from the EIT for two years beginning from their first profitable year and are entitled to a 50.0% reduction in EIT for the following three years. As a result, VeriSilicon Shanghai was exempt from EIT Law in 2011 and 2012 and enjoys a preferential enterprise income tax rate of 12.5% from 2013 through 2015. VeriSilicon Beijing obtained the qualification of HNTE in November 2011 but did not apply for the preferential tax rate of 15% with the Tax Bureau due to its accumulated loss position. Therefore, the applicable tax rate was still 25% for 2012 and 2013. VeriSilicon Chengdu is subject to income tax at a rate of 25.0%.

PRC preferential tax treatments are subject to review and may be adjusted or revoked at any time. The discontinuation of any preferential tax treatments available to us will cause our effective tax rate to increase, which could materially and adversely affect our financial condition and results of operations. See “Risk Factors—Risks Related to Doing Business in China—Failure to obtain any preferential tax treatments or the discontinuation, reduction or delay of any of the preferential tax treatments that may be available to us in the future could materially and adversely affect our business, financial condition and results of operations.”

Pursuant to the EIT Law and its implementation rules, a 10.0% withholding tax is generally levied on dividends declared by companies in China to their non-resident enterprise investors, which arises from profits earned after January 1, 2008, unless any applicable tax treaty or similar arrangement between the PRC and the investors’ jurisdiction of residence provides for a different income tax arrangement. As the equity holder of VeriSilicon Shanghai and VeriSilicon Beijing, we will be subject to a withholding tax on dividends received from these two PRC subsidiaries at a rate of 10%; VeriSilicon Hong Kong, as the equity holder of VeriSilicon Chengdu, may, subject to the approval from the applicable tax authority, be entitled to a reduced withholding tax rate of 5% for dividends received from VeriSilicon Chengdu pursuant to the arrangement between mainland China and the Hong Kong Special Administrative Region.

Business Tax, VAT and Other Levies

Our PRC subsidiaries are subject to 17.0% value added tax (VAT) for sales of tangible goods in China. Revenue is recognized net of VAT in our consolidated income statement. Our PRC subsidiaries were subject to business tax and related surcharges on revenue earned for services provided in China. The applicable business tax rate was 5.0%. In our consolidated income statement, business tax and related surcharges for revenue earned from our customers are recognized as cost of revenue. Effective from late 2012, our PRC subsidiaries became subject to VAT on revenue earned for most services under a national VAT reform program which replaced the business tax regime in China (VeriSilicon Shanghai from January 2012 and VeriSilicon Beijing from September 2012). In general, the applicable VAT rate on the revenue earned for services is 6.0% with companies entitled to credit VAT paid on certain purchases against VAT on sales. Revenue is recognized net of VAT in our consolidated income statement.

 

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Results of Operations

The following table summarizes our consolidated results of operations in absolute amounts and as a percentage of our total revenue for the periods indicated. Our business has grown rapidly since 2012. Period-to-period comparisons of historical results of operations should not be relied upon as indicative of future performance.

 

    Year Ended December 31,     Six Months Ended June 30,  
    2011     % of
Total
Revenue
    2012     % of
Total
Revenue
    2013     % of
Total
Revenue
    2013     % of
Total
Revenue
    2014     % of
Total
Revenue
 
    (As restated)           (As restated)           (As restated)                                
    (in thousands, except for percentages)  

Revenue:

                   

Turnkey products

  $ 41,522        54   $ 35,655        47   $ 79,806        62   $ 35,082        61   $ 48,128        63

NRE design services

    17,221        22        18,360        25        22,337        18        12,460        21        18,474        24   

License and royalties

    18,774        24        20,529        28        25,267        20        10,619        18        10,363        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    77,517        100     74,544        100     127,410        100     58,161        100     76,965        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost and expenses:

                   

Cost of revenue:

                   

Turnkey products

    (39,097     (51     (31,340     (42     (64,787     (50     (28,692     (49     (38,500     (50

NRE design services

    (18,076     (23     (14,927     (20     (20,188     (16     (11,000     (19     (15,532     (20

License and royalties

    (951     (1     (2,242     (3     (1,959     (2     (1,505     (3     (213     (0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

    (58,124     (75     (48,509     (65     (86,934     (68     (41,197     (71     (54,245     (70
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of intangible assets

    (2,533     (3     (2,897     (4     (3,047     (2     (1,503     (3     (1,888     (2

Research and development expenses

    (14,632     (19     (14,403     (19     (17,863     (15     (8,305     (14     (8,632     (12

Sales and marketing expenses

    (8,875     (11     (10,977     (15     (11,955     (9     (5,965     (10     (6,472     (8

General and administrative expenses

    (6,038     (8     (6,586     (9     (6,704     (5     (2,902     (5     (3,366     (4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (12,685     (16     (8,828     (12     907        1        (1,711     (3     2,362        3   

Other income (expense):

                   

Interest income

    18        0        8        0        6        0        3        0        86        0   

Interest expense

    (521     (1     (738     (1     (1,041     (1     (426     (1     (605     (1

Increase in fair value of warrants to purchase convertible redeemable preference shares and ordinary shares

    (490     (1     (346     (0     (764     (1     (514     (1     (897     (1

Decrease (increase) in fair value of liquidation features of Series A, B, C, D and E convertible redeemable preference shares

    (5,188     (7     (4,570     (6     (4,127     (3     (6,197     (10     13,264        17   

Increase in fair value of equity options of Series C, D and E convertible redeemable preference shares

    (7,067     (9     (10,620     (14     (21,573     (17     (11,568     (20     (39,942     (52

Other, net

    348        1        (2     (0     (126     (0     (203     (0