SILICON MOTION TECHNOLOGY CORPORATION Annual Report 2013 Financial Highlights Product Mix % of Net Sales (2013) Mobile Storage Mobile Communications Others Net Sales US$ million 2009 2010 2011 2012 2013 Contents Financial Highlights Letter to Shareholders About Silicon Motion Form 20-F Directors and Executives 01 02 04 82 % 14 % 4 % 89 133 224 281 225 Gross Margin % of Net Sales 2009 2010 2011 2012 2013 Diluted Earnings per ADS US$ 2009 2010 2011 2012 2013 41% 47% 48% 47% 47% - 2.54 - 0.18 1.28 1.40 0.81 01 Letter to Shareholders Dear Shareholders, 2013 was a transitional year for Silicon Motion as sales of removable storage controllers for mature card and USB flash drive markets declined while sales of SSD plus embedded storage controllers, especially for eMMC growth markets, grew rapidly. 2013 was also a transitional year for our LTE transceiver products as the market quickly moved to the significantly enhanced LTE-Advanced standard. While the negative effects of the transitions were dramatic from the perspective of revenue and profitability, we believe we have built a strong foundation for renewed, long-term growth by focusing on eMMC, SSD, and other embedded storage applications and are confident this will lead to strong growth in upcoming years. In 2013, sales of our SSD plus embedded products grew almost 100% year-over-year to account for almost half of our Mobile Storage sales. Sales of eMMC controllers, our largest SSD plus embedded product, are now already larger than our card and USB flash drive controllers sales, and account for roughly a third of our total revenue. Our eMMC controllers are designed for both SK Hynix and Samsung eMMC solutions and account for 15 to 20% of the overall eMMC controller market. Last year, our two NAND flash partners supplied eMMCs with our controllers to 8 out of the top 10 non-iOS smartphone OEMs for both their flagship and other devices, to leading Android and Windows tablet OEMs, and for other applications such as game consoles, set-top-boxes, smart TVs, and automotive infotainment systems. We have been expanding our engineering resources, and have added a third NAND flash partner that will focus on TLC NAND eMMC solutions, with sales to begin in the first quarter of 2014. We expect the eMMC market to continue growing rapidly in 2014 and believe we are very well positioned to grow our eMMC sales well in excess of market growth next year. 02 We have also been expanding our R&D resources to support our many SSD controller initiatives. Our first SATA 3 client SSD controller began commercial sampling in mid-2013, has been receiving very positive third-party reviews, and should contribute material revenue in 2014. We will introduce a SATA 3 client SSD controller to support TLC NAND flash in 2014 and our first PCIe SSD controller in late 2014 or early 2015. We have been marketing our SSD controllers to NAND flash vendors, other OEMs, and module makers and believe the success of our SSD controller market roll-out is important for our long-term growth. Sales of our older LTE transceiver parts declined throughout 2013. In the second half of 2013, we introduced a new LTE-Advanced transceiver for pairing with Samsung’s new LTE-Advanced baseband. This new LTE-Advanced chipset will complete testing at Samsung in early 2014 and enter production soon afterwards. While our revenue and profitability declined in 2013, we believe this setback is temporary as we transition our controller business from mature removable storage applications to long-term SSD plus embedded growth opportunities, and we believe we are on track to grow again in 2014. Once again, I want to thank our customers, employees and shareholders for their continued support. Sincerely, Wallace Kou President & Chief Executive Officer 03 About Silicon Motion We are a fabless semiconductor company that designs, develops and markets high performance, low-power semiconductor solutions to OEMs and other customers in the mobile storage and mobile communications markets. For the mobile storage market, our key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products. For the mobile communications market, our key products are handset transceivers and mobile TV IC solutions. Our products are widely used in smartphones, tablets, and industrial and commercial applications. For further information on Silicon Motion, visit www.siliconmotion.com. Mobile Storage Market Mobile Communications Market More NAND flash products, especially next We are the dedicated provider of 4G LTE transceiv- generation flash, whether produced by ers for Samsung’s smartphones and tablets and are Samsung, SanDisk, Toshiba, Micron or SK Hynix a leading provider of mobile TV SoCs. We market are supported by Silicon Motion controllers than our Mobile Communications products under the any other company. Silicon Motion is the “FCI” brand. leading merchant supplier of controllers for eMMC embedded memory used in smartphones and tablets and is increasingly focused on client SSD controllers for PCs and other applications. We market our Mobile Storage products under the “SMI” brand. 04 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 20-F ‘ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2013 OR ‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ‘ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR Date of event requiring this shell company report: N/A For the transition period from to Commission file number: 000-51380 Silicon Motion Technology Corporation (Exact name of Registrant as specified in its charter) Cayman Islands (Jurisdiction of incorporation or organization) 8F-1, No. 36, Taiyuan St., Jhubei City, Hsinchu County 302 Taiwan Tel: +886 3 552 6888 Fax: + 886 3 560 0336 (Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class Ordinary shares, par value US$0.01 per share* American Depositary Shares, each representing four ordinary shares Name of each exchange on which registered Nasdaq Global Select Market * Not for trading, but only in connection with the listing on the Nasdaq Global Select Market of American Depositary Shares, or ADSs, each representing four ordinary shares. Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities registered or to be registered pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 131,630,180 ordinary shares as of December 31, 2013, US$0.01 par value per share. Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ‘ No È If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ‘ No È Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes È No ‘ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes È No ‘ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filed. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Non-accelerated filer ‘ Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing: Other ‘ Large accelerated filer ‘ Accelerated filer È U.S. GAAP È International Financial Reporting Standards as issued by the International Accounting Standards Board ‘ If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ‘ Item 17 ‘ Item 18 If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes ‘ No È 1 1 1 1 16 23 23 40 48 48 50 50 55 56 57 57 57 57 60 60 60 60 61 61 61 62 62 62 62 TABLE OF CONTENTS PART I ITEM 1. ITEM 2. ITEM 3. ITEM 4. ITEM 4A. ITEM 5. ITEM 6. ITEM 7. ITEM 8. ITEM 9. ITEM 10. ITEM 11. ITEM 12. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS OFFER STATISTICS AND EXPECTED TIMETABLE KEY INFORMATION INFORMATION ON THE COMPANY UNRESOLVED STAFF COMMENTS OPERATING AND FINANCIAL REVIEW AND PROSPECTS DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS FINANCIAL INFORMATION THE OFFER AND LISTING ADDITIONAL INFORMATION QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES PART II ITEM 13. ITEM 14. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS CONTROLS AND PROCEDURES ITEM 15. ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT ITEM 16B. CODE OF ETHICS ITEM 16C. ITEM 16D. ITEM 16E. ITEM 16F. ITEM 16G. CORPORATE GOVERNANCE PRINCIPAL ACCOUNTANT FEES AND SERVICES EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT PART III ITEM 17. ITEM 18. ITEM 19. FINANCIAL STATEMENTS FINANCIAL STATEMENTS EXHIBITS i CONVENTIONS THAT APPLY TO THIS ANNUAL REPORT Unless otherwise indicated, references in this annual report to: • • • • • • • • • • • • • “ADRs” are to the American depositary receipts that evidence our ADSs; “ADSs” are to our American depositary shares, each of which represents four of our ordinary shares; “CAGR” are to compound annual growth rate; “China” or “PRC” are to the People’s Republic of China excluding the special administrative regions of Hong Kong and Macau; “Korea” are to the Republic of Korea, or South Korea; “Korea Won” are to the legal currency of South Korea; “Nasdaq” are to the Nasdaq Stock Market; “NT dollar,” “NT dollars” or “NT$” are to New Taiwan dollars, the legal currency of Taiwan; “ROC” or “Taiwan” are to Taiwan, the Republic of China, the official name of Taiwan; “shares” or “ordinary shares” are to our ordinary shares, with par value US$0.01 per share; “U.S. GAAP” are to generally accepted accounting principles in the United States; “U.S. dollar,” “U.S. dollars” or “US$” are to United States dollars, the legal currency of the United States; and “we,” “us,” “our company,” “our,” “SMTC” and “Silicon Motion” are to Silicon Motion Technology Corporation, its predecessor entities and subsidiaries including but not limited to (i) Silicon Motion, Inc., incorporated in Taiwan, or SMI Taiwan, and formerly known as Feiya Technology Corporation, (ii) Silicon Motion, Inc., a California, USA, corporation, or SMI USA, and (iii) FCI Inc., incorporated in Korea, or FCI. Silicon Motion, the Silicon Motion logo, FCI, the FCI logo, airRF, basicRF, ezRF, ezSYS, powerRF, twinRF, zipRF, zipSYS, SSDLifeGuard, SSDLifeSaver, TurboMLC, FerriSSD and Ferri-eMMC are our trademarks or registered trademarks. We may also refer to trademarks of other corporations and organizations in this document. Unless otherwise indicated, our financial information presented in this annual report has been prepared in accordance with U.S. GAAP. ii SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This annual report contains forward-looking statements. These forward-looking statements include statements regarding our financial position; our expectations concerning future operations, margins, profitability, liquidity and capital resources; our business strategy and other plans and objectives for future operations; and all other statements that are not historical facts. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “thinks,” “estimates,” “seeks,” “predicts,” “potential,” and similar expressions. Although we believe that these statements are based on reasonable assumptions, they are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected. These factors, risks and uncertainties include those listed under “Risk Factors” and elsewhere in this annual report. Those factors, among others, could cause our actual results and performance to differ materially from the results and performance projected in, or implied by, the forward-looking statements. They include: • • • • • • • • • • unpredictable volume and timing of customer orders, which are not fixed by contract but vary on a purchase order basis; the loss of one or more key customers or the significant reduction, postponement, rescheduling or cancellation of orders from these customers; general economic conditions or conditions in the semiconductor or consumer electronics market; decreases in the overall average selling prices of our products; changes in the relative sales mix of our products; changes in our cost of finished goods; the availability, pricing and timeliness of delivery of other components and raw materials used in our customers’ products; our customers’ financial health, sales outlook, purchasing patterns and inventory adjustments based on consumer demand, market adoption of new technologies and general economic conditions; our ability to successfully develop, introduce and sell innovative, new or enhanced products in a timely manner; and the timing of new product announcements or introductions by us or by our competitors. One or more of these factors could materially and adversely affect our operating results and financial condition in future periods. We cannot assure you that we will attain any meaningful estimates or maintain profitability or that the assumptions on which they are based are reliable. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this annual report. All forward-looking statements contained in this annual report are qualified by reference to this cautionary statement. As you read and consider this annual report, you should carefully understand that the forward-looking statements are not guarantees of performance or results. iii ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS Not applicable. PART I ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. ITEM 3. KEY INFORMATION Selected Consolidated Financial Data You should read the following information with our consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. The selected consolidated statements of income and cash flow data for the years ended December 31, 2011, 2012 and 2013 and the selected consolidated balance sheet data as of December 31, 2012 and 2013 are derived from our audited consolidated financial statements included elsewhere in this annual report and should be read in conjunction with, and are qualified in their entirety by reference to, these consolidated financial statements and related notes. The selected consolidated statements of income and cash flow data for the years ended December 31, 2009 and 2010 and the selected consolidated balance sheet data as of December 31, 2009, 2010 and 2011 are derived from our audited consolidated financial statements which are not included in this annual report. These consolidated financial statements are prepared in accordance with U.S. GAAP. Effective January 1, 2012, we changed the reporting currency of our consolidated financial statements from the NT dollar to the U.S. dollar because of a change in the functional currency of our largest subsidiary, SMI Taiwan. The business profile of SMI Taiwan had changed because the primary factors affecting business are now international in nature and the majority of cash flow are now U.S. dollar denominated. We believe that this change provides greater alignment of our reporting currency with our most significant functional currency and underlying financial performance. Unless otherwise specified, all financial information included in this Form 20-F has been stated in U.S. dollars. 2009 US$ Year Ended December 31, 2010 2011 2012 US$ US$ (in thousands, except for per share data) US$ 2013 US$ Consolidated Statements of Income Data: Net sales Cost of sales Gross profit Operating expenses (income): Research and development Sales and marketing General and administrative Amortization of intangible assets Impairment of goodwill and long-lived assets (1) Gain from settlement of litigation (2) Total operating expenses Operating income (loss) 88,540 52,173 132,793 70,605 223,845 115,806 281,370 149,650 225,308 118,698 36,367 62,188 108,039 131,720 106,610 34,354 12,108 14,221 5,784 37,398 — 33,772 11,936 9,652 2,081 — (1,273) 40,501 14,537 11,323 694 — — 50,975 15,919 12,156 — — — 46,460 13,597 11,250 — — — 103,865 56,168 67,055 79,050 71,307 (67,498) 6,020 40,984 52,670 35,303 1 2009 US$ Year Ended December 31, 2010 2011 2012 US$ US$ (in thousands, except for per share data) US$ 2013 US$ Total non-operating income (loss) Income (Loss) before income taxes Income tax expense (benefit) Net income (loss) Weighted average shares outstanding: Basic Diluted Earnings (Loss) per share: Basic Diluted Earnings (Loss) per ADS (3): Basic Diluted (2,495) (69,993) 242 (11,777) (5,757) (519) 6,232 47,216 5,747 1,664 54,334 7,116 1,845 37,148 9,772 (70,235) (5,238) 41,469 47,218 27,376 110,694 116,159 123,082 129,259 132,259 110,694 116,159 129,370 134,504 134,567 (0.63) (0.05) (0.63) (0.05) (2.54) (0.18) (2.54) (0.18) 0.34 0.32 1.35 1.28 0.37 0.35 1.46 1.40 0.21 0.20 0.83 0.81 (1) Impairment of goodwill and long-lived assets relating to FCI and Centronix (selected parts of Centronix mobile TV business of Korea Information Engineering Services Co., Ltd.) acquisitions. (2) Gain from favorable settlements of litigation with Advanced Semiconductor Engineering Inc. in 2010. (3) Each ADS represents four ordinary shares. Consolidated Balance Sheet Data: Cash and cash equivalents Other current assets Working capital Long-term investments Property and equipment, net Goodwill and intangible assets, net Other non-current assets Total assets Total liabilities Total shareholders’ equity Consolidated Cash Flow Data: Net cash provided by (used in) operating activities Net cash provided by (used in) investing activities Net cash provided by (used in) financing activities Depreciation and amortization Capital expenditures 2009 US$ 61,006 36,167 72,634 491 24,171 38,077 8,153 168,065 28,315 139,750 As of December 31, 2010 US$ 2011 US$ (in thousands) 2012 US$ 53,889 63,211 89,333 185 25,507 35,996 8,716 187,504 30,143 157,361 88,763 90,817 136,856 178 24,728 35,458 7,382 247,326 45,826 201,500 154,734 103,678 202,015 178 23,386 35,472 4,298 321,746 59,480 262,266 2013 US$ 161,720 84,819 205,872 133 30,195 35,474 4,422 316,763 46,066 270,697 9,456 (1,486) 556 5,011 (3,053) (11,987) (9,894) — 4,775 (4,339) 54,261 (13,947) 2,294 5,580 (4,916) 69,236 (4,749) 224 5,881 (4,280) 49,128 (12,815) (29,493) 6,429 (12,772) 2 Risk Factors Because our operating results for any period could be adversely affected by a number of factors and may therefore fluctuate significantly, our annual and quarterly operating results are difficult to predict. Our operating results have fluctuated in the past and could do so in the future. Fluctuations in our operating results may be due to a number of factors, including, but not limited to, those listed below and those identified throughout this “Risk Factors” section: • • • • • • • • • • • • • • • • continuing downward pressure on the average selling prices of our products caused by intense competition in our industry; decreases in demand for consumer electronics products, including smartphones and tablets, into which our semiconductor solutions are directly or indirectly incorporated; our customers’ financial health, sales outlook, purchasing patterns and inventory adjustments based on consumer demand, market adoption of new technologies and general economic conditions; the loss of one or more key customers or the significant reduction, postponement, rescheduling or cancellation of orders from these customers; changes in the seasonality of our sales, which generally has a tendency toward increased sales in the second half of each year; our ability to develop or acquire, introduce, market and transition to volume production new or enhanced products and technologies in a cost-effective and timely manner; changes in supply and availability of flash memory from educations in fab capacity and fabs operating at lower utilization rates; changes in the relative sales mix of our products; changes in foreign currency exchange rates; the availability and pricing of third party semiconductor foundry, assembly and test capacity and raw materials, as well as other changes in our cost of finished goods; the availability, pricing and timeliness of delivery of other components and raw materials used in our customers’ products; unpredictable volume and timing of customer orders, which are not fixed by contract but vary on an order-to-order basis; superior product innovations by our competitors; the timing of new product announcements or introductions by us or by our competitors; our ability to timely and accurately predict market requirements and evolving industry trends and to identify and capitalize upon opportunities in new markets; and the overall cyclicality of, and changing economic and market conditions in, the semiconductor industry. These and other factors make it difficult for us to assess our future performance. Our sales and operating results are difficult to predict and have in the past, and will likely in the future, fluctuate from period to period. We could fail to achieve the operating targets that we have announced, such as revenue growth, gross margin, and operating expense. In addition, our operating results in the future may be below the expectations of securities analysts or investors, which would likely cause the market price of our ADSs to decline. Any variations in our period-to-period performance may also cause the market price of our ADSs to fluctuate. Accordingly, you should not rely on the results of any prior periods as a reliable indicator of our future operating performance. 3 Our operating results and stock price may be adversely affected by worldwide economic uncertainties including political and social instability and industry-specific conditions in the markets we operate. Disruptions or uncertainties in the economy, including any political and social instability may lead consumers and business to postpone spending. This in turn may cause our customers to cancel, decrease or delay their existing and future orders with us. Furthermore, we operate primarily in the semiconductor industry, which is cyclical in nature and subject to evolving industry standards. In the past, the semiconductor industry has experienced significant downturns characterized by decreases in product demand, excess customer inventories and accelerated erosion of prices. The semiconductor industry also periodically experiences increased demand and production capacity constraints, which may affect our ability to deliver products to our customers. An increasing number of our products are being incorporated into consumer electronic products, which are subject to significant seasonality and fluctuations in demand. Economic volatility can cause extreme difficulties for our customers and vendors in accurately forecasting and planning future business activities. This unpredictability could cause our customers to reduce spending on our products and services, which would delay and lengthen sales cycles. Furthermore, during challenging economic times our customers and vendors may face challenges in gaining timely access to sufficient credit, which could impact their ability to make timely payments to us. The accurate forecasting and planning for our operations heavily rely on these worldwide economic and industry- specific conditions, the volatility and uncertainties associated with these factors may adversely affect our results of operation in a material manner. Since we have limited visibility as to the sales volume by our customers of devices using our products, our ability to accurately forecast future demand for and sales of our products is limited. The majority of our products are integrated into devices that are sold directly or indirectly into consumer electronics markets which are difficult for us to accurately forecast as consumer electronics demand is subject to significant seasonality and fluctuations. Also, as significant portion of our quarterly sales are from orders received and fulfilled in that quarter, our visibility as to expected orders from our customers in subsequent periods and for any extended period of time is limited. Additionally, we depend upon our customers’ procurement forecasts in order to forecast demand for our products. Our customers’ procurement forecast may be subject to change and failure to accurately forecast demand for our products and which in turn may result in lost sales or excess inventory and associated reserves or write-downs for our operations. Any of the aforementioned factors could affect our ability to accurately forecast future demands for and sales of our products and thereby harm our business, financial condition and operating results. If demand for our products declines in the major end-markets that we serve, our sales, net revenue and earnings will decrease. Demand for our products is affected by a number of factors, including the general demand for the products in the end-markets that we serve and price attractiveness of the devices incorporating our products that our customers and vendors offer to the end-markets. A significant amount of our sales revenue is derived from customers who use our microcontrollers in removable and embedded solid state storage solutions used in consumer electronics, such as smartphones, tablets, digital cameras, and notebook and desktop PCs. Any significant decrease in the demand for these devices in the end-market may decrease the demand for our semiconductor solutions and may result in a significant decrease in our revenues and earnings. Consumer electronic devices that use our components rapidly change as product capabilities are upgraded or new classes of products are introduced, and these changes may result in a significant reduction in demand for our products. We can not give any assurance that there will not be any downturn in the future or that any future downturn will not affect our results of operations. Any significant decrease in demand for end-user applications of semiconductors will negatively affect our sales, net revenue and earnings. 4 We may make acquisitions that are dilutive to existing shareholders, resulting in unanticipated one-time charges or that may otherwise adversely affect our results of operations, and which may result in difficulties in assimilating and integrating the operations, personnel, technologies, products and information systems of acquired companies or businesses. We continually evaluate and explore strategic opportunities as they arise, including business combinations and capital investments. If we issue equity securities in connection with an acquisition, the issuance may be dilutive to our existing shareholders. Alternatively, acquisitions made entirely or partially for cash would reduce our cash reserves. Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Even when an acquired company has already developed and marketed products, there can be no assurance that such products will be successful after our acquisition, will not cannibalize sales of our existing products, that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues. In April 2007 we completed the acquisition of FCI, a privately-held Korea-based fabless IC company focused on mobile TV and wireless communications RF applications, in November 2007 we acquired select parts of the Centronix mobile TV business of Korea Information Engineering Services Co., Ltd. (“Centronix”) and in October 2011 we acquired select assets of BTL Systems, Inc. (hereafter “BTL”) The products from our FCI, Centronix and BTL acquisitions comprise our mobile communications product line. In the fourth quarter of 2009, we determined that goodwill and certain long-lived assets relating to our mobile communication product line were impaired and recorded an impairment charge of US$37.4 million. See “We are exposed to potential impairment charges on intangible assets relating to recent acquisitions and on investments if business conditions deteriorate” below. Risks arising from these or other future acquisitions could include among other things: • • • • • • • • • • • • • • our ability to accurately assess the business and prospects of an acquisition or the anticipated benefits of an acquisition; delays in or failure to complete the development and application of the acquired technologies or products; timing of the rollout and adoption of new applications and technology standards; our ability to successfully integrate acquired technologies, operations and personnel; failure to achieve projected results of an acquisition or inability to realize the anticipated benefits of an acquisition; disruption of our ongoing business; diversion of management and employees’ attention from other business activities; risks associated with entering into a geographic region or business market in which we have little or no prior experience and specifically managing personnel in these regions; difficulties in establishing and maintaining uniform standards, controls, policies and procedures; deficiencies in the internal control of any acquired company resulting in a material weakness in our overall internal control; our ability to recover costs of the acquisition or investment; amortization expenses and large and immediate write-offs; impairment charges related to goodwill or other assets; negative impact on our relationships with customers, vendors, suppliers or contractors; 5 • • inability to retain key employees of an acquired business; and potentially dilutive issuance of equity securities. In addition, future acquisitions could result in the incurrence of debt or contingent liabilities, adverse tax consequences, deferred compensation charges, dilution to future earnings, and large fees for professional advisor services, any of which could negatively impact our financial conditions or results of operations and could cause our stock price to decline. We may be unable to identify suitable acquisition candidates or investment opportunities or consummate any such transactions on terms and conditions that are acceptable to us, if at all. We depend on a small number of customers for a significant portion of our revenues and a loss of some of these customers would result in the loss of a significant portion of our revenues. We derived a substantial portion of our revenue from sales to a relatively small number of customers. As a result, the loss of any significant customer could materially and adversely affect our financial condition and results of operations. Sales to our five largest customers represented approximately 51%, 61% and 65% of our net revenue in 2011, 2012 and 2013, respectively. Sales to one customer in 2011 and 2012 and two customers in 2013 accounted for 10% or more of our net revenue, represented 28%, 35% and 46% of our net revenue in 2011, 2012 and 2013, respectively. In 2011 and 2012, the significant customer was Samsung and in 2013, Samsung and SK Hynix. The identities of our largest customers and their respective contributions to our net revenue have varied and will likely continue to vary from period to period. We expect that we will continue to depend on a relatively limited number of customers for a substantial portion of our net sales and our ability to maintain good relationships with these customers will be important to the ongoing success of our business. We cannot assure you that the revenue generated from these customers, individually or in the aggregate, will reach or exceed historical levels in any future period. Our failure to meet the demands of these customers could lead to a cancellation or reduction of business from these customers. In addition, loss, cancellation or reduction of business from, significant changes in scheduled deliveries to, or decreases in the prices of products sold to any of these customers could significantly reduce our revenues and adversely affect our financial condition and operating results. Moreover, any difficulty in collecting outstanding amounts due from our customers particularly customers who place large orders, would harm our financial performance. In addition, if our relationships with our largest customers are disrupted for any reason, it could have a significant impact on our business. If the semiconductor industry suffers a shortage of flash memory, which is a key component in many of our customers’ end products, our revenues could be adversely affected. During many periods in past years, some of our customers have indicated that they were unable to acquire enough NAND flash memory to meet all of the anticipated demand for their products. Several manufacturers of flash memory have increased or are planning to increase manufacturing capacity for flash memory. However, we cannot assure you that there will continue to be enough additional capacity to satisfy worldwide demand for flash memory. Because flash memory is a key component in many of the products manufactured by our customers, if any shortage in the supply of flash memory occurs and is not remedied, our customers may not be able to purchase enough flash memory to manufacture their products and may therefore purchase fewer controllers from us than they would have otherwise purchased. Our ability to increase revenues and grow our profits could be materially and adversely affected as a result of any shortage or decrease in the supply of flash memory. We operate in a rapidly changing industry, and our failure to anticipate and respond quickly to changing industry trends relating to technology, standards, and consumer demand could adversely affect our growth and profitability. We operate in an intensely competitive industry that experience rapid technological developments, changes in industry standards, changes in customer requirements, and frequent new product introductions and improvements. If 6 we are unable to respond quickly and successfully to these developments, we may lose our competitive position, and our products or technologies may become uncompetitive. To compete successfully, we must maintain a successful R&D effort, develop new products and production processes, and improve our existing products and processes at the same pace or ahead of our competitors. Many types of events could have a variety of negative effects on our overall competitive position and our financial results, such as reducing our revenue, increasing our costs, lowering our gross margin percentage, lowering our operating profitability and requiring us to recognize impairments on our assets. We may not be able to develop and market new products successfully, new markets at which our products target may not grow as expected, the products we invest in and develop may not be well received by customers, and products developed and new technologies offered by others may affect demand for our products. Currently, a significant majority of our sales are controllers used in NAND flash memory storage devices. If new technologies for storing digital media are developed that compete with flash memory technology or render it obsolete and if we are not able to shift our product offerings accordingly, demand for our products would likely decline and our business would be materially and adversely affected. In addition, we may not have sufficient management resources to manage, R&D capabilities to address, and financial resources to fund all of the required research to develop future innovations and meet changing industry standards. Moreover, even if we have adequate management resources, R&D capabilities, and financial resources, our future innovations may be outpaced by competing innovations. As a result, we may lose customers and significant sales, and our business and operating results may be materially and adversely affected. We may be unsuccessful in developing and selling new products or in penetrating new markets required to maintain our competitiveness or expand our business. We expect that a high percentage of our future sales will come from sales of new products. We sell products in markets that are characterized by rapid technological change, evolving industry standards, frequent new product introductions and products with short life cycles. The markets for some of these products are extremely competitive and may entail technologies that are new, immature and/or unpredictable to us. These markets and our endeavors to meet the markets may not develop into profitable opportunities and we have in the past invested substantial resources in emerging technologies that did not achieve the market acceptance and generate returns that we had expected. Recently, we have made significant investments in eMMC and Solid State Drive (“SSD”) controller technologies and LTE transceiver technology. Failure to grow our eMMC, SSD and LTE products or to recoup on our investments in these technologies could materially adversely affect our results of operations and future business outlook. As a result, it is difficult to anticipate our future revenue streams from, or provide assurances on the success and the sustainability of, our new products. The average selling prices of our products have historically decreased rapidly and will likely do so in the future, which could harm our revenue and profitability. The products we develop and sell, especially those for flash memory storage solutions, are used for high volume applications and many of them are subject to rapid declines in average selling prices. Our average selling prices have historically decreased significantly, and we believe that it is possible they may also fall in the future. We may experience period-to-period fluctuations in future operating results if our average selling prices decline. We may be forced to reduce the average unit price of our products in response to new product introductions by our competitors, competitive pricing pressures and other factors. The consumer electronics market is extremely cost sensitive, which may result in rapidly declining average selling prices of electronic devices and components, such as those made by us, used in devices and create downward pressure on our average selling prices and operating results. To maintain acceptable operating results, we will need to develop and introduce new products and product enhancements on a timely basis and continue to reduce our costs. If we are unable to offset any reductions in our average selling prices by increasing our sales volumes or reducing corresponding production costs, or if we fail to develop and introduce new products and enhancements on a timely basis, our sales and operating results will be materially and adversely affected. 7 If we are unable to accurately predict our future sales and to appropriately budget for our expenses, our results of operations could suffer. The rapidly changing nature of the global economy and the markets in which we sell our products limits our ability to accurately forecast quarterly and annual sales. Because many of our expenses are fixed in the short term or are incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall of sales, or expand our R&D and other operating infrastructure in a timely manner to capture anticipated business opportunities. If we expand our business operations and demand for our products does not increase as we may have projected, our operating results could be affected by our higher operating expense levels. Conversely, if we maintain or reduce our business operations and related expenses in accordance with our projections and demand for our products increases more than expected, our operating results could be affected by lost business opportunity, less competitive economies of scale, and damaged relationships with our customers. A failure to accurately forecast customer demand may result in excess or insufficient inventory, which may increase our operating costs and harm our business. To ensure the availability of our products for our customers, in some cases we cause our manufacturers to begin manufacturing our products based on forecasts provided by these customers in advance of receiving purchase orders. However, these forecasts do not represent binding purchase commitments, and we do not recognize revenue from these products until they are shipped to the customer. As a result, we incur inventory and manufacturing costs in advance of anticipated revenue. Because demand for our products may not materialize, manufacturing based on forecasts subjects us to risks of high inventory carrying costs and increased obsolescence and may increase our costs. If we overestimate customer demand for our products or if purchase orders are cancelled or shipments delayed, we may end up with excess inventory that we cannot sell, which could have a material and adverse effect on our financial results. Conversely, if we underestimate demand, we may not have sufficient product inventory and may lose market share and damage customer relationships, which could also harm our business. The loss of any of our key personnel or the failure to attract or retain specialized technical and management personnel could impair our ability to grow our business. We rely heavily on the services of our key employees, including Wallace C. Kou, our President and Chief Executive Officer. In addition, our engineers and other key technical personnel are a significant asset and are the source of our technological and product innovations. We believe our future success will depend upon our ability to retain these key employees and our ability to attract and retain other skilled managerial, engineering, technical and sales and marketing personnel. The competition for such personnel, particularly technical personnel, is intense in our industry. We may not be successful in attracting and retaining sufficient numbers of technical personnel to support our anticipated growth. These technical personnel are required to design and develop integrated circuits, including firmware, and to introduce product enhancements for use in future applications. Despite the incentives we provide, our current employees may not continue to work for us, and if additional personnel were required for our operations, we may not be able to obtain the services of additional personnel necessary for our growth. In addition, we do not maintain “key person” life insurance for any of our senior management or other key employees. The loss of any of our key employees or our inability to attract or retain qualified personnel, including engineers, could delay the development and introduction of, and have an adverse effect on our ability to sell, our products as well as have an adverse effect on our overall growth. In addition, if any other members of our senior management or any of our other key personnel join a competitor or form a competing company, we may not be able to replace them easily and we may lose customers, business partners, key professionals and staff members. Substantially all of our senior executives and key personnel have entered into confidentiality and non-disclosure agreements. In the event of a dispute between any of our senior executives or key personnel and our operating companies in Taiwan, China or Korea, we cannot assure you the extent, if any, to which these provisions may be enforceable in Taiwan, China, or Korea due to constant evolving nature of the Taiwanese, Chinese, or Korean legal systems. 8 We may not be able to deliver our products on a timely basis if our relationships with our suppliers, our semiconductor foundries or our assembly and test subcontractors are disrupted or terminated. We do not own or operate semiconductor fabrication facilities. Instead, we rely on third parties to manufacture our semiconductors. Two outside foundries, Taiwan Semiconductor Manufacturing Company (“TSMC”) and Semiconductor Manufacturing International Corporation (“SMIC”), with fabs in Taiwan, Singapore, and China currently manufacture the majority of our semiconductors. As a result, we face several significant risks, including higher wafer prices, availability of wafers and other raw materials, lack of manufacturing capacity, quality assurance, manufacturing yields and production costs, limited control over delivery schedules and product quality, increased exposure to potential misappropriation of our intellectual property, labor shortages or strikes and actions taken by third party contractors that breach our agreements. The ability of each foundry to provide us with semiconductors is limited by its available capacity and access to wafers. We do not have long-term agreements with any of these foundries and we place orders on a purchase order basis. We place our orders based on our customers’ purchase orders and sales forecasts. However, the foundries can allocate capacity to the production of the products of their other customers and reduce deliveries to us on short notice or increase the price they charge us. It is possible that other foundry customers that are larger and better financed than we are, or have long-term agreements with these foundries, may induce these foundries to reallocate capacity to them. Any reallocation could impair our ability to secure manufacturing capacity that we need for our products. In addition, interruptions to the wafer manufacturing processes caused by a natural disaster or human error could result in partial or complete disruption in supply until we are able to shift manufacturing to another fabrication facility. It may not be possible to obtain sufficient capacity or comparable production costs at another foundry. Migrating our design methodology to a new third-party foundry could involve increased costs, resources and development time comparable to a new product development effort. Any reduction in the supply of semiconductors for our products could significantly delay our ability to ship our products and potentially have negative effects on our relationships with existing customers and our results of operations. In addition, if our subcontractors terminate their relationships with us, we would be required to qualify new subcontractors, which could take as long as six months, resulting in unforeseen operations problems, and our operating results may be materially and adversely affected. If the foundries that provide us with the products for our operations do not achieve satisfactory yield or quality, or if the assembly and testing services fail us in the quality of their output, then our revenue, operating results and customer relationships will be affected. The manufacture of semiconductors is a highly complex process. Minor deviations in the manufacturing process can cause substantial decreases in yield. In some situations, such deviations may cause production to be suspended. The foundries that manufacture our semiconductors have from time to time experienced lower than anticipated manufacturing yields, including yields for our semiconductors, typically during the production of new products or architectures or during the installation and start-up and ramp-up of new process technologies or equipment. If the foundries that manufacture our semiconductors do not achieve planned yields, our product costs could increase and product availability would decrease. After the wafer fabrication processes, our wafers are shipped to our assembly and testing subcontractors. We have a system to maximize consistent product quality, reliability and yield that involves our quality assurance team working closely with subcontractors in the various phases of the assembly and testing processes. We also emphasize a strong supplier quality management practice through which our quality assurance team pre-qualifies our manufacturing suppliers and subcontractors. However, despite our efforts to strengthen supplier quality management, if our foundries fail to deliver fabricated silicon wafers of satisfactory quality in the volume and at the price we require, or if our assembly and testing subcontractors fail to efficiently and accurately assemble and test our products, we will be unable to meet our customers’ demand for our products or to sell those products at an acceptable profit margin, which would have a material and adverse effect on our sales and margins and damage our customer relationships. 9 Failure to protect our proprietary technologies or maintain the right to certain technologies may negatively affect our ability to compete. We believe that the protection of our intellectual property rights is and will continue to be important to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, business partners and other third parties, and have implemented procedures to control access to and distribution of our documentation and other proprietary information. Despite these efforts, we cannot assure you that these measures will provide meaningful protection of our intellectual property rights. Further, these agreements do not prevent others from independently developing technologies that are equivalent to or superior to our technology. In addition, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology. Monitoring unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries such as Taiwan, Korea, and China where the laws may not protect our proprietary rights as fully as do the laws of the United States. In addition, if the foundries that manufacture our semiconductors lose control of our intellectual property, it could be more difficult for us to take remedial measures because our foundries are located in countries that do not have the same protection for intellectual property that is provided in the United States. Also, some of our contracts, including license agreements, are subject to termination upon certain types of change-of-control transactions. As of March 31, 2014, we had 433 patents and 790 patent applications pending in five countries. We cannot be certain that patents will be issued as a result of our pending applications nor can we be certain that any issued patents would protect or benefit us or give us adequate protection from competing products. For example, issued patents may be circumvented or challenged and declared invalid or unenforceable or provide only limited protection for our technologies. We also cannot be certain that others will not design around our patented technology, independently develop our unpatented proprietary technology or develop effective competing technologies on their own. Failure to successfully defend against intellectual property lawsuits brought against us may adversely affect our business. Companies in and related to the semiconductor industry often aggressively protect and pursue their intellectual property rights. From time to time, we have received, and may continue to receive, notices that claim we have infringed upon, misappropriated or misused other parties’ proprietary rights. Moreover, in the past we have been engaged in litigation with parties that claim that we infringed their patents or misappropriated or misused their trade secrets. In addition, we or our customers may be sued by other parties that claim that our products have infringed their patents or misappropriated or misused their trade secrets, or which may seek to invalidate one or more of our patents. An adverse determination in any of these types of disputes could prevent us from manufacturing or selling some of our products, increase our costs of revenue and expose us to significant liability. Any of these claims may materially and adversely affect our business, financial condition and results of operations. For example, in a patent or trade secret action, a court could issue a preliminary or permanent injunction that would require us or our customer(s) to withdraw or recall certain products from the market or redesign certain products offered for sales or under development. We may also be liable for damages for past infringement and royalties for future use of certain technologies. See “Legal Proceedings,” below. In addition, any litigation to defend ourselves against claims that we have infringed the intellectual property rights of others, could, regardless of the ultimate outcome, materially and adversely affect our operating results by requiring us to incur significant legal expenses and diverting the resources of the company and the attention of our management team. 10 Because the markets in which we compete are highly competitive and many of our competitors have greater resources than we have, we cannot be certain that our products will compete favorably in the market place. We face competition from a large number of competitors in each of our target markets. Our competitors in our mobile storage market include Alcor Micro, ASolid, LSI, Marvell, Phison, and Skymedi. In the mobile communications market, the companies with whom we compete include I&C and Raontech. We also face competition from our customers’ internal products and expect to face increased competition in the future from our current and potential competitors. In addition, some of our customers have developed products and technologies that could replace their need for our products or otherwise reduce their demand for our products. Some 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 we have. 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 products than we can. Our current and potential competitors may develop and introduce new products that will be priced lower, provide superior performance or achieve greater market acceptance than our products. In addition, in the event of a manufacturing capacity shortage, these competitors may be able to obtain capacity when we are unable to do so. The consumer electronics market, which is the principal end market for our products, has historically been subject to intense price competition. In many cases, low-cost, high-volume semiconductor component producers have entered markets and driven down profit margins. If a low-cost, high-volume producer should develop products that compete with our products, our sales and profit margins would suffer. Our products must meet exacting specifications and undetected defects and failures may occur, which may cause customers to return or stop buying our products and may expose us to product liability risk and risks of indemnification against defects in our products. Our products are complex and may contain undetected hardware or software defects or failures, especially when first introduced or when new versions are released. These errors could cause us to incur significant re- engineering costs, divert the attention of our engineering personnel from product development efforts and materially affect our customer relations and business reputation. If we deliver products with errors or defects, our credibility and the market acceptance and sales of our products could be harmed. Defects could also lead to liability for defective products as a result of lawsuits against us or against our customers. We have agreed to indemnify some of our customers in some circumstances against liability from defects in our products. A successful warranty or product liability claim could require us to make significant payments. Our intellectual property indemnification practices may adversely impact our business. We may be required to indemnify our customers and our third-party intellectual property providers for certain costs and damages of intellectual property infringement in circumstances where our products are a factor in creating infringement exposure. In some instances, our products are designed for use in devices manufactured by our customers that comply with international standards. These international standards are often covered by patent rights held by third parties, which may include our competitors. The combined costs of identifying and obtaining licenses from all holders of patent rights essential to such international standards could be high and could reduce our profitability or increase our losses. The cost of not obtaining these licenses could also be high if a holder of the patent rights brings a claim for patent infringement. In the contracts under which we sell semiconductor products, we may have agreed to indemnify our customers against losses arising out of claims of unauthorized use of intellectual property. In some of our licensing agreements, we have agreed to indemnify the licensee against losses arising out of or related to our conduct or services. We cannot assure you that claims for indemnification will not be made or that these claims would not have a material and adverse effect on our business, operating results or financial condition. 11 We are exposed to potential impairment charges on intangible assets relating to recent acquisitions and on investments if business conditions deteriorate. We are required to perform testing for impairment losses relating to long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns in our business, are present. Through our acquisitions of FCI and other assets, we acquired core technology, customer relationships, goodwill and other intangible assets. The carry value of goodwill relating to these acquisitions must be assessed for impairment at least on an annual basis. In November 2009, we recorded US$6.6 million of impairment charges relating to our long-lived assets. Additionally, in November 2009, as a result of our annual impairment assessment of the carrying value of goodwill, we determined that the goodwill balance was impaired, and wrote down the goodwill balance by US$30.8 million. As of December 31, 2013, we had goodwill associated with our acquisitions of US$35.5 million. Although we recorded an impairment on goodwill and other long-lived assets in 2009, we cannot be certain that these assets will not be subject to further write-downs in future periods and may record further impairment charges if sales of our LTE transceivers and mobile TV SoCs do not grow as expected. We have not made any passive investments in private companies since February 2007. If the companies in which we have invested in are unable to execute their plans and succeed in their respective markets, we may not benefit from such investments, and we could potentially lose the amounts we invested. We evaluate our investments on a regular basis to determine if impairments have occurred and have recorded impairment charges in past years. These and future impairment charges could have a material and adverse impact on our operating results. In 2011, 2012 and 2013, there were no impairments recorded. Any failure to achieve and maintain effective internal controls could have a material adverse effect on our business, results of operations and the market price of our ADSs. We are subject to reporting obligations under securities laws of the United States. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include in its annual report management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of the company’s internal controls over financial reporting. Our management and independent registered public accounting firm have concluded that our internal controls as of December 31, 2013 are effective. However, we cannot assure you that in the future we or our independent registered public accounting firm will not identify material weakness during the audit process or for other reasons. In addition, because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. As a result, if we fail to maintain effective internal controls over financial reporting or should we be unable to prevent or detect material misstatements due to error or fraud on a timely basis, investors could lose confidence in the reliability of our financial statements, which in turn could harm our business and results of operations, negatively impact the market price of our ADSs and harm our reputation. Laws and regulations to which we are subject, as well as customer requirements in the area of environmental protection and social responsibility, could impose substantial costs on us and may adversely affect our business. We are subject to various state, federal and international laws and regulations governing the environment, including restricting the presence of certain substances in electronic products. In addition, we are also subject to various industry requirements restricting the presence of certain substances in electronic products. Although our management systems are designed to maintain compliance, we cannot assure you that we have been or will be at 12 all times in complete compliance with such laws and regulations. If we violate or fail to comply with any of them, a range of consequences could result, including fines, import/export restrictions, sales limitations, criminal and civil liabilities or other sanctions. Recently there has been increased focus on environmental protection and social responsibility initiatives. We may be required or choose to implement various standards or processes due to the adoption of rules or regulations that result from these initiatives, such as the recently adopted United States rules on the disclosure of the use of “conflict minerals.” Our customers may also require us to implement environmental or social responsibility procedures or standards before they will continue to do business with us or order new products from us. Our adoption of these procedures or standards could be costly, and our failure to adopt these standards or procedures could result in the loss of business, fines or other costs. Our stock price has been, and may continue to be, volatile, which could result in investors losing all or part of their investments. Since we completed our initial public offering in June 2005, the market price of our ADSs has been and likely will continue to be highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following: • • • • • • • • • • actual or anticipated variations in our quarterly operating results or those of our competitors, customers, or NAND flash vendors; actual or anticipated changes in NAND flash supply-demand dynamics; actual or anticipated changes in our market share or the market share of our competitors; the commencement or results of litigation; announcements by us, our competitors, our customers, or their other suppliers of new products or technological innovations; changes in financial estimates or recommendations by securities analysts; the payment or non-payment of cash dividends at the discretion of our board of directors; the announcement and implementation of share repurchase programs; announcements by us or our competitors of significant acquisitions, divestitures or partnerships; and actual or anticipated changes in the global economic or industry outlook. Many of these factors are beyond our control and may negatively impact the market price of our ADSs, regardless of our performance. In addition, the stock market in general, and the market for technology and semiconductor companies in particular, have been highly volatile. Our ADSs may not trade at the same price levels as that of other semiconductor and technology companies, and shares of semiconductor and technology companies, in general, may not sustain their current market prices. These fluctuations as well as general economic, political, and market conditions may have an adverse effect on the market price of our ADSs. There can be no assurance that we will continue to declare cash dividends on a quarterly basis, if at all or in any particular amounts. Our Board of Directors declared payment of our first quarterly dividend on our common stock in January 2013 and the first dividend payment was made on March 4, 2013. Our Board of Directors has subsequently declared and paid dividends in the second, third and fourth quarters of 2013, as well as the first quarter of 2014, and our Board of Directors recently declared a dividend payment in the second quarter of 2014. The continuation of declaring quarterly dividends or if at all, depends on, among other things, that the dividend payment is in the best interests of our shareholders, our results of operations, capital availability and future capital requirements, financial condition, statutory requirements, and other factors that the board of directors may deem relevant. The 13 decision of any declaration of dividend payment, the amount and the frequency of such, if at all, is the discretion of our Board of Directors. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends, if at all or in any particular amounts. A reduction in or elimination of our dividend payments could have a negative effect on our share price. If we are characterized as a passive foreign investment company, U.S. Holders may experience adverse tax consequences. Based on the present and projected composition of our income and valuation of our assets, we believe we are not currently classified as a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes. We will generally be classified as a PFIC for any taxable year in which either (a) at least 75% of our gross income is passive income or (b) at least 50% of the value (determined on the basis of a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income. If we are characterized as a PFIC, U.S. Holders may experience adverse tax consequences. See “ ITEM 10. ADDITIONAL INFORMATION -Taxation-United States Federal Income Taxation.” We are subject to risks associated with international operations which may harm our business. We conduct our business worldwide. We are headquartered in Taiwan and have most of our operations outside of the United States. We undertake our design and development activities primarily in Korea and Taiwan. Our integrated circuits are manufactured, assembled, tested and packaged by third-parties located primarily in China, Korea, and Taiwan. We generated 89%, 93% and 90% of our revenue in 2011, 2012 and 2013, respectively, from sales to customers outside the United States. International operations are subject to many other inherent risks, including but not limited to: • • • • • • • • • international economic and political conditions, such as political tensions between countries in which we do business (please also refer to Risk Factors relating to Taiwan and Korea); unexpected changes in, or impositions of, legislative or regulatory requirements; complying with a variety of foreign laws; differing legal standards with respect to protection of intellectual property and employment practices; cultural differences in the conduct of business; inadequate local infrastructure that could result in business disruptions; exporting or importing issues related to export or import restrictions, tariffs, quotas and other trade barriers and restrictions; financial risks such as longer payment cycles and difficulty in collecting accounts receivable; adverse taxes rules, regulations and penalties; and • Other factors beyond our control such as nature disasters, terrorism, civil unrest, war and diseases such as severe acute respiratory syndrome, the Avian influenza, and the Swine influenza. Although our reporting currency is the U.S. dollar, and the majority of our sales and cost of sales are denominated in the U.S. dollar, the majority of our operating expenses are denominated in the NT dollar, and to a lesser extent Korean won, Chinese renminbi, and U.S. dollar. The functional currency of our Korean operations is the Korean Won. As a result, appreciation or depreciation of other currencies in relation to the U.S. dollar could result in material transaction and translation gains or losses that could adversely affect, or cause fluctuations in, our results of operations. We do not currently engage in currency hedging activities. Parts of the world, including Taiwan, Japan, China and the United States are susceptible to earthquakes. In 1999, 2008, and 2011 Taiwan, China, and Japan respectively, experienced severe earthquakes that caused significant property damage and loss of life. Although the 1998, 2008 and 2011 earthquakes did not have a 14 material impact on our business, a major earthquake and consequent disruptive events could severely disrupt the normal operations of our business and have a material and adverse effect on our financial condition and operating results. We face substantial political risks associated with doing business in Taiwan because of the tense political relationship between Taiwan and the People’s Republic of China. While we also, through our acquisition of FCI, maintain substantive operations in Korea, our principal executive offices and a majority of our employees and a significant portion of our research and development and operations are based in Taiwan. In addition, most of our foundries and assembly and testing suppliers such as TSMC, SMIC, Advanced Semiconductor Engineering Group (“ASE”), Siliconware Precision Industries Co., Ltd. (“SPIL”), Taiwan IC Packing Corp. (“TICP”), King Yuan Electronics Corp. (“KYEC”), and Youngtek Electronics Corp. (“YTEC”) are located in either Taiwan or China. Accordingly, our business and results of operations and the market price of our ADSs may be affected by changes in Taiwan or China governmental policies, taxation, inflation or interest rates and by social instability and diplomatic and social developments in or affecting Taiwan that are outside of our control. Taiwan has a unique international political status. China does not recognize the sovereignty of Taiwan. Although there have been significant economic and cultural ties between Taiwan and China in recent years, the political relations have often been strained. The government of China has indicated that it may use military force to gain control over Taiwan, particularly under what it considers as highly provocative circumstances, such as a declaration of independence by Taiwan or the refusal by Taiwan to accept China’s “One China” policy. On March 14, 2005, the National People’s Congress of China passed what is widely referred to as the “anti-secession” law, a law authorizing the Chinese military to attack Taiwan in order to block moves by Taiwan toward formalizing independence. Past and recent developments in relations between Taiwan and China have on occasion depressed the market prices of the securities of Taiwanese companies or companies with significant business activities in Taiwan. We cannot assure you any contentious situations between Taiwan and China will always resolve in maintaining the current status quo or remain peaceful. Relations between Taiwan and China and other factors affecting military, political or economic conditions in Taiwan could have a material adverse effect on our financial condition and results of operations, as well as the market price and the liquidity of our ADSs. We face substantial political risk associated from doing business in South Korea because of tensions in the political relationship between South Korea and North Korea. Relations between South Korea and North Korea have been tense over most of South Korea’s history. In recent years, there have been heightened security concerns stemming from North Korea’s nuclear weapons and ballistic missile capabilities and uncertainty regarding North Korea’s actions and possible responses from the international community. More recent concerns over North Korea’s nuclear and ballistic missile testing programs, hostile and threatened actions by North Korea against South Korea, North Korea’s leadership succession, and relations between the United States and North Korea, have created a global security issue that may adversely affect South Korean business and economic conditions. South Korea was not a signatory of the armistice agreement that ended the Korean War, and since no peace treaty was signed between South Korea and North Korea, the two countries are technically still at war. We cannot assure you as to whether or when this situation will be resolved or change abruptly as a result of current or future events, including, without limitation, the effects, if any, of (i) the transition of the “Supreme Leader” to Kim Jong Un that began after the passing of Kim Jong Il in 2011, (ii) recent increases to previously imposed UN sanctions on North Korea, (iii) the effects of the denial of access to South Koreans who manage jointly run factories in the North Korean city of Kaesong and (iv) the general increase in overtures and rhetoric by the North Korean government with respect to its nuclear capabilities and willingness to use such weapons as they see fit. We cannot give any assurance that the level of instability and tension in the Korean peninsula will not escalate in the future, or that the political regime in North Korea may not suddenly collapse. An adverse change in economic or political conditions in South Korea or North Korea or in South Korea’s relations with North Korea could have a material adverse effect on our South Korean subsidiary and our company. 15 Our business depends on the support of the Taiwanese and South Korean governments, and a decrease in this support may increase our tax liabilities and decrease our net income. The Taiwanese and South Korean governments have been supportive of technology companies such as ours. In particular, we, like many Taiwanese technology companies, have benefited from tax incentives provided by the Taiwanese government. For example, under the Statute for Upgrading Industries of Taiwan, we were granted tax credits by the Taiwan Ministry of Finance for qualifying research and development costs and in qualifying employee training expenses. In addition, Taiwan law offers preferential tax treatments to industries that are encouraged by the government. In 2010, “Statute for Industries Innovation” was passed to replace the “Statute for Upgrading Industries” in tax incentives. However, we are still eligible to use certain previously granted unutilized, unexpired tax credits and exemptions. See “Operating and Financial Review and Prospects — Principal Factors Affecting Our Results of Operations — Provision for income taxes” and note 13 to our consolidated financial statements for a more detailed description of our ability to enjoy these preferential tax treatments. If any of our tax credits or our ability to take advantage of these preferential tax treatments are curtailed or eliminated, our net income may decrease materially. The South Korean government provides a variety of tax incentives designed to promote designated industries such as the technology industry. We, like many Korean technology companies, have benefited from certain tax incentives, including tax credits for applicable research and development expenses and tax credit for investments made to improve business productivity. If these and other tax incentives are curtailed or eliminated, our net income may decrease materially. ITEM 4. INFORMATION ON THE COMPANY History and Development of the Company Silicon Motion Technology Corporation (“Silicon Motion”) is a corporation which was incorporated in the Cayman Islands in January 2005 and acquired Silicon Motion, Inc., a Taiwan corporation (“SMI Taiwan”) in April 2005. Originally SMI Taiwan was known as Feiya Technology Corporation (“Feiya”), a Taiwan corporation which was incorporated in April 1997 but had changed its name to SMI Taiwan after acquiring in August 2002 Silicon Motion, Inc., a California corporation (“SMI USA”), which was incorporated in November 1995. Feiya was originally a flash memory products company and SMI USA a graphics processor company. In April 2007, we acquired FCI Inc. (“FCI”), a leading designer of RF ICs for mobile TV and wireless communications based in Korea. In 2011, we established Silicon Motion BV in the Netherlands with the purpose of expanding our business activities in Europe, as well as to provide supervisory, financing, legal support, accounting services and shareholding for our businesses in other parts of the world. Our principal executive offices are located at 8F-1, No. 36, Taiyuan St., Jhubei City, Hsinchu County 302, Taiwan. The address of our United States subsidiary, Silicon Motion, Inc. is 1591 McCarthy Blvd., Milpitas, CA 95035. Our ADSs have been listed and traded on Nasdaq since June 2005. Subsidiaries of the Company Below is a list of subsidiaries of the Company. All subsidiaries are wholly owned. Name of Entity Jurisdiction of Incorporation FCI Inc. Silicon Motion BV Silicon Motion K.K. Silicon Motion Korea Ltd. Silicon Motion Technology Corp (HK) Silicon Motion, Inc. Silicon Motion, Inc. Silicon Motion, Inc. (Beijing) Silicon Motion, Inc. (Shanghai) Silicon Motion, Inc. (Shenzhen) Korea The Netherlands Japan Korea Hong Kong California Taiwan China China China 16 Overview We are a fabless semiconductor company that designs, develops and markets high performance, low-power semiconductor solutions to original equipment manufacturers (“OEMs”) and other customers in the mobile storage and mobile communications markets. Our products are widely used in smartphones, tablets, notebooks, desktop PCs and industrial and commercial applications. For the mobile storage market, our key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products. More NAND flash products, especially next generation flash, whether produced by Samsung, SanDisk, Toshiba, Micron or SK Hynix are supported by Silicon Motion controllers than any other company. We are the leading merchant supplier of controllers for eMMC embedded memory used in smartphones and tablets and are increasingly focused on client SSDs controllers for PCs and other applications. For the mobile communications market, our key products are handset transceivers and mobile TV SoCs. We are a dedicated provider of 4G LTE transceivers for Samsung’s smartphones and tablets. We market our mobile storage products under the “SMI” brand and mobile communications products under the “FCI” brand and sell our semiconductor solutions to leading OEMs and module makers worldwide. Our customers include industry leaders such as Micron, Samsung, SK Hynix, Sony, and Transcend. We sell our products through our direct sales force and distributors. Industry Background We operate in the semiconductor industry and primarily focus on designing, developing and marketing: (i) controllers for managing NAND flash used in embedded storage applications such as eMMC embedded memory and SSDs and removable storage applications such as flash memory cards and USB flash drives, and (ii) specialty RF ICs used in smartphones and tablets such as LTE transceivers and mobile TV SoCs. NAND Flash Controllers NAND flash is a type of non-volatile digital data storage technology that does not require power to retain data and has become the primary semiconductor technology for mass digital data storage. The benefits of NAND flash includes high data storage capacity at low cost per bit, fast data read and write access time, low operating power requirements, and is shock resistant. NAND flash is widely used for embedded and removable data storage in mobile consumer electronic devices such as smartphones, tablets, digital cameras, and notebook PCs and more recently is also being used in commercial-grade, industrial-grade, and enterprise-grade equipment. The NAND flash market is large and has grown rapidly, and the leading suppliers of NAND flash are Intel, Micron, Samsung, SanDisk, SK Hynix, and Toshiba. All NAND flash storage devices require a controller and almost all storage devices use a discrete controller IC. Key functions of a flash memory controller include: • managing the interfacing of the NAND flash in the flash memory storage product with the host device; • • ensuring data reliability in NAND flash by detecting and correcting individual bit errors in the NAND flash caused by read/write disturbance and adjacent cell interference; ensuring data integrity in NAND flash by mapping bad blocks and preventing bad blocks from being used for storing data; 17 • maximizing the life of NAND flash with wear-leveling algorithms which spread out the use of the memory array and equalize the use of all the memory cells; • • • • enhancing the sequential and random read and write performance of NAND flash by utilizing two- plane architecture, interleaving, or other technologies; preventing data loss during sudden, unexpected host device power failures with advanced power cycling solutions; implementing security features to protect software code, personal data and multimedia digital rights; and ensuring that flash memory storage solutions are compatible with host devices. We believe that our controllers are designed to meet the specifications of the majority of NAND flash currently being produced by different flash memory manufacturers, including small and big block Single-Level Cell (“SLC”) and Multi-Level Cell (“MLC”) NAND flash. Most of our controllers support two-bits per cell MLC and three-bits per cell MLC NAND flash, which is also known as Triple-Level Cell (“TLC”) NAND flash. Our controllers also support NAND flash designed and fabricated at all the primary process geometries, including the most advanced process geometries. Mobile Device Specialty RF ICs The RF IC industry is large and fragmented and encompasses several major markets, such as mobile connectivity, broadcast TV, and broadband data. Since major markets demand large supplies of standard solutions, these markets are intensively competitive and are dominated by large semiconductor companies with significant engineering, financial, intellectual property, and other resources. Within and outside of the traditional major markets are niche and customs solutions sub-markets. We have significant RF, analog, and mixed signal IC design expertise and experience relating to several key sub-markets: • LTE transceivers. Custom-designed LTE transceiver solutions specifically for Samsung for pairing with Samsung LTE baseband ICs; and • Mobile TV SoCs. Tuner plus demodulator SoCs for T-DMB and ISDB-T, specifically 1-Seg, Full-Seg, and ISDB-Tmm. Our Markets and Products We design, develop and supply a portfolio of products that address two main markets, mobile storage and mobile communications. In the mobile storage market we provide products for both the embedded storage and the removable storage market segments. The following is a brief description of each of our markets and key products. Mobile Storage Market Embedded Storage Market Embedded memory controllers. Embedded NAND flash-based storage devices, especially eMMC embedded memory, have become very common as memory solutions for smartphones, tablets, and other consumer electronics devices. We provide controllers for eMMC and its derivative multi-chip package (“MCP”) embedded memory, which combine NAND flash and mobile DRAM in an integrated solution. We also develop and supply controllers for other embedded memory solutions, such as those based on the USB flash drive and Secure Digital (“SD”) interface. In addition to providing consumer-grade embedded memory controllers to our customers, we also supply commercial-grade and industrial-grade products. 18 SSD controllers and solutions. SSD is a next generation storage technology designed to replace or compliment hard disk drives. SSDs are potentially faster in terms of data read and write speed, are more durable and not prone to mechanical malfunction, more power efficient, generate less heat, and are quieter and smaller in form factor. We provide SATA 6Gb/s SSD controllers for both NAND-cache SSDs and full-size client SSDs. We also provide controllers for single-chip SSDs and IDE/PATA disk-on-modules (“DOMs”), which are commonly used in industrial applications. In addition to controllers, we also offer Ferri single-package SSD solutions, small single-chip SSDs with either a standard SATA, PATA or eMMC interface in a BGA form factor that allows for easy integration of this embedded storage into industrial-grade or commercial-grade devices and applications. Removable Storage Market Flash memory cardcontrollers. We believe we offer the broadest line of high-performance controllers for all major flash memory card formats, including Compact Flash (“CF”), SD and Memory Stick (“MS”). For SD cards, we offer controllers for (i) different physical card sizes, such as SD card’s miniSD card and microSD card, (ii) different speed class, which refer to how quickly information can be read from, or written to, the card, including the significantly faster Secure Digital High Capacity (“SDHC”) and Secure Digital eXtended Capacity (“SDXC”) cards that use the Ultra High Speed (UHS) bus, (iii) different storage capacities, including the significantly higher-capacity SDHC and SDXC cards, which also have faster speed and added capabilities. Smaller form factor cards are primarily used for smartphones and larger form factor cards are more often used in digital cameras. USB flash drive controllers. USB flash drives are NAND flash memory data storage devices integrated with a standard USB interface, commonly high speed USB 2.0 and increasingly the newer USB3.0 with significantly faster read and write speed. USB flash drives are popular in computing and consumer electronics markets for the portable storage of files. Certain application software can be booted from a USB flash drive, such as a Windows 8 system from a USB flash drive that supports Windows to Go. Mobile Communications Market Mobile TV SoCs. Our products include integrated mobile TV tuner plus demodulator SoCs for mobile phones and other portable devices. Our solutions are designed for many mobile TV broadcast standards, especially T-DMB for the Korean market and ISDB-T for the Japanese and South American markets. LTE transceivers. We offer 4G LTE transceivers that are designed to specifically support Samsung LTE baseband solutions. Our high performance, low power, multi-mode diversity LTE and LTE-Advanced transceivers support GSM, GPRS, EDGE, HSPA, HSPA+, and TD-SCDMA, in addition to FDD-LTE and TD-LTE. Our Customers We sell our semiconductor solutions to leading OEMs and module makers, worldwide. We provide our high performance flash memory storage controller to companies such as Netcom, Micron, Samsung, SK Hynix, Sony and Transcend. We are a leading supplier of controllers used in eMMC embedded memory used in smartphones and tablets manufactured by the handset and tablet industry’s leading OEMs and a leading supplier of controllers used in flash memory cards and USB flash drives. We provide our innovative mobile communications ICs primarily to Samsung. We supply our LTE transceivers to Samsung and mobile TV SoCs to Samsung and other Korea handset OEMs. Sales to our five largest customers represented approximately 51%, 61% and 65% of our net revenue in 2011, 2012 and 2013, respectively. Sales to one customer in 2011 and 2012 and two customers in 2013 accounted for 10% or more of our net revenue, represented 28%, 35% and 46% of our net revenue in 2011, 2012 19 and 2013, respectively. In 2011 and 2012, the significant customer was Samsung and in 2013, Samsung and SK Hynix. The identities of our largest customers and their respective contributions to our net revenue have varied and will likely continue to vary from period to period. The majority of our customers purchase our products through purchase orders, as opposed to entering into long-term contracts with us. The price for our products is typically agreed upon at the time a purchase order is placed. Sales and Marketing We market and sell our products worldwide through a combination of direct sales personnel and independent electronics distributors. Our direct sales personnel are strategically located near our major OEM and modular maker customers in Taiwan, Korea, China, the United States, and Japan. Approximately 77% of our sales in 2011, 82% of our sales in 2012 and 83% of our sales in 2013 were attributable to our direct sales force while the remainder was attributable to distributors. To supplement our direct sales, we have independent electronics distributors with locations throughout the world. We selected these distributors based on their ability to provide effective field sales, marketing communications and technical support for our products to our customers. Our marketing group focuses on our product strategy, product development road maps, new product introduction process, demand assessment, competitive analysis, and product marketing. We seek to work with potential and existing customers early in their design process in order to best match our products to their needs, and more broadly, to ensure that product development activities, product launches, and on-going demand and supply planning occur in a well-managed, timely basis in coordination with our research and development, operations, and sales groups, as well as our customers and distributors. We also attend industry tradeshows and technical conferences to promote our products and solutions, maintain close contact with our existing customers to assess demand, and keep current with industry trends. Our participation in industry standards associations, such as JEDEC and the SD Association for flash memory cards, helps us monitor the latest industry developments and promote our corporate profile. Our marketing group also works with our sales teams to identify new business opportunities. We also have field application engineers, or FAEs, who provide technical support and assistance to existing and potential customers in designing, testing and qualifying systems that incorporate our products. Our FAE organization is segmented by product and market to support our customers. Research and Development We devote a significant amount of resources to research and development for broadening and strengthening our portfolio of products and solutions. Our engineering team has expertise in system architecture, digital, mixed- signal and RF IC design, and software engineering. As of March 31, 2014, we had 433 patents in China, Japan, Korea, Taiwan, and the United States and 790 patents pending. We continue to actively pursue the filing of additional patent applications in China, Japan, Korea, Taiwan, and the United States. We believe technology research and product development are essential to our growth. Our primary research and development centers are located in Hsinchu and Taipei, Taiwan, Seoul, South Korea, Shanghai and Shenzhen, China and Milpitas, California. Our facilities in Milpitas focus primarily on graphics products, our facilities in Seoul focus primarily on our specialty RF IC products, our facilities in Hsinchu and Taipei focus primarily on our NAND flash controller products, and our facilities in Shanghai and Shenzhen focus primarily on specific product requirements of our customers in China. Our research and development expenses were approximately US$40.5 million, US$51.0 million and US$46.5 million for the years ended December 31, 2011, 2012 and 2013, respectively. 20 Manufacturing We design and develop our products and electronically transfer our proprietary designs to independent foundries for the manufacturing and processing of silicon wafers. Once the wafers are manufactured, they are then shipped to third-party assembly and testing subcontractors. Individual dies on each wafer are assembled into finished chips and undergo several stages of testing before delivery to our customers. We also ship bare dies to our customers. We believe that our strategy of outsourcing wafer fabrication, packaging and testing enables us to benefit from the research and development efforts of leading manufacturers without the requirement to commit our own substantial capital investments. Our fabless business model also provides us with the flexibility to engage vendors who offer services that best complement our products and technologies. Wafer fabrication. TSMC and SMIC are currently our primary foundries that manufacture most of our semiconductors. We use their fabs in Taiwan, Singapore, and China to fabricate our devices using mature and stable CMOS process technology, primarily with line-widths from 55 to 160 nanometers. We regularly evaluate the benefits and feasibility, on a product-by-product basis, of migrating to more cost efficient manufacturing process technologies. Assembly and testing. Following wafer fabrication, our wafers are shipped to our assembly and test subcontractors where they are probed, singulated into individual dies, assembled into packaged chips, and undergo the process of electronic final testing. In order to minimize cost and maximize turn-around time, our products are designed to use low cost, industry standard packages and can be tested with widely available automatic testing equipment. We currently engage companies such as ASE, SPIL, TICP, KYEC, and YTEC in Taiwan and Amkor in Korea as our primary subcontractors for the assembly and testing of our products. We have dedicated teams of manufacturing engineers who maintain control over the process from the early stages of manufacturing. Our engineers work closely with our subcontractors to develop product testing and packaging programs to ensure these programs meet our product specifications, thereby maintaining our ownership of the functional and parametric performance of our semiconductors. Quality and Reliability Assurance. We have designed and implemented a quality assurance system that provides the framework for continual improvement of products, processes and customer service. To ensure consistent product quality, reliability and yield, our quality assurance teams perform reliability engineering, quality control, ISO system development, document control, subcontractor quality management and customer engineering services to closely monitor the overall process from IC design to after-sale customer support. In particular, we rely on in-depth simulation studies, testing and practical application testing to validate and verify our products. We emphasize a strong supplier quality management practice in which our manufacturing suppliers and subcontractors are pre-qualified by our quality assurance teams. Our suppliers are required to have a quality management system, certified to ISO 9000 standard. Our operations have been ISO 9001 certified since November 18, 1999. Competition The semiconductor industry is characterized by intense competition. Our customers face supply shortages or oversupply, rapid technological changes, evolving industry standards and declining average selling prices. Our competitors in our mobile storage market include Alcor Micro, ASolid, LSI, Marvell, Phison, and Skymedi. In the mobile communications market, the companies with whom we compete include I&C and Raontech. We also face competition from some of our customers, such as Samsung. Seasonality See “Risk Factors — Because our operating results for any period could be adversely affected by a number of factors and therefore fluctuate significantly, our annual and quarterly operating results are difficult to predict” in Item 3 above and “Operating and Financial Review and Prospects — Principal Factors Affecting Our Results of Operations” in Item 5 below. 21 Intellectual Property Our success and future revenue growth depends, in part, on our ability to protect our intellectual property. We rely on a portfolio of intellectual property rights, registered in the United States, Taiwan, and other countries, including patents, copyright rights, trademark registrations, trade secret laws, contractual provisions, licenses, and other methods to protect our intellectual property. As of March 31, 2014, we held 433 patents in the United States, Taiwan, and other countries and have 790 pending patent applications in the United States, Taiwan, and other countries. There can be no assurance that patents will ever be issued with respect to these pending applications. Furthermore, it is possible that any patents held by us may be invalidated, circumvented, challenged or licensed to others. In addition, there can be no assurance that such patents will provide us with competitive advantages or adequately safeguard our proprietary rights. While we continue to file new patent applications with respect to our recent developments, existing patents are granted for prescribed time periods and will expire at various times in the future. We expect to continue to file patent applications where appropriate to protect our proprietary technologies. Companies in the semiconductor industry have frequently demonstrated a readiness to commence litigation based on allegations of patent and other intellectual property infringement. From time to time, third parties may assert infringement claims against us. We may not prevail in any such litigation or may not be able to license any valid and infringed patents from third parties on commercially reasonable terms, if at all. Litigation, regardless of the outcome, is likely to result in substantial cost and diversion of our resources, including our management’s time. Any such litigation could materially adversely affect us. We intend to protect our intellectual property rights vigorously, but there can be no assurance that our efforts will be successful. In addition, the laws of other countries in which our products are sold may not protect our products and intellectual property rights to the same extent as the laws of the United States. While our ability to effectively compete depends in large part on our ability to protect our intellectual property, we believe that our technical expertise, customer support capabilities, and ability to introduce new products in a timely and cost effective manner will be important factors in maintaining our competitive position. We claim copyright and trademark protection for proprietary documentation for our products and a variety of branding marks. We have registered “Silicon Motion” and its logo (a three-dimensional cube depiction of the letters “SM”), FCI, the FCI logo, “airRF,” “basicRF,” “ezRF,” “ezSYS,” “powerRF,” “twinRF,” “zipRF,” “zipSYS,” “SSDLifeGuard,” “SSDLifeSaver,” “TurboMLC,” “FerriSSD,” and “Ferri-eMMC” as trademarks in the United States, Taiwan, and other countries. We also attempt to protect our trade secrets and other proprietary information through agreements with our customers, suppliers, employees and consultants, and through other customary security measures. We have entered into license agreements with third party intellectual property vendors for wafer fabrication tool libraries, semiconductor IP core, computer aided design tools, and software. Facilities Our corporate headquarters are located in Hsinchu, Taiwan. As of the date of this annual report, we own this 137,700 square feet facility, which houses our management and administration, operations, and research and development departments. In Taiwan, we also lease premises in Taipei, occupying approximately 50,500 square feet of floor space, which houses our sales and marketing, as well as research and development departments. In addition to these facilities in Taiwan, in 2008 we purchased a facility in Shanghai, China with an aggregate floor space of approximately 15,900 square feet. We lease facilities in Seoul, Korea; Shenzhen, and 22 Beijing, China; Milpitas, California; and Yokohama, Japan for research and development, sales and marketing, and administration. These facilities in aggregate consist of approximately 63,000 square feet of floor space with lease terms expiring at various dates between 2015 and 2019. We also own commercial property in Taipei of approximately 6,200 square feet, which we purchased in October 1998 for NT$32 million. This property, which was formerly our Taipei sales office, has not been used by us since 2004, and we currently lease out as office premises. It is our intention that we will sell this property as we do not intend to use it for operating purposes. Government Regulation See Risk Factors — “We face substantial political risks associated with doing business in Taiwan because of the tense political relationship between Taiwan and the People’s Republic of China,” “Our business depends on the support of the Taiwanese and South Korean governments, and a decrease in this support may increase our tax liabilities and decrease our net income,” and “We face substantial political risk associated from doing business in South Korea because of tensions in the political relationship between South Korea and North Korea” in Item 3 above. ITEM 4A. UNRESOLVED STAFF COMMENTS None. ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS General Information We are a fabless semiconductor company that designs, develops and markets high performance, low-power semiconductor solutions to OEMs and other customers in the mobile storage and mobile communications markets. Our products are widely used in smartphones, tablets, digital cameras, notebooks, desktop PCs and industrial and commercial applications. For the mobile storage market, our key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products. More NAND flash products, especially next generation flash, whether produced by Samsung, SanDisk, Toshiba, Micron or SK Hynix are supported by Silicon Motion controllers than any other company. We are the leading merchant supplier of controllers for eMMC embedded memory used in smartphones and tablets and are increasingly focused on client SSD controllers for PCs and other applications. For the mobile communications market, our key products are handset transceivers and mobile TV SoCs. We are a dedicated provider of 4G LTE transceivers for Samsung’s smartphones and tablets. We market our mobile storage products under the “SMI” brand and mobile communications products under the “FCI” brand and sell our semiconductor solutions to leading OEMs and module makers worldwide. Our customers include industry leaders such as Micron, Samsung, SK Hynix, Sony, and Transcend. We sell our products through our direct sales force and distributors. Our revenue growth and product mix has been constantly evolving due to continued technological advancement of solid state storage solutions using NAND flash and the introduction of new consumer electronics devices with more advanced capabilities. Historically, controllers for removable flash memory cards used in mobile phones and digital cameras provided the majority of our revenue. Recently, a growing portion of our revenue growth have come from controllers for SSDs and embedded memory, specifically eMMC embedded memory used in smartphones and tablets. In 2013, our SSD and embedded product sales accounted for almost half our overall NAND flash controller sales and exceeded the sales of our card controllers and USB flash drive 23 controllers. We believe that over the next few years, as the market for devices using SSDs and embedded memory further expands, the majority of our revenue could come from these new growth products. We continue to focus on adapting our business to the changing end-markets for NAND flash memory and aligning our resources accordingly. We have no assurance that our SSD and embedded memory products will grow consistently over the next few years, or at all. The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. We caution you that our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information provided under the caption “Risk Factors” included in Item 3 of this annual report. Principal Factors Affecting Our Results of Operations Net sales. Our net sales consist primarily of sales of our semiconductors, after deducting sales discounts and allowances for returns. The semiconductors that we sell are primarily for mobile storage and mobile communications markets. Net sales generated by these product groups for the periods indicated are as follows: Year Ended December 31, 2011 2012 2013 US$ % US$ % US$ % (in thousands, except percentage data) Net Sales Mobile Storage (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mobile Communications (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others (3) 152,838 56,629 14,378 68 25 7 202,093 67,564 11,713 72 24 4 185,488 31,022 8,798 82 14 4 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223,845 100 281,370 100 225,308 100 (1) (2) (3) Includes controllers for flash memory cards, USB flash drives, SSDs, and eMMCs. Includes mobile TV IC solutions and handset transceiver ICs. Includes embedded graphics processors, demo boards, and non-recurring engineering income. For the years ended December 31, 2011, 2012 and 2013 we derived approximately 27%, 26%, and 21% respectively, of our net sales from customers located in Taiwan and approximately 11%, 7%, and 10% respectively, of our net sales from customers located in the United States. We anticipate that a majority of our net sales will continue to come from customers located outside of the United States. The percentages of our net sales by geographic area for the periods indicated were as follows: Year Ended December 31, 2011 2012 2013 Country Taiwan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27% 35% 22% 11% 5% 26% 21% 49% 51% 13% 13% 7% 10% 5% 5% 24 Our net sales are denominated primarily in U.S. dollars. The percentages of our net sales by currency for the periods indicated are set forth in the following table: Year Ended December 31, 2011 2012 2013 Currency U.S. dollars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NT dollars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korean won . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93% 89% 4% — 7% 7% 97% — 3% The length of our sales cycle, from the day purchase orders are received until products are shipped to customers, is dependent on the availability of our product inventories. If we do not have sufficient inventories on hand to meet customer demands, approximately three months are generally required from the day purchase orders are received until finished goods are manufactured and shipped to customers. This cycle can take up to six months during times when capacity at independent foundries is being fully utilized. The potential delays inherent in the manufacturing process increase the risk that we may not be able to fulfill a customer’s order on time. All of our sales are made by purchase orders. Because our practice, which is consistent with industry practice, allows customers to reschedule orders on relatively short notice, order backlog may not be a good indicator of our future sales. Because many of our semiconductor solutions are designed for the multimedia consumer electronics market such as smartphones, tablets, digital cameras, and desktop and notebook PCs, we expect our business to be subject to seasonality, with increased net sales in the second half of each year, when customers place orders to meet increased demand during year-end holiday seasons, and decreased net sales in the first half of each year. However, our rapid sales growth in recent years makes assessment of the impact of seasonal factors on our business difficult. Cost of sales. Our cost of sales consists primarily of the following costs: • • • • • cost of wafer fabrication; assembly, testing and shipping costs of our semiconductors; personnel and equipment costs associated with manufacturing support; quality assurance; cost of raw materials; and • write-off of inventory. We engage independent foundries for the manufacturing and processing of our semiconductors. Our manufacturing cost is subject to the cyclical supply and demand conditions typical of the semiconductor industry. Our cost per wafer generally fluctuates with the availability of capacity at independent foundries. We believe that our cost of sales is substantially variable in nature, and will likely fluctuate as our market conditions change. Research and development expenses. Our research and development expenses consist primarily of employee salaries and related costs, stock-based compensation expense, fees paid for the use of intellectual properties and design tools developed by third parties, development cost of software, expenses for the design, development and testing of system architecture, new product or product alternatives, costs for the construction of prototypes, occupancy costs and depreciation on research and development related equipment. We expense research and development expenditures as they are incurred. We expect research and development expenses to increase in absolute terms in future periods as our net sales increase. 25 Sales and marketing expenses. Our sales and marketing expenses consist primarily of employee salaries and related costs, stock-based compensation expense, commissions paid to independent distributors and costs for our advertising and promotional activities. We expect that our sales and marketing expenses will increase in absolute terms over the next several years as our net sales increase. General and administrative expenses. Our general and administrative expenses consist primarily of general employee salaries and related costs, stock-based compensation expense, insurance premiums, professional fees and allowance for doubtful accounts. We expect that general and administrative expenses will increase in absolute terms in future periods as our net sales increase. Amortization of acquired intangible assets. Amortization of acquired intangible assets relates to intangible assets, such as core technology and customer relationships, but excluding goodwill. Impairment of goodwill and long-lived assets. We evaluate the recoverability of goodwill and long-lived assets annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. Accounting for stock-base compensation. We grant both stock options and restricted stock units to our employees and members of the Board of Directors. The value of our restricted stock units is based on the closing price of our shares on the date of grant and expensed over the vesting period. We estimate the fair value of stock options on the date of grant using the Black-Scholes option-pricing model and recognize stock compensation expense over the requisite service period of the individual grantees, which generally equals the vesting period. Non-operating income and expenses. Our non-operating income and expenses include gains or losses on the sales of investments, interest from deposited cash or short-term investments, gains or losses on foreign exchange rates, impairment of long-term investments, interest paid on loans and capital leases and other non-operating income and expenses not categorized above. We conduct an assessment on the value of our long-term investments quarterly and make corresponding write-downs as required to the value of the long-term investments. Provision for income taxes. We must make certain estimates and judgments in determining income tax expenses for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, deductions and allowance, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period. We have operations in several countries and determine income taxes for each of the jurisdictions where we operate. Taiwan and Korea are our two primary countries of operations. In Taiwan, we have received tax exemptions from the government that are valid for a number of years and for certain income streams relating to the expansion of production capacity or the development of new technologies. We also receive significant amounts of tax credits for applicable research and development expenses incurred in Korea. Because of these and other tax benefits, the effective tax rates of our Taiwan and Korea operations have been lower than statutory tax rates. See “Risk Factors — Our business depends on the support of the Taiwanese and South Korean governments, and a decrease in this support may increase our tax liabilities and decrease our net income” for the risks relating to our ability to enjoy favorable tax policies of the Taiwanese and Korean governments. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 26 The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to product returns and pricing allowances, allowances for doubtful accounts, inventories, goodwill, long-lived assets, long-term investments, income taxes, litigation and contingencies. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Because our estimates may vary in each situation, our actual results may differ from our estimates under different assumptions and conditions. Our management considers the following factors in reviewing our financial statements: • • the selection of critical accounting policies; and the judgments and other uncertainties affecting the application of those critical accounting policies. The selection of critical accounting policies, the judgments and other uncertainties affecting the application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements. Our principal accounting policies are set forth in detail in Note 2 to our consolidated financial statements included elsewhere in this annual report. We believe the following critical accounting policies affect our more significant judgments used in the preparation of our financial consolidated statements. Revenue recognition. Revenue from product sales are generally recognized upon shipment to the customer provided that we have received a signed purchase order, the price has been fixed or is determinable, transfer of title has occurred in accordance with the shipping terms specified in the arrangement with the customer, collectability from the customer is considered reasonably assured, product returns are reasonably estimable and there are no remaining significant obligations or customer acceptance requirements. Revenue on development service orders is generally recognized upon completion and customer acceptance of contractually agreed milestones. We record reserves to cover the estimated returns from our customers. Certain of our distributors have limited rights of return and price protection rights on unsold inventory. The return rights are generally limited to five percent of the monetary value of products purchased within the preceding six months, provided the distributor places a corresponding restocking order of equal or greater value. The allowance for sales returns for distributors and all customers is recorded at the time of sale based on historical returns information available, management’s judgment and any known factors at the time the financial statements are prepared that would significantly affect the allowance. However, because of the inherent nature of estimates, actual returns and allowances could be significantly different from our estimates. To the extent rates of return change, our estimates for the reserves necessary to cover such returns would also change which could have a negative impact on our recorded revenue and gross margin. We reserved approximately US$4.0 million, US$0.3 million and US$1.3 million in 2011, 2012 and 2013, respectively, for estimated sales returns and discounts, representing approximately 1.8%, 0.1% and 0.6% of our gross sales for those respective periods Occasionally, we have reduced our product pricing due to market conditions, competitive considerations and other factors. Price protection rights are granted to certain distributors under our distribution agreements. When we reduce the price of our products, price protection allows the distributor to claim a credit against its outstanding accounts receivable balances based on the new price of the inventory it has on hand as of the date of the price reduction. A reserve for price adjustments is recorded at the time of sale based on our historical experience. The amount of our reserve for price adjustments to distributors is minimal. Allowance for doubtful accounts. We record an allowance for doubtful accounts based on our evaluation of the collectability of our accounts receivable. Normal payment terms are provided to customers and applied upon transfer of title. On an ongoing basis, we analyze the payment history of customer accounts, including recent customer purchases. In circumstances where we are aware of a specific customer’s inability to meet its financial 27 obligations to us, we record a specific allowance against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other accounts receivable due from customers, we categorize accounts receivable and make provisions based on a percentage of each category. We determine these percentages by examining our historical collection experience and current trends in the credit quality of our customers as well as our internal credit policies. If the financial condition of our customers or economic conditions in general were to deteriorate, additional allowances may be required in the future and such additional allowances would increase our operating expenses and therefore reduce our operating income and net income. Our allowance for trade-related doubtful accounts were approximately US$2.6 million, US$1.6 million and US$1.3 million as of December 31, 2011, 2012 and 2013, respectively, representing approximately 6.0%, 4.1% and 3.8% of our gross accounts receivables at the end of each respective periods. Inventory valuation. We value inventories at the lower of cost or market value. Inventories are recorded at standard cost and adjusted to the approximate weighted-average cost at the balance sheet date. Market value represents the current replacement cost for raw materials, finished goods and work in process. We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not subsequently reversed to income even if circumstances later suggest that increased carrying amounts are recoverable. In estimating our reserves for obsolescence, we primarily evaluate estimates based on the timing of the introduction of our new products and the quantities remaining of our old products and write down the value of inventory on hand in excess of the estimated demand. We wrote down US$4.6 million, US$1.6 million and US$2.5 million in 2011, 2012 and 2013, respectively, for estimated obsolete or unmarketable inventory. Stock-based compensation. All share-based payments, including grants of stock options and restricted stock units, are recognized in our financial statements based upon their respective grant date fair values. Calculating the fair value of stock option awards at the date of grant requires the use of an appropriate valuation model and judgment. We use the Black-Scholes valuation formula to estimate the fair value of employee stock options. The Black-Scholes formula requires the use of input assumptions, including expected volatility, expected term, expected dividend rate and expected risk-free rate of return. Risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatilities are based on historical volatilities of our ADS prices. We estimated our options’ expected terms using our best estimate of the period of time from the grant date that we expect the options to remain outstanding. If we determined that another method for estimating expected volatility or expected term is more reasonable than our current methods, or if another method for calculating these input assumptions was prescribed by authoritative guidance, the fair value calculated for future stock option awards could change significantly from those used for past awards, even if the critical terms of the awards were similar. Higher volatility and expected term will result in an increase to the fair value of stock option awards at the date of grant. The expected dividend rate and expected risk-free rate of return are not as significant to the calculation of fair value. Stock option awards are expensed over the requisite service period of the individual grantees, which generally equals the vesting period. Valuation of long-lived assets and intangible assets with finite useful life. We evaluate the recoverability of long-lived assets and intangible assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the sum of the anticipated undiscounted cash flows from such asset is separately identifiable and is less than the carrying value. If impairment occurs, a loss based on the excess of carrying value over the fair market value of the long-lived asset is recognized. Fair market value is determined by reference to quoted market prices, if available, or discounted cash flows, as appropriate. The impairment evaluations and the estimate of fair market value involve management estimates of assets’ useful lives and future cash flows. Actual useful lives and cash flows could be different from those estimated by management. This could have a material effect on our operating results and financial condition. No impairment losses were recognized in 2011, 2012 and 2013. 28 Impairment of long-term investments. We evaluate the recoverability of long-term investments whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment charges are determined based on the difference between our carrying value and our proportionate ownership of the investee company’s net assets at year end. No impairment losses were recognized in 2011, 2012 and 2013. Business combinations. When we acquire businesses, we allocate the purchase price to tangible assets and liabilities and identifiable intangible assets acquired. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on historical experience and information obtained from the management of the acquired companies. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the synergistic benefits expected to be derived from the acquired business. These estimates are inherently uncertain and unpredictable. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates. Goodwill. We record goodwill when the consideration paid for an acquisition exceeds the fair value of net tangible and intangible assets acquired. We measure and test goodwill on an annual basis or more frequently if we believe indicators of impairment exist. Our impairment review process compares the fair value of the reporting unit in which the goodwill resides to its carrying value. We determined that our reporting units are equivalent to our operating segments or components of an operating segment for the purposes of completing our impairment test. We utilize a two-step approach to testing goodwill for impairment. The first step tests for possible impairment by applying a fair value- based test. In computing fair value of our reporting units, we use estimates of future revenues, costs and cash flows from such units. The second step, if necessary, measures the amount of such impairment by comparing the implied fair value of goodwill to its carrying value. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. In 2011, 2012 and 2013, no impairment charges were recorded. The assessment was based upon a discounted cash flow analysis and analysis of our market capitalization. The estimate of cash flow was based upon, among other things, certain assumptions about expected future operating performance such as revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, and determination of appropriate market comparables. We based our fair value estimates on assumptions we believed to be reasonable but that are unpredictable and inherently uncertain. The long-term financial forecast represented the best estimate that we had at that time and we believed that its underlying assumptions were reasonable. However, actual performance in the near-term and longer-term could be materially different from the forecast, which could impact future estimates of fair value of our reporting units and may result in a charge to earnings in future periods due to the potential for further write-down of goodwill in connection with future impairment tests. Accounting for income taxes. In preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income within the relevant jurisdiction and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. We provide for a valuation allowance to the extent we believe that it is more likely than not that the deferred tax assets will not be recovered from future taxable income. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including our ability to generate taxable income within the period during which the temporary differences reverse, the outlook for the economic environment in which we operate, and the overall future industry outlook. 29 Should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an additional allowance for the deferred tax asset would be charged to income in the period the determination was made. We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The total amount of unrecognized tax benefits as of December 31, 2011, 2012 and 2013 was US$2.7 million, US$3.5 million and US$5.8 million, respectively, excluding accrued interest and penalties. As of December 31, 2012 and 2013, US$1.3 million and US$1.4 million of interest and penalties were accrued. Fiscal years 2007 through 2013 remain subject to examination by the US Internal Revenue Service. Fiscal years 2008 through 2013 remain subject to examination by other foreign tax jurisdictions. The ultimate outcome of tax matters may differ from our estimates and assumptions. Unfavorable settlement of any particular issue would require the use of cash and could result in increased income tax expense. Favorable resolution could result in reduced income tax expense. Within the next 12 months, we do not expect that our unrecognized tax benefits would change significantly. See Note 13 to the Consolidated Financial Statements for further information regarding changes in unrecognized tax benefits during 2013. Functional Currency. Based on an evaluation of economic facts and circumstances together with the functional currency analysis prescribed in ASC 830, on January 1, 2012, we changed the functional currency of our largest operating subsidiary, SMI Taiwan, from the NT dollar to the U.S. dollar. As a result of SMI Taiwan’s functional currency change, we changed its reporting currency from the NT dollar to the U.S. dollar. In 2005, at the time of our IPO, we determined that SMI Taiwan’s functional currency was the NT dollar, and this determination was used consistently until we determined significant and permanent changes in economic facts and circumstances warranted a change in functional currency. Since the business profile and activities of SMI Taiwan had changed significantly and did not appear to be temporary, we re-evaluated the functional currency of SMI Taiwan based on recent economic facts and circumstances, including analysis prescribed in ASC 830, and determined that the U.S. dollar had become the functional currency of SMI Taiwan. The business activities of SMI Taiwan have changed significantly since 2005. In the past, the majority of SMI Taiwan sales were to Taiwanese module maker customers; in 2012 the majority of SMI Taiwan sales were to international OEMs. We believe this trend is not temporary because a fast growing and increasingly large and material source of SMI Taiwan’s sales are from SSD and embedded memory products, and these products are predominately sold to international OEM customers. The significance of SMI Taiwan’s other products, primarily card and USB flash drive controller products, has been declining and will continue to decline due to the maturity of their markets, and a majority of these products are now sold to non-Taiwan-based customers. SMI Taiwan’s cash flow, sales price, sales markets, expenses, financing and intercompany transactions are now primarily U.S. dollar-based. Economic facts and circumstances, as well as functional currency analysis support our determination that the U.S. dollar has become the functional currency of SMI Taiwan as of January 1, 2012. As from January 1, 2012, we have reported our consolidated results in U.S. dollars, and we have recasted our historical financial statements included in this Form 20-F from the NT dollar to the U.S. dollar. Items on our historical balance sheet and income statement were converted from the NT dollar to the U.S. dollars at the following rates: 2008 2009 2010 2011 Balance Sheet (at year-end NT dollar to U.S. dollar rate) Income Statement (at average NT dollar to U.S. dollar rate) 32.80 31.99 29.13 30.28 30 31.42 32.55 31.56 29.53 Litigation and contingencies. From time to time, we have been subject to legal proceedings and claims relating to intellectual property rights and other actions arising out of the normal course of business, as well as other matters identified in “Legal Proceedings,” in Item 8 of this Annual Report. Our success and future revenue growth will depend, in part, on our ability to protect our intellectual property. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies. We have been issued patents and may have additional patents in the future; however, we cannot provide assurance that any patent will be issued as a result of any applications or, if issued, that any claims allowed will be sufficiently broad to protect our technology. In addition, it is possible that existing or future patents may be challenged, invalidated or circumvented. It may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization, develop corresponding technology independently or design around our patents. Effective copyright, trademark and trade secret protection may be unavailable or limited in foreign countries. These disputes may result in costly and time consuming litigation or the license of additional elements of our intellectual property for free. It is possible that other companies may pursue litigation with respect to any claims such companies purport to have against us. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products that could arise in the future, we could be required to obtain licenses to the infringed technology, pay substantial damages under applicable laws, cease the use and sale of infringing products or to expend significant resources to develop non-infringing technology. Litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. We have been or are currently involved in various claims and legal proceedings and have incurred certain costs associated with defending litigation matters. Periodically, we review the status of each significant matter and assess the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. Given the uncertainties associated with litigation, if our assessments prove to be wrong, or if additional information becomes available such that we estimate that there is a possible loss or possible range of losses associated with these contingencies, then we would record the reasonably estimated liability, which could have a material and adverse effect on our operations, financial condition and cash flows. Results of Operations The following table sets forth our statements of operations as a percentage of net sales for the periods indicated: Net sales Cost of sales Gross profit Operating expenses: Research and development Sales and marketing General and administrative Amortization of intangible assets Total operating expenses Operating income 31 Year Ended December 31, 2011 2012 2013 100.0% 100.0% 100.0% 53.2 51.7 52.7 48.3 46.8 47.3 18.1 6.5 5.1 0.3 30.0 18.3 18.1 5.7 4.3 — 28.1 18.7 20.6 6.0 5.0 — 31.6 15.7 Non-operating income (expenses): Gain from disposal of short-term investments Unrealized holding gain (loss) on short-term investment Interest income Dividend income Interest expense Foreign exchange gain (loss), net Other income (loss), net Total non-operating income (loss) Income (loss) before income taxes Income tax expense (benefit) Net income (loss) Year Ended December 31, 2011 2012 2013 0.0 — 0.3 — (0.0) 2.5 0.0 2.8 21.1 2.6 0.0 0.0 (0.0) — 0.8 0.5 — 0.0 (0.0) (0.0) (0.0) 0.1 0.0 0.0 0.6 19.3 2.5 0.8 16.5 4.3 18.5% 16.8% 12.2% Comparison of Year Ended December 31, 2013 to Year Ended December 31, 2012 Net sales. Net sales Mobile storage Mobile communications Others Net sales Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) 202,093 67,564 11,713 281,370 72 24 4 100 185,488 31,022 8,798 225,308 82 14 4 100 (16,605) (36,542) (2,915) (56,062) (8) (54) (25) (20) Our net sales decreased 20% year-over-year to approximately US$225.3 million in 2013, primarily because of decreasing mobile storage and mobile communications sales. Our mobile storage revenue decreased 8% year-over-year primarily because of decreasing card and USB flash drive controller sales, partially offset by strong eMMC and SSD controller sales. Mobile communications revenue decreased 54% because of decreasing LTE transceiver sales relating to our customer’s product transition. Gross profit. Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) Gross profit 131,720 47 106,610 47 (25,110) (19) Gross profit as a percentage of net sales was unchanged at 47% in 2013 as compared to 2012. Our gross profit excluding obsolete and unmarketable inventory write-downs as a percentage of revenue increased from 47% in 2012 to 48% in 2013. 32 Research and development expenses. Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other research and development Research and development 26,423 7,055 17,497 50,975 (in thousands, except percentage data) 9 3 6 19,333 6,351 20,776 9 3 9 (7,090) (704) 3,279 18 46,460 21 (4,515) (27) (10) 19 (9) Our research and development expenses decreased 9% year-over-year to approximately US$46.5 million in 2013. Salary and benefits decreased 27% year-over-year to approximately US$19.3 million, primarily because of less compensation expenses in 2013. Stock-based compensation decreased 10% year-over-year to approximately US$6.4 million, primarily because of lower RSU cost in 2013. Other expenses increased 19% year-over-year to approximately US$20.8 million, primarily because of higher IC tape-out and other project expenses in 2013. Sales and marketing expenses. Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other sales and marketing Sales and marketing 8,897 2,494 4,528 15,919 (in thousands, except percentage data) 3 1 2 7,411 2,197 3,989 3 1 2 (1,486) (297) (539) 6 13,597 6 (2,322) (17) (12) (12) (15) Our sales and marketing expenses decreased 15% year-over-year to approximately US$13.6 million in 2013. Salary and benefits decreased 17% year-over-year to approximately US$7.4 million, primarily because of less compensation expenses in 2013. Stock-based compensation decreased 12% year-over-year to approximately US$2.2 million, primarily because of lower RSU cost in 2013. Other sales and marketing expenses decreased 12% year-over-year to approximately US$4.0 million primarily because of less testing fees in 2013. General and administrative expenses. Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other general and administrative General and administrative 7,428 1,878 2,850 12,156 (in thousands, except percentage data) 2 1 1 6,330 1,406 3,514 3 1 1 (1,098) (472) 664 4 11,250 5 (906) (15) (25) 23 (7) Our general and administrative expenses decreased 7% year-over-year to approximately US$11.3 million in 2013. Salary and benefits decreased 15% year-over-year to approximately US$6.3 million, primarily because of less compensation expenses in 2013. Stock-based compensation decreased 25% year-over-year to approximately US$1.4 million, primarily because of lower RSU cost in 2013. 33 Stock-based compensation The following table presents details of total stock-based compensation expense that is included in each functional line item in our consolidated statements of income: Cost of sales Research and development Sales and marketing General and administrative Total stock-based compensation Years Ended December 31 2012 2013 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) 375 7,055 2,494 1,878 11,802 — 3 1 1 5 308 6,351 2,197 1,406 10,262 — 3 1 1 5 (67) (704) (297) (472) (1,540) (18) (10) (12) (25) (13) Total stock-based compensation decreased 13% primarily because of lower RSU cost in 2013. See Note 15 of Notes to Consolidated Financial Statements for a discussion of activity related to share- based awards. Interest income . Our interest income increased to approximately US$1.8 million for the year ended December 31, 2013 from approximately US$1.4 million for the year ended December 31, 2012 because of higher levels of cash and cash equivalents. Interest expense. Our interest expense increased to approximately US$110 thousand for the year ended December 31, 2013 from approximately US$61 thousand for the year ended December 31, 2012. Foreign exchange gain (loss). For the year ended December 31, 2013, we had a foreign exchange loss less than US$0.1 million, compared with a foreign exchange gain of US$0.4 million for the year ended December 31, 2012. We do not presently engage in any hedging activities. Income tax expense (benefit). Our income tax expense was approximately US$9.8 million for the year ended December 31, 2013 compared to an income tax expense of approximately US$7.1 million for the year ended December 31, 2012. Net income (loss). Net income was approximately US$27.4 million for the year ended December 31, 2013 compare to a net income of approximately US$47.2 thousand million for the year ended December 31, 2012. Comparison of Year Ended December 31, 2012 to Year Ended December 31, 2011 Net sales. Net sales Mobile storage Mobile communications Others Net sales Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) 152,838 56,629 14,378 223,845 68 25 7 100 202,093 67,564 11,713 281,370 72 24 4 100 49,255 10,935 (2,665) 57,525 32 19 (19) 26 Our net sales increased 26% year-over-year to approximately US$281.4 million in 2012, primarily because of increasing mobile storage and mobile communications sales. 34 Our mobile storage revenue increased 32% year-over-year primarily because of strong eMMC and card controller sales. Mobile communications revenue increased 19% because of strong LTE transceiver sales. Gross profit. Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) Gross profit 108,039 48 131,720 47 23,681 22 Gross profit as a percentage of net sales decreased from 48% in 2011 to 47% in 2012 primarily because of lower card and USB flash drive gross margins. Our gross profit excluding obsolete and unmarketable inventory write-downs as a percentage of revenue decreased from 50% in 2011 to 47% in 2012. Research and development expenses. Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other research and development Research and development 21,522 5,049 13,930 40,501 (in thousands, except percentage data) 10 2 6 26,423 7,055 17,497 9 3 6 4,901 2,006 3,567 18 50,975 18 10,474 23 40 26 26 Our research and development expenses increased 26% year-over-year to approximately US$51.0 million in 2012. Salary and benefits increased 23% year-over-year to approximately US$26.4 million, primarily because of higher headcount and compensation expenses in 2012. Stock-based compensation increased 40% year-over-year to approximately US$7.1 million, primarily because of higher cost of RSUs granted to employees in 2012. Other expenses increased 26% year-over-year to approximately US$17.5 million, primarily because of higher IC tape- out and other project expenses in 2012. Sales and marketing expenses. Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other sales and marketing Sales and marketing 8,203 2,060 4,274 14,537 (in thousands, except percentage data) 4 1 2 8,897 2,494 4,528 3 1 2 694 434 254 7 15,919 6 1,382 8 21 6 10 Our sales and marketing expenses increased 10% year-over-year to approximately US$15.9 million in 2012. Salary and benefits increased 8% year-over-year to approximately US$8.9 million, primarily because of the higher headcount and compensation expenses in 2012. Stock-based compensation increased 21% year-over- year to approximately US$2.5 million, primarily because of higher cost of RSUs granted to employees in 2012. Other sales and marketing expenses increased 6% year-over-year to approximately US$4.5 million primarily because of higher testing fees in 2012. 35 General and administrative expenses. Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change Salary and benefits Stock-based compensation Other general and administrative General and administrative 6,446 1,514 3,363 11,323 (in thousands, except percentage data) 3 1 1 7,428 1,878 2,850 2 1 1 5 12,156 4 982 364 (513) 833 15 24 (15) 7 Our general and administrative expenses increased 7% year-over-year to approximately US$12.2 million in 2012. Salary and benefits increased 15% year-over-year to approximately US$7.4 million, primarily because of higher compensation expenses in 2012. Stock-based compensation increased 24% year-over-year to approximately US$1.9 million, primarily because of higher cost of RSUs granted to employees in 2012. Stock-based compensation The following table presents details of total stock-based compensation expense that is included in each functional line item in our consolidated statements of income: Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change Cost of sales Research and development Sales and marketing General and administrative Total stock-based compensation 255 5,049 2,060 1,514 8,878 (in thousands, except percentage data) — — 375 7,055 2,494 1,878 11,802 2 1 1 4 120 2,006 434 364 2,924 47 40 21 24 33 3 1 1 5 Total stock-based compensation increased 33% primarily because of higher cost of RSUs granted to employees in 2012. See Note 15 of Notes to Consolidated Financial Statements for a discussion of activity related to share- based awards. Amortization of intangible assets. Years Ended December 31 2011 2012 US$ % of net sales US$ % of net sales $ change % change (in thousands, except percentage data) Amortization of intangible assets 694 — — — (694) (100) The intangible assets were fully amortized in 2011 and we had no amortization of intangible assets expenses in 2012. Interest income . Our interest income increased to approximately US$1.4 million for the year ended December 31, 2012 from approximately US$0.6 million for the year ended December 31, 2011 because of higher levels of cash and cash equivalents. 36 Interest expense. Our interest expense decreased to approximately US$61 thousand for the year ended December 31, 2012 from approximately US$75 thousand for the year ended December 31, 2011 primarily because of smaller government R&D grants in 2012 compared with 2011. Foreign exchange gain (loss). For the year ended December 31, 2012, we had a foreign exchange gain of US$0.4 million, compared with a foreign exchange gain of US$5.7 million for the year ended December 31, 2011. We do not presently engage in any hedging activities. Income tax expense (benefit). Our income tax expense was approximately US$7.1 million for the year ended December 31, 2012 compared to an income tax expense of approximately US$5.7 million for the year ended December 31, 2011. Net income (loss). Net income was approximately US$47.2 million for the year ended December 31, 2012 compare to a net income of approximately US$41.5 thousand million for the year ended December 31, 2011. Liquidity and Capital Resources As of December 31, 2013, we had approximately US$161.7 million in cash and cash equivalents and approximately US$0.7 million in short-term investments. We maintain our cash balances in bank deposits and in money market instruments. We do not currently engage in any currency hedging activities. Our short-term investments consist primarily of trading bond funds. We believe our existing cash balances and short-term investments, together with cash we expect to generate from operating activities, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors, including the level of our net sales, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products, the costs to ensure access to adequate manufacturing capacity, the continuing market acceptance of our products, availability of attractive acquisition opportunities, dividend payments, and share repurchases. We could be required, or could elect, to seek additional funding through public or private equity or debt financing, and additional funds may not be available on terms acceptable to us or at all. The following table sets forth a summary of our cash flows for the periods indicated: Consolidated Cash Flow Data: Net cash provided by (used in) operating activities Net cash provided by (used in) investing activities Net cash provided by (used in) financing activities Depreciation and amortization Capital expenditures Year Ended December 31, 2011 US$ 2012 US$ (in thousands) 2013 US$ 54,261 (13,947) 2,294 5,580 (4,916) 69,236 (4,749) 224 5,881 (4,280) 49,128 (12,815) (29,493) 6,429 (12,772) Operating activities Our net cash provided by operating activities was approximately US$49.1 million for the year ended December 31, 2013, compared to net cash provided by operating activities of approximately US$69.2 million and US$54.3 million during 2012 and 2011, respectively. For the year ended December 31, 2013, cash flow provided by operations of US$49.1 million resulted primarily from our net income of US$27.4 million and the following reasons: • Our net income includes substantial non-cash charges, namely US$6.4 million of depreciation and amortization and US$10.3 million of stock-based compensation. • Our disposal of short-term investments net of purchase of short-term investments were US$14.1 million. 37 • We reduced working capital by US$10.3 million due to declining sales. Inventory increased by US$1.5 million, notes and accounts receivable decreased by US$5.6 million, notes and accounts payable decreased by US$12.0 million, income tax payable increased by US$3.5 million, and other assets net of other liabilities used US$5.9 million of cash. For the year ended December 31, 2012, cash flow provided by operations of US$69.2 million resulted primarily from our net income of US$47.2 million and the following reasons: • Our net income includes substantial non-cash charges, namely US$5.9 million of depreciation and amortization and US$11.8 million of stock-based compensation. • Our purchase of short-term investments net of disposal of short-term investments were US$12.0 million. • We increased working capital by US$14.6 million to support increasing sales. Inventory increased by US$1.8 million, notes and accounts receivable decreased by US$2.0 million, notes and accounts payable increased by US$5.6 million, income tax payable increased by US$1.3 million, and other assets net of other liabilities provided US$7.5 million of cash. Investing activities Our net cash used in investing activities was approximately US$12.8 million for the year ended December 31, 2013, compared to net cash used in investing activities of approximately US$4.7 million for the year ended December 31, 2012. In 2013, we purchased additional facilities in Hsinchu, Taiwan and design tools. Our net cash used in investing activities was approximately US$4.7 million for the year ended December 31, 2012, compared to net cash used in investing activities of approximately US$13.9 million for the year ended December 31, 2011. In 2011 we provided more collateral to our foundry supplier. Financing activities Our net cash used by financing activities was approximately US$29.5 million for the year ended December 31, 2013, compared to net cash provided by financing activities of approximately US$0.2 million for the year ended December 31, 2012. Our cash used in financing activities in 2013 was primarily for US$10.0 million of ADS repurchases and US$19.9 million of dividend payments. Our net cash provided by financing activities was approximately US$0.2 million for the year ended December 31, 2012, compared to net cash provided by financing activities was approximately US$2.3 million for the year ended December 31, 2011. Our cash generated from financing activities in 2012 was primarily from issuance of ordinary shares upon exercise of employee stock options. Contractual Obligations The following table sets forth our commitments to settle contractual obligations in cash as of December 31, 2013: Operating leases Capital leases Pension Other long term liabilities Contractual cash obligations Amount of Commitment Maturing by Year Total US$ 6,106 15 1,363 418 7,902 Less Than 1 Year US$ 2,080 4 1,363 207 3,654 1-3 Years 3-5 Years US$ US$ (in thousands) 2,799 9 (a) 211 3,019 1,227 2 (a) — 1,229 More Than 5 Years US$ — — (a) — — (a) Our pension obligation after one year has not been estimated. 38 We increased long-term taxes payable of US$1,883 thousand related to uncertain tax positions as of December 31, 2013. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing and outcome of tax audit. Off-balance Sheet Arrangements We currently do not have any outstanding derivative financial instruments, off-balance sheet guarantees or arrangements, interest rate swap transactions, or foreign currency forward contracts. We do not engage in any trading activities involving non-exchange traded contracts. Recent Accounting Pronouncements In December 2011, Financial Accounting Standards Board (“the FASB”) issued an accounting update, which creates new disclosure requirements regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. Certain disclosures of the amounts of certain instruments subject to enforceable master netting arrangements or similar agreements would be required, irrespective of whether the entity has elected to offset those instruments in the statement of financial position. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013 with retrospective application required. The adoption of this guidance did not have a material impact on the Company’s financial statement disclosures since the financial instruments and derivative instruments to which it applies are not significant. In February 2013, the FASB amended its presentation guidance on comprehensive income to improve the reporting of reclassifications out of accumulated other comprehensive income (“AOCI”). The new accounting guidance requires entities to provide information about the amounts reclassified out of AOCI by component. In addition, entities are required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures that provide additional details about those amounts. The amended guidance is effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or cash flows. In February 2013, the FASB issued an accounting update, which provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The new guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flows. In March 2013, the FASB issued an accounting update that amended guidance on a parent’s accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flows. In July 2013, the FASB issued an accounting update, which creates new guidance regarding the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit 39 carryforward exists. Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The guidance is effective for fiscal years beginning after December 15, 2013 and early adoption is permitted. Since this guidance is a change in financial statement presentation only, its adoption is not expected to have material impact on the Company’s result of operations, financial position or cash flows. In April 10, 2014, the FASB issued an accounting update, which changes the criteria for reporting discontinued operations for all public and nonpublic entities. The guidance requires only disposals that represent a strategic shift that has (or will have) a major effect on the entity’s results and operations would qualify as discontinued operations. The guidance also requires entities 1) to expand their disclosures about discontinued operations to include more information about assets, liabilities, income, and expenses and 2) to disclose the pre- tax income attributable to a disposal of “of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements.” The guidance is effective for fiscal years beginning after December 15, 2014 and early adoption is prohibited. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES Executive Officers and Directors Members of our board of directors are elected by our shareholders. Our board of directors consists of seven directors. Our executive officers are appointed by, and serve at the discretion of, our board of directors. The following table sets forth information regarding our directors and executive officers as of the date of this annual report. Name James Chow Wallace C. Kou Steve Chen Tsung-Ming Chung Kenneth Kuan-Ming Lin Lien-Chun Liu Yung-Chien Wang Riyadh Lai Frank Chang Ken Chen Nelson Duann Sangwoo Han John (Chun-O) Kim Arthur Yeh John (Jong Ryul) Lee Kevin Yeh Frank Shu Jason Chiang Robert Fan Age Position President, Chief Executive Officer and Director 63 Chairman of the Board 55 42 Director 64 Director 61 Director 56 Director 51 Director 45 Chief Financial Officer 48 VP of R&D, Mobile Storage 52 VP of Operations 45 VP of Product Marketing, Mobile Storage 45 53 VP of Sales, Mobile Communications 53 VP of Sales, Mobile Storage 50 VP of R&D, Mobile Communications 50 VP of R&D, Algorithm & Technology 57 VP of R&D, SSD System Technology and VCT 46 VP of HR and Administration, and Special Assistant to CEO 50 VP and General Manager, SMI U.S. Senior VP and General Manager, Mobile Communications Executive Officers and Directors James Chow, Chairman of the Board of Directors Mr. Chow has served as the Chairman of our board of directors since April 2005. Mr. Chow has been the Chairman of Concord Financial Co., Ltd. since 1993. Concord Financial Co., Ltd. is an investment holding company and was one of our significant shareholders. Mr. Chow has an MBA from Columbia University. 40 Wallace C. Kou, President, Chief Executive Officer, Director Mr. Kou founded Silicon Motion in 1995 and has been our President and Chief Executive Officer since our founding. Prior to founding Silicon Motion, Mr. Kou was the Vice President and Chief Architect at the Multimedia Products Division of Western Digital Corporation, which developed graphics processors for notebook PCs and was sold to Philips Semiconductor in 1995. Before Western Digital, Mr. Kou worked for Wyse Technology. Mr. Kou has a BS in Electrical & Control Engineering from the National Chiao Tung University in Taiwan and an MS in Electrical & Computer Engineering from the University of California at Santa Barbara. Steve Chen, Director Mr. Chen has been the chairman of Mercuries Bakery Co., Ltd. since 2008 and is a Director of Mercuries & Associates, Ltd., Mercuries Furniture Co., Ltd., Mercuries General Media Inc., Cameo Communications, Inc., and Tons Lightology Inc. Mr. Chen has a Master of Engineering degree from Cornell University. Tsung-Ming Chung, Director Mr. Chung joined our board of directors in June 2005. Mr. Chung is the Chairman of Dynapack International Technology Corp, a leading provider of battery packs for notebook PCs and tablets. From 1985 to 2000, Mr. Chung was an audit partner at Arthur Andersen. He is also a director at Far East International Bank and Taiwan Mobile Corporation. Mr. Chung has a BA in Business Administration from the National Taiwan University and an MBA from the National Cheng-chi University in Taiwan. Kenneth Kuan-Ming Lin, Director Mr. Lin joined our board of directors in September 2009. Mr. Lin is the Chairman of Premier Capital Management Corp., the Taiwan Private Equity and Venture Capital Association, and Ruby Tech Corp., and is a member of the board of directors of the Straits Economics & Cultural Interchange Association. He was previously Assistant Vice President of MiTAC Corporation from 1977 to 1984, Vice President of Synnex Corporation from 1984 to 1987, President of TaiDevelop Information Corp. from 1987 to 1990 and Chairman of the board of System General Corp. from 1998 to 2001. Mr. Lin has a BS in Electrical Engineering from the National Taiwan University. Lien-Chun Liu, Director Ms. Liu joined our board of directors in June 2005. Ms. Liu is a research fellow at the Taiwan Research Institute. She also currently serves on the board of supervisors of Concord VIII Venture Capital Co., Ltd and on the board of directors of New Tamsui Golf Course. From 2000 to 2004, she also served on the board of supervisors of China Television Corp. Ms. Liu has a BA from Wellesley College and a JD from Boston College Law School. Yung-Chien Wang, Director Mr. Wang joined our board of directors in June 2005. Mr. Wang has over 20 years of working experience in the human resource and legal services industries. Mr. Wang has been a consultant of Professional Trust Co., Ltd., a human resource consulting firm in Taiwan since August 1998 and is currently its Vice President. Mr. Wang has a law degree from Fu Jen Catholic University in Taiwan. Riyadh Lai, Chief Financial Officer Mr. Lai joined us in April 2007 from ING Corporate Finance, Asia, where he was the Head of the Technology Group. Previously, he was also an investment banker at Morgan Stanley and ABN AMRO and finance manager at PepsiCo in Hong Kong and New York. Mr. Lai has over a decade of financial management and M&A transaction experience. He has a BA in Economics from Georgetown University and an MBA from New York University. 41 Frank Chang, VP of R&D, Mobile Storage Mr. Chang has served as our Vice President of research and development since 2008. Mr. Chang is head of research and development for our mobile storage products and has around 20 years of experience in the integrated circuit design industry. He was previously a project manager of firmware development at Holtek Semiconductors. Mr. Chang has a BS in Electrical Engineering from the National Changhua University of Education in Taiwan. Ken Chen, VP of Operations Mr. Chen has served as our Vice President in charge of operations since November 2003. Mr. Chen has over 20 years of manufacturing and operations experience in the semiconductor industry, managing supply chain and virtual manufacturing systems including wafer fabrication, mask tooling, as well as assembly and testing. Mr. Chen previously served in management positions at Faraday Technology and UMC, and joined us in 2003. Mr. Chen has a BS in Industrial Engineering from Chung Yuan Christian University in Taiwan and an MS in Industrial Engineering and Engineering Management from the National Tsing Hua University, Taiwan. Nelson Duann, VP of Product Marketing, Mobile Storage Mr. Duann became our Vice President in charge of our mobile storage marketing in September 2010. He joined Silicon Motion in August 2007 as a product marketing director and R&D team leader. Mr. Duann has almost 15 years of experience in the semiconductor industry in product design, development and marketing. Prior to Silicon Motion, he worked for Sun Microsystems Inc., focusing on UltraSPARC micro Processor projects. He has an MS in Communications Engineering from National Chiao Tung University in Taiwan and an MS in Electrical Engineering from Stanford University. Sangwoo Han, Senior VP and General Manager, Mobile Communications Mr. Han became the General Manager of our Mobile Communications product line in July 2008. He was formerly the Chief Technology Officer at FCI, a company that we acquired in April 2007. Mr. Han joined FCI in 2003 and had been in charge of product design, development, production and marketing. In 1997, he co-founded RF Solutions Inc. in Atlanta, Georgia, which became the Anadigics Wireless LAN Center of Excellence. Mr. Han has a BS in Electrical Engineering from Carnegie-Mellon University, an MS in Electrical Engineering from the University of Pennsylvania, and a PhD in Electrical Engineering from the Georgia Institute of Technology. John (Chun-O) Kim, VP of Sales, Mobile Communications Mr. Kim became the Vice President of our Mobile Communications product line in July 2008. He was formerly the Vice President of Sales at FCI, a company that we acquired in April 2007. Mr. Kim joined FCI in 2006 and had previously served in management positions at Hewlett-Packard’s semiconductor division (now Avago Technologies) and as a CEO of a private company. Mr. Kim has over 16 years of semiconductor sales leadership experience, including managing marketing strategies, product promotions and sales activities. He has an MS in Electrical Engineering from Ajou University in Korea. Arthur Yeh, VP of Sales, Mobile Storage Mr. Yeh has served as our Vice President in charge of our mobile storage sales since November 2004. Mr. Yeh has over 15 years of sales experience managing marketing strategies, including product promotions and sales activities for semiconductor products. Mr. Yeh previously served in management positions at VIA Technologies for 10 years and joined us in 2004. Mr. Yeh holds an MS degree in Management Business Administration from the National Chung Hsing University, Taiwan. 42 John (Jong Ryul) Lee, VP of R&D, Mobile Communications Mr. Lee became the Vice President of our Mobile Communications product line in July 2008. He was formerly the Vice President of R&D at FCI, a company that we acquired in April 2007. Mr. Lee joined FCI in 2000 and had been in charge of product design, development, production and quality systems. In 2013, he became a director of the Semiconductor & Device Society of The Institute of Electronics Engineers of Korean (IEEK). He was previously a senior engineer at the Electronics and Telecommunications Research Institute (ETRI) in Korea. Mr. Lee has a BS and an MS in Electronics Engineering from Chung Ang University in Korea. Kevin Yeh, VP of R&D, Algorithm & Technology Mr. Yeh became our Vice President of research and development in August 2012. He joined Silicon Motion in September 2003 as a product marketing director and then he led the Algorithm and Technology R&D team. Mr. Yeh has more than 20 years of experience in semiconductor product design, development and marketing. Prior to Silicon Motion, Mr. Yeh worked in Taiwan Semiconductor Manufacturing Company, Neo Magic, VLSI Technology and LSI. Mr. Yeh holds a BS degree in Control Engineering from National Chiao Tung University in Taiwan and an MS degree in Electronic Engineering from Syracuse University. Frank Shu, VP of R&D, SSD System Technology and VCT Mr. Shu has served as our Vice President of SSD System Technology since July 2012. Mr. Shu has more than 20 years of experience in the storage and PC system industry. Before joining Silicon Motion, Mr. Shu was the VP of R&D in charge of SSD testing at Allion Test Lab Inc. Mr. Shu also worked for Microsoft and played a key role in defining and developing the software storage stack for the Windows operating system. Prior to Microsoft, Mr. Shu worked for Fujitsu, Seagate and Everex. Mr. Shu has a BS in Electronic Engineering from Nanjing Aeronautical Institute in China and an MS degree in Computer Science from the Oregon Graduate Institution of Science & Technology. Jason Chiang, VP of HR and Administration and Special Assistant to CEO Mr. Chiang joined Silicon Motion in 2002 and has been serving as our Vice President of HR and Administration and Special Assistant to our CEO since 2005. Mr. Chiang has more than 18 years of finance and business administration experience. Prior to joining Silicon Motion, Mr. Chiang was a Director at Concord Venture Capital. Mr. Chiang has a BS in Economics from the National Taiwan University and an MS degree in Business Administration from Rochester University. Robert Fan, VP and General Manager, SMI U.S. Mr. Fan has served as our Vice President and General Manager of SMI U.S. since May 2013. He manages Silicon Motion’s business operations in the U.S. and Europe and has over 20 years of sales and marketing experience. Prior to Silicon Motion, Mr. Fan served in executive management roles at Spansion, Entorian, Berkana Wireless (acquired by Qualcomm) and Resonext (acquired by RF Micro Devices). He also spent over nine years at Intel in sales, marketing and management positions. Mr. Fan holds a BS in Electrical Engineering from the University of California, Berkeley and MSEE from Santa Clara University, and completed the General Management Executive Program at McCombs School of Business, University of Texas. There is no arrangement or understanding with major shareholders, customers, suppliers or others pursuant to which any person referred to above was selected as a director or member of senior management. 43 Board Practices Board Committees Our board of directors has established an audit committee, a compensation committee, and a nominating and corporate governance committee. Audit Committee. The audit committee is responsible for reviewing the financial information that will be provided to shareholders and others, reviewing the systems of internal controls that management and the board of directors have established, appointing, retaining and overseeing the performance of the independent registered public accounting firm, overseeing our accounting and financial reporting processes and the audits of our financial statements, and pre-approving audit and permissible non-audit services provided by the independent registered public accounting firm. Tsung-Ming Chung, Lien-Chun Liu, and Yung-Chien Wang are members of our audit committee. Our board of directors has determined that Mr. Chung, the Chairman of the audit committee, is the committee’s “Audit Committee Financial Expert” as required by Nasdaq and U.S. Securities and Exchange Commission (“SEC”) rules. Compensation Committee. The compensation committee’s basic responsibility is to review the performance and development of management in achieving corporate goals and objectives and to assure that our senior executives are compensated effectively in a manner consistent with our strategy, competitive practice and the requirements of the appropriate regulatory bodies. Toward that end, this committee oversees, reviews and administers all of our compensation, equity and employee benefit plans and programs. Lien-Chun Liu, Steve Chen, and Yung-Chien Wang are members of our compensation committee, with Mr. Chen serving as the Chairman of the committee. Nominating and Corporate Governance Committee. The nominating and corporate governance committee is responsible for overseeing, reviewing and making periodic recommendations concerning our corporate governance policies, and for recommending to the full board of directors candidates for election to the board of directors. Lien-Chun Liu, Steve Chen, and Yung-Chien Wang are members of our nominating and corporate governance committee, with Ms. Liu serving as the Chairman of the committee. Our board of directors has adopted a code of ethics, which is applicable to all of our employees. Our Code of Ethics is posted on our website at www.siliconmotion.com. Duties of Directors Under Cayman Islands law, our directors have a duty to act honestly, in good faith and with a view to the best interests of our company. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to our company, our directors must ensure compliance with our memorandum and articles of association. The functions and powers of our board of directors include, among others: • • • • • • convening shareholders’ meetings and reporting its work to shareholders at such meetings; implementing shareholders’ resolutions; determining our business plans and investment proposals; formulating our profit distribution plans and loss recovery plans; determining our debt and finance policies and proposals for the increase or decrease in our registered capital and the issuance of debentures; formulating our major acquisition and disposition plans, and plans for merger, division or dissolution; 44 • • proposing amendments to our amended and restated memorandum and articles of association; and exercising any other powers conferred by the shareholders’ meetings or under our amended and restated memorandum and articles of association. Terms of Directors and Officers Under Cayman Islands law and our articles of association, our directors hold office until a successor has been duly elected and qualified. Our articles of association provide that our directors serve for a term of three years, with one-third of the directors (or, if their number is not a multiple of three, the number nearest to but not greater than one-third) subject to re-election at each annual general meeting of shareholders (chairman and managing director not subject to retirement by rotation nor to be taken into account in determining the number of directors to retire), unless the director was appointed by the board of directors, in which case such director holds office until the next annual meeting of shareholders at which time such director is eligible for re-election. One of our seven directors is currently subject to re-election at our next annual general meeting of shareholders. All of our executive officers are appointed by and serve at the discretion of our board of directors. Limitation on Liability and Other Indemnification Matters Cayman Islands law and our articles of association allow us to indemnify our directors, secretary and other officers acting in relation to any of our affairs against actions, costs, charges, losses, damages and expenses incurred by reason of any act done or omitted in the execution of their duties as our directors, secretary and other officers. Under our memorandum and articles of association, indemnification is not available to any matter in respect of any fraud, dishonesty, willful misconduct or bad faith which may attach to any of them. Compensation of Directors and Executive Officers For the year ended December 31, 2013, the aggregate compensation to our directors and senior executive officers was approximately US$3.25 million. In 2013, we granted options and restricted stock units to our executive officers as a group to acquire an aggregate of 370,000 ordinary shares. The options and restricted stock units granted to our executive officers and non-executive directors are subject to the same vesting conditions as those of our employees. Service Contracts We currently do not have service contracts with our directors. Share-Based Compensation Plans and Option Grants In April 2005, our board of directors and shareholders adopted our 2005 Incentive Plan. Our shareholders approved our Amended and Restated 2005 Incentive Plan (referred to in this report as the “Plan”) at our Annual General Meeting in August 2006, including an amendment to increase the authorized number of shares available for issuance under the plan from 10,000,000 shares to 25,000,000 shares. In 2009, the board of directors amended the Plan to increase the authorized shares available for issuance under the Plan to 40,000,000 shares. The Plan provides for the grant of stock options, stock bonuses, restricted stock awards, restricted stock units and stock appreciation rights, which may be granted to our employees (including officers), directors and consultants. Share Reserve. The aggregate number of ordinary shares that may be issued pursuant to awards granted under the Plan will not exceed 40,000,000 shares, inclusive of ordinary shares issuable upon exercise of awards previously granted under the Silicon Motion, Inc. Guidelines for Issuance and Subscription of Employee Stock Option, which options we have, subject to the consent of the respective option-holders, agreed to assume in the share exchange. 45 The following types of shares issued under the Plan may again become available for the grant of new awards under the Plan: restricted stock issued under the Plan that is forfeited or repurchased by us prior to it becoming fully vested; shares withheld for taxes; shares tendered to us to pay the exercise price of an option; and shares subject to awards issued under the Plan that have expired or otherwise terminated without having been exercised in full. Administration. The board of directors will administer the Plan and may delegate this authority to administer the plan to a committee. Subject to the terms of the Plan, the plan administrator, which is our board of directors or its authorized committee, determines recipients, grant dates, the numbers and types of stock awards to be granted and the terms and conditions of the stock awards, including the period of their exercisability and vesting. Subject to certain limitations, the plan administrator will also determine the exercise price of options granted, the purchase price for restricted stock and restricted stock units, and, if applicable, the strike price for stock appreciation rights. Capitalization adjustments. In the event of a dividend or other distribution (whether in the form of cash, ordinary shares, other securities, or other property), recapitalization, stock split, reorganization, merger, consolidation, exchange of our ordinary shares or our other securities, or other change in our corporate structure, the board of directors may adjust the number and class of shares that may be delivered under the Plan and the number, class and price of the shares covered by each outstanding stock award. Changes in control. In the event of a change in control of the company, all outstanding options and other awards under the 2005 Incentive Plan may be assumed, continued or substituted for by any surviving or acquiring entity. If the surviving or acquiring entity elects not to assume, continue or substitute for such awards, the vesting of such awards held by award holders whose service with us or any of our affiliates has not terminated will be accelerated and such awards will be fully vested and exercisable immediately prior to the consummation of such transaction, and the stock awards shall automatically terminate upon consummation of such transaction if not exercised prior to such event. Amendments to Plan in 2009 and 2010. In 2009, our board of directors amended the Plan to (i) increase the authorized shares to 40,000,000 as discussed above and (ii) allow certain unilateral amendments to outstanding options and RSU grants. Shareholder approval for such amendments was not required under Cayman law and we used the home-country exemption for foreign private issuers under Nasdaq rules to effect such amendments without a shareholder vote. In 2009, the Company cancelled 1,221,875 RSUs. There were no changes to outstanding options in 2009. In 2010, the Company exchanged 4,369 thousand stock options for 3,785 thousand new stock options with a similar value. Future amendments and termination. The board of directors may amend (subject to shareholder approval as required by applicable law), suspend or terminate the Plan at any time. Unless sooner terminated by the board of directors, the Plan will terminate pursuant to its terms on April 22, 2015. Employees The following table sets forth the number of our employees categorized by function as of the dates indicated. Management and administration Operations Research and development Sales and marketing Total 46 As of December 31, 2011 2012 2013 98 22 388 134 642 98 24 429 137 688 100 24 468 139 731 As of December 31, 2013, we had 731 total employees, including 476 in Taiwan, 27 in the United States, 104 in China, 118 in Korea, and 6 in Japan. 582 of our total employees are engineers. We do not have any collective bargaining arrangements with our employees and consider our relations with our employees to be good. Share Ownership Under U.S. securities law, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be the beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Under these rules, more than one person may be deemed a beneficial owner of securities as to which such person has no economic interest. There were 134,849,960 of our ordinary shares outstanding as of March 31, 2014. The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of March 31, 2014, less otherwise indicated in the footnotes, by each of our directors and officers: Shares Beneficially Owned Number % Executive Officers and Directors: James Chow (1) Wallace C. Kou (2) Steve Chen Tsung-Ming Chung (3) Kenneth Kuan-Ming Lin (4) Lien-Chun Liu (5) Yung-Chien Wang (6) Riyadh Lai (7) Frank Chang (8) Ken Chen (9) Nelson Duann (10) Sangwoo Han (11) John (Chun-O) Kim (12) Arthur Yeh (13) John (Jong Ryul) Lee (14) Kevin Yeh (15) Frank Shu (16) Jason Chiang (17) Robert Fan (18) 1.79 2.72 — 2,407,546 3,664,394 — 76,280 50,000 176,280 790,674 1,650,500 286,040 437,049 80,000 210,816 54,734 431,628 305,780 216,000 25,000 — 690,060 8,000 * * * * 1.22 * * * * * * * * * * Less than one percent * (1) Represents 2,407,546 shares owned by Mr. Chow. Mr. Chow is the chairman of Concord Consulting Inc. and Concord Financial Co. Ltd. which owned 42,445 and 196,491 shares, respectively. Mr. Chow disclaims any beneficial ownership of these shares. (2) Represents 3,109,100 shares owned by Mr. Kou, 35,094 shares owned by his spouse and 520,200 shares that Mr. Kou has the right to acquire within the next 60 days upon the exercise of RSUs or options. (3) Represents 76,280 shares owned by Mr. Chung. (4) Represents 50,000 shares owned by Mr. Lin. (5) Represents 176,280 shares owned by Ms. Liu. 47 (6) Represents 790,674 shares owned by Mr. Wang. (7) Represents 499,200 shares owned by Mr. Lai, 767,000 shares owned by his spouse, 384,300 shares that Mr. Lai has the right to acquire within the next 60 days upon the exercise of options or RSUs. (8) Represents 286,040 shares owned by Mr. Chang. (9) Represents 431,324 shares owned by Mr. Chen and 5,725 shares owned by his spouse. (10) Represents 80,000 shares owned by Mr. Duann. (11) Represents 210,816 shares owned by Mr. Han. (12) Represents 54,734 shares owned by Mr. Kim. (13) Represents 431,628 shares owned by Mr. Yeh. (14) Represents 305,780 shares owned by Mr. Lee. (15) Represents 216,000 shares owned by Mr. Yeh. (16) Represents 25,000 shares owned by Mr. Shu. (17) Represents 523,360 shares owned by Mr. Chiang and 11,448 shares owned by his spouse, 155,252 shares that Mr. Chiang has the right to acquire within the next 60 days upon the exercise of options or RSUs. (18) Represents 8,000 shares owned by Mr. Fan. ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS Major Shareholders As of March 31, 2014, there were 134,849,960 of our ordinary shares outstanding. The Bank of New York Mellon, the depositary under our ADS deposit agreement, has advised us that as of March 31, 2014, we had 33,594,442 ADSs, representing 134,377,768 ordinary shares. The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of March 31, 2014: Identity of person or group Number of shares owned Percentage Owned Point72 Asset Management, Point 72 Capital Advisors Inc., SAC Capital Associates, Cubist Systematic Strategies, Steven A. Cohen and SAC Capital Advisors LP (1) 1,694,756 5.2 Notes: (1) According to the Schedule 13G filed by Point72 Asset Management, Point 72 Capital Advisors Inc., SAC Capital Associates, Cubist Systematic Strategies, Steven A. Cohen and SAC Capital Advisors LP with the SEC on April 7, 2014. To our knowledge, we are not owned or controlled, directly or indirectly, by another corporation, by any foreign government or by any other natural or legal persons, severally or jointly. We are not aware of any arrangement which may at a later date result in a change of control of our company. No holder of our ordinary shares has preferential voting rights. Related Party Transactions No related party transactions occurred between January 1, 2011 and April 20, 2013. ITEM 8. FINANCIAL INFORMATION Consolidated Financial Statements See “Item 18. Financial Statements” and pages F-1 through F-32 of this annual report. Legal Proceedings We are subject to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. Although the outcome of such proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these matters will have a material adverse effect on our business, results of operations, financial position or cash flows. Any litigation, however, involves potential risk 48 and potentially significant litigation costs, and therefore there can be no assurance that any litigation which is now pending or which may arise in the future would not have such a material adverse effect on our business, financial position, results of operations or cash flows. All American Semiconductor, Inc. (“All American” or “AASI”) was a former distributor for the Company. On April 25, 2007, All American filed for Chapter 11 bankruptcy protection. At the time of the filing, the Company had US$256 thousand of unpaid accounts receivable from All American. On April 17, 2009, SMI USA and related entities were named as defendants in an adversary proceeding filed by the AASI Creditor Liquidating Trust (“CLT”) in the bankruptcy case pending in the U.S. Bankruptcy Court for the Southern District of Florida. The CLT was seeking the return of allegedly avoidable transfers in the amount of US$854 thousand. The Company filed an answer and affirmative defenses. In March 2010, SMI USA settled with the CLT by paying the amount of US$220 thousand and on April 1, 2010, the Bankruptcy Court granted the motion to approve stipulations to compromise controversy. On August 23, 2010, the Court entered an order dismissing the adversary proceeding. In June 2011, Liquidating Trustee for the CLT filed the AASI Creditor Liquidating Trustee’s Seventeenth Omnibus Objection to Claims but in August 2011, withdrew it with respect to SMI USA’s proof of claim. According to the CLT’s letter dated September 9, 2011, it is currently finalizing its claims review process and preparing for distribution to beneficiaries who are holders of allowed claims and have rights to a distribution pursuant to the Plan. In January 2012 and 2014, we received the first distribution of US$21 thousand and the second distribution of US$36 thousand, respectively. In 2006, FCI joined with other technology companies and invested in the Pangyo Silicon Park Construction Project Cooperative (“Pangyo Cooperative”) in Korea. In July 2010, FCI, TLi Inc. (“TLI”), OCI Materials Co., Ltd (“OCI”) and other companies withdrew from the Pangyo Cooperative and forfeited 10% of their total investment. FCI believes its loss was caused by bad will actions taken by TLI. In December 2011, FCI and OCI together filed a complaint against TLI at the Suwon District Court in Korea. In April 2013, the court dismissed the plaintiffs’ complaints. The plaintiffs have decided not to appeal the court’s decision. Policy on Dividend Distributions Pursuant to the laws and regulations of the ROC and the Articles of Incorporation of SMI Taiwan, our subsidiary in Taiwan must make appropriations from annual earnings to a non-distributable reserve which could affect our ability to pay cash or stock dividends, if any. The Taiwan subsidiary may only distribute dividends after it has made allowances as determined under ROC GAAP at each year-end for: a. Payment of taxes; b. Recovery of prior years’ deficits, if any; c. d. 10% of remaining balance after deduction for a and b as legal reserve; Special reserve based on relevant laws or regulations or 10% of remaining balance for deduction from above a to c as special reserve when necessary; e. Cash or stock bonus to employees at 0.01% of any remaining earnings after the above reserves have been appropriated, based on a resolution of the board of directors. If bonus to employees is in the form of stock, the bonus may also be appropriated to employees of subsidiaries under the board of directors’ approval. Dividends Although no dividends were declared in our fiscal years ended 2011 and 2012. We announced and paid a total of $19.9 million in dividends during 2013. Future dividends, if any, on our outstanding ADSs and ordinary shares will be declared by and subject to the discretion of our board of directors. If our board of directors decides 49 to distribute dividends, the form, frequency and amount of such dividends will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors our board of directors may deem relevant. Any future dividend we declare will be paid to the holders of ADSs, subject to the terms of the deposit agreement, to the same extent as holders of our ordinary shares, to the extent permitted by applicable laws and regulations, less the fees and expenses payable under the deposit agreement. Any dividend we declare will be distributed by the depositary bank to the holders of our ADSs. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars. ITEM 9. THE OFFER AND LISTING Market and Share Price Information Our ADSs, each representing four of our ordinary shares, have been listed on Nasdaq since June 30, 2005. Our ADSs trade under the symbol “SIMO.” The Nasdaq Global Select Market is the principal trading market for our ADSs, which are not listed on any other exchanges in or outside the United States. The high and low sales prices of our ADSs on Nasdaq since 2008 are as follows: Annual: 2009 2010 2011 2012 2013 Quarterly: First Quarter, 2012 Second Quarter, 2012 Third Quarter, 2012 Fourth Quarter, 2012 First Quarter, 2013 Second Quarter, 2013 Third Quarter, 2013 Fourth Quarter, 2013 First Quarter, 2014 Monthly November 2013 December 2013 January 2014 February 2014 March 2014 April 2014 (through April 29) Price per ADS (US$) High Low 4.48 6.50 21.60 24.98 16.19 24.98 22.20 17.07 16.10 16.19 11.85 13.25 15.48 18.44 15.48 15.41 17.36 17.70 18.44 17.89 1.90 2.64 4.14 11.32 9.90 16.65 12.91 11.32 11.87 11.57 9.90 10.38 11.71 12.92 12.23 13.63 12.92 16.17 16.32 15.58 ITEM 10. ADDITIONAL INFORMATION Memorandum and Articles of Association The information called for by Item 10B (“Memorandum and Articles of Association”) is incorporated by reference to the information under the heading “Description of Share Capital” in our Registration Statement on Form F-1, as amended (Registration Number 333-125673) and as filed with the SEC on June 5, 2005. 50 Material Contracts We have not entered into any material contracts within the past two fiscal years other than in the ordinary course of business and other than those described in Item 4, “Information on the Company” or elsewhere in this annual report. Taxation United States Federal Income Taxation The following discussion summarizes certain U.S. federal income tax consequences to a U.S. Holder, as defined below, who purchases our ADSs and ordinary shares. This discussion assumes that investors will hold their ADSs or ordinary shares as capital assets (generally, property held for investment). This discussion does not discuss all aspects of U.S. federal income taxation which may be important to particular investors in light of their individual circumstances, including investors subject to special taxation, such as: • • • • • • • • • • • banks and financial institutions; brokers and dealers in securities or currencies; insurance companies; tax-exempt organizations and retirement plans; grantor trusts; S corporations; persons holding ADSs or ordinary shares as part of hedging, conversion, constructive sale, straddle or other integrated transactions; persons who acquired their ordinary shares upon the exercise of employee stock options or otherwise as compensation; persons who have elected the mark-to-market method of accounting; persons who own 10% or more of our ADSs or shares; real estate investment trusts or regulated investment companies; • U.S. persons whose “functional currency” is not the U.S. dollar; • certain former citizens or long-term residents of the United States; and • Non-U.S. Holders (as defined below). This discussion is based in part on representations by the depositary and assumes that each obligation under the deposit agreement and any related agreement will be performed in accordance with its terms. Furthermore, the discussion below is based upon the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), and U.S. Treasury regulations, rulings and judicial decisions hereunder as of the date hereof. Such authorities are subject to change, possibly on a retroactive basis, which may result in U.S. federal income tax consequences different from those discussed below. A person considering an investment in our ADSs or ordinary shares is urged to consult its tax advisor concerning U.S. federal, state, local and non-U.S. income and other tax consequences. A U.S. Holder is a beneficial owner of ADSs or ordinary shares that is for U.S. federal income tax purposes: • • a citizen or resident individual of the United States; a corporation or other entity taxable as a corporation created or organized in or under the laws of the United States, any state thereof, or the District of Columbia; 51 • • an estate the income of which is subject to U.S. federal income taxation, regardless of its source; or a trust if it is subject to the primary supervision of a court within the United States and one or more U.S. persons have the authority to control all substantial decisions of the trust or has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person. A beneficial owner of ADSs or ordinary shares that is not a U.S. Holder is referred to herein as a “Non-U.S. Holder.” If a partnership or limited liability company treated as a partnership for U.S. federal income tax purposes holds ADSs or ordinary shares, the tax treatment of a partner or member will generally depend on the status of the partner or member and the activities of the partnership or such limited liability company. A partner of a partnership or a member of such a limited liability company holding ADSs or ordinary shares is urged to consult its tax advisors regarding an investment in our ADSs or ordinary shares. ADSs. In general, for U.S. federal income tax purposes, a U.S. Holder of ADSs will be treated as the owner of the underlying ordinary shares that are represented by such ADSs. Deposits and withdrawals of ordinary shares in exchange for ADSs will not be subject to U.S. federal income taxation. Distributions on ADSs or ordinary shares. Unless the passive foreign investment company rules, as discussed below, apply, the gross amount of the distributions in respect of the ADSs or ordinary shares will be subject to tax as dividend income to the extent of our current and accumulated earnings and profits, as determined under U.S. federal income tax principles. Subject to certain limitations, dividends paid to non- corporate U.S. Holders, including individuals, may be eligible for a reduced rate of taxation if we are deemed to be a “qualified foreign corporation” for U.S. federal income tax purposes and provided that such holder satisfies certain holding period requirements with respect to the ownership of our ADSs, or ordinary shares. The reduced rate of tax applicable to dividends from a “qualified foreign corporation” does not apply to taxable years beginning after December 31, 2012, absent further legislation. Subject to the exceptions discussed below, a corporation is a qualified foreign corporation if it is: • • a foreign corporation that is eligible for the benefits of a comprehensive income tax treaty with the United States that includes an exchange of information program; or a foreign corporation if its stock with respect to which a dividend is paid or its ADSs backed by such stock are readily tradable on an established securities market within the United States. The Cayman Islands does not currently have a comprehensive income tax treaty with the United States. A foreign corporation (even if it is described above) does not constitute a qualified foreign corporation if, for the taxable year in which the dividend is paid or the preceding taxable year, the foreign corporation is or was a passive foreign investment company. Although we believe that we are a qualified foreign corporation because the ADSs will be traded on an established U.S. securities market, no assurance can be given in this regard. In addition, our status as a qualified foreign corporation may change. A U.S. Holder that exchanges its ADSs for ordinary shares may not be eligible for the reduced rate of taxation on dividends if the ordinary shares are not deemed to be readily tradable on an established securities market within the United States. Dividends will be includable in a U.S. Holder’s gross income on the date actually or constructively received by the depositary, in the case of ADSs or, in the case of ordinary shares, by such U.S. Holder. These dividends will not be eligible for the dividends-received deduction generally allowed to U.S. corporations in respect of dividends received from other U.S. corporations. To the extent we pay dividends on the ADSs or ordinary shares in a currency other than the U.S. dollar, the U.S. dollar value of such dividends should be calculated by reference to the exchange rate prevailing on the date of actual or constructive receipt of the dividend, regardless of whether the foreign currency is converted into U.S. 52 dollars at that time. If the foreign currency is converted into U.S. dollars on the date of actual or constructive receipt of such dividends, the tax basis of the U.S. Holder in such foreign currency will be equal to its U.S. dollar value on that date and, as a result, the U.S. Holder generally should not be required to recognize any foreign currency exchange gain or loss. Dividends paid in respect of the ADSs or ordinary shares generally will be treated as income from sources outside the United States. To the extent that the amount of any distribution exceeds our current and accumulated earnings and profits, the distribution will first be treated as a tax-free return of capital, causing a reduction in the adjusted basis of the ADSs or ordinary shares, and the balance in excess of adjusted basis will be taxed as capital gain. Sale, exchange or other disposition of ADSs or ordinary shares. Unless the passive foreign investment company rules, as discussed below, apply, upon the sale, exchange or other disposition of ADSs or ordinary shares a U.S. Holder generally will recognize capital gain or loss equal to the difference between the amount realized upon the sale, exchange or other disposition and the adjusted tax basis of the U.S. Holder in the ADSs or ordinary shares. The capital gain or loss generally will be long-term capital gain or loss if, at the time of sale, exchange or other disposition, the U.S. Holder has held the ADS or ordinary share for more than one year. Net long-term capital gains of non-corporate U.S. Holders, including individuals, are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. Any gain or loss that a U.S. Holder recognizes generally will be treated as gain or loss from sources within the United States for U.S. foreign tax credit limitation purposes. Additional tax on net investment income. An additional 3.8% federal income tax may be assessed on net investment income (including dividends, other distributions, and gain realized on the sale of ADSs or ordinary shares) earned by certain U.S. Holders. This tax does not apply to U.S. Holders who hold ADSs or ordinary shares in the ordinary course of certain trades or businesses. Passive foreign investment company rules. In general, we will be classified as a passive foreign investment company for any taxable year in which either (a) at least 75% of our gross income is passive income or (b) at least 50% of the value (determined on the basis of a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income. For this purpose, passive income generally includes dividends, interest, royalties, rents (other than rents and royalties derived in the active conduct of a trade or business and not derived from a related person), annuities and gains from assets that produce passive income. If we own directly or indirectly at least 25% by value of the equity shares of another corporation, we will be treated for purposes of the passive foreign investment company tests as owning a proportionate share of the assets of the other corporation, and as receiving directly a proportionate share of the other corporation’s income. We believe, based on our present and projected composition of our income and valuation of our assets, we are not currently classified as a passive foreign investment company for U.S. federal income tax purposes, although no assurance can be given in this regard. Whether we are a passive foreign investment company for any particular taxable year is determined on an annual basis and will depend on the composition of our income and assets, including goodwill. The calculation of goodwill will be based, in part, on the then market value of our capital stock, which is subject to fluctuation. In addition, the composition of our income and assets will be affected by how we spend the cash we raise in this offering. Accordingly, there can be no assurance that we will not be classified as a passive foreign investment company in the current or any future taxable year. If we are a passive foreign investment company for any taxable year during which a U.S. Holder has an equity interest in our company, unless the U.S. Holder makes a mark-to-market election as discussed below, such U.S. Holder will be subject to special tax rules in any future taxable year regardless of whether we are classified as a passive foreign investment company in such future years with respect to (a) “excess distributions” and (b) gain from the disposition of stock. Excess distributions are defined generally as the excess of the amount received with respect to the equity interests in the taxable year over 125% of the average annual distributions received in the shorter of either the three previous years or a U.S. Holder’s holding period before the taxable year 53 and must be allocated ratably to each day of the U.S. Holder’s holding period. The amount allocated to the current taxable year or any year before we became a passive foreign investment company will be included as ordinary income in a U.S. Holder’s gross income for that year. The amount allocated to other prior taxable years will be taxed as ordinary income at the highest rate in effect for a U.S. Holder in that prior year and the tax is subject to an interest charge at the rate applicable to deficiencies in income taxes. The entire amount of any gain realized upon the sale or other disposition of the equity interests will be treated as an excess distribution made in the year of sale or other disposition and as a consequence will be treated as ordinary income and, to the extent allocated to years prior to the year of sale or disposition with respect to which we were a passive foreign investment company, will be subject to the interest charge described above. In certain circumstances, instead of being subject to the excess distribution rules discussed above, a U.S. Holder may make an election to include gain on the ADSs or ordinary shares of a passive foreign investment company as ordinary income under a mark-to-market method, provided that the ADSs or ordinary shares are regularly traded on a qualified exchange. Under current law, the mark-to-market election is only available for ADSs or ordinary shares that are regularly traded within the meaning of U.S. Treasury regulations on certain designated U.S. exchanges and foreign exchanges that meet trading, listing, financial disclosure and other requirements to be treated as a qualified exchange under applicable U.S. Treasury regulations. The Nasdaq Stock Market is a qualified exchange. The ordinary shares may not be eligible for mark-to-market treatment under the foregoing rule even if the ADSs otherwise satisfy the applicable requirement. If a U.S. Holder makes a mark-to-market election, the U.S. Holder will include each year as ordinary income, rather than capital gain, the excess, if any, of the fair market value of the U.S. Holder’s ADSs or ordinary shares at the end of the taxable year over such U.S. Holder’s adjusted basis in the ADSs (or ordinary shares, if applicable) and will be permitted an ordinary loss in respect of the excess, if any, of the adjusted basis of these ADSs or ordinary shares over their fair market value at the end of the taxable year, but only to the extent of the net amount previously included in income as a result of the mark-to-market election. A U.S. Holder’s basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. Any gain or loss on the sale of the ADSs or ordinary shares will be ordinary income or loss, except that this loss will be ordinary loss only to the extent of the previously included net mark-to-market gain. If we are a passive foreign investment company, then under certain circumstances a U.S. Holder must file Internal Revenue Service Form 8621. Information Reporting and Back-up Withholding. U.S. holders generally are subject to information reporting requirements with respect to dividends on, or proceeds from the disposition of, our ordinary shares. In addition, a U.S. holder may be subject, under certain circumstances, to backup withholding at a rate of up to 28% with respect to dividends paid on, or proceeds from the disposition of, our ordinary shares unless the U.S. holder provides proof of an applicable exemption or correct taxpayer identification number, and otherwise complies with the applicable requirements of the backup withholding rules. A U.S. holder of our ordinary shares who provides an incorrect taxpayer identification number may be subject to penalties imposed by the IRS. Amounts withheld under the backup withholding rules are not an additional tax and may be refunded or credited against the U.S. holder’s U.S. federal income tax liability, provided the required information is furnished to the IRS. A U.S. Holder is urged to consult its tax advisor concerning the U.S. federal income tax consequences of an investment in our ADSs or ordinary shares if we are or become a passive foreign investment company, including the possibility of making a market-to-market election. Cayman Islands Taxation The Cayman Islands currently levy no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to our company levied by the Government of the Cayman Islands except for stamp 54 duties that may be applicable on instruments executed in, or after execution brought within the jurisdiction of, the Cayman Islands. The Cayman Islands are not party to any double taxation treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands. We have, pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, obtained an undertaking from the Governor-in-Council that: • • no law which is enacted in the Cayman Islands imposing any tax to be levied on profits or income or gains or appreciation applies to us or our operations; and the aforesaid tax or any tax in the nature of estate duty or inheritance tax are not payable on our ordinary shares, debentures or other obligations. The undertaking that we have obtained is for a period of 20 years from March 1, 2005. Documents on Display We have previously filed with the SEC our registration statement on Form F-1 and Form F-6 under the Securities Act of 1933, as amended (the “Securities Act”) with respect to our ADSs. We are subject to the periodic reporting and other informational requirements of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F no later than four months after the close of each fiscal year, which is December 31. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and our officers, directors, and principal shareholders are exempt from the reporting and short- swing profit recovery provisions of Section 16 of the Exchange Act. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the Securities and Exchange Commission at the SEC’s public reference room in Washington D.C. at 100 F Street, N.E., Room 1580, Washington D.C. 20549. You can request copies of these documents upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms. The SEC also maintains a Website at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest rate risk. Our exposure to changes in interest rates is limited to interest income generated by our cash deposited with banks and short-term investments maintained in bond funds and structured notes. We do not believe that a 1% change in interest rates would have a significant impact on our operations. Foreign currency risk. Since 2012, we consider our direct exposure to foreign exchange rate fluctuations to be minimal. Prior to 2012, we reported our financial results in NT dollars and our direct exposure to foreign exchange rate fluctuations was more significant. Gains or losses from foreign currency re-measurement are included in “Non-Operating Income (Expenses)” in our Consolidated Financial Statements. The impact of foreign currency transaction gain or loss included in determining net income (loss) for 2013, 2012 and 2011 was nil, $0.4 million and $5.7 million, respectively. Currently, the majority of our revenue, cost of sales, accounts receivable, and accounts payable are denominated in U.S. dollars. Increases in the value of the U.S. dollar relative to other currencies would make our products more expensive, which could negatively impact our ability to compete. Conversely, decreases in the value of the U.S. dollar relative to other currencies could result in our suppliers raising their prices in order to continue doing business with us. Fluctuations in currency exchange rates could harm our business in the future. We do not utilize foreign exchange derivatives contracts to protect against changes in foreign exchange rates. 55 Also refer to “Risk Factors — We are subject to risks associated with international operations which may harm our business.” Investment Risk. Prior to March 2007, we invested in equity instruments of privately held companies. We have minority stake equity investments in Cashido and Vastview Technology, private companies related to semiconductor and other technology industries. These investments are accounted for under the cost method because our ownership is less than 20% and we do not have the ability to exercise significant influence over the operations of these companies. As of December 31, 2013, the aggregate carrying value of these investments on our balance sheet was US$0.1 million. We monitor these investments for impairment and make appropriate reductions in carrying value when an impairment is deemed to be other than temporary. There were no impairments for the years ended on December 31, 2011, 2012 and 2013, respectively. As of December 31, 2013, we also had US$0.7 million of short-term investments maintained in bond funds. ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Depositary Fees and Charges. For the year-ended December 31, 2013, we received from our depositary bank a reimbursement of US$0.5 million, net of withholding tax, for our continuing annual stock exchange listing fees and our other expenses incurred in connection with maintaining and promoting our ADS program. In addition, the depositary bank has agreed to reimburse us annually for a fixed number of years for our continuing annual stock exchange listing fees and our other expenses incurred in connection with maintaining and promoting our ADS program. The amount of annual reimbursements is subject to certain limits. 56 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES Not applicable. PART II ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS Not applicable. ITEM 15. CONTROLS AND PROCEDURES Disclosure Controls and Procedures We performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2013. Disclosure controls and procedures are designed to ensure that the material financial and non-financial information required to be disclosed in this annual report on Form 20-F and filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The evaluation was performed with the participation of our key corporate senior management, and under the supervision of our Chief Financial Officer, or CFO, Riyadh Lai, and our President and Chief Executive Officer, or CEO, Wallace Kou. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective. Management’s Report on Internal Control over Financial Reporting Our management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. Our management assessed the effectiveness of our internal control over financial reporting as of the end of the period covered by this annual report based on the criteria set forth in the Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Their assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of our internal control over financial reporting. Based on that assessment, our management concluded that as of December 31, 2013 the company’s internal control over financial reporting was effective. Deloitte & Touche, the independent registered public accounting firm that audited our consolidated financial statements included in this annual report has issued an attestation report regarding internal control over financial reporting. 57 Changes in Internal Control over Financial Reporting During 2013, no change to our internal control over financial reporting occurred that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Inherent Limitations on Effectiveness of Controls All internal control systems no matter how well designed and implemented have inherent limitations. Even systems determined to be effective may not prevent or detect misstatements or fraud and can only provide reasonable assurance with respect to disclosure and financial statement presentation and reporting. Additionally, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changed conditions and the degree of compliance with the policies or procedures may deteriorate. 58 Attestation Report Of The Independent Registered Public Accounting Firm REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have audited the internal control over financial reporting of Silicon Motion Technology Corporation and subsidiaries (the “Company”) as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013 based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2013 of the Company and our report dated April 29, 2014 expressed an unqualified opinion on those financial statements. /s/ Deloitte & Touche Taipei, Taiwan Republic of China April 29, 2014 59 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT Our board of directors has determined that Mr. Tsung-Ming Chung, the Chairman of our audit committee and an independent director, is an “audit committee financial expert” under Nasdaq and SEC rules. ITEM 16B. CODE OF ETHICS Our board of directors has adopted a code of business conduct and ethics applicable to every employee of our company, including our CEO and our CFO, consistent with the requirements of the Nasdaq Stock Market. A copy of our code of ethics has been filed with the SEC as Exhibit 11.1 to our annual report on Form 20-F filed on June 30, 2006. For further information, see our Code of Ethics posted on our website (www.siliconmotion.com) . ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES Deloitte & Touche has acted as the independent registered public accountants of our company and its subsidiaries for 2012 and 2013. The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by Deloitte & Touche for the periods indicated. Audit Fees (1) Audit-Related Fees (2) Tax Fees (3) All Other Fees (4) Total 2012 2013 US$ US$ (in thousands) 747 698 — — 126 172 — — 873 870 (1) Audit Fees. This category includes the audit and review of our annual financial statements and services that are normally provided by the independent auditors in connection with regulatory filings or engagements, consultations provided on audit and accounting matters that arise during, or as a result of, the audits or the reviews of interim financial statements, audit procedures related to reviews of offering documents, registration statements and issuance of comfort letters. (2) Audit-Related Fees. This category consists of assurance and related services by Deloitte & Touche that are reasonably related to the performance of the audit or review of our financial statements and are not reported above under “Audit Fees.” Deloitte & Touche did not provide any services under this category in 2012 or 2013. (3) Tax Fees. This category consists of professional services rendered by Deloitte & Touche for tax compliance and tax advice. The services for the fees disclosed in this category include tax return preparation and technical tax advice. (4) All other fees. Deloitte & Touche did not provide any services under this category in 2012 or 2013. Our audit committee is responsible for the retention of our independent registered public accounting firm, which currently is Deloitte & Touche. Our audit committee has adopted its own rules of procedure, in the form of an audit committee charter. The audit committee’s rules of procedure provide for a process with respect to the prior approval of all non-audit services to be performed by our independent auditors. Our audit committee reports to our board of directors regarding the scope and results of our annual audits, compliance with our accounting and financial policies and management’s procedures and policies related to the adequacy of our internal accounting controls. In 2013 our audit committee approved all of the audit services provided by Deloitte & Touche, and the other services provided by Deloitte & Touche. ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES Not applicable. 60 ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS Not applicable. ITEM 16F. CHANGE IN REGISTRANT’ S CERTIFYING ACCOUNTANT Not applicable. ITEM 16G. CORPORATE GOVERNANCE We are incorporated in the Cayman Islands and our corporate governance practices are governed by applicable Cayman Islands law. In addition, because our ADSs are listed on the Nasdaq Global Select Market, we are subject to Nasdaq corporate governance requirements. Nasdaq Listing Rule 5615(a)(3) permits foreign private issuers like us to follow “home country practice” with respect to certain corporate governance matters. We are committed to a high standard of corporate governance. As such, we endeavor to comply with the Nasdaq corporate governance practices and believe that we are currently in compliance with Nasdaq corporate governance practices that are applicable to foreign private issuers. 61 PART III ITEM 17. FINANCIAL STATEMENTS Not applicable. ITEM 18. FINANCIAL STATEMENTS Our consolidated financial statements are included in this annual report at pages F-1 through F-32. ITEM 19. EXHIBITS Exhibit Number Description 1.1 1.2 2.1 2.2 2.3 4.1 4.2 4.3 4.4 4.5 Memorandum of Association of the Registrant (incorporated by reference to Exhibit 3.1 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Articles of Association of the Registrant (incorporated by reference to Exhibit 3.2 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Specimen of American Depositary Receipt (incorporated by reference to Exhibit 4.1 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Form of Deposit Agreement (incorporated by reference to Exhibit 4.2 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Second Amended and Restated Silicon Motion Technology Corporation Equity Incentive Plan 2005 (incorporated by reference to Exhibit 2.3 of the company’s Form 20-F for the year ended December 31, 2009, filed June 25, 2010). Lease Agreement between Silicon Motion, Inc. (Taiwan) and Fang Shinn Industrial Co., Ltd. dated May 4, 2004 (incorporated by reference to Exhibit 10.1 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Lease Agreement between Silicon Motion, Inc. (Taiwan) and TaiHsing Printing and Binding Co., Ltd dated February 23, 2005 (incorporated by reference to Exhibit 10.2 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Lease Agreement between Silicon Motion, Inc. (Taiwan) and Winsome Development Inc. dated November 27, 2003 (incorporated by reference to Exhibit 10.3 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Lease Agreement between Silicon Motion, Inc. (Taiwan) and Richtek Technology Corp. dated February 4, 2005 (incorporated by reference to Exhibit 10.4 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Lease Agreement between Silicon Motion, Inc. (California) and Orchard Investment Company Number 205 dated January 21, 2004 (incorporated by reference to Exhibit 10.5 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). 62 Exhibit Number 4.6 4.7 4.8 4.11 4.12 Description Bank Line of Credit Agreement between Silicon Motion, Inc. (Taiwan) and Chinatrust Commercial Bank Co., Ltd. dated November 25, 2004 (incorporated by reference to Exhibit 10.6 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Financial Transaction Agreement between Silicon Motion, Inc. (Taiwan) and Chinatrust Commercial Bank Co., Ltd. dated November 25, 2004 (incorporated by reference to Exhibit 10.7 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Specific Clause Agreement between Silicon Motion, Inc. (Taiwan) and Chinatrust Commercial Bank Co., Ltd. dated November 25, 2004 (incorporated by reference to Exhibit 10.8 to the company’s Registration Statement on Form F-1 (file no. 333-125673) filed with the Securities and Exchange Commission on June 9, 2005). Purchase and Supply Agreement between Lexar Media, Inc. and Silicon Motion Technology Corporation, dated September 1, 2005 (incorporated by reference to Exhibit 4.11 to the Company’s Annual Report on Form 20-F filed with the Securities and Exchange Commission on June 30, 2006). Share Purchase Agreement dated as of April 18, 2007 among Silicon Motion Technology Corporation, Lake Tahoe Investment Corporation, FCI Inc. and Kwang Jun Yun and the shareholders of FCI (incorporated by reference to Exhibit 4.12 to the Company’s Annual Report on Form 20-F filed with the Securities and Exchange Commission on July 2, 2007). 8.1 * List of Subsidiaries. 11.1 12.1 * 12.2 * 13.1 * Code of Ethics (incorporated by reference to Exhibit 11.1 to the company’s Annual Report on Form 20-F filed with the Securities and Exchange Commission on June 30, 2006). Certification of Chief Executive Officer Required by Rule 13a-14(a). Certification of Chief Financial Officer Required by Rule 13a-14(a). Certification of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. 23.1 * Consent of Deloitte & Touche. 101.INS* XBRL Instance Document 101.SCH* XBRL Taxonomy Extension Schema Document 101.CAL* XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF* XBRL Taxonomy Extension Definition Linkbase Document 101.LAB* XBRL Taxonomy Extension Label Linkbase Document 101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document * Filed herewith. 63 The registrant hereby certifies that it meets all the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf. SIGNATURES SILICON MOTION TECHNOLOGY CORPORATION By: /S/ WALLACE C. KOU Wallace C. Kou, President and Chief Executive Officer Date: April 30, 2014 64 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2 Consolidated Balance Sheets as of December 31, 2012 and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-3 Consolidated Statements of Income for the Years Ended December 31, 2011, 2012 and 2013 . . . . . . . . . . . . F-4 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2011, 2012 and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-5 Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2011, 2012 and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6 Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2012 and 2013 . . . . . . . . F-7 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-8 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Silicon Motion Technology Corporation We have audited the accompanying consolidated balance sheets of Silicon Motion Technology Corporation and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2013, all expressed in U.S. dollars. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the consolidated financial statements, on January 1, 2012, SMI Taiwan, one of the subsidiaries of Silicon Motion Technology Corporation, changed its functional currency to the U.S. dollar. The Company also changed its reporting currency to the U.S. dollar. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 29, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting. /s/ Deloitte & Touche Taipei, Taiwan Republic of China April 29, 2014 F-2 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands, Except Par Value) ASSETS Current Assets Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes and accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restricted assets-current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income tax assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income tax assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 US$ 2013 US$ 154,734 14,882 36,785 32,143 15,283 2,369 2,216 258,412 178 23,386 804 35,472 3,494 161,720 742 31,213 33,666 15,299 1,278 2,621 246,539 133 30,195 714 35,474 3,708 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321,746 316,763 LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Notes and accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Current portion of long-term payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term payable, net of current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,642 4,668 252 24,835 56,397 — 3,083 14,661 8,189 207 17,610 40,667 211 5,188 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,480 46,066 Commitments and Contingencies (Note 16) Shareholders’ Equity Ordinary Shares at US$ 0.01 par value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Authorized: 500,000 thousand shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issued and outstanding: 130,040 thousand shares in 2012 and 131,630 thousand shares in 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional paid-in capital Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300 173,852 3,665 83,449 1,316 180,016 4,095 85,270 Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262,266 270,697 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321,746 316,763 The accompanying notes are an integral part of the consolidated financial statements. F-3 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In Thousands, Except Earnings Per Share) NET SALES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . COST OF SALES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31 2011 2012 2013 US$ (Note 2) 223,845 115,806 US$ 281,370 149,650 US$ 225,308 118,698 GROSS PROFIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108,039 131,720 106,610 OPERATING EXPENSES Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,501 14,537 11,323 694 50,975 15,919 12,156 — 46,460 13,597 11,250 — Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,055 79,050 71,307 OPERATING INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,984 52,670 35,303 NON-OPERATING INCOME (EXPENSES) Gain from disposal of short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized holding loss on short-term investment . . . . . . . . . . . . . . . . . . . . . . Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange gain (loss), net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 — — 597 5,683 (75) 17 6,232 2 (118) 17 1,433 390 (61) 1 1,664 122 — — 1,845 (25) (110) 13 1,845 INCOME BEFORE INCOME TAX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . INCOME TAX EXPENSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,216 5,747 54,334 7,116 37,148 9,772 NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,469 47,218 27,376 EARNINGS PER ORDINARY SHARE: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.34 0.32 0.37 0.35 0.21 0.20 WEIGHTED AVERAGE ORDINARY SHARES OUTSTANDING Basic (Thousands) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123,082 129,259 132,259 Diluted (Thousands) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129,370 134,504 134,567 EARNINGS PER ADS (one ADS equals four ordinary shares): Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.35 1.28 1.46 1.40 0.83 0.81 WEIGHTED AVERAGE ADS OUTSTANDING Basic (Thousands) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,771 32,315 33,065 Diluted (Thousands) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,343 33,626 33,642 The accompanying notes are an integral part of the consolidated financial statements. F-4 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In Thousands) NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX EFFECT OF NIL Year Ended December 31 2011 2012 2013 US$ (Note 2) 41,469 US$ 47,218 US$ 27,376 Change in net foreign currency translation adjustments . . . . . . . . . . . . . . . . . . . . Change in deferred pension gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,476) 76 1,947 (337) OTHER COMPREHENSIVE INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,400) 1,610 633 (203) 430 TOTAL COMPREHENSIVE INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,069 48,828 27,806 The accompanying notes are an integral part of the consolidated financial statements. F-5 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (In Thousands, Except Per Share Data) Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings (accumulated deficit) Treasury Stock Total Shareholders’ Equity Ordinary Share Shares Amount (thousands) US$ US$ US$ US$ US$ US$ 117,139 1,172 150,972 10,455 (5,238) — 157,361 BALANCE, JANUARY 1, 2011 (Note 2) . . . . . . . . . . . . . . . . . . . . . . Components of comprehensive income, net of tax . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . Other comprehensive loss . . . . . . Total comprehensive income . . . . Stock-based compensation expenses . . . . . . . . . . . . . . . . . Issuance of ordinary shares upon exercise of employee stock options and restricted stock units . . . . . . . . . . . . . . . . . . . . . BALANCE, DECEMBER 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . Components of comprehensive income, net of tax . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . Other comprehensive income . . . Total comprehensive income . . . . Stock-based compensation expenses . . . . . . . . . . . . . . . . . Issuance of ordinary shares upon exercise of employee stock options and restricted stock units . . . . . . . . . . . . . . . . . . . . . BALANCE, DECEMBER 31, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . Components of comprehensive income, net of tax . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . Other comprehensive income . . . Total comprehensive income . . . . Stock-based compensation expenses . . . . . . . . . . . . . . . . . Issuance of ordinary shares upon exercise of employee stock options and restricted stock units . . . . . . . . . . . . . . . . . . . . . Share repurchase . . . . . . . . . . . . . Dividends declared (US$0.15 per ordinary share) . . . . . . . . . . . . . Treasury stock retired . . . . . . . . . BALANCE, DECEMBER 31, — — — — — — — — — — — 8,878 7,433 74 2,118 — (8,400) 41,469 — — — — — — — 124,572 1,246 161,968 2,055 36,231 — — — — — — — — — — — 11,802 5,468 54 82 — 1,610 47,218 — — — — — — — 130,040 1,300 173,852 3,665 83,449 — — — — 5,154 — — (3,564) — — — — 52 — — (36) — — — 10,262 294 — — (4,392) — 430 — — — — — — 27,376 — — — — — (19,965) (5,590) — 10,018 — — — — — — — — — — — — — — — — — (10,018) 41,469 (8,400) 33,069 8,878 2,192 201,500 47,218 1,610 48,828 11,802 136 262,266 27,376 430 27,806 10,262 346 (10,018) (19,965) — 2013 . . . . . . . . . . . . . . . . . . . . . . . . . 131,630 1,316 180,016 4,095 85,270 — 270,697 The accompanying notes are an integral part of the consolidated financial statements. F-6 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) Year Ended December 31 2012 2013 2011 CASH FLOWS FROM OPERATING ACTIVITIES Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income to net cash provided by operating 41,469 47,218 27,376 activities: US$ (Note 2) US$ US$ Unrealized holding loss on short-term investment . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain from disposal of short-term investments . . . . . . . . . . . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss (gain) on disposal of property and equipment . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in operating assets and liabilities: — 5,580 694 (10) 8,878 (1) 2,510 (2) Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes and accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes and accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other current liabilities . . . . . . . . . . . . . . . . . Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,658) (10,952) (6,334) (1,052) (547) 9,667 3,948 2,015 56 118 5,881 — (2) 11,802 26 1,582 — (12,018) 2,002 (1,828) 248 590 5,644 6,390 1,362 221 — 6,429 — (122) 10,262 5 1,181 — 14,265 5,572 (1,523) (403) (143) (11,981) (7,415) 3,520 2,105 Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . 54,261 69,236 49,128 CASH FLOWS FROM INVESTING ACTIVITIES Return of capital from long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . Business acquisition-net of cash and cash equivalents acquired . . . . . . . . . . . Purchase of property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in restricted assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (700) (4,916) (8,331) — — (4,280) (469) 46 — (12,772) (89) Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . (13,947) (4,749) (12,815) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of ordinary shares upon exercise of employee stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share repurchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided by (used in) financing activities . . . . . . . . . . . . . . . . . 2,294 — — 2,294 422 224 — (10,018) — (19,897) 224 (29,493) NET INCREASE IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . . . . EFFECT OF EXCHANGE RATE CHANGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR . . . . . . . . . . . . . . 42,608 (7,734) 53,889 64,711 1,260 88,763 6,820 166 154,734 CASH AND CASH EQUIVALENTS, END OF YEAR . . . . . . . . . . . . . . . . . . . . . 88,763 154,734 161,720 SUPPLEMENTAL INFORMATION Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 988 — 86 3,256 2,947 The accompanying notes are an integral part of the consolidated financial statements. F-7 SILICON MOTION TECHNOLOGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands) 1. ORGANIZATION AND OPERATIONS Silicon Motion Technology Corporation (“SMTC”, collectively with its subsidiaries the “Company”) is a holding company incorporated in the Cayman Islands on January 27, 2005. Significant parts of the Company’s operations are conducted through Silicon Motion, Inc. (“SMI Taiwan”), a wholly-owned subsidiary of SMTC, located in Taiwan and FCI Inc. (“FCI”), a wholly-owned subsidiary of SMTC, located in Korea. The Company is a fabless semiconductor company that designs, develops and markets, high-performance, low-power semiconductor solutions to OEMs and other customers in the mobile storage and mobile communications markets. In the mobile storage market, the Company’s key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products such as flash memory cards and USB flash drives. For the mobile communications market, the Company’s key products are handset transceivers and mobile TV IC solutions. The Company acquired SMI Taiwan in April 2005. Originally SMI Taiwan was known as Feiya Technology Corporation (“Feiya”), a Taiwan corporation which was incorporated in April 1997 but had changed its name to SMI Taiwan after acquiring in August 2002 Silicon Motion, Inc., a California corporation (“SMI USA”), which was incorporated in November 1995. Feiya was originally a flash memory products company and SMI USA a graphics processor company. In April 2007, the Company acquired FCI, a leading designer of RF ICs for mobile TV and wireless communications based in South Korea. The Company established Silicon Motion BV in the Netherlands in 2011 with the purpose of expanding its business activities in Europe, as well as providing supervisory, financing, legal support, accounting services and shareholding for the Company’s businesses in other parts of the world. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The consolidated financial statements include the accounts of SMTC and its wholly-owned subsidiaries. The Company owns 100% of the outstanding shares in all of its subsidiaries, except for FCI which the Company owns over 99.9%. All significant intercompany balances and transactions have been eliminated upon consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. The actual results could differ from those estimates. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, investment in debt securities and accounts receivable. Cash is deposited with high credit-quality financial institutions. For accounts receivable, the Company performs ongoing credit evaluations of its customers’ financial condition and the Company maintains an allowance for doubtful accounts receivable based upon a review of the expected collectibility of individual accounts. F-8 The Company sells semiconductor solutions to leading module makers and OEMs worldwide. The Company provides high performance flash memory storage controllers to companies such as SK Hynix, Netcom, Micron, Samsung, Sony, and Transcend. The Company is a leading supplier of controllers used in eMMC embedded memory, flash memory cards, and USB flash drives. The Company provides innovative mobile communications ICs primarily to LG and Samsung. Sales to one customer in 2011 and 2012 and two customers in 2013 accounted for 10% or more of our net revenue, represented 28%, 35% and 46% of our net revenue in 2011, 2012 and 2013, respectively. In 2011 and 2012, the significant customer was Samsung and in 2013, Samsung and SK Hynix. The Company’s top ten customers in 2011, 2012 and 2013 accounted for approximately 64%, 75% and 76% of net sales. Fair Value of Financial Instruments The carrying amount of the Company’s financial instruments, including cash and cash equivalents, notes and accounts receivable and notes and accounts payables approximates fair value due to the short-term maturity of the instruments. Fair values of short-term investments represent quoted market prices, if available. If no quoted market prices are available, fair values are estimated based on discounted cash flow, or other valuation techniques. Long-term investments are privately-held companies where there is no readily determinable market value and are recorded using the cost method, since the cost of obtaining verifiable fair value is unreasonably high. The Company periodically evaluates these investments for impairment. If it is determined that an other- than-temporary decline has occurred in the carrying value, an impairment loss is recorded for that period. The Company’s long-term liabilities approximate their fair values as they contain interest rates that vary according to market interest rates. Fair value is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that assets or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the Company. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is reported in one of the three levels which is determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 — Use unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 — Use observable inputs other than Level 1 prices such as quoted prices for identical or similar instruments in markets that are not active, quoted prices for similar instruments in active markets, and model- based valuation in which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 — Use inputs that are generally unobservable and reflect the use of significant management judgments and estimates. See Note 18, “Fair Value Measurement”, for the related disclosure. Cash Equivalents The Company considers all highly liquid investments with maturities within three months from the date of purchase to be cash equivalents. Short-term Investments The Company’s short-term investments are short-term income yielding investments with original maturities greater than three months from the purchase date and remaining maturities less than one year. These short-term F-9 investments consist primarily of bond funds that are bought and held principally for the purpose of selling them in the near term and are classified as trading securities as well as structured notes designated at the fair value. They are reported at fair value with the subsequent changes in fair value recorded in earnings as unrealized gains and losses. Allowance for Doubtful Receivables An allowance for doubtful receivables is provided based on a review of the collectability of accounts receivables. The Company determines the amount of allowance for doubtful receivables by examining the historical collection experience and current trends in the credit quality of its customers as well as its internal credit policies. Inventories Inventories are stated at the lower of cost or market value. Inventories are recorded at standard cost and adjusted to the approximate weighted-average cost at the balance sheet date. Market value represents the current replacement cost for raw materials, work in process and finished goods. The Company assesses its inventory for estimated obsolescence or unmarketable inventory based upon management’s assumptions about future demand and market conditions. In estimating reserves for obsolescence, the Company primarily evaluates estimates based on the timing of the introduction of new products and the quantities remaining of old products and provides reserves for inventory on hand in excess of the estimated demand. Estimated losses on slow-moving items are recognized and included in the allowance for losses. Long-term Investments The Company has long-term investments in companies that it does not exercise significant influence and accounts for these investments under the cost method. Management regularly evaluates financial information related to these investments to determine whether an other than temporary decline in their value exists. Factors indicative of an other than temporary decline include recurring operating losses, credit defaults and subsequent rounds of financings at an amount below the cost basis of the investment. Management periodically weighs all quantitative and qualitative factors in determining if any impairment loss exists. When a decline in value is deemed to be other-than-temporary, the Company recognizes an impairment loss in other income and expense. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Significant additions, renewals and betterments are capitalized, while maintenance and repairs are expensed as incurred. Depreciation is computed using the straight-line method over estimated useful lives that range as follows: buildings — 25 to 50 years; machinery and equipment — 3 to 6 years; furniture and fixtures — 3 to 8 years; software — 1 to 5 years; leasehold and buildings improvement — the shorter of the estimated useful life or lease term, which is generally 2 to 6 years. Depreciation expense recognized for the years ended December 31, 2011, 2012 and 2013 was approximately US$5,580 thousand, US$5,881 thousand and US$6,429 thousand, respectively. Upon the sale or other disposal of property and equipment, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to operating income. Government Grants Grants received by the Company from the Korean government to assist with specific research and development activities are deducted from those research and development costs incurred, in the period in which F-10 the related expenses are incurred, to the extent that they are non-refundable. Government grants that were used for the acquisition of fixed assets are deducted from the acquisition costs of the acquired assets and amortized over the useful lives of the related assets. The Company recognizes refundable government grants as long-term payable and current portion of long-term payable on its consolidated balance sheet. Goodwill and Intangible Assets Goodwill is the excess of the purchase price paid over the fair value of the net tangible and intangible assets acquired in a business combination. Intangible assets, which consist primarily of core technology and customer relationship, are amortized over their estimated useful lives, of 4 years at the time of acquisition. Impairment of Goodwill and Long-Lived Assets The Company evaluates the recoverability of long-lived assets whenever events or changes in circumstances indicate the carrying value may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of an asset and its eventual disposition. The estimate of cash flows is based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. Estimates of undiscounted cash flows may differ from actual cash flows due to, among other things, technological changes, economic conditions, changes to the business model or changes in operating performance. If the sum of the undiscounted cash flows is less than the carrying value, an impairment loss is recognized, measured as the amount by which the carrying value exceeds the fair value of the asset. Fair value is determined by reference to quoted market prices, if available, or discounted cash flows, as appropriate. See Note 10, “Goodwill and Acquired Intangible Assets,” regarding impairment testing in fiscal year 2012 and 2013. The Company monitors the recoverability of goodwill recorded in connection with acquisitions, by reporting unit, annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company conducts its annual impairment test of goodwill on November 30. Reporting units may be operating segments as a whole or an operation one level below an operating segment, referred to as a component. Goodwill impairment is tested using a two-step approach. The first step compares the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered impaired and the second step is not required. If the fair value of the reporting unit is less than its carrying amount, the second step of the impairment test measures the amount of the impairment loss, if any, by comparing the implied fair value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized equal to that excess. The implied fair value of goodwill is calculated in the same manner that goodwill is calculated in a business combination, whereby the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit, with the excess purchases price over the amounts assigned to assets and liabilities. Estimating fair value is performed by utilizing various valuation approaches, such as income approach or market approach. The total of all reporting unit fair values was also compared to the Company’s market capitalization plus control premium for reasonableness. See Note 10, “Goodwill and Acquired Intangible Assets,” regarding impairment testing. Other Assets Other assets primarily consist of intellectual property and deposits for office leases. Restricted Assets Restricted assets consist of deposits required for litigation and restricted cash. Restricted cash represents cash set aside as collateral for obtaining capacity and borrowings as well as cash received from government grants with restriction on its usage. F-11 Pension Costs For employees under defined contribution pension plans, pension costs are recorded based on the actual contributions made to employees’ individual pension accounts. For employees under defined benefit pension plans, pension costs are recorded based on actuarial calculations. Revenue Recognition Revenue from product sales is generally recognized upon shipment to the customer provided that the Company has received a signed purchase order, the price is fixed or determinable, transfer of title has occurred in accordance with the shipping terms specified in the arrangement with the customer, collectibility from the customer is considered reasonably assured, product returns are reasonably estimable and there are no remaining significant obligations or customer acceptance requirements. Revenue on development service orders is generally recognized upon completion and customer acceptance of contractually agreed milestones. The Company grants certain distributors limited rights of return and price protection rights on unsold products. The return rights are generally limited to five percent of the monetary value of products purchased within the preceding six months, provided that the distributor places a corresponding restocking order of equal or greater value. An allowance for sales returns for distributors and all customers is recorded at the time of sale based on historical returns information available, management’s judgment and any known factors at the time the financial statements are prepared that would significantly affect the allowance. Price protection rights are based on the inventory products the distributors have on hand at the date the price protection is offered. A reserve for price adjustments is recorded based on the estimated products on hand at the distributors and historical experience. The Company incurred actual price adjustments to distributors are minimal. The Company provides a warranty period of one year for manufacturing defects of its products. Warranty returns have been infrequent and relate to defective or off-specification parts. The Company estimates a reserve for warranty based on historical experience and records this amount to cost of sales. For the years ended December 31, 2011, 2012 and 2013, the Company did not experience significant costs associated with warranty returns. Research and Development Research and development costs consist of expenditures incurred during the course of planned research and investigation aimed at the discovery of new knowledge that will be useful in developing new products or at significantly enhancing existing products as well as expenditures incurred for the design and testing of product alternatives. All expenditures related to research and development activities of the Company are charged to operating expenses when incurred. Third-party research and development costs are expensed when the contracted work has been performed or as milestone results have been achieved. Income Taxes The provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the years. Deferred income tax assets are recognized for net operating loss carryforwards, research and development credits, and temporary differences. The Company believes that uncertainty exists regarding the realizability of certain deferred income tax assets and, accordingly, has established a valuation allowance for those deferred income tax assets to the extent the realizability is not deemed to be more likely than not. Deferred income tax assets and liabilities are measured using enacted tax rates. The Company utilizes a two step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained in a dispute with taxing authorities, including resolution F-12 of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. SMI Taiwan, the Company’s largest operating company is a Taiwan registered company. Under Taiwan tax regulations, the current year’s earnings, on an after tax basis, that are not distributed in the following year are subject to a 10% additional income tax. This 10% additional income tax is recognized in the period during which the related earnings are generated. The Taiwan government enacted the Income Basic Tax Act (“the IBT Act”), which became effective on January 1, 2006. The alternative minimum tax (“AMT”) imposed under the IBT Act is a supplemental tax levied at a rate of 10% which is payable if the income tax payable determined pursuant to the Income Tax Law is below the minimum amount prescribed under the IBT Act. The taxable income for calculating the AMT includes most of the income that is exempted from income tax under various laws and statutes. The Company has considered the impact of the IBT Act in the determination of its tax liabilities. Under the IBT Act amended in August 2012, the standard deduction and the tax rate of AMT were amended from NT$1,000 thousand to be NT$500 thousand and from 10% to 12%, respectively. The amended IBT Act is effective on January 1, 2013. Foreign Currency Transactions Foreign currency transactions are recorded at the rates of exchange in effect when the transaction occurs. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into the entities’ functional currency, or when foreign currency receivables and payables are settled, are credited or charged to income in the period of conversion or settlement. At the balance sheet date, assets and liabilities denominated in foreign currencies are remeasured based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. Translation of Foreign Currency Financial Statements The reporting currency of the Company is the New Taiwan dollars until December 2011. The functional currency of each one of the Company’s subsidiaries is the local currency of the respective entity. Accordingly, the financial statements of the foreign subsidiaries were translated into New Taiwan dollars at the following exchange rates: assets and liabilities — current rate on the balance sheet date; shareholders’ equity — historical rates; income and expenses — average rate during the period. The resulting translation adjustment is recorded as a separate component of comprehensive income. Change in Functional Currency and Reporting Currency On January 1, 2012, the Company changed the functional currency of SMI Taiwan, its largest operating subsidiary, from the NT dollar to the U.S. dollar based on an evaluation of economic facts and circumstances and functional currency analysis prescribed in ASC 830. As a result of SMI Taiwan’s functional currency change, the Company changed its reporting currency from the NT dollar to the U.S. dollar. In 2005, at the time of the Company’s IPO, the Company determined that SMI Taiwan’s functional currency was the NT dollar and this determination was used consistently until the Company determined significant and permanent changes in economic facts and circumstances warranted a change in functional currency. Since the business profile and activities of SMI Taiwan had changed significantly and did not appear to be temporary, the Company re-evaluated the functional currency of SMI Taiwan based on recent economic facts and circumstances, including analysis prescribed in ASC 830, and determined that the U.S. dollar had become the functional currency of SMI Taiwan. The business activities of SMI Taiwan have changed significantly since 2005. In the past, the majority of SMI Taiwan sales were to Taiwanese module maker customers; in 2012 the majority of SMI Taiwan sales were F-13 to international OEMs. The Company believes this trend is not temporary because a fast growing and increasingly large and material source of SMI Taiwan’s sales are from SSD and embedded memory products, and these products are predominately sold to international OEM customers. The significance of SMI Taiwan’s other products, primarily card and USB flash drive controller products, has been declining and will continue to decline due to the maturity of their markets, and a majority of these products are now sold to non-Taiwan-based customers. SMI Taiwan’s cash flow, sales price, sales markets, expenses, financing and intercompany transactions are now primarily U.S. dollar-based. Economic facts and circumstances, as well as functional currency analysis support the Company’s determination that the U.S. dollar has become the functional currency of SMI Taiwan as of January 1, 2012. As from January 1, 2012, the Company has reported the consolidated results in U.S. dollars, and the Company has recasted the historical financial statements from the NT dollar to the U.S. dollar. Items on the historical balance sheet and income statement were converted from the NT dollar to the U.S. dollars at the following rates: 2008 2009 2010 2011 Balance Sheet (at year-end NT dollar to U.S. dollar rate) 32.80 31.99 29.13 30.28 Income Statement (at average NT dollar to U.S. dollar rate) 31.42 32.55 31.56 29.53 Comprehensive Income (Loss) Comprehensive income and loss represents net income (loss) plus the results of certain changes in shareholders’ equity during a period from non-owner sources. The following table presents the components of accumulated other comprehensive income (loss) as of December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 Year Ended December 31, 2012 Year Ended December 31, 2013 Foreign currency items 10,452 Beginning balance . . Current-period change . . . . . . . . . (8,476) Ending balance . . . . 1,976 US$ US$ US$ Defined benefit pension plans Accumulated other comprehensive income (loss) Foreign currency items Defined benefit pension plans Accumulated other comprehensive income (loss) Foreign currency items Defined benefit pension plans Accumulated other comprehensive income (loss) 3 76 79 10,455 1,976 79 (8,400) 2,055 1,947 3,923 (337) (258) 2,055 1,610 3,665 3,923 (258) 3,665 633 4,556 (203) (461) 430 4,095 Legal Contingencies The Company is currently involved in various claims and legal proceedings. Periodically, the Company reviews the status of each significant matter and assesses the potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to the pending claims and litigation and revises these estimates as appropriate. Such revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial position. F-14 Earnings Per Share Basic earnings per share are computed by dividing net earnings attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if stock options and other dilutive securities were exercised. Dilutive securities are excluded from the computation of the diluted income per share in periods when their effect is anti-dilutive. The Company’s dilutive securities consist of employee stock options and restricted stock units. The effect of dilutive securities including employee stock options and restricted stock units were 6,288 thousand shares (1,572 thousand ADSs), 5,245 thousand shares (1,311 thousand ADSs) and 2,308 thousand shares (577 thousand ADSs) for the year ended December 31, 2011, 2012 and 2013, respectively. Stock-Based Compensation The Company accounts for stock-based compensation in accordance with ASC 718 Compensation — Stock Compensation. The Company uses the Black-Scholes valuation model for the valuation of stock options and recognizes compensation expense on a straight-line basis over the requisite service period of the award. The value of our restricted stock units is based on the fair value of our shares on the date of grant and expensed over the vesting period. Prior to the initial declaration of a quarterly cash dividend on January 22, 2013, the fair value of restricted stock units (“RSUs”) was measured based on the grant date share price, as we did not historically pay cash dividends on our common stock. For awards granted on or subsequent to January 22, 2013, the fair value of RSUs was measured based on the grant date share price, less the present value of expected dividends during the vesting period, discounted at a risk-free interest rate. Treasury Stock Treasury stock is stated at cost and shown as a reduction to shareholders’ equity. The Company retires ordinary shares repurchased under a share repurchase plan. Accordingly, upon retirement the excess of the purchase price over par value is allocated between additional paid-in capital and retained earnings based on the average issuance price of the shares repurchased. A repurchase of ADSs is recorded as treasury stock until the Company completes the withdrawal of the underlying ordinary shares from the ADS program. Dividends On January 22, 2013, the Company declared the first quarterly dividend of US$0.15 per ADS, equivalent to US$0.0375 per ordinary share, and paid this dividend on March 4, 2013. The payment of future cash dividends are subject to the Board’s continuing determination that the payment of dividends are in the best interests of the Company’s shareholders and are in compliance with all laws and agreements of the Company applicable to the declaration and payment of cash dividends. Recent Accounting Pronouncements In December 2011, Financial Accounting Standards Board (“the FASB”) issued an accounting update, which creates new disclosure requirements regarding the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. Certain disclosures of the amounts of certain instruments subject to enforceable master netting arrangements or similar agreements would be required, irrespective of whether the entity has elected to offset those instruments in the statement of financial position. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013 with retrospective application required. The adoption of this guidance did not have a material impact on the Company’s financial statement disclosures since the financial instruments and derivative instruments to which it applies are not significant. F-15 In February 2013, the FASB amended its presentation guidance on comprehensive income to improve the reporting of reclassifications out of accumulated other comprehensive income (“AOCI”). The new accounting guidance requires entities to provide information about the amounts reclassified out of AOCI by component. In addition, entities are required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures that provide additional details about those amounts. The amended guidance is effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or cash flows. In February 2013, the FASB issued an accounting update, which provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The new guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flows. In March 2013, the FASB issued an accounting update that amended guidance on a parent’s accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective for fiscal years beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flows. In July 2013, the FASB issued an accounting update, which creates new guidance regarding the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The guidance is effective for fiscal years beginning after December 15, 2013 and early adoption is permitted. Since this guidance is a change in financial statement presentation only, its adoption is not expected to have material impact on the Company’s result of operations, financial position or cash flows. In April 10, 2014, the FASB issued an accounting update, which changes the criteria for reporting discontinued operations for all public and nonpublic entities. The guidance requires only disposals that represent a strategic shift that has (or will have) a major effect on the entity’s results and operations would qualify as discontinued operations. The guidance also requires entities 1) to expand their disclosures about discontinued operations to include more information about assets, liabilities, income, and expenses and 2) to disclose the pre- tax income attributable to a disposal of “of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements.” The guidance is effective for fiscal years beginning after December 15, 2014 and early adoption is prohibited. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or cash flow. 3. BUSINESS ACQUISITION On October 25, 2011, FCI acquired the majority of the operating assets and employees of BTL System, Inc. (“BTL”), a Korea mobile TV-related software and module company. The aggregate purchase price was US$700 thousand in cash. Goodwill arising from the acquisition was US$160 thousand. F-16 The following table summarizes the estimated fair values of the assets acquired assumed at the date of acquisition based on third-party asset valuations: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill Total assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ 60 480 160 700 Of the total assets acquired, US$480 thousand of software have a weighted-average useful life of approximately 4 years. The Company is not materially impacted by the acquisition of BTL and therefore has not presented pro forma results of operations. The operating results of BTL have been included in the Company’s operations beginning October 25, 2011. The amounts of net sales and net loss of BTL since the acquisition date was nil and US$135 thousand for the year ended December 31, 2011. 4. CASH AND CASH EQUIVALENTS Cash and deposits in bank . . . . . . . . . . . . . . . . . . . . . . . . . . . Time deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 2013 US$ 31,087 123,647 US$ 19,025 142,695 154,734 161,720 5. SHORT-TERM INVESTMENTS The Company classified certain short-term investments as trading securities in 2011, 2012 and 2013. Realized gains on sales of these trading securities were US$10 thousand, US$2 thousand and US$4 thousand for the years ended December 31, 2011, 2012 and 2013, respectively. The amount of unrealized losses related to trading securities at year end were nil, US$118 thousand and nil for the years ended December 31, 2011, 2012 and 2013, respectively. Structured notes matured in May 2013 and the Company recognized the gain of US$118 thousand. 6. NOTES AND ACCOUNTS RECEIVABLE Notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for doubtful accounts . . . . . . . . . . . . . . . . . . . . . . . Allowance for sales returns and discounts . . . . . . . . . . . . . . . . December 31 2012 US$ 807 39,531 40,338 (1,634) (1,919) 2013 US$ 251 33,296 33,547 (1,275) (1,059) 36,785 31,213 F-17 The changes in the allowances are summarized as follows: Year Ended December 31 2011 US$ 2012 US$ 2013 US$ Allowances for doubtful accounts Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . Additions (reversals) charged to expense . . . . . . . . . . . . . Write-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,118 (469) (1) 2,648 (663) (351) 1,634 (359) — Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,648 1,634 1,275 Year Ended December 31 2011 US$ 2012 US$ 2013 US$ Allowances for sales returns and discounts Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Write-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,057 3,982 (3,330) 2,709 297 (1,087) 1,919 1,320 (2,180) Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,709 1,919 1,059 7. INVENTORIES The components of inventories are as follows: Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Work in process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 US$ 7,181 17,718 7,244 2013 US$ 9,117 17,218 7,331 32,143 33,666 The Company wrote down US$4,644 thousand, US$1,631 thousand and US$2,503 thousand in 2011, 2012 and 2013, respectively, for estimated obsolete or unmarketable inventory. 8. LONG-TERM INVESTMENTS As of December 31, 2012 and 2013, the Company held equity investments in several privately-held companies with the carrying value as follows: Cost method: Cashido Corp. (Cashido) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vastview Technology, Corp. (Vastview) . . . . . . . . . . . . . . . . . . . . . 2.1% 2.1% 104 3.9% 2.9% 74 178 F-18 Percentage of Ownership 2012 2013 December 31 2012 US$ 2013 US$ 104 29 133 In July 2001, the Company invested in the common stock of Cashido. At the time of our investment, Cashido manufactured flash memory storage devices. Cashido currently focuses on the manufacture of computer accessories and ozone based sterilization devices. In December 2006 and February 2007, the Company invested US$3,360 thousand in the common stock of Vastview. Vastview is a fabless semiconductor company that develops and markets driver ICs and other ICs for the TFT-LCD industry. In September 2009, Vastview reduced 70% of its share capital and distributed US$ 808 thousand to the Company. In March and December 2010, the Company recognized an impairment loss of US$73 thousand and US$27 thousand, respectively, in its investment in Vastview. In April 2013, Vastview reduced 33.33% of its share capital and distributed US$46 thousand to the Company. The Company accounts for these investments using the cost method. These investments are evaluated for impairment on an annual basis or as circumstances warrant. The Company believed there was no other than temporary impairment for the years ended December 31, 2011, 2012 and 2013, respectively. 9. PROPERTIES AND EQUIPMENT December 31 2012 US$ 2013 US$ Cost: Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leasehold and buildings improvement . . . . . . . . . . . . . . . Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,429 13,398 10,362 3,974 3,320 21,122 6,650 16,711 12,038 4,407 3,753 25,939 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,605 69,498 Accumulated depreciation: Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leasehold and buildings improvement . . . . . . . . . . . . . . . Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepayment and construction in progress . . . . . . . . . . . . . . . . . 1,532 7,725 2,947 2,692 18,377 33,273 54 1,869 9,083 3,224 2,988 22,160 39,324 21 23,386 30,195 In April 2006, the Company leased its land and buildings located in Taipei, Taiwan, to a third party under a three-year operating lease. Net carrying value of the leased land and building as of December 31, 2013 was US$603 thousand and US$180 thousand, respectively. The lessee renewed the three year operating lease with the Company in March 2012. Annual rental income from the lease is about US$41 thousand each year. F-19 10. GOODWILL AND ACQUIRED INTANGIBLE ASSETS Intangible assets: The intangible assets acquired from the Company’s acquisition of FCI and Centronix in 2007 are as follows: 2012 US$ December 31 2013 US$ Cost Accumulated Impairment Accumulated Amortization Net Carrying Amount Cost Accumulated Impairment Accumulated Amortization Net Carrying Amount Core technology . . . . . . . . 15,809 8,325 Customer relationship . . . 1,243 Order backlog . . . . . . . . . . (4,474) — — (11,335) (8,325) (1,243) — 15,809 8,325 — 1,243 — (4,474) — — (11,335) (8,325) (1,243) Total . . . . . . . . . . . . . 25,377 (4,474) (20,903) — 25,377 (4,474) (20,903) — — — — No impairment losses were recognized in 2011, 2012 and 2013. Amortization expense of acquisition-related intangible assets was US$694 thousand, nil and nil thousand for the years ended December 31, 2011, 2012 and 2013, respectively. Goodwill: Goodwill is not amortized, but instead is reviewed and tested for impairment at least annually and whenever events or circumstances occur which indicate that goodwill might be impaired. Impairment of goodwill is tested at the Company’s reporting unit level by comparing the carrying amount, including goodwill, to the fair value. In performing the analysis, the Company uses the best information available, including reasonable and supportable assumptions and projections. If the carrying amount of the reporting unit exceeds its implied fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. The Company performed its annual impairment test on November 30. The goodwill that resulted from the Company’s acquisition of FCI and Centronix in 2007 was US$66,300 thousand. The Company’s fiscal 2011, 2012 and 2013 impairment test concluded there was no impairment. In October 2011, the Company purchased BTL’s assets and assumed US$156 thousand of goodwill. Total goodwill was US$35,472 thousand and US$35,474 thousand as of December 31, 2012 and 2013, respectively. 11. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Wages and bonus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Research and development payable . . . . . . . . . . . . . . . . . . . . . License fees and royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 US$ 14,532 3,417 2,045 1,663 3,178 2013 US$ 6,741 3,012 2,637 1,765 3,455 24,835 17,610 12. PENSION PLAN SMI Taiwan, the Company’s largest operating company is a Taiwan registered company and subject to Taiwan’s Labor Pension Act (the “Act”), which became effective on July 1, 2005, and the pension mechanism under the Act is deemed a defined contribution plan. The employees who were subject to the Labor Standards Law prior to July 1, 2005 were allowed to choose to be subject to the pension mechanism under the Act or continue to be subject to the pension mechanism under the Labor Standards Law. For those employees who were subject to the Labor Standards Law prior to July 1, 2005 and still work for the same company after July 1, 2005 and have F-20 chosen to be subject to the pension mechanism under the Act, their seniority as of July 1, 2005 were maintained. The Act prescribes that the rate of contribution by an employer to employees’ pension accounts per month will not be less than 6% of each employee’s monthly salary. According to the Act, SMI Taiwan made monthly contributions and recognized pension costs of US$607 thousand, US$716 thousand and US$788 thousand for the years ended December 31, 2011, 2012 and 2013, respectively. The Company provides a defined benefit plan to the employees of SMI Taiwan under the Labor Standards Law that offers benefits based on an employee’s length of service and average monthly salary for the six-month period prior to retirement. The Company contributes an amount equal to 2% of salaries paid each month to a pension fund (the “Fund”), which is administered by the Labor Pension Fund Supervisory Committee established by the government (the “Committee”) and deposited in the Committee’s name in the Bank of Taiwan. The government is responsible for the administration of all the defined benefit plans for the companies in Taiwan under the Labor Standards Law. The government also sets investment policies and strategies, determines investment allocation and selects investment managers. As of December 31, 2012 and 2013, the asset allocation was primarily in cash, equity securities and debt securities. Furthermore, under the Labor Standards Law, the rate of return on assets shall not be less than the average interest rate on a two-year time deposit published by the local banks. The government is responsible for any shortfall in the event that the rate of return is less than the required rate of return. However, information on how investment allocation decisions are made, inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets is not fully made available to the Company by the government. Therefore, the Company is unable to provide the required fair value disclosures related to pension plan assets. Future contributions will be based on 2% of the employee salaries at that time. The Company estimates its contribution for the year ending December 31, 2014 to be US$59 thousand which was determined based on 2% of estimated salaries in 2014. Starting in 2010, the Company provides a defined benefit pension plan to the Korean employees of FCI, the Company’s second largest operating company with at least one year of service. FCI’s overall investment strategy is to avoid a negative return on plan assets. For employees under defined contribution pension plans, pension costs are recorded based on the actual contributions made to employees’ individual pension accounts. For employees under defined benefit pension plans, pension costs are recorded based on actuarial calculations. Determining the cost associated with such benefits is dependent on various actuarial assumptions, including discount rate, expected return on plan assets, compensation increase, employee mortality and turnover rates. The Company reviewed its actuarial assumptions at the measurement date on December 31 every year. The effect of modifications to assumptions is recorded in accumulated other comprehensive loss and amortized to net periodic cost over future periods using the corridor method. The company believes that assumptions utilized in recording its obligations under its plans are reasonable based on its experience and market conditions. Independent actuaries perform the required calculations to determine expense in accordance with U.S. GAAP. Actual results may differ from the actuarial assumptions and are generally accumulated and amortized into earnings over future periods. The net periodic costs are recognized as employees render services necessary to earn the benefits. F-21 The changes in benefits obligation and plan assets and the reconciliation of funded status are as follows: December 31 2012 US$ 2013 US$ Change in benefit obligation Projected benefit obligation at beginning of year . . . . . . . . . Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,458 608 77 (187) (59) 1,897 440 58 (202) (95) Projected benefit obligation at end of year . . . . . . . . . . . . . . 1,897 2,098 Change in plan assets Fair value of plan assets at beginning of year . . . . . . . . . . . . Actual return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . Employer contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,376 43 546 (40) 1,925 43 433 (82) Fair value of plan assets at end of year . . . . . . . . . . . . . . . . . 1,925 2,319 Reconciliation of funded status Funded status recognized as an other asset . . . . . . . . . . . . . . Net gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 257 1 221 460 1 Total recognized in accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258 461 Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . . . 1,332 1,369 The components of net periodic benefit cost are as follows: Year Ended December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Service cost Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Projected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of unrecognized net transition obligation and 2011 US$ 399 40 (30) unrecognized net actuarial gain . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 2012 US$ 608 77 (43) — 642 2013 US$ 440 58 (47) (3) 448 Other changes in plan assets and benefit obligation recognized in other comprehensive loss: Recognize the decrease in net gain . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of net gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of net transition obligation . . . . . . . . . . . . . . . . . . . . . . Total recognized in accumulated other comprehensive loss . . . 2012 2013 US$ 336 1 — 337 US$ 203 — — 203 F-22 Expected benefit payments: 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 and thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . US$ 128 248 115 147 226 788 The actuarial assumptions to determine the benefit obligations were as follows: Weighted-average assumptions used to determine benefit obligations: Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rate of compensation increase . . . . . . . . . . . . . . . . . . . . . . Weighted-average assumptions used to determine net projected benefit cost: 2011 2012 2013 Taiwan Korea Taiwan Korea Taiwan Korea 1.75% 5.40% 1.63% 4.00% 1.88% 5.20% 4.25% 7.00% 4.25% 3.00% 4.25% 2.60% Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected long-term return on plan assets . . . . . . . . . . . . . . Rate of compensation increase . . . . . . . . . . . . . . . . . . . . . . 1.75% 5.40% 1.63% 4.00% 1.88% 5.20% 2.00% 4.30% 1.88% 3.10% 2.00% 3.00% 4.25% 7.00% 4.25% 3.00% 4.25% 2.60% FCI’s pension plan assets at December 31, 2012 and 2013 were invested in guaranteed interest contracts insurance and fixed deposit, which are principal and interest guaranteed products and its fair value level is level 2. The assets out of which the obligations have to be settled, measured at their market value by discounting future cash flow with discount rate. The discount rate was determined based on the average future life of the plan’s participants and the market yields on the high quality Korean Corporate Bonds (AA-). Therefore, FCI has no concentration of risk in its plan assets. The fair values of FCI’s pension plan assets at December 31, 2012 and 2013 are as follows: Guaranteed interest contract Kyobo Life Insurance Co. Ltd. . . . . . . . . . . . . . . . . . . . . . . . Fixed deposit Industrial Bank of Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 US$ 2013 US$ 504 537 534 855 1,041 1,389 13. INCOME TAXES The components of income tax expense are as follows: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-23 Year Ended December 31 2011 US$ 3,237 2,510 5,747 2012 US$ 5,534 1,582 7,116 2013 US$ 8,591 1,181 9,772 The income (loss) before income taxes for domestic and foreign entities is as follows: Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign entities SMI Taiwan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FCI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SMI USA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31 2011 US$ (8,730) 2012 US$ (11,039) 2013 US$ (8,080) 42,382 12,572 911 81 47,216 51,997 12,645 253 478 50,628 (4,312) (1,235) 147 54,334 37,148 Since the Company is based in the Cayman Islands, a tax-free country, domestic tax on pretax income is calculated at the Cayman Islands statutory rate of zero for each year. The Company and its subsidiaries file separate income tax returns. A reconciliation of income tax expense on pretax income at statutory rate and income tax expense is shown below: Year Ended December 31 2011 US$ 2012 US$ 2013 US$ Cayman statutory rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Tax on pretax income at statutory rate . . . . . . . . . . . . . . . . . . . . . 7,859 8,142 6,788 Tax-exempt income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,477) (5,149) (4,325) Permanent differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,919 861 1,730 (622) (2,290) 1,732 Temporary differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Alternative minimum tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,804 4,340 2,203 Income tax (10%) on undistributed earnings . . . . . . . . . . . . . . . . 2,277 2,631 3,396 Net changes in income tax credit 708 Net changes in valuation allowance of deferred income tax . . . . . . . . . . . . . . . . . . . . . . . . . 252 5,518 — — assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,830) (3,879) (2,364) (189) (39) 132 604 Net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities related to unrealized tax benefits . . . . . . . . . . . . . . . . . 832 Adjustment of prior years’ taxes and others . . . . . . . . . . . . . . . . . (3,040) (4,494) 341 (736) Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,747 7,116 9,772 Deferred income tax assets are as follows: Current: Notes and accounts receivable . . . . . . . . . . . . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . Allowance for sales return . . . . . . . . . . . . . . . . . . . . . . . . . Inventory reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign currency translation . . . . . . . . . . . . . . . . . . . . . . . . Investment tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-24 December 31 2012 US$ 2013 US$ 1,128 473 222 686 1,063 1,126 523 (2,852) 142 679 123 544 312 — 561 (1,083) 2,369 1,278 Non-current: Inventory reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . Investment tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . Net operating loss carryforwards . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31 2012 US$ 2013 US$ 691 753 5,862 6,248 (401) (12,349) 590 651 7,011 8,540 (885) (15,193) 804 714 The valuation allowance shown in the table above relates to net operating loss carryforwards, tax credits and temporary differences for which the Company believes that realization is uncertain. The valuation allowance decreased by US$3,271 thousand and increased by US$1,075 thousand for the years ended December 31, 2012 and 2013, respectively. The decrease in the valuation allowance in 2012 was primarily due to the utilization of net operating loss carryforward in 2012 which had been previously fully provided. The increase in valuation allowance in 2013 is primarily due to the Company being unable to generate sufficient taxable income in the future to utilize operating loss carryforwards and research and development credits before they expire. In addition, profits generated from certain products of SMI Taiwan are exempted from income tax for five years beginning January 1, 2010 and January 1, 2012. As of December 31, 2013, FCI had unused research and development tax credits of approximately US$3,006 thousand which will expire in 2015 to 2018. As of December 31, 2013, the Company’s United States federal net operating loss carryforwards for federal income tax purposes were approximately US$5,431 thousand. If not utilized, the federal net operating loss carryforwards will expire in 2023. As of December 31, 2013, the Company’s United States federal and state research and development tax credit carryforwards for federal and state income tax purposes were approximately US$2,358 thousand and US$1,647 thousand, respectively. If not utilized, the federal tax credit carryforwards will expire starting in 2023 while the state tax credit carryforward has no expiration date. Current United States federal and California state laws include substantial restrictions on the utilization of net operating losses and credits in the event of an “ownership change” of a corporation. Accordingly, the Company’s ability to utilize net operating loss and tax credit carryforwards may be limited as a result of such “ownership change”. Such a limitation could result in the expiration of carryforwards before they are utilized. Unrecognized Tax Benefit A reconciliation of the beginning and ending balances of the total amounts of unrecognized tax benefits is as follows: Year Ended December 31 Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . Increases in tax positions taken in current year . . . . . . . . . Decrease in tax position taken in prior year primarily 2012 US $ 2,657 917 related to the resolution of tax audit . . . . . . . . . . . . . . . . (54) Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,520 2013 US$ 3,520 2,947 (652) 5,815 F-25 At December 31, 2013, the Company had US$5,815 thousand of unrecognized tax benefits that if recognized would affect the effective tax rate. For the years ended December 31, 2011, 2012 and 2013, the total amount of interest expense and penalties related to uncertain tax positions recorded in the provision for income tax expense was approximately US$485 thousand, US$499 thousand and US$627 thousand, respectively. The total amount of accrued interest and penalties recognized as of December 31, 2012 and 2013 was US$1,305 thousand and US$1,412 thousand, respectively. The Company does not anticipate any material change in the total amount of unrecognized tax benefits to occur within the next twelve months. The Company files income tax returns in United States and foreign jurisdictions. The following table summarizes the Company’s major jurisdictions and tax year that remain subject to examination by tax authorities as of December 31, 2013: Tax Jurisdiction Tax Years SMI Taiwan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FCI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SMI USA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2008 and onward 2008 and onward 2007 onward 14. SHAREHOLDERS’ EQUITY Appropriations from Earnings Pursuant to the laws and regulations of the ROC and the respective Articles of Incorporation, SMI Taiwan, the Company’s largest subsidiary, must make appropriations from annual earnings to non-distributable reserve which could affect the Company’s ability to pay cash or stock dividends, if any. SMI Taiwan subsidiary may only distribute dividends after it has made allowances as determined under ROC GAAP at each year-end for: a. Payment of taxes; b. Recovery of prior years’ deficits, if any; c. d. 10% of remaining balance after deduction for a and b as legal reserve; Special reserve based on relevant laws or regulations or 10% of remaining balance for deduction from above a to c as special reserve when necessary; e. Cash or stock bonus to employees at 0.01% of any remaining earnings after the above reserves have been appropriated, based on a resolution of the board of directors. If bonus to employees is in the form of stock, the bonus may also be appropriated to employees of subsidiaries under the board of directors’ approval; Dividends The Company declared cash dividends per ordinary share during the periods presented as follows: First quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-26 Dividends Per Share (US$) $0.0375 $0.0375 $0.0375 $0.0375 2013 Amount (in US$ thousands) $ 5,056 5,042 4,932 4,935 $19,965 No dividends were declared in our fiscal years ended 2011 or 2012. Future dividends, if any, on the Company’s outstanding ADSs and ordinary shares will be declared by and subject to the discretion of the Company’s board of directors. If the Company’s board of directors decides to distribute dividends, the form, frequency and amount of such dividends will depend upon the Company’s future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors our board of directors may deem relevant. Any future dividend the Company declares will be paid to the holders of ADSs, subject to the terms of the deposit agreement, to the same extent as holders of the Company’s ordinary shares, to the extent permitted by applicable laws and regulations, less the fees and expenses payable under the deposit agreement. Any dividend the Company declares will be distributed by the depositary bank to the holders of our ADSs. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars. Treasury Stock On January 21, 2013, our Board of Directors approved share buyback plans to repurchase up to US$40 million of the Company’s ADSs during the period from January 22, 2013 to January 21, 2014. The program does not obligate the Company to acquire any particular amount of ADS and the program may be modified or suspended at any time at the Company’s discretion. All the treasury stock under this share repurchase program was retired in July 2013. In the year ended December 31, 2013, the Company repurchased 891 thousand of ADSs for a total cost of US$10.0 million. The weighted average purchase price per ADS repurchased was US$11.24. 15. EQUITY INCENTIVE PLAN 2004 Stock Option Plan and 2005 Equity Incentive Plan In 2004, SMI Taiwan adopted a 2004 Employee Stock Option Plan (“the 2004 Plan”). The 2004 Plan reserved 8,000 options with each option exercisable into for 1,000 shares of common stock. The options may be granted to qualified employees of the Company or any of its domestic or foreign subsidiaries and expire no later than six years from the date of grant. The options were granted at an exercise price not lower than the market value of SMI Taiwan’s common stock at the date of the grant and vest over four years at certain percentages after two years from the date of grant. As part of the share exchange between the Company and the shareholders of SMI Taiwan effective on April 25, 2005, the Company agreed to assume the share options previously issued by SMI Taiwan. Subsequently on June 3, 2005, the Company amended the 2004 Plan such that options under the 2004 Plan are granted at an exercise price not lower than the market value of the Company’s ordinary shares at the date of the grant and vest over four years at certain percentages after one year from the date of grant. On April 22, 2005, the Company adopted its 2005 Equity Incentive Plan (“the 2005 Plan”). The 2005 Plan provides for the grant of stock options, stock bonuses, restricted stock awards, restricted stock units and stock appreciation rights, which may be granted to employees (including officers), directors and consultants. The 2005 Plan reserved 10,000 thousand shares of ordinary shares, inclusive of the number of assumed share options under the 2004 Plan, for issuance upon the exercise of stock options. In 2006, the Company amended the 2005 Plan to reserve an additional 15,000 thousand ordinary shares for issuance upon exercise of stock options and restricted stock units. In 2009, the Company amended the Plan to reserve an additional 15,000 thousand ordinary shares for issuance upon exercise of stock options and restricted stock units. Restricted stock units are converted into shares of the Company’s ordinary shares upon vesting on one-for- one basis. The vesting of restricted stock unit is subject to the employee’s continuing service to the Company. F-27 The cost of these awards is determined using the fair value of the Company’s ordinary share on the date of the grant, and compensation is recognized on a straight-line basis over the requisite service period. The Company’s restricted stock units are considered non-vested share awards as defined under ASC 718. In April 2010, the Company’s Board of Directors and Compensation Committee approved an employee stock option exchange program that required certain employees to exchange eligible stock options for a lesser number of new stock options that have approximately the same fair values as the options surrendered. Eligible options included stock options granted between August 17, 2005 and July 31, 2008 that had an exercised price above US$1.85. In 2010, 4,369 thousand eligible stock options were exchanged for 3,785 thousand new stock options granted. The new stock options have an exercise price of US$1.47, which was equal to the market price of the Company’s ordinary share on April 26, 2010, the date eligible stock options were surrendered and new stock options granted. The new stock options were issued under the 2005 Plan and are subject to its terms and conditions. The new stock options will continue to vest according to the original vesting schedule. Using the Black-Scholes option pricing model, the Company determined that the fair value of the surrendered stock options on a grant-by-grant basis was approximately equal, as of the date of the exchange, to the fair value of the new stock options granted, resulting in insignificant incremental share-based compensation. Stock Option and Restricted Stock Units Activity The following is a summary of, the 2004 Plan, and the 2005 Plan, which includes stock options and restricted stock units: Available for grant at January 1, 2011 . . . . . . . . . . . . . . . Restricted stock units granted . . . . . . . . . . . . . . . . . . . . . Option and restricted stock units forfeited . . . . . . . . . . . . Available for grant at December 31, 2011 . . . . . . . . . . . . Restricted stock units granted . . . . . . . . . . . . . . . . . . . . . Option and restricted stock units forfeited . . . . . . . . . . . . Available for grant at December 31, 2012 . . . . . . . . . . . . Restricted stock units granted . . . . . . . . . . . . . . . . . . . . . Option and restricted stock units forfeited . . . . . . . . . . . . Available for grant at December 31, 2013 . . . . . . . . . . . . Unit (in Thousands) 12,319 (6,387) 574 6,506 (1,461) 291 5,336 (1,893) 123 3,566 Stock Options A summary of the stock option activity and related information is as follows: Number of Options Shares (in Thousands) Weighted Average Exercise Price (US$) Weighted Average Remaining Contractual Life (Years) Outstanding at January 1, 2013 . . . . . . . . . . . . . . . Options forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . Outstanding at December 31, 2013 . . . . . . . . 1,697 — (287) 1,410 Options vested and expected to vest after December 31, 2013 . . . . . . . . . . . . . . . . . . 1,410 Options exercisable at December 31, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,410 1.47 — 1.47 1.47 1.47 1.47 2.14 2.14 2.14 F-28 No stock options were granted in 2011, 2012 and 2013. The intrinsic value of options exercised, determined as of the date of option exercise, was US$5,797, US$318 and US$594 thousand in 2011, 2012 and 2013, respectively. As of December 31, 2013, total unrecognized compensation cost related to non-vested share-based compensation awards granted under the Company’s stock option plans, net of estimated forfeitures, was nil. The aggregate intrinsic value represents the total intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal year 2013 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2013. Intrinsic value will change in future periods based on the fair market value of the Company’s stock and the number of shares outstanding. The total cash received from employees as a result of employee stock option exercises were US$2,294, US$224 and US$422 thousand for the years ended December 31, 2011, 2012 and 2013, respectively. The related tax effect for stock-based compensation benefit (expense) were US$215 thousand, US$631 thousand, and US$343 thousand for 2011, 2012 and 2013, respectively. The related tax effect for stock-based compensation expense for option and restricted stock units exercised during 2011, 2012 and 2013 was US$756 thousand, US$1,560 thousand and US$1,599 thousand, respectively. The related tax effect was determined using the applicable tax rates in jurisdictions to which this expense relates. Determining Fair Value The Company estimated the fair value of each option grant on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the option valuation model requires the input of highly subjective assumptions, including the expected stock price volatility. Risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatilities are determined based on historical volatilities of the stock prices of the Company. Expected life represents the periods that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience regarding similar awards, giving consideration to the contractual term of the share based awards. The dividend yield is zero as the Company has never declared or paid dividends on the ordinary shares or other securities by 2012. Restricted Stock Units A summary of the status of restricted stock units and changes during the year ended December 31, 2013 is as follows: Weighted Average Grant Date Fair Value (US$) 2.68 3.13 2.60 2.60 2.90 Weight Average Remaining Recognition Period (Years) 0.43 Number of Non-vested Stock Units (in Thousands) 7,018 1,893 (4,867) (123) 3,921 Non-vested at January 1, 2013 . . . . . . . . . . . . . . . Restricted stock units granted . . . . . . . . . . . . . . . . Restricted stock units vested . . . . . . . . . . . . . . . . . Restricted stock units forfeited . . . . . . . . . . . . . . . Non-vested at December 31, 2013 . . . . . . . . . . . . F-29 As of December 31, 2013, there was US$3,412 thousand of total unrecognized compensation cost related to restricted stock units granted under the 2005 Plan. Stock-based Compensation Expense The following table shows total stock-based compensation expense included in the Consolidated Statements of Income for the years ended December 31, 2011, 2012 and 2013. Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales and marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31 2011 US $ 255 5,049 2,060 1,514 8,878 2012 US $ 375 7,055 2,494 1,878 2013 US$ 308 6,351 2,197 1,406 11,802 10,262 16. COMMITMENTS AND CONTINGENCIES FCI provided their employees with collateral for personal loans by depositing at a designated bank US$937 thousand and US$946 thousand at December 31, 2012 and 2013, respectively. Such amounts were accounted for as restricted cash. Operating Leases The Company entered into various operating lease agreements for office space that expire on various dates through March 2017. The Company recognized rent expense for the years ended December 31, 2011, 2012 and 2013 of US$1,465 thousand, US$1,609 thousand and US$1,763 thousand, respectively. The minimum operating lease payments expected under these leases as of December 31, 2013 were US$2,080 thousand, US$1,734 thousand, US$1,065 thousand, US$645 thousand, and US$582 thousand for the years ending December 31, 2014, 2015, 2016, 2017 and 2018, respectively. Litigation The Company are subject to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. Although the outcome of such proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these matters will have a material adverse effect on our business, results of operations, financial position or cash flows. Any litigation, however, involves potential risk and potentially significant litigation costs, and therefore there can be no assurance that any litigation which is now pending or which may arise in the future would not have such a material adverse effect on our business, financial position, results of operations or cash flows. All American Semiconductor, Inc. (“All American” or “AASI”) was a former distributor for the Company. On April 25, 2007, All American filed for Chapter 11 bankruptcy protection. At the time of the filing, the Company had US$256 thousand of unpaid accounts receivable from All American. On April 17, 2009, SMI USA and related entities were named as defendants in an adversary proceeding filed by the AASI Creditor Liquidating Trust (“CLT”) in the bankruptcy case pending in the U.S. Bankruptcy Court for the Southern District of Florida. The CLT was seeking the return of allegedly avoidable transfers in the amount of US$854 thousand. The Company filed an answer and affirmative defenses. In March 2010, SMI USA settled with the CLT by paying the amount of US$220 thousand and on April 1, 2010, the Bankruptcy Court granted the motion to approve stipulations to compromise controversy. On August 23, 2010, the Court entered an order dismissing the adversary proceeding. In June 2011, Liquidating Trustee for the CLT filed the AASI Creditor Liquidating F-30 Trustee’s Seventeenth Omnibus Objection to Claims but in August 2011, withdrew it with respect to SMI USA’s proof of claim. According to the CLT’s letter dated September 9, 2011, it is currently finalizing its claims review process and preparing for distribution to beneficiaries who are holders of allowed claims and have rights to a distribution pursuant to the Plan. In January 2012 and 2014, the Company received the first distribution of US$21 thousand and the second distribution of US$36 thousand, respectively. In 2006, FCI joined with other technology companies and invested in the Pangyo Silicon Park Construction Project Cooperative (“Pangyo Cooperative”) in Korea. In July 2010, FCI, TLi Inc. (“TLI”), OCI Materials Co., Ltd (“OCI”) and other companies withdrew from the Pangyo Cooperative and forfeited 10% of their total investment. FCI believes its loss was caused by bad will actions taken by TLI. In December 2011, FCI and OCI together filed a complaint against TLI at the Suwon District Court in Korea. In April 2013, the court dismissed the plaintiffs’ complaints. The plaintiffs have decided not to appeal the court’s decision. 17. SEGMENT INFORMATION The Company designs, develops and markets high performance, low-power semiconductor products for the multimedia consumer electronics market. The Company currently operates as one reportable segment. The chief operating decision maker is the Chief Executive Officer. The Company groups its products into three categories, based on the markets and products in which its ICs may be used. The following summarizes the Company’s revenue by product category: Mobile Storage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mobile Communications . . . . . . . . . . . . . . . . . . . . . . . . . . Other products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31 2011 2012 2013 US$ 152,838 56,629 14,378 US$ 202,093 67,564 11,713 US$ 185,488 31,022 8,798 223,845 281,370 225,308 Revenue is attributed to a geographic area based on the bill-to location. The following summarizes the Company’s revenue by geographic area: Taiwan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Major customers representing at least 10% of net sales Samsung . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SK Hynix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . * Less than 10% F-31 Year Ended December 31 2011 US$ 61,174 25,535 2,769 78,718 49,000 6,649 2012 2013 US$ 74,034 20,230 5,363 137,797 37,507 6,439 US$ 47,653 22,528 3,936 115,287 29,129 6,775 223,845 281,370 225,308 Year Ended December 31 2011 2012 2013 US$ 61,370 * % 28 * US$ 98,368 * % 35 * US$ 36,037 67,977 % 16 30 Long-lived assets (property and equipment, net) by geographic area were as follows: Taiwan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31 2011 US$ 17,317 91 2,980 4,340 2012 US$ 16,799 58 2,226 4,303 2013 US$ 24,066 54 1,773 4,302 24,728 23,386 30,195 18. FAIR VALUE MEASUREMENT The following section describes the valuation methodologies the Company uses to measure assets and liabilities at fair value. The Company uses quoted prices in active markets for identical assets to determine fair value where applicable. This pricing methodology applies to Level 1 investments such as bond funds. The fair value of the structure note investments was estimated by the Company using a discounted cash flow model that incorporates transaction details such as contractual terms, maturity and timing and amount of future cash flows, references to the observable market data such as the risk free rate, discount rate and yield rate related to the underlying bond securities as well as unobservable inputs related to liquidity, default likelihood, and credit valuation adjustments. Due to the unobservable inputs are insignificant to the measurement in its entirety, such investments were classified as Level 2 instruments as of December 31, 2012. For the years ended December 31, 2012 and 2013, none of the Company’s assets measured on a recurring basis was determined by using significant unobservable inputs. The following table presents our assets measured at fair value on a recurring basis as of December 31, 2012 and 2013: December 31, 2012 Assets Level 1 Level 2 Level 3 US$ US$ US$ Total US$ Short-term investments — designated at the fair value structured note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 14,882 — 14,882 December 31, 2013 Assets Level 1 Level 2 Level 3 US$ US$ US$ Total US$ Short-term investments — trading bond funds . . . . . . . . . . . 742 — — 742 Those assets required to be measured at fair value on a nonrecurring basis and the associated losses were nil during the years ended December 31, 2011, 2012 and 2013 and please refer to Note 2, “Summary of Significant Accounting Policy” and Note 10, “Goodwill and Acquired Intangible Assets” for the significant assumption were used. The Company reviews the carrying values of financial assets carried at cost when impairment indicators are present. The fair values of assets without quoted market price are determined based on management judgment with the best available information. The impairment charge was determined based on the difference between the Company’s carrying value and the proportionate ownership of the investee’s net assets at year end. F-32 Directors and Executives Board of Directors Executive Officers James Chow Chairman of the Board Silicon Motion Technology Corporation Wallace C. Kou President & Chief Executive Officer Silicon Motion Technology Corporation Steve Chen Chairman Mercuries Bakery Co., Ltd. Tsung-Ming Chung Chairman Dynapack International Technology Corp. Kenneth Kuan-Ming Lin Chairman Premier Capital Management Corp. Lien-Chun Liu Research Fellow Taiwan Research Institute Yung-Chien Wang Vice President Professional Trust Co., Ltd. Wallace C. Kou President & Chief Executive Officer Riyadh Lai Chief Financial Officer Frank Chang VP of R&D, Mobile Storage Ken Chen VP of Operations Nelson Duann VP of Product Marketing, Mobile Storage Sangwoo Han Senior VP and General Manager, Mobile Communications John (Chun-O) Kim VP of Sales, Mobile Communications Arthur Yeh VP of Sales, Mobile Storage John (Jong Ryul) Lee VP of R&D, Mobile Communications Kevin Yeh VP of R&D, Algorithm & Technology Frank Shu VP of R&D, SSD System Technology and VCT Jason Chiang VP of HR and Administration, and Special Assistant to CEO Robert Fan VP and General Manager, SMI U.S. ADS Listing Our American Depositary Shares (ADSs) trade on the NASDAQ Global Select Market under the symbol "SIMO" ADS Depositary The Bank of New York Mellon, New York, NY Legal Counsel, Taipei, Taiwan K&L Gates, Taipei, Taiwan Independent Auditors Deloitte & Touche, Taipei, Taiwan Investor Relations For more information about Silicon Motion, please visit our website at www.siliconmotion.com or e-mail us at ir@siliconmotion.com Silicon Motion Technology Corporation www.siliconmotion.com